What Are Blue-sky Laws?
In the 1920s, a number of states began to adopt what are called "blue sky laws," designed to protect investors from securities fraud by requiring the parties engaged in the purchase and sale of securities to register these transactions. While the blue sky laws of different states still vary somewhat, they typically require that securities offerings be registered at the state level, that notice filings be made, or that an exemption from registration be obtained from the state.
The name blue sky is often used to refer to any states securities law, but the term was originally used to apply only to state securities laws. The phrase stems from the idea that the law would prevent potential fraud artists from selling imaginary securities , including stocks in ventures such as a scheme to sell blue sky itself. Therefore, a blue sky law could be thought of as keeping trading in securities focused on the activities and companies that were real, rather than preventing schemes put into place by people trying to benefit from unwary investors.
Few, if any, people benefit from a scam. Because of this, blue sky laws have historically been put into place to add another layer of protection for investors. Brokers, investment advisers, issuers and other participants in the purchase and sale of securities should be mindful of the laws in each state in which they do business in order to avoid violations of these important laws.
An Overview of Florida’s Blue-sky Law Requirements
Florida’s blue sky laws are primarily embodied in Chapter 517 of the Florida Statutes, along with various rules and regulations promulgated by the Office of Financial Regulation. Taken together, Chapter 517 and the accompanying rules and regulations outline Florida securities law and the requirements best described as Florida’s blue sky rules. This chapter authorizes the OFR to appoint the Director of the Division of Securities, who is responsible for administering and enforcing Florida’s security laws.
Similar to most states, Florida blue sky laws require registration for the offer and sale of securities in the state. Consequently, these laws regulate interstate securities transactions, security salespersons, broker-dealers, and government and not-for-profit securities, including those in which offers are made from or to protected persons, i.e. those with a net worth equal to or greater than $250,000,000.
Florida blue sky laws also provide an exemption for private offerings under Regulation D, Rule 506 of the Securities Act of 1933, as amended (the "Securities Act"), and there are no registration requirements or broker-dealer licensing requirements for securities exempt under Rule 147 of the Securities Act. Finally, for unregistered securities registered by the OFR on a conditional basis, the OFR generally may not revoke registration except for good cause shown.
Disclosures Required of Issuers
To issue securities in Florida, the security must be registered or exempt from registration under Florida securities laws. The following requirements generally apply to registration: (1) filing a registration statement with the SEC (or filing an exemption from registration with the SEC); (2) filing a registration statement with the Florida Department of State; Division of Corporations (the "Department"); (3) paying a registration fee; and (4) filing Form D. Florida has several exemptions from registration that may apply to your offering including, without limitation, the following:
Rule 506 – the exemption available with respect to an offering of unregistered securities under the Federal Securities Act which is in minimum amounts of $5 million and is not subject to the integration rule if sold within 12 months from the date of initial sale;
401 (k) plans – If a company is going to offer securities to its employees, it must comply with the requirements of Section 404(c) of the Employee Retirement Income Security Act (ERISA); and
Section 550.151 – an offering in the state of Florida which does not exceed $1 million in value, and if the acquiring owner is not an accredited investor.
The Florida Office of Financial Regulation
The Role of the Florida Office of Financial Regulation in Implementing Blue Sky Laws
In the Sunshine State, the Florida Office of Financial Regulation, known as OFR, is the body responsible for the implementation of its securities laws, commonly referred to as blue sky laws. Their duties include overseeing the state’s registration of securities, licensing the providers of those financial services, maintaining databases and statute books, and providing issuers and broker-dealers with access to forms and instructions for filing documents with the Division of Securities.
The OFR supervises the registration of all securities that will be sold within the State of Florida. In order to sell securities in Florida, you or your business need to apply to the OFR for an order granting an exemption from registration, or for a registration of your securities under the Florida Securities and Investor Protection Act. A full list of exemptions can be found in Rule 3E-700, Florida Administrative Code. The list below contains some examples of securities that are exempt from the registration process:
All securities must be registered under state and federal securities laws. A common way of complying with these laws would be to have the issuer of the security submit federal registration documents to the OFR, and also to submit those registration materials to each state where the security will be issued. This, however, can be a costly process because you would need to hire local counsel to assist with the filing in each state where the security is being issued.
