Every American state has its own securities laws that aim to protect investors against fraud. These laws, called blue sky laws, also oversee the licensing and reporting requirements placed on broker-dealer firms, individual brokers and financial advisors. Here’s what you need to know about blue sky laws and how they protect the public from fraud and misinformation.
Federal Securities Laws and Blue Sky Laws
Federal securities laws take precedence over state securities laws. Further, individual states can’t regulate the national sale of securities. The primary enforcer of national securities laws is the Securities and Exchange Commission, along with exchanges such as the New York Stock Exchange (NYSE) and Nasdaq and also the Financial Industry Regulatory Authority.
However, the states do have considerable ability to control the marketing and offering of securities within their borders, as well as the people and businesses selling securities. These state laws are known as blue sky laws, and they vary among themselves.
Background of Blue Sky Laws
The origin of the name is generally traced to 1917. That was when a Supreme Court justice ruling on the validity of state securities laws used the term to warn against fly-by-night fraudsters attempting to sell securities with no more basis for value than the “blue sky.” Since then, all the state securities laws have come to be known as blue sky laws.
Nearly all states base their blue sky laws on legislation modeled by the Uniform Securities Act, first passed in 1956 and since updated numerous times. The laws generally provide for each state’s security commission or agency to evaluate the information sellers provide about securities and how they are being sold. State securities laws are typically enforced by a state securities commissioner.
Before selling a security in any given state, the security must be registered, which involves providing substantial information about the offering. In addition, the brokerage and the individual broker both have to be registered. The laws provide penalties for failing to disclose information as well as making fraudulent statements.
Variations of Blue Sky Laws
Despite the similarities, individual states have typically deviated, sometimes in significant ways, from the template of the Uniform Securities Act. The result was a complex patchwork of laws that made it challenging for securities sellers to operate in multiple states. In response, Congress passed the National Securities Markets Improvement Act in 1996.
The new law granted the federal government greater control and reduced states’ ability to set standards for sellers and require registration and evaluation of securities. States essentially act now as second-level overseers of the securities industry.
The blue sky laws still vary significantly, however. For instance, in some states, including New York, private investors do not have the right to take legal action for fraudulent securities deals. They are limited to suing for breach of fiduciary duty and ordinary fraud in civil court. In these states, only attorneys general can bring civil and criminal actions for fraudulent securities transactions.
Restrictions on brokers also vary. For instance, California is one of several states that differs from the rest by not allowing brokers to take standard examinations and use universal forms when registering with the securities agency. In these states, registrants and test-takers have to use varieties unique to the state.
Not all securities are subject to the same requirements set by blue sky laws. In many states, for instance, private offerings of securities are not subject to the same state registration requirements as public offerings. However, these exempted offerings still have to follow the SEC rules for private offerings. And, depending on the state, rules may call for other filings and restrictions for private offerings.
Blue Sky Laws and Venture Capital Funds
Covered securities for blue sky laws include any security listed on a national stock exchange any security sold in accordance with Rule 506 of Regulation D under the securities act of 1933. Most venture capital fund offerings are conducted under Rule 506. This means that, essentially, most offerings by venture funds are exempt from blue sky laws and may be exempt from the registration requirements with each state.
Here is a breakdown of the two parts of Rule 506 under Regulation D that are important for venture funds:
- Rule 506(b): Permits private offerings to accredited investors without advertising or solicitation.
- Rule 506(c): Permits private offerings to accredited investors with advertising and solicitation but with more stringent accreditation requirements.
The Bottom Line
State securities laws known as blue sky laws set standards for disclosing information and registering securities with the goal of protecting investors against fraud. The laws also regulate brokerage firms, brokers and financial advisors. While federal securities laws take precedence, following state blue sky laws is still an important concern for anyone selling securities.
Tips for Investing
- A financial advisor can help you understand what laws and regulations govern the securities business in your state. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- The Securities and Exchange Commission requires registered investor advisor firms (RIA) to disclose information about their operations that can be useful to investors considering professional help. RIAs are required to disclose any and all relevant information pertaining to their business practices or disciplinary actions on their Form ADV. It’s also helpful to use tools like FINRA’s Broker Check to take a closer look at an advisor’s professional background.
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