What is Blue Sky Law?

Blue sky law is an individual state law designed to protect investors from securities fraud. The laws vary by state, but they all ensure licensing of brokerage firms, individual stockbrokers, and their offerings. Public mergers are also required to comply with the applicable blue sky laws. 

The name is believed to come from a mention in the United States Supreme Court decision, Hall v. Geiger-Jones Co., 242 U.S. 539 (1917). This case dealt with the constitutionality of state security regulations. 

Blue sky laws developed in the years leading up to the Great Depression. This was due to the influx of fraudulent money schemes promising high returns. These included foreign country investments and oil fields. Companies offered enticing investment opportunities with very little legitimate backing in an attempt to make fast money from unsuspecting or naive investors. Because of this, states needed to enact the blue sky laws, requiring that details of new securities are registered with state authorities to ensure the public remained educated and aware of a fund's legitimacy. 

By 1933, on the eve of federal securities legislation, all states with the exception of Nevada had blue sky laws. 

Why Are Blue Sky Laws Important?

Blue sky laws are important as they allow investors to base decisions on trustworthy data. They vary from state to state, with most requiring that companies register the securities they wish to sell before they can make an offering of the securities in that state.

With the federal legislation of 1933, securities regulation became more complicated. This legislation resulted in cases where state and federal laws overlapped in some areas, like registration and liability. 1956 brought on the Uniform Securities Act of 1956, which many states adopted.  

The Uniform Securities Act of 1956 includes the following main provisions: 

  • 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.

What this means is a securities dealer can't market a company's stock for sale, unless it complies with both local state and SEC regulations. 

Today, there is still some debate and varying state laws, especially when it relates to differing state court interpretations. Although there is not a clear alignment between states when it comes to blue sky laws, they share certain features in their methodology. The goal of these laws is to prevent agents from overpromising and under delivering while ensuring investors receive accurate information about investment risks. Two important areas blue sky laws address in regards to oversight of the sales process and liability for fraudulent sales are: 

  1. The laws require the registration of securities offered or intended to be offered in the state unless they fall within certain exemptions. 
  2. Brokerage firms, issuers selling their own securities, and individual brokers must be registered and licensed in each state in which they do business, with some states requiring extra certifications from brokers. 

The state's securities agency or commission monitors compliance with these terms. 

Blue sky laws are similar to federal law in that they operate under a disclosure-driven basis. This mandates that companies accurately disclose any and all information that will allow investors to make informed and educated investment decisions. The anti-fraud provisions help create the liability when a broker doesn't disclose information as required. What constitutes a fraud claim will vary based on that state's statutes and presiding case law. 

The right to bring an action and the subsequent remedies available to investors also varies by state. Some actionable damages may include rescission of the transactions, which forces the seller to give up its profits. In other states, like New York, private actions are not legal and only the attorney general can sue for fraudulent securities sales. Individual plaintiffs are required to bring a lawsuit with causes of action like common-law fraud and breach of fiduciary duty. 

Because many firms are large and operate in multiple states, blue sky laws can be challenging. They must comply with each and every state's version of the law. Because of that issue, Congress passed legislation that preempts blue sky law if federal law duplicates. This is the National Securities Market Improvement Act of 1996 (NSMIA), which amended the Securities Exchange Act of 1934 Section 15(h). It also amended the Securities Act of 1933, so that certain types of covered securities are not subject to state registration. However, they are still required to register offers and sales. Also, the parties themselves are still required to register and can be held accountable under state fraud laws for any individual wrongdoing.  

Do Not Use Blue Sky Law If: 

Blue sky law doesn't apply when securities offered are considered "covered securities" under Section 18(b)(4) of the 1996 National Securities Markets Improvement Act. This states that any securities offered under Rule 506 of Regulation D qualify, thereby allowing them an exemption from the registration requirements of blue sky laws. 

Do note that states can still ask issuers to notice the filings and pay filing fees with respect to Rule 506 private placements if the investors are residents of their state. Most states make the process fairly easy, you only need a copy of Form D and the filing fees, which often range from $100 to $300. Other states require more documentation. This includes New York, which has a laundry list of compliance requirements. 

An example of when an issuing entity is exempt from the blue sky law is when the security is listed on a national stock exchange, like the NASDAQ. Businesses listed in this manner can ask for a "manual exemption," which ironically is an automatic exemption that allows them to sell securities within the state. Where it gets a little fuzzy is with securities that are available only in the over the counter (OTC) market. If a securities issuer registers with one of the credit rating agencies and maintains the renewal each year, many states allow a registration exemption. Some states still require direct registration. These include: 

  • Alabama
  • California
  • Georgia
  • Illinois
  • Kentucky
  • Louisiana
  • New York
  • Pennsylvania 
  • Tennessee
  • Virginia
  • Wisconsin

Because blue sky laws are designed to protect investors, the cost and possible delays of complying with these provisions can be off-putting for small companies or those just starting to grow their business. Registering your securities in various states may be both time consuming and expensive, especially if you have a securities attorney handling all the tasks like research and filing. 

Reasons You Should Consider Blue Sky Law

On December 15, 2014, the North American Securities Administrators Association (NASAA) launched an Electronic Filing Depository System, or EFD. This allows issuers to file Form D and applicable fees to various states at one time. The public can also view the filings by any issuer in the states who participate in the EFD. Issuers get electronic receipts as proof of compliance, allowing them to monitor the progress of each state's review. 

