Blue Sky Forecast

The paralegal’s role in blue sky securities laws.

By Daniel P. McAndrews

November/December 2005 Table of Contents 

“Blue Sky” is a term that brings a smile to most people’s faces with thoughts of sunny days and good weather ahead. However, to most corporate paralegals, it brings a look of horror to their faces. Why? One reason might be that, instead of contacting, researching and filing documents with one judge, one court or one governmental authority for a single matter, the paralegal could potentially be forced to contact, research and file documents with 50 states for one single offering of securities by a corporation, limited partnership, limited liability company or other entity. There are many variables that determine the number of states involved and the amount of work involved.

The History of Blue Sky

In 1911, Kansas became the first state to enact a comprehensive state blue sky securities law in response to its residents being taken by salesman selling worthless securities of fly-by-night corporations. Through this law, corporations were required to register their securities and the individuals who sold their securities with the Office of the Securities Commissioner in full detail before they could offer or sell in Kansas. By enacting this law, state residents gained additional protection because the Kansas Securities Commissioner reviewed the offering of securities, the corporation and the people selling the securities before any consideration was exchanged.

The protection of purchasers is the fundamental purpose of state blue sky securities laws and the main reason corporate and securities paralegals work on blue sky filings in various states. Following Kansas’ lead, the other 49 states passed similar state blue sky securities laws to protect their residents. The laws at the time attempted to create a level playing field for issuers and purchasers.

Eighteen years after the first blue sky law was passed, the great stock market crash of 1929 occurred, followed by the Great Depression. In response to these two events, an increased number of scams and lack of information about investments, the Securities Act of 1933 (the ’33 Act) was enacted. A Securities and Exchange Commission was created in 1934 to administer the ’33 Act on the federal level. The SEC added another level of registration of securities to the state blue sky securities laws by providing additional requirements for corporations offering securities and those selling the securities.

More than 60 years later, the states’ powers were severely cut back with the enactment of The National Securities Markets Improvement Act of 1996. NSMIA was enacted due to the states’ failure to uniformly regulate certain types of national securities offerings such as those securities listed or approved for listing on the New York Stock Exchange, American Stock and Options Exchange and the Nasdaq/National Market, and those offerings complying with Rule 506 of Regulation D under the ’33 Act. The states still have the ability to investigate and prosecute fraud for such offerings. However, corporations are not required to register with state securities administrators for the previously described offerings.

The First Step: Research

I can only speak from a law firm perspective. Your role as the paralegal in researching blue sky securities filings depends on your years of experience, what types of transactions you have worked on and, as with any transaction, the client.

Normally, the legal counsel for the underwriter, placement agent or broker/dealer performs the state blue sky securities laws research and filings. This is because the underwriter, placement agent or broker/dealer are the parties who will offer and sell the securities, and they will want to make sure they are allowed to offer and sell in the various states related to their offering. Less frequently, and certainly in offerings not including an underwriter or placement agent, the legal counsel to the issuer performs state blue sky securities research and filings.

So why do paralegals have horrified looks on their faces when blue sky is mentioned? The preparation of multiple documents for each state can be a bit overwhelming depending on the number of states involved. You have to deal with an ever-changing registration statement due to drafting. You also have to find the proper citation for each state, calculate the filing fee for each state, coordinate with the firm’s client for execution of documents to be filed, prepare and deliver the checks, and file the documents in each state, which includes following up with each state securities administrator and possible supplemental filings.

In some cases, all of this can be avoided. The goal of state blue sky securities laws research is to find an exemption from registration on the state level by reading the state securities acts of the states involved in the offering, the states where the securities for the offering will be offered and sold.

Because of the numerous types of offerings, I can only provide an overview and some examples I found through experience. States give exemptions from registrations for two specific purposes: 1) the security itself; and 2) the transaction itself. One example of where registration is avoided is if the paralegal is dealing with an initial public offering or secondary offering for a corporation whose securities are listed on the NYSE, AMEX or Nasdaq/National Market. Then, no state blue sky securities laws research is needed due to NSMIA.