An alternative to this is to submit a Uniform Application to Register Securities (Form U-1). Another alternative step available is to seek an order for three other Register Securities filings (Form U-1). These orders would exempt you from registering under the Florida Securities and Investor Protection Act, except when selling to Florida residents ten or more times in twelve month period. Rules 3E-100 through 3E-110, Florida Applications, Florida Administrative Code.
You would also be required to pay the filing fees associated with your application.
Most Important Cases and Statutes
The evolution of Florida’s blue sky laws has been governed by a number of key court rulings. These decisions provide insight into challenges for practitioners as well as the likely direction for enforcement priorities, and their implications on compliance.
One of the earliest and most significant case decisions impacting Florida’s blue sky laws is Geller v. Hays, 1 So. 2d 219 (Fla. 1941). This 1941 case set the precedent for how corporations would be dealt with under the state securities laws. The court in Geller held that a corporation is an "issuer" under Act. Prior to Geller, the focus of regulations under the Act was almost exclusively on the agents of the issuer. In Geller, the court found that plaintiffs who purchased shares of stock from a corporation could sue both the corporation and the selling agents for damages caused by the sale.
In 1963, the decision in Bookman v. State, 160 So. 2d 706 (1966) further defined debtor/creditor transactions under the Act. The court held that under creditor/debtor transactions, the definition of a "security" would include a promissory note for a sum of money due at a future date. In this case, a debtor was given promissory notes for 25 percent in a mining and milling business. In rejecting a challenge to the state constitutionality of the Act, the court found that the notes should be registered under the Act because the issue of promissory notes was also an issue of controlling interest of the issuer.
In 1982, the court in Warren v. State, 419 So. 2d 632 (Fla.), further defined what would not be considered a security. Section 517.02(11)(h), Fla. Stat. (1981), excepted from the definition of a "security" any "bond, note, or evidence of indebtedness issued by a banking business." In Warren, the court held that the Act’s definition of a "security" did not include money to be paid under a lease purchase agreement between a bank and a landlord. The court held that the landlord’s promise was not to repay money but rather to surrender possession of real property at a specified time. The court distinguished the money loaned to a bank from bonds and notes because it did not give rise to an indebtedness and further indicated that the "evidences of indebtedness" exception included only those bonds and notes issued by a financial institution.
The court’s analysis in Warren hinged on the interpretation of what constituted both money and a loan , and ultimately the relationship under which the money was dispersed. In doing so, the court drew a distinction between money secured by a contractual obligation and money loaned without an obligation to although the court ultimately pointed out that there would have been an obligation to pay even if only the lender’s business practice. But a principal distinction was drawn as to whether that relationship arose from a contract or a sale.
In 1970 the court in Novosel v. Nationwide Movers, Inc., 248 So. 2d 206 (Fla. 1971), rejected the trial court’s interpretation of Section 517.19, Fla. Stat. (1971), in finding that the court’s misinterpretation prevented certain sellers from the rescission of their investments. The court held that under the plain meaning of the statute, the right of rescission does not depend upon the purchaser having actually purchased stock or bonds. Rather, the right of rescission exists if there is a violation of the regulation with respect to what the purchaser purported to have purchased.
The court in 1999 in Milbrad v. Pruitt, 735 So. 2d 1181 (Fla. 5th DCA 1999), held that the Act defines an investment contract as a "contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party." This is often referred to as the Howey test after the case of SEC v. W.J. Howey Co., 328 U.S. 293 (1946), and is derived from the U.S. Supreme Court case, SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344 (1943), which set forth the initial test to determine whether a particular transaction is an "investment contract".
In Pruitt, three elderly investors were introduced to a retired doctor who had formed a corporation to rehabilitate and manage mobile home parks and investor partnerships to provide investment capital. Under the partnership agreement the doctor would exercise full control over the management of the investments made by any investor partner. The partners’ role was passive and solely to provide the funds necessary to purchase real estate properties. The arrangement was to provide annual distributions to each partner totaling 40 percent return each year. The court held that the contracts involved were investment contracts within the definition of an investment security contract under the Act.