The only downside is not all states and territories participate in the EFD. As of January 2017, EFD is not available in: 

  • Arizona
  • Connecticut
  • Florida
  • Louisiana
  • Massachusetts
  • New York
  • North Carolina

Use the EFD filing website to keep up to date on which states require it, allow it, or don't participate. Some states may ask for additional documentation, like a consent to service of process or copy the offering memo. This may need to be sent separately. There is a fee for using the system as well for each offering. This covers the issuer's initial Form D filing plus all amendments and renewal filings made through the EFD 

Implications of Conforming (or not) to Blue Sky Law

The penalties imposed by the Uniform Securities Act of 1956 help keep most dealers honest since those provisions may require them to purchase back the investment. This could bankrupt a dealer depending on how much the security went down in value. 

If a dealer sells a security that doesn't conform to the local blue sky law, then section 410(a) of the 1956 Act applies: 

"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."

Frequently Asked Questions

  • Who typically pays the blue sky law filing fees? 

Some people want to know whether the fund or the management company is the one ultimately responsible for paying the filing fees. The general consensus is that fees are an expense of the fund. Even if it's specifically named as a fund expense, most funds have a general catch-all for expenses like filing fees. 

  • Is the fee paid to each state on a yearly basis?

It will depend on the specific state. Some states require a one-time filing fee while others require it to be paid annually. 

  • Are NASDAQ and NYSE listed securities exempt from blue sky registration?

Yes, NASDAQ and NYSE listed securities are exempt from blue sky registration. However, OTC listed securities are typically not exempt. As discussed previously here, businesses listed under NASDAQ and the like are given a "manual exemption," which is an automatic approval to sell securities within the state's borders. 

  • What is Regulation A+ and how does it affect blue sky law in regards to secondary trading?

Regulation A was amended and included in the rules adopted by the SEC on March 25, 2015. Reg A+ became effective on June 19, 2015. Reg A+ allows companies to raise up to $50 million a year from both accredited and non-accredited investors. It's divided into two tiers: 

  • Tier I: Allows up to $20 million and issuers are not required to provide audited financial statements in their Reg A+ offering circular. Must comply with individual state blue sky laws of each state where they plan to sell. This is one of the reasons the pre-amended Regulation A was not used for years and is far less popular than Regulation D.
  • Tier II: You can raise up to $50 million per year, exempt from state blue sky registration and qualifications, but you must provide two years of audited financials. Satisfying state filing requirements is easier than the full blue sky compliance, so the exemption offered here is more popular. Even if you don't hit the $20 million benchmark, you still may benefit from this option.

The securities issued under both are unrestricted and transferable, allowing for secondary trading. However, you'll want to do ample research to determine the exemptions and potential blue sky law compliance. The securities may be subject to blue sky laws once they've passed into secondary trading territory. 

Steps to File Blue Sky Law

When you're getting ready to file your securities offerings, register brokers, etc., you'll want to have all the accurate contact information. The NASAA, or the North American Securities Administrators Association, has a comprehensive list of each state regulator. To recap, every offer, or sale, of a security must be registered, or be exempt, under the blue sky laws of the state where it is offered in sold -- before it is offered for sale. Every brokerage firm and every individual broker or representative must also be registered in said state, or be otherwise exempt from the registration requirements. 

Again, most states modeled their blue sky laws after the USA or the Uniform Securities Act of 1956. Blue sky laws can still vary widely and may not be very uniform. Start by reviewing each of the state's statutes and regulations before starting any securities sales activities. Don't forget that while some states have identical statutory language, precedent can be very different. Don't hesitate to ask the state Securities Commission Staff if you have questions. 

Next, check for exemptions, like Regulation D private offerings, provided there is compliance with SEC Rules 501-503. Just remember that even when some states may not require registration, they may still require filings or place additional conditions on exemptions. Covered securities, which are now exempted, were defined by NSMIA (National Securities Markets Improvement Act of 1996) amended Section 18 of the Securities Act of 1933. Covered securities include: 

  • Securities listed (of approved for listing) on NYSE, AMEX, and NASDAQ
  • Securities of the same issuer which are equal in rank or senior to such listed securities
  • Mutual fund shares
  • Securities sold to certain qualified purchasers (not yet defined by SEC)
  • Securities exempt from registration under the Act if sold in transactions complying with Rule 506 of Regulation D

Hedge fund administrators will need to make a blue sky filing in each state where one of its investors resides. It should be made within 15 days of the date of the investment into the hedge fund. The investment manager will need to pay a fee, which ranges from $75 to $300 or more. Please take note that New York is completely different and you'll need a manager to file before the initial investment takes place. The fee is also approximately four times the cost of other states. 

Your hedge fund attorney will need to the following information: 

  • State where investor resides
  • What is the investment amount, which includes all prior investments into the fund
  • Minimum investment amount, which will be found in the hedge fund offering docs
  • Management fee, which is also found in the hedge fund offering docs

Once the attorney obtains this information, he or she will need to complete a Form D and Form U-2, which help the filing process with the state administrator. Also, your attorney should send a copy of Form D to the SEC for filing. If you're looking for Form D, you can find it on the SEC website

If you need help with blue sky laws, you can post your question or concern on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Stripe, and Twilio.