Overview of the Blue Sky Laws in New York

Defining Blue Sky Laws

The term "Blue Sky laws" refers to state regulations that govern the buying and selling of securities. Enacted in the early 20th century, Blue Sky Laws generally require businesses issuing securities to make full disclosures to investors. Investors benefit from transparency provided by these laws, while businesses can raise capital without worrying about fraud claims.
The origin of the term "Blue Sky laws" is attributed to an opinion from the Kansas Supreme Court in 1917. In State v. Seacat, the court stated that no one was able to list the names of all the people who were cheated out of their money in the speculative market for oil , gas, and minerals. The term was used to describe the "endless blue sky" of opportunities where speculators could go to cheat investors seeking financial gain.
The Securities Act of 1933 and Securities Exchange Act of 1934 essentially replaced most Blue Sky laws. Federal securities law considers a private placement offering for sales of securities to 35 or fewer non-accredited investors to be subject to state-level regulation. State securities commissions use Blue Sky laws to provide investors with information about a company’s financial circumstances.

The Particulars of Blue Sky Laws in New York

As mentioned, there is no longer a need to be licensed in New York to conduct securities business. Despite this lapse in traditional licensing requirements, New York has always maintained robust Blue Sky Laws that impose numerous requirements for issuers and investors. New York’s regulations apply to both the offering and sale of securities within its borders. Furthermore, these Blue Sky Laws also cover those who attempt to offer and/or sell securities into New York.
The Martin Act is New York’s Blue Sky Law. It was first enacted in 1921 and has been amended numerous times. One of the hallmarks of the Act is its broad language. This language provides for an extremely expansive reach into the actions of issuers, broker-dealers and investors in the corporate finance arena. New York’s Attorney General is charged with enforcing the provisions of the Martin Act. In terms of securities fraud, the Attorney General may bring an action alleging that the defendant’s acts or practices "are fraudulent, deceptive, a device, scheme or artifice to defraud or otherwise contrary to the public interest".
Another hallmark of the Martin Act is its broad range of alleged violations. On its face, the law is written so as to arguably permit an enforcement proceeding for almost any transaction or communication that involves an offering or sale of a security. What help do investors and issuers get from the Martin Act? Due to its broad language, the Martin Act simplifies the enforcement of securities fraud by not having to allege the essentials of common law fraud. The Attorney General’s one packable case for fraud under the Martin Act does not require, in most instances, allegations of scienter, reasonable reliance by a victim or causation.
In addition to the Act’s broad language, it also uses the securities definition of an "investment contract". This definition provides a ready and often used vehicle for the application of the Act to interest-bearing notes, various contracts and other financial arrangements that do not fit neatly into the definition of securities. These vehicles have allowed the Attorney General to use the Act to pursue private placements as well as governmental bonds.
Notably, the Martin Act confers upon the Attorney General more than adequate enforcement powers. These include civil as well as criminal penalties. These powers allow the Attorney General to punish defendants with heavy fines of up to $5,000.00 per violation. In addition, a defendant can be criminally prosecuted with imprisonment for as long as four years (if intentional). While all the securities regulatory authorities are given broad authority to sanction the issuance of securities through the imposition of registration, filing fees and taxes, the Martin Act is the only law that vests the Attorney General with powers to regulate the distribution of securities and their subsequent sale in a particular geographical area. The Act does not specifically exclude federal preemption. However, the Attorney General often argues that his powers to regulate securities are non-federal and, as such, independent of federal preemption.

Blue Sky Registration Obligations

Under New York’s Blue Sky Laws, securities offered in New York must be registered unless an exemption from registration applies. New York has the lowest de minimus standards for securities offerings of any state; however, all issuers relying on a small offering exemption must file Form 99 with the Department of Law. From the Department’s website: "Form 99 requires that the issuer give a general overview of its business operations, a description of the current offering, a discussion of the risks associated with an investment in the offering, and a discussion of factors that may affect the value of the investment. The issuer also must provide certain financial information to the Department of Law that varies depending on the type of entity offering the securities (for example, a noncorporate issuer must provide copies of its balance sheet and income statement for the past two years)."
The requirement to register under New York’s Blue Sky Laws is likely to be dealt with in the new SEC rules adopting Regulation Crowdfunding. It will be interesting to see how the SEC reconciles the Federal preemption with NY’s Form 1-A exemption and the requirement to file Form 99 where no Federal preemption applies.
A few other points: Issuers should be advised that exemptions from registration by the New York Department of Law only provide an exemption from the registration with the Department. The Securities and Exchange Commission registration requirements and other state law registration requirements would still apply.
Although ease of compliance may be present when filing Form 99, non-compliance with the requirements of New York law can be devastating. A violation of the State’s securities laws may be punished both civilly and criminally.