A second example of where registration is avoided is when a corporation offers securities to its officers, directors and employees as part of written compensation agreements as long as total sales of stock during a 12-month period don’t exceed more than $1 million, 15 percent of the corporation’s total assets or 15 percent of all the outstanding securities of that corporation’s class under Rule 701 of the ’33 Act due to NSMIA. Both of these make sense because in the first example, the national securities markets already are heavily regu­lated, and in the second example, the purchaser works for the corporation from which the securities are being issued versus a fly-by-night corporation.

Unfortunately, the state securities acts are complicated. They can be found on state securities administrators’ Web sites or in the CCH Blue Sky Reporter books. Fortunately, the staff of most state securities administrator offices can be helpful in answering questions. The state securities administrators know their securities laws well. If you put forth a strong effort to find an exemption and need confirmation that your offering meets the exemption, a state securities administrator is helpful. However, if you don’t read the state securities laws and simply call the state securities administrator to find an exemption for you, the administrators might not be helpful because they will not know all the facts, such as the securities being offered, how many people in the state are being offered the securities, what the dollar amount of the aggregate offering is and so forth.

In addition to answering your questions, contacting a state securities administrator is highly recommended because all the state securities administrators interpret the state blue sky securities laws differently.

For example, you might have an offering where one state doesn’t require a filing; however, another state might say a filing is required because a commission is involved with the offering. Based on these differences, I recommend that a state blue sky securities law memorandum be prepared, stating the details of the offering and providing the citation of the state securities law in each state that is used for the offering.

Registering Securities

Assume you can’t find an exemption from registration and need to register in the various states where the securities are being offered and sold. While the attorney drafts the registration statement that is filed on the federal level with the SEC, you need to determine what documents need to be filed on the state level for each state where the securities will be offered and sold.

When registering securities on the state level, most of the states require a Form U-1 Uniform Application to Register Securities, a Form U-2 Con­sent to Service of Process, a Form U-2A Uniform Corporate Res­olution, two copies of the Registration Statement filed with the SEC and a filing fee.

Form U-1. The Form U-1 is the state form that gives a synopsis of the registration statement filed on the fed­eral level with the SEC. The only difference is that the Form U-1 is state specific, while the registration statement focuses on the aggregate offering of securities. A couple of different things you need to provide on the Form U-1 are the citation of the statute that you will use to register in the state where the Form U-1 is being filed and a breakdown of how many securities are being offered and sold in that specific state.

Form U-2. The Form U-2 is the state form that provides the contact information for an officer at the corporation whose securities are being offered. This officer will be sent all notices, lawsuits, etc. that the state securities administrator receives regarding the offering in the specific state.

Form U-2A. Some states require the Form U-2A to provide backup that the corporation’s board of directors approved the securities offering.

Once these documents are drafted, an attorney should review them for accuracy and completeness. These forms and other state forms can be retrieved from the North American Securities Administrators Association Web site (www.nasaa.org). The filing fees for each state vary greatly and usually the calculation fee is based on the amount of securities being offered and sold in that specific state versus a flat fee. Also, some states have a maximum filing fee, while others, such as Texas, don’t.

Shortly after the registration statement is filed initially with the SEC on the federal level, you need to file the Form U-1, Form U-2, Form U-2A and filing fee in each state as required based on where the purchasers reside. You should perform this task as soon as the registration statement is filed with the SEC because the state securities administrators are able to provide additional comments and changes to the registration statement filed with the SEC on the federal level. As a result, the comments from the state level are needed just as quickly as the comments from the SEC.

Most of the time, the state comments, if any, are the same as the fed­eral comments, but sometimes state-level comments that are not the same as the federal-level comments will need to be incorporated into the registration statement. Your goal is to try to get clearance to become effective on the state level before the securities become effective and can be offered and sold on the federal level. Normally, until the securities are effective on both the state and federal level — also known as concurrent effectiveness — the securities can’t be offered or sold. I say “normally” because in some states if you receive the federal effectiveness, the corporation can offer the securities in its state.

However, the securities can’t be sold until the state gives its effectiveness order. With that being said, you should follow up with each state to check the status and provide anything necessary to gain effectiveness as soon as possible.