The Effect of Federal Securities Law in Florida
Because of the widespread nature of securities transactions, federal securities laws substantially preempt the application of state blue sky laws, including those of Florida. See, e.g., SEC v. National Sec. Inc., 393 U.S. 453, 467-468 (1969) ("the national interest clearly requires that the effective regulation of members of national exchanges be reserved wholly to the federal government"); Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 735 (1975) (noting that "[n]o one can doubt the propriety or the necessity of limiting the scope of securities or other trading in a State if to allow the State to continue that traffic would pose an unreasonable danger of frustrating the purposes of the federal securities laws"); see also 15 U.S.C.A. § 77v(a), (b); 15 U.S.C.A. § 78bb (noting that the Securities and Exchange Commission (SEC) has exclusive authority to enact rules governing broker-dealers and securities exchanges). As a result, the federal securities laws tend to preempt state blue sky laws. Florida Domicile. In 15 U.S.C.A. § 77z-3, federal law expressly authorizes Florida to adopt and enforce state blue sky laws. However, the Florida Securities and Investor Protection Act, Fla. Stat. § 517.02, provides that its provisions do not apply to securities issued by federal and state government agencies and governmental agencies of other states. The Florida act also preempts provisioning relating to securities transactions by issuers who have filed under Article 4 of the Uniform Simplification Act for the Out-of-State Corporations (USRA), Fla. Stat. § 607.1106. Conditions exist also for preemption of registrants of the Investment Company Act and "investment adviser" registrants under the Investment Advisers Act, but such preemption does not apply to fraud-based claims, private remedies, or the rights of state governments to enforce their laws. The Florida act does not apply to securities issued by federal and state government agencies and governmental agencies of other states. Florida Stat. §§ 517.051(9), 517.061(11), 517.070(13). Finally, there are certain exemptions for private offering memoranda that are more strict than federal requirements. Fla. Stat. § 517.061(9). Federal Preemption. Federal law only preempts state blue sky laws to the extent they violate the U.S. Constitution and/or to the extent that state laws and rules and regulations of the SEC conflict with provisions of the Securities Act of 1933, 15 U.S.C.A. §§ 77a et seq. (1933), or the Exchange Act of 1934, 15 U.S.C.A. §§ 78a et seq. (1934). 15 U.S.C.A § 77r(c), (d), 78bb. Federal law does not preempt state laws that affect securities offerings where the offering is completely intrastate in nature. See, e.g., Stedman v. SEC, 408 F.2d 875, 877 (2d Cir. 1969) (upholding a conviction under New York’s blue sky laws for violating the insider trading provisions of the Securities Exchange Act of 1934, 15 U.S.C.A. § 78j(b), where the company issuing the stock was not traded on any national exchange and its shares were largely held by residents of New York). If a federal rule will operate uniformly across the nation in regard to trading in securities, it is said to provide uniformity where the interests of the United States as a whole can be justified. The inroads of federal regulation in the nation’s capital can also be traced to influences exerted by the many economic forces at work in the securities markets that are state and local in origin. See generally Smith v. SEC, 129 F.2d 265, 267 (2d Cir. 1942) ("that a business, an investment, a commodity, a security is interstate is of course not to say, without more, that it can be put beyond the influence of state police regulations"). See generally Rothenberg, Federal Preemption of State Securities Law: Limiting the Scope of Preemption of State Securities Law Liability, 20 U.C. Davis L.Rev. 1255 (1986).
