What Are the Blue Sky Laws?
Simply put, Blue Sky Laws are state securities laws. They were named at the turn of the century by a Kansas State Supreme Court judge "because of the blue sky that fraudsters are said to sell to the unwary." In other words, these are the laws that regulate the sale of stocks, bonds and other securities within the states. Any time someone offers or sells securities, they must look into whether Blue Sky filing requirements are triggered. Failure to comply with these laws can lead to the securities issuance failing to be enforceable and exposure to state and federal liability.
Although we refer to them as state laws, there are six states with no Blue Sky Law of their own. These state are:
- Arizona
- Colorado
- Montana
- New Mexico
- South Dakota
- Wyoming
The origins of Blue Sky Laws date back to the early 1900s when a rash of fraudulent stock sales was being perpetrated around the country in the wake of the stock market crash. More specifically, Kansas was the first state to pass a Blue Sky Law in 1911. The Kansas act purposefully targeted fraudulent sales but was the first to provide for an administrative authority to oversee sales. Not only was it the first, it encouraged other states to follow suit and model laws after the Kansas legislation .
Within 10 years 37 states had passed some form of Blue Sky Law and by 1930 at least 48 states had such legislation. At the national level, under the new deal’s first phase, Congress passed the Federal Securities Act in 1933 which established a national scheme for securities regulation. But it did not preempt other laws and thus resulted in a hodgepodge of state laws and organizations spouting out conflicting legal opinions.
In 1956, Congress passed the Uniform Securities Act to resolve this issue. The 1956 Uniform Securities Act did not eliminate state blue sky regulations. What it did do was create a model for states to adopt laws that would mirror federal law. With graduation trends, nearly every state adopted the Uniform Securities Act. Thus, those that do not reflect some form of the Uniform act are similar in nature to the federal law.
States vary in enforcement of their blue sky laws but they all have the same goal – investor protection. Individual investors are often disadvantaged and fooled by sophisticated and experienced sellers. Before investing, it is important to know what jurisdiction has the most regulatory authority over the transaction.
Importance of Blue Sky Filings
Strict compliance with Blue Sky Filing requirements is mandatory in order to assure the orderly growth and development of the securities markets and assure investors a full disclosure of the facts upon which they can make an informed decisions. Incorrect Blue Sky Filings (whether as to content or timing) can result in rescission liability, state securities enforcement action and substantial business and reputational harm to the issuer. Rescission liability will occur in circumstances where the filing omission or misstatement is deemed to be material. The issuing entity will usually be given the right to remedy the omission or misstatement, either by filing a late Form D, amending the Form D or upgrading the exemption from a safe harbor to one requiring extensive disclosures. Where the remedy is possible, there typically is a grace period before the state will take action against the issuer. Where an offering is not remedied in a timely manner, or where the director believes the omission or misstatement is not capable of being cured by filing an amended form, this could lead to a cease and desist order, a fine and potentially a referral to federal authorities for a parallel investigation.
Requirements for Blue Sky Filings by State
Blue Sky filing requirements vary considerably from state to state. While every state generally requires an issuer or a broker-dealer to file (or qualify) any offerings made in the state, the substance of the required filings and qualifications for those filings differs from state to state. We attempt to provide below a summary of these requirements on a state-by-state basis, but such requirements should be verified prior to a securities offering by consulting the appropriate state agency or outside counsel. In the following table, we summarize the general state Blue Sky filing requirements when making unregistered offerings using the Regulation D, Rule 506 "safe harbor" exemption. These requirements include filing Form D, State Blue Sky filings and state licensing (not pre-qualification) requirements, respectively. Only the state filing requirements for the 50 U.S. states are summarized. The regulation and rationale supporting each state’s filing requirements is not summarized here. Rather, we simply note the type of filing requirement and a source for verifying such requirement.
Form D Required
Blue Sky Filing and Qualification Required?
