Blue Sky Laws
Overview of Blue Sky Laws
The state governments individually enacted blue sky laws to prevent securities dealers from committing fraud through the sale of fake securities to investors. The "blue sky" name is derived from being able to "sell the sky" to an investor without the restrictions of any regulations. In this article, we will describe the requirements of these laws, how they impact securities dealers, and how the laws can impact a business.
In essence, blue sky laws mandate that securities being offered for sale for the first time be qualified by the state regulatory commission, and registered with the state. Further, the terms and prices of the securities must follow the statutory guidelines imposed by the state. These guidelines are usually modeled on the Uniform Securities Act of 1956, for which the main provisions are:
- Reason for existence. The securities issuer is engaged in business. It is not bankrupt or in an organizational stage, nor is it a blind pool, blank check, or shell company that has no purpose for being in existence.
- Price. The security is priced at a reasonable level in comparison to its current market price.
- Unsold allotment. The security is not related to any unsold allotments given to a securities dealer who has underwritten the security.
- Asset base. The issuer owns a minimum amount of assets.
Consequently, it is not possible for a securities dealer to market a company's stock for sale, unless the stock conforms to both state and SEC regulations. If a security is sold that does not conform to state blue sky laws, then the following comment applies (as taken from section 410(a) of the 1956 Act):
“Any person who offers or sells a security is liable to the person buying the security from him, who may sue… to recover the consideration paid for the security, together with interest at six percent per year from date of payment, [court] costs, and reasonable attorneys’ fees, less the amount of income received on the security, upon tender of the security, or for damages if he no longer owns the security.”
Implications of Blue Sky Laws
The onerous penalties of the 1956 Act are a major concern for securities dealers, since its provisions may require them to buy securities back from investors. Since a buy back would only happen if securities had lost some or all of their value, the buy back could bankrupt a securities dealer. Given the ramifications of this penalty, securities dealers are very careful to ensure that blue sky laws are always followed.
Blue Sky Law Exemptions
An issuing entity is exempt from the blue sky laws if its securities are listed on a national stock exchange, such as the NASDAQ or New York Stock Exchange. For businesses listed in this manner, states issue a "manual exemption," which (despite the name) automatically allows securities to be sold within their borders. This exemption was initiated under the National Securities Markets Improvement Act of 1996.
The exemption is not so clear if an issuer's securities are only available for sale in the over the counter (OTC) market. If an issuer registers with one of the credit rating agencies and renews the registration each year, the majority of state governments will allow a registration exemption. This registration is a lengthy filing that includes the issuer's financial statements, the names of the executive officers of the business, and a description of what the entity does. Despite the presence of this registration facility, some states continue to require registration directly with them; these states are Alabama, California, Georgia, Illinois, Kentucky, Louisiana, New York, Pennsylvania, Tennessee, Virginia, and Wisconsin.
Your Knowledge of Blue Sky Laws
The content of blue sky laws vary by state. Consequently, if a company intends to sell its securities in a specific state, it should obtain legal advice in that state, to ensure that the local regulations are being followed. Also, anyone participating in a road show should be able to answer questions about the company's blue sky status, since this question is commonly asked by investors and brokers.