SEC provides comfort on ‘bad actor’ rules

The Securities and Exchange Commission (SEC) provided some relief to private equity firms concerned about technical violations of the commission’s “bad actor” provisions.

The rules disqualify private funds from using a safe harbor under Regulation D if any of the fund’s senior professionals, significant stakeholders or placement agents have been convicted of a felony or fraud in connection with the selling of securities.

In new guidance, the SEC said GPs can cure a bad actor event with a placement agent by terminating their relationship with the agent. The Commission also clarified that a bad actor event, with respect to a placement agent, could be remedied simply by having the agent remove the bad actor.

Legal advisors have advised GPs to add indemnification clauses to placement agent agreements to ensure the agent has adequately screened for bad actors. Until the SEC’s clarification, GPs were concerned they would instantly lose their safe harbor if a placement agent became a bad actor.

GPs were also given comfort that they do not violate the bad actor rules if the advisor can show it did not know and, in the exercise of reasonable care, could not have known it had a bad actor in its midst.

The guidance also addresses questions about how often GPs must verify that a bad actor is not within its ranks. The SEC’s guidance says if a fund is not actively in the market, then GPs do not have to periodically update their ‘bad actor’ due diligence. The guidance however doesn’t provide any details on how often a GP needs to update its bad actor due diligence when actively fundraising.

To read the full version of the SEC’s guidance click HERE.