The New “Bad Actor” Provisions and CLOs: Why the Gloves Don’t Fit

October 17, 2013

The U.S. SEC’s recent amendments to Rule 506 regarding “bad actors” have caused undue alarm among CLO market participants. Perhaps CLO market participants are a bit on edge as of late, having come to expect nothing but the worst from any new regulatory proposals. In any event, some CLO market Cassandras have conjectured, since CLOs frequently include subordinated certificated securities that are placed with “accredited investors,” and Rule 506 applies to the offering and sale of securities to accredited investors, that CLOs must comply with the administrative burdens imposed by the new “bad actor” provisions of Rule 506. Our view, however, is that CLOs should not be impacted by this new rule (provided the CLOs do not use a general solicitation) for the simple reason that CLOs generally rely on a different exemption from registration. CLOs (like other asset-backed securitization transactions) are predominantly institutional offerings and, when they sell subordinated certificated securities to accredited investors, they generally do so pursuant to the statutory exemption from registration for private placements under Section 4(a)(2) of the Securities Act and the interpretive exemption for resales under so-called Section 4(a)(1½). Thus, the good news is that CLOs should not get entangled in the new “bad actors” requirements under Rule 506 since such provisions do not apply to private placements pursuant to Section 4(a)(2), resales pursuant to Section 4(a)(1½) and Rule 144A, and sales to non-U.S. persons in offshore transactions pursuant to Regulation S.

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