Blue sky laws are state laws focused on preventing securities fraud. While blue sky laws vary from state to state, they generally require a high degree of disclosure for any securities traded in the state and for any broker-dealers operating in the state to be registered and regulated.

Purpose of Blue Sky Laws

Most state and federal securities regulations were developed after the market crash that precipitated the Great Depression. This was an era of extreme laissez-faire capitalism, and many share and bond offerings were highly speculative and represented tenuous business propositions.

Blue sky laws were designed to weed out the most extreme of these speculative offerings by creating a standardized format for securities offerings. With a boilerplate set of key information, investors would be better able to evaluate securities offerings based on relevant facts. The formal requirement also acted as a barrier to entry for many offerings that could not, for example, name a dedicated headquarters or provide accounting statements.

From these simple origins, contemporary blue sky laws now offer investors a sense of assurance that securities and brokers are held to a high standard of reporting and compliance that makes it extremely difficult to offer outright fraudulent securities. Blue sky laws allow investors to focus on the quality of the information provided to determine the value of a security, as opposed to worrying about the accuracy or veracity of the information.

Blue Sky Laws and Federal Securities Regulation

Securities are regulated at a federal level under the Securities and Exchange Commission (SEC). Many blue sky laws overlap with the regulations of the SEC, but states maintain these laws so that they can act to enforce securities regulations when the SEC is perceived to be too slow or too lax in securities enforcement.

Blue Sky Laws and Trading

The precise details of blue sky laws become important to traders in the event of actual securities fraud. If the state securities regulator chooses to enforce their blue sky laws against a security, then the restitution for any securities fraud will follow the regulations set out by that state’s blue sky laws.

This makes blue sky laws particularly important to short sellers who focus on fraudulent activities, as the regulatory process will affect the price of the security and the end result of any penalties, including dissolution.

Final Thoughts

While securities regulation may seem unimportant and mundane compared to the daily flow of market news and information, it can have an enormous impact on the price and fate of a security when it comes to bear.

Traders should be comfortable with the basics of both federal securities regulation and blue sky laws across the various states, particularly those states where many companies are headquartered and where many initial public offerings (IPOs) take place.

Short sellers who focus on fraudulent activity should be particularly aware of the details of the blue sky laws in states that are relevant to the securities that they intend to short sell.