Reference

Bad actor disqualification: the diligence nobody runs on themselves

One covered person with the wrong history removes your exemption entirely. The list of covered people is wider than most first-time managers assume, and the only defence has to be built before the sale.

This is the rule that can remove your exemption without you doing anything wrong personally. If a “covered person” connected to your offering has the wrong history, Rule 506 is simply unavailable to you — not reduced, not conditioned. Unavailable.

Who is covered

The list is the part people get wrong, because it reaches well past the manager:

No exemption under this section shall be available for a sale of securities if the issuer; any predecessor of the issuer; any affiliated issuer; any director, executive officer, other officer participating in the offering, general partner or managing member of the issuer; any beneficial owner of 20% or more of the issuer’s outstanding voting equity securities, calculated on the basis of voting power; any promoter connected with the issuer in any capacity at the time of such sale; any investment manager of an issuer that is a pooled investment fund; any person that has been or will be paid (directly or indirectly) remuneration for solicitation of purchasers in connection with such sale of securities…
17 C.F.R. § 230.506(d)(1)

Read the three that catch first-time managers. A 20% voting owner — your anchor investor may qualify, and you may never have asked them anything about their regulatory history. Any promoter connected in any capacity — broad by design. Anyone paid for solicitation — which is the placement agent, if you use one.

What triggers it

Has been convicted, within ten years before such sale (or five years, in the case of issuers, their predecessors and affiliated issuers), of any felony or misdemeanor: (A) In connection with the purchase or sale of any security; (B) Involving the making of any false filing with the Commission; or (C) Arising out of the conduct of the business of an underwriter, broker, dealer, municipal securities dealer, investment adviser…
17 C.F.R. § 230.506(d)(1)(i)

Convictions are only the first limb. The rule also reaches court injunctions, SEC and banking-regulator orders, suspensions and expulsions, and certain stop orders. The look-back varies by limb, which is a reason to check the current text against the specific event rather than work from a summary.

The only defence, and why it must be built early

There is a reasonable-care exception, and its wording tells you exactly what is required:

If the issuer establishes that it did not know and, in the exercise of reasonable care, could not have known that a disqualification existed under paragraph (d)(1) of this section.
17 C.F.R. § 230.506(d)(2)(iv)

The burden is on the issuer, and the standard is not ignorance but diligent ignorance. In practice that means questionnaires from every covered person, run before the sale and refreshed for later closings — a covered person can join the list mid-raise when a new investor crosses 20%.

Events before 23 September 2013 do not disqualify, but they are not simply irrelevant either:

The issuer shall furnish to each purchaser, a reasonable time prior to sale, a description in writing of any matters that would have triggered disqualification under paragraph (d)(1) of this section but occurred before September 23, 2013.
17 C.F.R. § 230.506(e)

So an older event converts from a disqualifier into a mandatory written disclosure. Finding one is not the end of the offering; failing to look might be.

The practical order of operations

Identify every covered person before the first sale, not at the first close. Get written representations covering both the disqualifying events and the pre-2013 disclosable ones. Re-run the check at each subsequent closing. Keep the questionnaires — the exception is something you must establish, which means evidence, and the evidence has to have existed before the sale rather than been assembled after a problem surfaced.

Fetched from Cornell’s copy of the CFR; the eCFR was returning 503 throughout. Check the current text before relying on any limb of this.

Primary sources

Quotations are from the official text as published, retrieved 2026-08-30. Statutes and rules change; check the current text before relying on any of this.

This is general information about how private funds are structured. It is not legal advice, it is not a recommendation, and it is not a substitute for advice about your own facts.

Independent publication. Advertising does not influence what is reported here.