Blue Sky Laws

Blue sky laws are state laws regulating securities. They gained their unusual name from concerns that fraudulent securities offerings were so brazen and commonplace that issuers would sell building lots in the blue sky. In general, these laws predate the Securities Act of 1933 and the Securities Exchange Act of 1934 and were not preempted by those federal acts. In the 20-year period between 1911 and 1931, 47 of the existing 48 states adopted such laws.

Blue sky laws typically require the registration of any securities sold in the state, regulate broker-dealer and investment advisers, impose liability for false and misleading information relating to securities, and establish administrative agencies to enforce the laws. The registration requirements often include a “merit review” that gives the administrative agency the power to prohibit the sale of securities that it considers not to be “fair” or “equitable.” This is in contrast to the federal securities law approach that relies on the market to determine a fair price after ensuring full disclosure of relevant information. It should also be noted that blue sky laws do not regulate interstate trading of securities.

Although the majority of states have adopted the Uniform Securities Act (USA), these states have made variations to the USA, which creates significant differences from state to state. In addition, judicial interpretations of the USA can also vary significantly from state to state. Thus, actions that may be considered fraudulent under the USA in one state may not be fraudulent under the USA in a different state.

In an attempt to achieve greater uniformity between the states and thus reduce the burden on issuers and broker-dealers, Congress passed the National Securities Markets Improvement Act (NSMIA) of 1996. The NSMIA classifies certain securities as “covered securities,” which are exempt from state registration or merit review requirements. The covered securities include securities listed on a national stock exchange, mutual funds, and other offerings. Certain types of intrastate and small-scale securities offerings continue to be regulated by the states.

In addition, Congress passed the Securities Litigation Uniform Standards Act (SLUSA) of 1998 to place limits on state court jurisdiction over securities fraud lawsuits. Under the act, federal courts have exclusive jurisdiction over class actions alleging fraud. This subjects the plaintiffs to the reforms of the Private Securities Litigation Reform Act of 1995, which has significantly more difficult procedural hurdles than typical blue sky laws. It is unclear, however, to what extent the SLUSA requires nonfraud class action claims, such as a breach of a fiduciary duty claims, to be heard only in federal courts.

The SLUSA does not prohibit state and local governments (and their pension funds) from bringing securities fraud claims. The importance of this exception became clear in 2002, when the New York attorney general used the state's blue sky law (known as the Martin Act) to reach a settlement with Merrill Lynch that required Merrill Lynch to make significant changes to its operating and disclosure practices. This settlement became a leading example of regulation by prosecution. Subsequently, other states have amended their blue sky laws to increase their attorney general's prosecutorial powers, and Congress has considered new legislation in an ongoing attempt to find the appropriate balance between federal and state powers in securities regulation.

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