When it comes to securities, regulatory exposure doesn’t begin and end with the U.S. Securities and Exchange Commission. In fact, every state in the union has its own set of securities laws — and failing to adhere to their requirements can cause significant legal and financial headaches for issuers and broker-dealers.
Commonly referred to as “blue sky laws,” state-level securities regulations are designed to protect investors against fraudulent sales practices and activities. (The term “blue sky,” is often attributed to an early 20th Century judge who worried that investors were buying securities not worth a “patch of blue sky.”)
While the laws vary from state to state, the SEC says most “typically require companies making offerings of securities to register their offerings before they can be sold in a particular state, unless a specific state exemption is available. The laws also license brokerage firms, their brokers, and investment adviser representatives.”
For the most part, states follow model rules, adopted in the 1950s, which help promote uniformity among their security laws. And Congress passed a law in the 1990s attempting to clarify which federal requirements preempt state regulations.
Still, many state regulatory regimes have their own quirks that differ significantly from federal laws and from the rules in other states. For instance, some states only require registration at time of sale; others require registration prior to marketing.
Most states also require an initial filing fee, and the size of that fee is often determined by the volume of securities for sale. Fees can differ significantly from state to state. A filing in Texas can cost a company ten times more than it does in Virginia. And the Texas filing must be renewed if 12 months lapse between the filing date and an offering. Another fee is applied at that stage of the process.
A company unaware of the various fees might register an offering and then face a far greater expense than it was prepared to pay. Fortunately, a strategically minded legal adviser can help a company rein in expenses and pay only that which is absolutely necessary. At KVCF, for instance, we typically reduce costs by registering a minimum size of the offering and amending later if the offering grows in size. By doing so, we help a registrant determine each state’s activity without an excessive initial outlay.
Reg A Requirements
The type of offering also can have a sizeable impact on whether blue sky regulations apply. Consider, for example, securities offered under Regulation A.
One of the primary benefits for companies making a Regulation A offering is the exemptions it allows from federal registration requirements. In 2012, President Obama signed into law changes that expanded the ability of smaller companies and startups to access capital via Reg A offerings.
Among the changes were reduced regulatory burdens that allowed Regulation A Tier II offerings to qualify as a “covered security” under the National Security Markets Improvement Act of 1996, which preempts state blue-sky requirements for registration of the securities prior to offer or sale. (Regulation A permits two offering tiers: Tier 1 offerings allow companies to offer a maximum of $20 million in a one-year period. Tier 2 allows offerings up to $50 million.)
In spite of the changes, specific state-level can rules still govern the conduct of Regulation A offerings in each state. All states require notice filings for Regulation A offerings. And some states have exerted greater jurisdiction over Regulation A transactions by requiring a domestically registered broker-dealer or a registered offering agent to be associated with the deal. Companies may choose an internal officer to serve as offering agent, though choosing an external broker-dealer provides a buffer for the company and expedites the process.
Because certain federal laws like Regulation A or Regulation D relieve significant federal regulatory requirements, companies and broker-dealers may believe state laws are preempted. Yes, but , as with many areas of the law, it’s a bit more complicated. Unfortunately, those assumptions can lead to mistakes that heighten exposure in any number of U.S. states.
The key to avoiding these problems and, frankly, taking maximum advantage of these exemptions, is having expert advisers who understand the rules in every jurisdiction and who can offer your organization strategic advice that allows you to comply with the law and save time and money.
Contact us for a consultation to learn more about how KVCF can help you navigate in the “blue sky” environment and limit your regulatory and financial exposure.