State
Form D is required
No Blue Sky Filing or Qualification
No Blue Sky Filing but pre-qualification required
Paper Filing Required (or other than EDGAR)
Pre-qualification required
Electronic Filing Required
Blue Sky Filing Exemptions
State
Blue Sky exemption filing exemption for registration, in connection with an offer and sale of securities that satisfy the definitional requirements of the "Private Offering Exemption" (Section 230.502(b)), which is primarily for federal securities regulatory purposes
Blue Sky exemption filing exemption for registration, in connection with an offer and sale of securities that satisfy the definitional requirements of the "Section 4(2) Exemption," which is primarily for federal securities regulatory purposes
Blue Sky exemption filing exemption for registration, in connection with an offer and sale of securities that are not offered to residents of its state (for example, NY, in connection with certain transactions by out-of-state issuers)
Blue Sky exemption filing exemption for registration, in connection with an offer and sale of securities made in connection with rescission offers, which are primarily for federal securities regulatory purposes
Blue Sky exemption filing Market Maker legal opinion exemption for prospective market makers that make a "de minimus" offering of securities under certain circumstances, which is primarily for federal and certain state securities regulatory purposes
Blue Sky Federal Rule of Evidence exemption exemption for securities offered in connection with public and private offering exemptions (Rule of Evidence 504, to be codified as Federal Rule of Evidence rule 502), which is primarily for federal securities regulatory purposes
Blue Sky Private Securities Placement exemption exemption for private securities placements (in accordance with the federal definition of private placement as defined under Section 4(2)), which is primarily for federal securities regulatory purposes
Blue Sky issuer exemption exemption for issuers and their affiliates (including issuers to Qualified Institutional Buyers (QIBs)), which is primarily for federal securities regulatory purposes
Blue Sky Investment Advisor exemption exemption for investment advisors, including institutional investors (for example, QIBs), which is primarily for federal securities regulatory purposes
Blue Sky qualified investor exemption exemption for qualified investors defined broadly as individuals with at least $750,000 of investable assets or $250,000 of income and other financial criteria, which is primarily for federal securities regulatory purposes
How to File Against Blue Sky Laws
Although each state is different, getting started with a Blue Sky filing is relatively easy. Once you know the requirements for each state in which you plan to sell securities, you should determine whether you qualify for an exemption under either federal (Reg D) or state law. If you do not qualify for an exemption, you will have to register your securities in any state where an investor resides prior to the sale of the securities to such investor.
If you are filing for an exemption, simply work out the details of your offering and work on a private placement memorandum (PPM) that is compliant with the requirements of each respective state. Many PPMs are drafted to comply with the federal guidelines, since the federal regulations are much stricter than the state requirements (most state restrictions relate to unfair, unsound or unjust practices). Then you have to file an exemption form via Blue Sky filing in each state within which you plan to offer or sell securities.
If you are registering your offering, however, your filing will include a public offering prospectus. Depending on the state, this could be a difficult and arduous process. For a public offering, you also need to include details such as the timing, price, location, underwriting and distribution plan for the offerings. It is highly recommended that an issuer complies with the registration procedures of each state so it can be listed as qualifying to sell in each state. Typically, there are no formal filing fees for an initial filing if you are using a PPM or other offering document at the same time. However, if this is a post-qualification filing, there will be a filing fee.
Most states allow paper filings only (no e-filing) and some states require additional documents according to their specific requirements. After the filing is submitted, it may take anywhere from a few days to several weeks to clear.
Common Issues with Blue Sky Filings
Each state has its own set of Blue Sky laws, and has idiosyncrasies that must be taken into account when preparing to file. These laws can also change at any moment, which means preparing to file can be a moving target. There are three common challenges that often arise for companies attempting to comply with Blue Sky registration requirements.
Challenge 1: Staying in Compliance
The first challenge for companies to deal with when it comes to Blue Sky filings is simply staying in compliance. Many companies are unaware that they are subject to the laws of multiple states. Ironically, companies who may be flying under the radar in one state may become immediately subject to the laws of another state. For example, a company who markets and sells exclusively to residents of Georgia and Florida will likely be subject to Georgia’s Blue Sky laws but may not be required to file in Florida. However, once that company makes a sale to a California resident, it is now subject to California’s Blue Sky laws as well.
Challenge 2: Challenges with Meeting Filing Deadlines
The second challenge companies have to deal with is the varying deadlines for filing in each state. The table above demonstrates how different the filing requirements can be among states. It is important to know which states have specific requirements that differ from the norm. One option that most states provide is qualification by filing an application later than the scheduled date . Each state has its own procedure that they follow when a company fails to file on time. Moreover, the rules and procedure governing the late filings are not always clear. As a general rule, you should seek only the advice of professionals that regularly deal with Blue Sky law and transfer agents when dealing with these matters.
