Understanding Blue Sky Laws: Protecting Investors from Fraudulent Practices

A comprehensive guide to blue sky laws and how they safeguard investors against securities fraud. Learn about the history, key takeaways, and the regulatory mechanisms in place to ensure fair investing.

Blue sky laws are state regulations established as safeguards for investors against securities fraud. The laws, which may vary by state, typically require sellers of new issues to register their offerings and provide financial details of the deal and the entities involved. As a result, investors have a wealth of verifiable information on which to base their judgment and investment decisions.

Key Takeaways

  • Blue sky laws are state-level, anti-fraud regulations that require issuers of securities to be registered and to disclose details of their offerings.
  • Blue sky laws create liability for issuers, allowing legal authorities and investors to bring action against them for failing to live up to the laws’ provisions.
  • Most states’ blue sky laws follow the model Uniform Securities Act of 1956 and are superseded by federal securities laws in case of duplication.

Understanding Blue Sky Laws

Blue sky laws—which serve as an additional regulatory layer to federal securities regulations—usually mandate licenses for brokerage firms, investment advisors, and individual brokers offering securities in their states. These laws require that private investment funds register not only in their home state but in every state where they wish to do business.

Issuers of securities must reveal the terms of the offering, including disclosures of material information that may affect the security. The state-based nature of these laws means each jurisdiction can include different filing requirements for registering offerings. The process usually includes a merit review by state agents who determine whether the offering is balanced and fair for the buyer.

While blue sky laws vary by state, they all aim to protect individuals from fraudulent or overly speculative investments. The laws’ provisions also create liability for any fraudulent statements or failure to disclose information, allowing lawsuits and other legal actions to be brought against issuers.

The intent of such laws is to deter sellers from taking advantage of investors who lack experience or knowledge and to ensure that investors are presented with offers for new issues that have already been vetted by their state administrators for fairness and equitability.

There are certain exceptions regarding the types of offerings that must be registered. These exemptions include securities listed on national stock exchanges, aiming to streamline the oversight process where possible. Offerings that fall under Rule 506 of Regulation D of the Securities Act of 1933, for example, qualify as covered securities and are also exempt.

The History of Blue Sky Laws

The term “blue sky law” is said to have originated in the early 1900s, gaining widespread use when a Kansas Supreme Court justice declared his desire to protect investors from speculative ventures that had “no more basis than so many feet of blue sky.”

In the years leading up to the 1929 stock market crash, such speculative ventures were rife. Many companies issued stock, promoted real estate, and other investment deals while making lofty, unsubstantiated promises of greater profits to come. There was no Securities and Exchange Commission (SEC) and little regulatory oversight of the investment and financial industry. Securities were sold without corroborating material evidence to support these claims, and in some cases, details were fraudulently hidden to attract more investors. Such activities contributed to the hyper-speculative environment of the 1920s that led to inflation of the stock market before its inevitable collapse.

Although blue sky laws did exist during that time period—Kansas enacted the earliest one, in 1911—they tended to be weakly worded and enforced, and the unscrupulous could easily avoid them by doing business in another state. After the stock market crash and the onset of the Great Depression, Congress enacted several securities acts to regulate the stock market and the financial industry on a federal level and to establish the SEC.

In 1956 the Uniform Securities Act was passed, a model law providing a framework that guides states in the crafting of their own securities legislation. It forms the foundation for 40 out of 50 state laws today and is often nicknamed the Blue Sky Law. Subsequent legislation, such as the National Securities Markets Improvement Act of 1996, pre-empts blue sky laws where they duplicate federal law.

Related Terms: Securities and Exchange Commission, Uniform Securities Act, Regulation D, Securities Act of 1933, National Securities Markets Improvement Act.

References

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--- primaryColor: 'rgb(121, 82, 179)' secondaryColor: '#DDDDDD' textColor: black shuffle_questions: true --- ## What are Blue Sky Laws designed to protect investors from? - [ ] Federal income tax - [x] Securities fraud - [ ] Inflation - [ ] Market volatility ## Which level of government enforces Blue Sky Laws? - [ ] International - [ ] Federal - [x] State - [ ] Municipal ## What is the origin of the term "Blue Sky Laws"? - [ ] It refers to the clear broadcasting of laws - [ ] It’s derived from an investment book title - [x] It aims to protect investors from speculative schemes that have "no more basis than so many feet of 'blue sky'" - [ ] It symbolizes transparency in market operations ## Who ensures compliance with Blue Sky Laws within each state? - [ ] Federal Reserve - [ ] SEC (Securities and Exchange Commission) - [ ] FDIC (Federal Deposit Insurance Corporation) - [x] State Securities Commissioners ## Blue Sky Laws require which of the following from companies? - [ ] Exemption from federal registrations - [ ] Filing of shareholder agreements - [x] Disclosure of important financial information and, in some cases, registration of securities offerings - [ ] Implementation of stock buy-backs ## Which entities commonly benefit from the protection offered by Blue Sky Laws? - [x] Individual investors - [ ] Corporate monopolies - [ ] Federal agencies - [ ] Stock exchanges ## How do Blue Sky Laws differ from federal securities regulations? - [ ] They apply to international securities transactions - [ ] They are generally more lenient - [ ] They are administered by the NASDAQ - [x] They are state-level regulations focused more narrowly on preventing fraud ## What consequence can a company face for violating Blue Sky Laws? - [ ] Federal endorsement - [ ] Increase in stock price - [x] Penalties and restrictions on selling their securities - [ ] Listing on a premium stock exchange ## Blue Sky Laws are primarily concerned with monitoring: - [ ] Real estate investments - [ ] Commodity trading - [ ] Crypto currencies - [x] The issuance and sale of investment securities within the state ## Which organization might work in cooperation with state enforcers to monitor securities? - [ ] WTO (World Trade Organization) - [ ] ECB (European Central Bank) - [ ] IMF (International Monetary Fund) - [x] SEC (Securities and Exchange Commission)