While many startups are aware of the US federal securities law issues they may face when raising capital or issuing equity to employees and other service providers, fewer startups know that each US state has its own set of securities laws that are commonly called blue sky laws. As with the federal securities laws, startups that are issuing securities must either register the securities under the applicable blue sky laws or meet an exemption.
These state-specific securities laws apply in addition to the federal framework set out in the Securities Act of 1933. Blue sky laws apply based on the location of the issuer as well as the state of residence of the recipient of the security. While these laws are state-specific, many states have adopted or modeled their blue sky law on the Uniform Securities Act of 1956. Blue sky laws generally set out the requirements for the registration of the security with the applicable state securities regulator of any security offered in that state, and also include various exemptions from registration. While some of these exemptions mirror those at the federal level or use the uniform limited offering exemption (ULOE), issuers should review the exemptions at each state carefully to confirm compliance prior to or at the offering; otherwise, the startup may be liable for state securities law claims.
Any entity selling a security in a state must either register the security prior to the offering or be exempt from registration under the federal and any applicable state securities laws. The definition of a security is set by both state and federal laws. Even if a security is exempt from registration with a state securities regulator, the issuer may still need to register the offer and sale at the federal level.
The patchwork nature of blue sky laws prompted Congress to pass the National Securities Market Improvement Act of 1996 (NSMIA), which preempts blue sky laws that duplicate those at the federal level. Congress also amended the Securities Act of 1933 so that certain types of “covered securities” are not subject to registration under blue sky laws and regulations. Covered securities include any securities:
- listed on a national exchange like the New York Stock Exchange or Nasdaq;
- issued by an investment company that is registered under the Investment Company Act of 1940; and
- offered under Rule 506 of Regulation D of the Securities Act of 1933.
This last prong of the definition is the one startups most often use when evaluating whether they must register under blue sky laws.
Even if a startup is not required to register a security under a blue sky law, some states may still require an issuer to make a notice filing and pay a filing fee for a Rule 506 private placement if there are any investors in that state. These notice filings may need to be completed before an offering, so startups should ensure their securities advisors conduct a review prior to any equity financings or employee equity awards.
Compliance with state blue sky requirements is usually manageable with limited filings and disclosures, especially with advance planning. However, it is important for startups and their advisors to pay close attention to both blue sky laws and federal laws to ensure compliance with registration and notice requirements, when issuing equity as part of a financing or compensation package.