Actions and Other Enforcement Mechanisms

New York, like many other states, enforces its Blue Sky Laws through its Attorney General’s office. The Attorney General is empowered to investigate securities violations, which typically consist of false statements in a prospectus, or the sale of unregistered securities. In practicing law, it is natural for attorneys (such as myself) to focus on civil lawsuits that have been initiated by the Attorney General, and to overlook what else New York does to investigate and prosecute fraud. Of course, the Attorney General may initiate court proceedings for a restraining order or injunction to stop any persons from selling unregistered securities. The Attorney General may also seek an order to freeze assets, to prevent them from being hidden from discovery. If such action is instituted, a hearing is usually scheduled. If the court finds probable cause that securities laws were violated, then it will usually grant a temporary restraining order, which lasts approximately 10 days. The court even has the power to bring a temporary restraining order that freezes the assets of the broker-dealer, the registrant, and the person who controlled the registrant. At that point, the Attorney General will have a hearing within 10 days to determine if there is sufficient cause that the receiving of future payments from investors for the benefit of the broker and company would endanger the invetsors’ money . If there is an emergency situation where the court cannot be contacted, an ex parte temporary court order may be issued. Under this situation, the funds that may be in jeopardy of being transferred can be frozen until a judicial determination has been made. The Attorney General can also order the appointment of a receiver, who is responsible for taking over the assets to be liquidated. The receiver can be appointed over a defendant, broker-dealer, and any person that was involved in the securities fraud. The receiver will then distribute the funds in accordance with order of the priority of credible claims. The Attorney General may prosecute violations of securities in court by filing an action within 10 years from the date the securities laws were violated. Based on Section 352-b of the General Business Law, upon conviction for willfully violating the securities law, the defendant faces: Section 352-c of the General Business Law states that any person that knowingly violates the securities law is guilty of a felony punishable by the tougher of $5,000 per violation of the law or three times the monetary loss suffered by the person or persons defrauded. These criminal actions are separate and distinct from the ability of the Attorney General to seek civil remedies for violations of the securities laws. With this in mind, the Attorney General is able to pursue both civil and criminal actions.

Implications for Companies and Investors

The application of New York’s Blue Sky Laws can have significant implications for both businesses and investors. For businesses, these laws can present challenges regarding regulatory compliance and costs. Businesses must determine the states whose laws should be considered as part of their securities transactions. At the same time, compliance with these laws can provide significant benefits to businesses by ensuring their securities offerings are in compliance and providing additional legitimacy to the offering. While businesses may have concerns with the potential challenges and costs associated with complying with these laws, the benefit of being able to tout that they have complied with all the relevant state securities laws in the process of a securities offering may outweigh any such costs.
Applicable Blue Sky Laws may also provide for exemptions from certain state registration requirements. Therefore, a business that qualifies for an exemption may have additional flexibility or may be able to save costs that would otherwise be incurred in complying with the registration requirements.
For investors, the Blue Sky Laws can provide them with additional protections and resources as individuals who are harmed by fraudulent securities transactions can turn to those laws for a cause of action based upon the failure to register under a state’s laws or the violation of other state laws. Further, Blue Sky Laws require certain disclosures and set forth a fiduciary duty that issuers must adhere to. Disclosures that are required pursuant to Blue Sky Laws provide investors with a level of information that may better inform their investment decisions.
The increased amount of information and the fiduciary duty imposed on issuers within the context of Blue Sky Laws are intended to act as an additional protection for investors. The fiduciary duty that is imposed on issuers can be a powerful tool for investors who have suffered from any misdeeds by an issuer, as it places a high duty of responsibility on issuers to act in the best interest of investors in those instances.
The net impact of New York’s Blue Sky Laws can have implications for investors and businesses alike. By establishing and maintaining a high degree of integrity and order in the sale of the securities within the state, as well as creating sufficient safeguards, this system can help to drive down fraud in the state and foster the sentiment that the state operates as a bona fide financial center.

Trends and Future Developments

New York’s Blue Sky Laws are due for a shake-up, according to a report issued in November 2012 by the New York Mayor’s Office and the New York State Attorney General, which makes 31 recommendations to reform the regulatory framework for securities in New York State and City. Some of these recommendations are significant: the state would adopt a "notice filing" regime, which would align it more closely with the federal system; and the state would make the federal safe harbor provisions for issuers of equity securities available under state law (under certain conditions).
New York State’s Blue Sky laws are governed by the Martin Act, which gives it the broad "blue sky" powers that make it an outlier among the states. It also has the considerable power of its own Office of the Attorney General to enforce its laws. In addition, the state has a very solid resource in the NYS Attorney General’s Investor Protection Bureau, headed by Eric Dinallo, a former Deputy Attorney General, who reports directly to the Attorney General, and whose members are knowledgeable and experienced.
Two peculiarities of the Martin Act make it different from the typical Blue Sky laws. First , it permits an investor to sue only on a misrepresentation or omission made in a registered offering neither of which is required to be made knowingly or even recklessly. Second, no one can avoid liability for a violation of the Martin Act by proving that he or she exercised reasonable care in the making of the representation or omission, and an objective standard of care is applicable to defendant’s conduct.
The state is in the process of studying and preparing a legislative package that would incorporate the most important of the recommended reforms into new state securities laws. Therefore, New York can be expected to catch up with the federal securities laws, making their respective regulations more consistent in several important respects. As this occurs, it is likely one of the practical effects will be the increase in regulating bodies better suited to address questions arising with regard to cross-border offerings and federal exemptions, especially for non-public offers, such as Regulation D, that pose more questions than cross-border, registered offerings.