What Are Blue Sky Laws and How Do They Protect Investors?
Blue sky laws are state-specific regulations regarding the sale of securities. Blue sky laws are meant to add another layer of protection for investors in addition to the federal regulations provided by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). Blue sky laws codify many of the issues raised by The Securities Act of 1933 and specifically prohibit brokers from using deception or fraud in the sale of securities. Blue sky laws also help states establish exactly which financial products fit the definition of a security.
Most states have blue sky laws requiring companies to register their offerings with a state securities board and provide similar information when registering an offering with the SEC. Brokers and brokerage firms must register with their state as well as FINRA. Investors can see which states their broker is registered to sell securities on their BrokerCheck profile.
Investors should note that not all investments must register with the SEC and state securities boards. Rule 506 of Regulation D of the Securities Act offers exemptions to registration. Under Regulation D, certain offers may be exempt from blue sky registration.
Blue sky laws help state governments more effectively prevent securities fraud. The SEC and FINRA cannot detect and address every instance of securities fraud and broker misconduct. Blue sky laws allow states to uncover and prevent securities fraud without having to wait for the SEC or FINRA to take action.
History of Blue Sky Laws
Supreme Court Justice Joseph McKenna is the first official known to have used the term “blue sky law,” referring to “speculative schemes that have no more basis than so many feet of blue sky.” He elaborated that these laws are meant “to stop the sale of stock in fly-by-night concerns, visionary oil wells, distant gold mines and other like fraudulent exploitations.” Before the formation of the SEC in 1934, many fraudsters raised money by making up investment opportunities, only to disappear with the investors’ money. In 1956, the Uniform Securities Act offered guidelines on how each state should implement its own blue sky laws. It also addresses potential differences between state and federal regulations.
Blue Sky Laws by State
Blue sky laws are regulated by the state’s security board. Most states require that brokers, investment advisers, and brokerage firms register in each state where they plan to work. Brokers must pass the Series 63 Securities Agent State Law Examination before selling securities in a particular state. States may fine a broker or a financial advisor for failing to register with their state before they start selling securities and providing investment advice. Offerers must also register their securities with state regulators unless specific exemptions apply.
Certain states seem to specialize in a particular type of securities fraud. For instance, Colorado has particularly high rates of penny stock fraud, while Utah has the highest per capita number of pyramid schemes. There is no federal statute designed to prevent pyramid schemes from forming, so many states have tailored their blue sky laws to address this type of fraud.
Pyramid schemes may claim that the initial “investment” does not qualify as a security, and therefore does not need to register with the SEC. It is essential for the scam that the business avoids filing official documents. Today, many states require that companies offering recruits a “business opportunity” provide them with documents disclosing essential financial information. This disclosure must also be filed with the state. States are better equipped to address pyramid scheme complaints, as these types of frauds tend to target specific geographic areas.
There are no federal guidelines regarding the sale of cryptocurrencies, which has made them a particularly popular financial instrument for scammers. Florida’s Attorney General recently issued a consumer alert regarding a cryptocurrency bait-and-switch scam that tricks investors into transferring their money to a fraudulent platform. Blue Sky authorities in Alabama, Kentucky, New Jersey, and Texas have stated that they believe businesses offering interest on cryptocurrencies are securities and should register with state regulators.
Recently, New York Attorney General Leticia James issued a press release that warned cryptocurrency companies to register as securities under the Martin Act. The Martin Act establishes New York’s blue sky laws. The letter from the NYAG states, “The OAG has, for several years, expressed its concern that many virtual currency businesses – including trading platforms, issuers, and those engaging in purchase or sale of assets on behalf of clients – expose New Yorkers to significant undisclosed risks.”
Several virtual currency platforms claim to generate interest for their customers and therefore fit the Martin Act definition of a security. AG James also stated, “We’ve already taken action against a number of crypto platforms and coins that engaged in fraud or that illegally operated in New York. Today’s actions build on that work and send a message that we will not hesitate to take whatever actions are necessary against any company that thinks they are above the law.”
Violation of Blue Sky Laws
Common securities frauds like pyramid schemes and cryptocurrencies demonstrate why investors need state-level securities protection. Under the Uniform Securities Act, if a state regulator determines that it is in the public’s best interest, they can terminate a broker’s registration. They may also terminate a registration if they discover any part of the broker’s filing contains misleading or incomplete information.
Blue Sky Bonds
Some states require securities dealers to acquire blue sky bonds. This type of surety bond protects investors and gives them a path for recourse if the securities dealer issues false securities. If an investor makes a bond claim, it is usually in the dealer’s best interest to settle, as bond claims can be quite expensive.
Blue Sky Law Exemptions
As mentioned above, some securities may be exempt from state registration under Regulation D. Blue sky laws may also include a few exemptions. For instance, a broker may not need to register if their only clients are investment companies. Each state may also offer certain exemptions for Canadian brokers.
Did Your Broker Violate Blue Sky Laws?
If your broker violated blue sky laws, they have almost certainly violated FINRA rules and regulations as well. Kurta Law is a national law firm and can assist with FINRA arbitration in any state. Our securities attorneys understand how each state regulates securities and will address blue sky laws in addition to violations of federal regulations.