Common Issues and Mistakes
Navigating the complexities of Florida blue sky laws can present a minefield of potential challenges for even the most diligent company. One of the most significant challenges is ensuring that all securities being offered or sold fall within a recognized exemption. If a company fails to offer or sell any offered security pursuant to a recognized exemption, then the company may have to register that security and its respective offer with the Office of Financial Regulation (the "OFR") or face severe consequences. The OFR attempts to monitor the sale of securities in Florida, but the OFR’s success rate can be sporadic. Just because there may not be an immediate OFR action taken against a company, does not mean that the company complies with Florida securities laws. The consequences can be disastrous to a growing company. Violations of Florida blue sky laws can result in legal actions, and in severe circumstances, imprisonment. Depending on the size and scope of the violations, the OFR may seek to hold the officers, directors, partners, and controlling stockholders personally liable for any damages incurred. So it is important to understand whether the company’s offering involves a security, and if so, whether the security falls within an exempt offering. Furthermore, even if the company’s offering does involve a security and also falls within an exempt offering, the company must ensure that it is not selling those securities to non-accredited investors. If the company plans on selling its securities to non-accredited investors, it must ensure that is registers its offering with the OFR or applies for the appropriate exemptions being offered by the OFR. Another common pitfall is to forget that most of the blue sky laws require that the company’s securities be registered in each state in which an offer or sale is made. Florida blue sky law regulates the offer and sale of securities in Florida. The term "sale" is given its "ordinary meaning" and includes every contract of sale of, contract to sell, contract to purchase, option for a purchase or other disposition, and any attempted disposition of a security for value. In determining what activities in this state constitute an offer or sale of a security, it is immaterial whether the offer or sale originates in this state or elsewhere and whether or not either the purchaser or seller is then present in this state. Even though the term "security" is broadly defined under Florida blue sky law, it does not include certificates representing interest in a mortgage loan. Under Florida blue sky law, securities that are subject to regulation are those: The OFR has the authority and discretion to issue rules, regulations, and orders for the purpose of implementing this chapter. A copy of the rules, regulations, forms, application, and orders are available in the office of the OFR. Also, compliance with a blue sky exemption will not eliminate the company’s liability under Florida blue sky law for making any false statements, omissions, or other violations of the law in connection with the offer or sale of a security. It is important to remember that the use of conclusory language or a statement of opinion is not sufficient to establish compliance by the issuance of securities by the company. Another pitfall to be avoided by the company is its failure to advise the purchasers that they may have a right to rescind the investment. Under Florida blue sky law, no purchaser of a security shall have a right of action for rescission of a sale unless within 10 days after the receipt of a notice from the issuer or the seller setting forth the substance of the material fact of which disclosure is required, the purchaser pays or tenders to the issuer or seller the consideration paid for the security, and in every case the purchaser is entitled to such return on the securities as is specified in the contract of the sale.
Future Developments
While the full impact of the existing legislative efforts is yet to materialize, it is clear that decreased judicial deference and increased regulatory supervision are significant trends. This is particularly true with respect to broker-dealer and investment adviser cases. Decreased judicial deference means that plaintiff investors (and state regulators) are having increased success in persuading courts to apply a legal standard that is more favorable to their claims. States have responded by substantially increasing funding for exam teams and establishing specialized state-level divisions that are responsible for regulating investment advisers.
A notable new trend in Florida is a push toward adopting "hiring protocols" in the broker-dealer context. Similar to the focus on supervision and hiring protocols in the investment adviser context, the idea is to ensure firms have policies and procedures in place to ensure that bad actors do not come onboard. The Santiago decision, when coupled with a potential rules change that would require a hiring protocol in Florida, might cause a sea change in this area . For example, broker dealers may proactively implement a high bar hiring protocol so as to avoid being susceptible to a Santiago-type liability theory. While this would be a potentially significant shift in how broker-dealers see hiring an individual representative, it is also possible such hiring protocols will be viewed as the price of doing business in the securities industry in Florida.
The imposition of liability on broker-dealers for registered representatives’ conduct through the imposition of hiring protocols will require a shift in focus from RIA cases and appear to signal a different, harder look from the state at these institutions. With increased regulatory scrutiny in the broker-dealer arena, broker-dealer exam audits will undoubtedly increase. Furthermore, rule-making from the OIR and various initiatives of the Division, such as the promising recommendation specific to broker-dealers regarding financial examination teams, indicate that there are potentially significant changes on the horizon in both the regulatory landscape for broker-dealer institutions.
