SEC Issues New C&DIs on Securities Act Rule 506(d) and Exchange Act Rule 13d-3

Practical Law Legal Update 1-553-7566 (Approx. 5 pages)

SEC Issues New C&DIs on Securities Act Rule 506(d) and Exchange Act Rule 13d-3

by Practical Law Corporate & Securities

Rule 506(d) C&DIs

The new C&DIs relating to Rule 506(d) are located in the Securities Act Rules C&DIs at Questions 260.28 through 260.32.

A shareholder that first becomes a 20% beneficial owner by purchasing securities in an offering is not a covered person under Rule 506(d) with respect to that offering. Rule 506(d) looks to the time of each sale of securities and provides that no exemption will be available for the sale if any covered person is subject to a bad actor triggering event at that time. A shareholder that first becomes a 20% beneficial owner on completion of a sale of securities is not a 20% beneficial owner at the time of that sale. However, the shareholder would be a covered person with respect to any sales of securities in that offering that take place after it becomes a 20% beneficial owner. (Question 260.28.)
The term "beneficial owner" in Rule 506(d) is interpreted the same way as under Rule 13d-3 under the Exchange Act. The term "beneficial owner" under Rule 506(d) means any person who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, under Rule 13d-3 has or shares, or is deemed to have or share:
- voting power, which includes the power to vote, or to direct the voting of, the security; and/or
- investment power, which includes the power to dispose, or to direct the disposition of, the security. (Question 260.29.)
For purposes of determining 20% beneficial owners under Rule 506(d), it is necessary to "look through" entities to their controlling persons. Beneficial ownership for purposes of Rule 506(d) includes both direct and indirect interests, as determined under Rule 13d-3. (Question 260.30.)
Under Rule 506(d), beneficial ownership of group members and groups should be analyzed the same as under Rules 13d-3 and 13d-5(b). This C&DI poses a hypothetical where some of the shareholders of a Rule 506 issuer have entered into a voting agreement under which each party agrees to vote its shares of voting equity securities in favor of director candidates designated by one or more of the other parties. The C&DI then asks whether the parties to the agreement are required to aggregate their holdings for purposes of determining whether they as a group are, or any single party is, a 20% beneficial owner of the issuer and, therefore, a covered person under Rule 506(d).
Under an analysis under Rules 13d-3 and 13d-5(b), the shareholders have formed a group, and the group itself beneficially owns all of the shares beneficially owned by each of its members. As a result of this aggregation, the group may become a 20% beneficial owner.
In addition, each party to the voting agreement that has or shares the power to vote or direct the vote of shares beneficially owned by other parties to the agreement (through, for example, the receipt of an irrevocable proxy or the right to designate director nominees for whom the other parties have agreed to vote) will beneficially own such other parties' shares. A party that does not have or share the power to vote or direct the vote of other parties' shares would not beneficially own such other parties' shares solely as a result of entering into the voting agreement (see Rule 13d-3 C&DI below).
If the group is a 20% beneficial owner, then disqualification or disclosure obligations would arise from court orders, injunctions, regulatory orders or other triggering events against the group itself (not against any individual members of the group). If a party to the voting agreement becomes a 20% beneficial owner because shares of other parties are added to its beneficial ownership, disqualification or disclosure obligations would arise from triggering events against that party. (Question 260.31.)
An order issued by a court or regulator in accordance with Rule 506(d)(2)(iii) does not waive the disclosure obligation set out in Rule 506(e). Rule 506(e) requires an issuer to provide investors disclosure of disqualifying events that would have triggered disqualification except that those events occurred before the September 23, 2013 effective date of Rule 506(d). Rule 506(d)(2)(iii) permits issuers to rely on the self-executing statement of a regulatory authority to avoid Rule 506 disqualification when that regulatory authority advises the SEC in writing or in its order, decree or judgment, that Rule 506 disqualification should not arise as a consequence of a disqualifying event that occurred on or after September 23, 2013.
A regulatory authority may, however, determine that an order entered before September 23, 2013 would not have triggered disqualification under Rule 506(d)(1), which determination would eliminate the requirement to make Rule 506(e) disclosure. (Question 260.32.)

For more information on the Rule 506(d) bad actor disqualification provisions, see Practice Note, Section 4(a)(2) and Regulation D Private Placements: Bad Actors Disqualified from Relying on Safe Harbor.

Rule 13d-3 C&DI

The new C&DI relating to Rule 13d-3 is located in the Exchange Act Sections 13(d) and 13(g) and Regulation 13D-G Beneficial Ownership Reporting C&DIs at Question 105.06.

This new C&DI poses a hypothetical where certain shareholders have entered into a voting agreement under which each shareholder agrees to vote the shares of a voting class of equity securities registered under Section 12 that it beneficially owns in favor of the director candidates nominated by one or more of the other parties to the voting agreement. The C&DI then asks under what circumstances the beneficial ownership of a party to the voting agreement will be attributed to one or more other parties to the agreement.

Under Rule 13d-5(b), the shareholders have formed a group because they have agreed to act together for the purpose of voting the equity securities of the issuer. Under Section 13(d)(3) of the Exchange Act, the group itself is treated as a new "person" for purposes of Section 13(d)(1), and the group is deemed to have acquired, by operation of Rule 13d-5(b), beneficial ownership of the shares beneficially owned by its members.

However, the formation of a group under Rule 13d-5(b), without more, does not result in the attribution of beneficial ownership to each group member of the securities beneficially owned by other members. For one party to the voting agreement to be treated as having or sharing beneficial ownership of securities held by any other party to the voting agreement, evidence beyond formation of the group under Rule 13d-5(b) would need to exist.

For example, if a party to the voting agreement (Party A) has the right to designate one or more director nominees for whom the other parties (Party B and Party C) have agreed to vote, then Party A becomes a beneficial owner of the securities beneficially owned by Parties B and C under Rule 13d-3(a), because the agreement gives Party A the power to direct the voting of Party B's and Party C's securities. Similarly, if a voting agreement confers the power to vote securities pursuant to a bona fide irrevocable proxy, the person to whom voting power has been granted becomes a beneficial owner of the securities under Rule 13d-3.

Conversely, parties that do not have or share the power to vote or direct the vote of other parties' shares would not beneficially own such shares solely as a result of entering into the voting agreement. Note, however, that a contract, arrangement, understanding or relationship concerning voting or investment power among parties to the agreement, other than the voting agreement itself, may result in a party to the voting agreement having or sharing beneficial ownership of securities held by other parties to the voting agreement under Rule 13d-3.

For more information on determining beneficial ownership under Section 13(d) of the Exchange Act and related rules, see Practice Note, Section 13(d) Beneficial Ownership Reporting.

SEC Issues New C&DIs on Securities Act Rule 506(d) and Exchange Act Rule 13d-3 | Practical Law