Each U.S. state enforces its own set of securities laws, known as “blue sky laws.” These laws are designed to shield investors from fraud and deceptive practices. These laws require broker-dealer firms, individual brokers and financial advisors to meet stringent licensing and reporting standards. This helps ensure those who manage investments operate with transparency and accountability. Blue sky laws don’t just regulate the actions of these financial professionals, however. They also mandate comprehensive disclosures, helping investors make informed decisions. Here’s a closer look at blue sky laws and how they safeguard the public from fraud and misinformation in the financial market.
A financial advisor can help you understand what laws and regulations govern the securities business in your state.
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 (SEC). The SEC also works with exchanges such as the New York Stock Exchange (NYSE) and Nasdaq, as well as the Financial Industry Regulatory Authority.
However, the states do have control of the marketing and offering of securities within their borders, as well as the people and businesses. These state laws are known as blue sky laws, and they vary.
What Are 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. The Act was first passed in 1956, and has since been 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’re 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. This 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. It also required the 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, 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 or 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 most offerings by venture funds are exempt from blue sky laws. They may also 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.
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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