Blue sky laws are state securities regulations. That is, in addition to federal securities regulations, mainly the Securities Act of 1933 and the Exchange Act of 1934, states may also require issuers of securities to register with their state and regulate securities fraud.
In the early 1900s, decades before Congress passed the federal securities acts, individual states adopted legislation regulating the sale of securities. The term “blue sky” derives from the characterization of baseless and broad speculative investment schemes which such laws targeted. The U.S. Supreme Court in Hall v. Geiger Jones Co., 242 U.S. 539 (1917), described the targeted activity as “speculative schemes which have no more basis than so many feet of ‘blue sky.’' Blue sky laws developed in the years leading up to the Great Depression in response to ordinary investors losing money in highly speculative or fraudulent schemes promising high investment returns, such as oil fields and exotic investments in foreign countries.
By 1933, when Congress began regulating securities, all states except Nevada had blue sky laws. Securities regulation in the United States thus consisted of a nationwide patchwork of state laws, which became even more complicated once Congress passed federal securities laws that duplicated some of the areas regulated by blue sky laws. While securities regulation remains a patchwork of federal and state law, the National Securities Market Improvement Act of 1966 (NSMIA) provided for greater clarity and uniformity. Under it, certain securities listed on stock exchanges, such as NASDAQ or NYSE, are exempt from state blue sky laws. Securities exempt by Rule 506 under federal law are also exempt under blue sky laws. States may still enforce the anti-fraud provision of their blue sky laws even where the NSMIA exempts the security from that state’s blue sky law.
Even where blue sky laws apply today, states vary widely in their method of regulation. New York, for example, does not require registration of securities except for securities sold in real estate or intrastate offerings under N.Y. GBL Article 23-A. California, on the other hand, requires issuers to meet a merit test to show that their securities are fair for investors under Title 4, Division 1 of the California Corporations Code.
Despite the differences from state to state, blue sky laws share certain features in their approach to prevent misinformation about investment returns and risks. The state laws provide for oversight of the sales process and create liability for fraudulent sales in two ways. First, the laws require the registration of securities that will be offered or sold within the state, unless the offerings fall within specified exemptions from registration; e.g. Title 4, Div. 1, Part 2 of the Cal. Corp. Code. These processes are administered by a state’s securities agency or commission. The registration process for securities and securities transactions prevents fraudulent transactions by allowing state security commissions to review the securities offerings and ensure that the individuals transacting in the securities markets are qualified and regulated by the state. Similar to the federal laws, blue sky laws generally operate on a disclosure-driven basis, and mandate that companies accurately disclose information that will help investors make informed decisions.
Second, blue sky laws have antifraud provisions that create liability for any fraudulent statements or failure to disclose information as required; e.g. Title 4, Div. 1, Part 5 of the Cal. Corp. Code. The specific kinds of statements and acts that can form the basis of a fraud claim will depend on a state’s statutes and case law. The cause of action available and remedies available to investors bringing private suits also differs from state to state, but may include rescission of the transactions, forcing the seller to give up profits, or other measures of damages.
Originally prepared by Deepa Sarkar of the Cornell Law School Securities Law Clinic.
[Last updated in December of 2021 by the Wex Definitions Team]