With respect to private offerings complying with Rule 506 of Regulation D under the ’33 Act, the states can and do require a notice filing versus a registration filing that also is made with the SEC via a Form D Notice of Sale of Securities and a Form U-2. Those securities listed or approved for listing on the NASDAQ/SmallCap Market and the OTC Bulletin Board are not covered by NSMIA, and these securities might have to be registered in the states where the purchasers reside.

The tricky part is that there is an exemption from registration on both the federal and state levels for offerings made pursuant to Rule 506 of Regulation D of the ’33 Act. Even though there is an exemption, you are still required to file a Form D and a Form U-2. The Form D is available at the SEC Web site (www.sec.gov/divisions/corpfin/forms/ formd.htm). Like the Form U-1, the Form D is a synopsis of the offering. It’s a notice filing advising the SEC and the appropriate states of an offer and sale that is limited in the number of purchasers. However, unlike the Form U-1 that is filed only on the state level, the Form D is filed with the SEC as well as each state. One of the requirements for the Form D is that it’s to be filed with the SEC 15 days after the first sale is made, and it’s to be filed in the specific state 15 days after the first sale is made in that specific state. The Form U-2 is only filed on the state level, not the federal level. Unlike registering securities, you don’t need to follow up regarding effectiveness.

The Silver Lining in Blue Sky

State blue sky securities laws are a complicated web of regulations that are burdens to corporations, limited liability companies, partnerships and, of course, paralegals. However, these rules benefit purchasers and the country as a whole. Because many paralegals avoid this subject matter, it can be a real advantage to learn about this specialty and become a master at assisting attorneys with this aspect of corporate law. There are many challenging aspects to blue sky securities laws, and the benefits of overcoming these challenges can be personally and professionally rewarding.

Helpful Web Sites   

• U.S. Securities and Exchange Commission — www.sec.gov

• North American Securities Administrators Association — www.nasaa.org

• SECLaw.com, an online guide to securities laws — www.seclaw.com

• Consumer Action Web site, State Securities Administrators — www.consumeraction.gov/security.shtml

• Practising Law Institute — www.pli.edu

Resources    

• A Brief History of Securities Regulation Wisconsin Department of Financial Institutions www.wdfi.org/fi/securities/regexemp/history.htm

• Exemption from Securities Registration Under Rule 701 The National Center for Employee Ownership www.nceo.org/library/rule701.html

• “Introduction to the Blue Sky Laws: Yes, there are 50 other securities regulators other than the SEC” by Richard I. Alvarez, Esq. and Mark J. Astarita, Esq. www.seclaw.com/bluesky.htm

• Securities Act of 1933 Securities Industry Association www.sia.com/capitol_hill/html/securities_act_of_1933.html

• Uniform Securities Act The National Conference of Commissioners on Uniform State Laws www.nccusl.org/nccusl/uniformact_summaries/uniformacts-s-usa2002.htm

Daniel P. McAndrews is a senior paralegal at Patton Boggs in Washington, D.C. He assists attorneys who advise publicly held and emerging companies in connection with corporate and securities matters, regulatory issues, reporting and compliance obligations under federal and state laws, insider trading prohibitions and corporate governance matters. McAndrews also helps attorneys focused on mergers and acquisitions and transactional work that involve the representation of securities issuers and underwriters with initial and secondary public offerings. These include equity and debt offerings, rights offerings and trust preferred offerings. He also supports counsel currently advising clients involved in raising capital through venture capital funding. McAndrews is a member of the National Federation of Paralegal Association and the National Capital Area Paralegal Association.

Disclaimer: Information contained in this article doesn’t constitute legal advice or the advertisement of legal services. You should not rely on any information in this article and should consult an attorney regarding specific legal issues. This article is not intended to be a substitute for obtaining legal, professional, financial, and technical or tax advice from legal counsel. The opinions expressed within this article are solely those of the individual author and might not reflect the opinions of his employer, Patton Boggs, individual attorneys and personnel or the opinions of clients of Patton Boggs.