Challenge 3: Understanding Exemptions
In addition to having different requirements for registration, each state has different exemptions from registration. States categorize the transactions into two categories: exempt and non-exempt. Exempt offerings do not have to be registered and buyers are not subject to rescission rights. Under some exemptions the issuer may have to file a notice with the state regarding the exempt transaction. Non-exempt offerings, on the other hand, must have the securities registered per the requirements of each issuing state. If you wish to issue shares under an exemption, you need to understand the requirements for your issuer, the exempt offering, and whether the exemption requires the issuer to file anything with the state.
Key Considerations
Properly prepared Blue Sky filings are proactive, not reactive measures. The key to successful Blue Sky compliance is anticipating its requirements from the outset. Companies that anticipate how Blue Sky filings will impact their business are more apt to start the process off correctly. In contrast, problems begin to occur when a company discovers too late the consequences of not filing its Blue Sky filings.
Blue Sky Law Resources
In order to ensure thorough and accurate compliance with Blue Sky Laws, businesses must keep abreast of any changes in state laws, as well as deadlines and requirements for stock filing, renewal and related obligations. Government websites are a key source for this information. Blue Sky filings are used by both private companies engaged in private placements and public companies. Private companies must make Blue Sky filings in states where they intend to sell securities. For public companies, the investment banking firm that conducts the underwritings for its IPO will take care of all Blue Sky filings. First Research offers a highly rated Blue Sky Filing Service. Each state has authority over Blue Sky compliance, and each also has an office of "Securities". Phone numbers, addresses, online resources, and other informational support are provided via these offices. The North American Securities Administrators Association (NASAA) is made up of all state securities regulators that work together to coordinate disclosure requirements and other regulatory advice. It provides helpful publications, including dozens of Investor Alerts on current issues, and lists of state resources and links to corporate finance regulatory offices. The NASAA Unclaimed Property Resources contains links to all state unclaimed property websites. A number of reputable law firms provide online Blue Sky materials, including strategies, forms, practical information, and links to corporate finance resources.
Blue Sky Situations: Case Examples
To illustrate the importance of understanding Blue Sky Filing requirements, let’s consider two real-world scenarios: one company that did things right and successfully navigated the filings process and another that failed to file and incurred legal problems as a result.
Case Study 1 – Company B: Doing it Right
Company B, a development stage biotech firm, initially funded its operations through a private placement in the United States, which did not include any sales of the securities to accredited investors, with two notable exceptions. The company was seeking additional funding in Canada, so it properly registered with the jurisdictional regulator in Ontario through the use of the National Registration Database ("NRD"). As a result, providing information through the NRD eliminated the need for the company to file its offering documents with the Ontario Securities Commission. The regulators allowed Company B to proceed with its financing in Canada with one simple caveat – that the securities would only be offered on a "private placement" basis and would not be sold to non-accredited investors. The company obtained this exemption from filing, entailed submitting a signed representation signed by the directors and signing a notice filing under the Exemption from Registration/Prospectus/Annual Information Form for Investment Fund International Issuer ("Form 45-106F1") .
Case Study 2 – Company A: Doing it Wrong
First off the rank is Company A – a company that applications to the security Commissions of the countries across North America and Canada, but failed to get their offering documents, and in doing so, discovered the hard way that the concept of "doing it right" is conceptually easy, but a far more difficult exercise in practical terms. The example of Company A hails from University of Alberta in Canada where the broker-dealer just raised $5,000,000 in funding towards the $25,000,000 project. The state of blue sky was right ahead when the service providers and the law firms, who were unable to procure the relevant regulatory filings in Alberta and British Columbia, could have been howling in the dark like howling wolves. Instead, they made sure that sheeple knew what underlings had done for the shareholders of a company with no regulatory filings. Company A misguidedly found that Section 1 of Chapter 51.505 of the Ohio Revised Code, which defines the scope of "Blue Sky Laws" in Ohio, required the appointment of a broker as an agent to "solicit and sell" the "securities" in the state of Ohio. In Company A’s case, it was found that the failure to comply with the blue sky laws in Ohio would likely result in its securities being un-saleable in that state. However, Company A received some consolation as the "Blue Sky Law" does allow subsequent sales in Ohio without additional registration requirements for offers or sale.