Editor’s Note: Matthew A. Cordell is a member of the Financial Institutions Practice Group of Ward and Smith, P.A.
The "Other" Securities Regulators
The U.S. Securities and Exchange Commission ("SEC") is not the only regulator keeping tabs on securities. Almost every state (and territory) has an agency or division dedicated to enforcing that state’s securities laws, commonly referred to as "blue sky laws." That colorful term is attributed to a United States Supreme Court decision which explained that state securities laws were designed to protect investors from "speculative schemes which have no more basis than so many feet of blue sky." This article discusses the effects of state securities laws and regulations in the context of a nonpublic offering and the most common exemptions from state securities registration requirements.
When Do Blue Sky Laws Apply?
Blue sky laws usually apply to both the offer and the sale of securities. This means that blue sky laws must be reviewed before securities can even be offered for sale. It also means that a company issuing securities cannot avoid registration in certain states by making a widespread offer of securities and then simply declining to sell to investors in states where exemptions from registration are unavailable or where state regulators have not approved the security. Prudent issuers will consider the blue sky laws at the beginning of the process and tailor their efforts to both the federal and the state securities laws.
How Are States Involved In Securities Regulation?
State securities laws often apply in addition to, rather than instead of, federal securities laws, creating dual layers of regulation. As a result, companies issuing securities may be required to undergo state registration processes resembling the federal securities registration process. Although there is some overlap between the two regulatory systems, they are not identical. Therefore, situations exist in which an exemption from federal registration is available but in which registration is required in some states. Further, some state regulators have the authority to deny registration if they believe the price is unfair or the security is too speculative. Although it is rare, a securities offering could be exempt or approved by the SEC but rejected by a state regulator.
While most state securities statutes reflect common themes, the statutes of a few states differ dramatically from the typical state statutes. For example, while most state statutes regulate the securities being offered, New York’s securities laws focus exclusively on the participants in the securities offering. Furthermore, even where state statutes resemble one another, the state securities regulators, who usually have the authority to create regulations implementing the statutes, may interpret similar or even identical statutory language differently from state to state. As a consequence, every securities offering requires a careful review of the statutes, agency regulations, and interpreting opinions of each and every state in which the securities will be offered.
There Are Exceptions to the Rules, Right?
Just as there are exemptions from the registration requirements of the federal securities laws, several types of securities and transactions are exempt from the registration requirements of most states. The following are some common registration exemptions under blue sky laws:
• Exemption for Regulation D Securities
Three distinct exemptions from securities registration under the federal securities laws are collected in SEC Regulation D: Rule 504, 505, and 506 offerings. SEC Rule 506 offerings involve a number of requirements regarding advertising of the offering, qualifications for purchasers, and the ability of purchasers to resell the securities. Under Rule 506, an unlimited amount of securities may be sold to an unlimited number of high income or high net worth investors and up to 35 other "sophisticated" investors without federal registration. Under federal law, states are not permitted to require SEC Rule 506 securities to be registered at the state level. States remain free, however, to insist that they be "notified" of the offering and to impose a notification fee. If your offering conforms to the requirements of SEC Rule 506, state registration will not be necessary, but notification and payment of a fee to the relevant states may be required.
There is no similar prohibition against state registration when it comes to SEC Rule 504 and SEC Rule 505 offerings. Most states, however, have adopted exemptions that will be available for many Rule 504 and Rule 505 offerings. A model state securities statute, the Uniform Securities Act of 1956 ("1956 Act"), has been adopted (with modification) by 28 states, and permits offers or sales to fewer than ten investors – regardless of their level of sophistication or resources – without registration. Therefore, you can raise capital from up to nine investors without registering within a state whose statutes are based on the 1956 Act.
In 2002, a revised model statute was created, the Uniform Securities Act of 2002 ("2002 Act"), and it has been adopted in some form by 14 states. The 2002 Act exempts sales to 25 or fewer investors in a 12-month period. To be eligible to use this exemption, you are not permitted to publicly advertise the offering or pay commissions based on the sales, and you may sell only to persons you reasonably believe are buying with an intent to hold the securities as an investment. The 2002 Act also exempts offers and sales to institutional investors. Therefore, in a state that has adopted the 2002 Act, you may be able to raise an unlimited amount of capital from institutional investors or from 25 or fewer non-institutional investors without registering the securities.
• Existing Security Holders
Most state blue sky laws do not require registration for offers and sales to existing security holders because those security holders are presumed to already have sufficient information about the issuer. If your existing shareholders are willing to invest additional funds, you can issue securities to them without registration in most states.
• Exchange-Listed Securities
There is a nationwide exemption from state registration for any security listed on the New York Stock Exchange, the American Stock Exchange, or NASDAQ, as well as for any security issued by a company that already has listed securities, so long as the offered security is of equal or higher rank than the listed security. This exemption extends to such things as warrants and options for listed securities, and means that once your stock is listed on an exchange, certain subsequent offerings may be exempt from state securities registration.
Other Blue Sky Requirements
Even when an exemption from state registration applies, some states require that issuers of securities notify the state securities regulator of the offering or sale, and pay a notification fee. Additionally, some states do not require certain securities to be registered, but still may require certain individuals dealing in the securities, including sometimes officers and employees of the company, to register. Finally, states almost always retain the authority to bring enforcement actions for fraud in connection with all offerings, including exempt offerings. In sum, even if your securities are not required to be registered, other blue sky laws still may apply, so a careful check of the laws of every state in which you plan to offer or sell securities is a necessity.
© 2008, Ward and Smith, P.A.
Ward and Smith, P.A. provides a multi-specialty approach to the representation of technology companies and their officers, directors, employees, and investors. Matthew A. Cordell practices in the Financial Institutions Practice Group, where he concentrates his practice on securities and banking regulation and transactions, and corporate law. Comments or questions may be sent to email@example.com.
This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.