Blue sky laws are passed by the individual states to prevent unscrupulous securities dealers from committing fraud by selling bogus securities to investors. The “blue sky” term comes from the concept that an unscrupulous person could “sell the sky” to someone without the presence of proper regulation. This article addresses the general requirements of blue sky laws, their implications for securities dealers, and how this impacts the accountant.
Blue sky laws require that securities originally offered for sale be qualified and registered with the proper state authorities, and that their price and terms be consistent with statutory guidelines. The usual guidelines, which are based on the Uniform Securities Act of 1956, are:
- The issuer of a security is engaged in business, is not in the organizational stage or bankrupt, and is not a blank check, blind pool, or shell company that has no business plan or purpose.
- The security should be sold at a price reasonably related to its current market price.
- The security is not part or all of an unsold allotment to the securities dealer as an underwriter of the security.
- The company has a minimum asset base.
Thus, for a securities dealer to sell a company’s stock, the stock must conform to both SEC regulations and the laws in the state where the dealer is located. If the security does not conform with the local blue sky law, then (as stated in section 410(a) of the 1956 Act),
“Any person who offers or sells a security is liable to the person buying the security from him, who may sue… to recover the consideration paid for the security, together with interest at six percent per year from date of payment, [court] costs, and reasonable attorneys’ fees, less the amount of income received on the security, upon tender of the security, or for damages if he no longer owns the security.”
This legal requirement is clearly of massive concern to securities dealers, who may be forced by investors to take back securities previously sold to them. Of course, this would only happen if the securities subsequently lost some portion or all of their value, resulting in significant losses or even bankruptcy for the dealer. Thus, compliance with blue sky laws is absolutely critical for the establishment of a state-level market in a company’s securities.
This legal requirement is not a problem for any company whose stock is listed on a national exchange, such as the American Stock Exchange, NASDAQ, or New York Stock Exchange. In these cases, states give a “manual exemption,” so that the stock is automatically cleared for trading. This exemption was created under the National Securities Markets Improvement Act of 1996.
If a company is only listed on the over the counter market, then the situation is more complex. Most of the states allow a registration exemption if a company registers and annually renews that registration through either Standard & Poor’s, Moody’s, or Fitch’s Investor Service (the specific entity varies by state). This registration involves a multi-page filing that includes historical financial statements, a description of the business, and the names of all executive officers. However, some states still require direct registration, which usually requires the services of a local attorney. The states that currently allow no registration exemption are Alabama, California, Georgia, Illinois, Kentucky, Louisiana, New York, Pennsylvania, Tennessee, Virginia, and Wisconsin.
Individual state requirements change constantly, so have a local securities attorney update this list from time to time.
Given the broad range of state “blue sky” laws, the primary advice for the accountant is to engage local counsel in every state where a company intends to sell its securities, to verify that it has complied with the local regulations. In addition, be aware of the local blue sky laws whenever going on a road show, since both brokers and investors are very likely to bring up the issue at that time.