The following is a guest post by Chris Rohde, associate corporate counsel at WealthForge. WealthForge Holdings, Inc., is a diversified financial services company focused on providing private investment solutions to its customers. WealthForge Holdings, Inc. includes subsidiaries that specialize in providing technology solutions and facilitating private placements. This post originally appeared on WealthForge.com.
On the federal level, when you sell a security in the United States, you must either register that security or sell it under a valid exemption. Issuers may rely on a host of exemptions, the most common being Regulation D. All you need to do is comply with the exemption and make the proper filing, called a Form D with the SEC. But what do states have to say about you selling the very same securities? Surprisingly a lot.
I know what you are thinking: “Doesn’t federal law preempt state law?” The answer: sort of. Federal law preempts, or overrides, state law in several circumstances, but not all. In securities regulation, there are some areas where the federal government has assumed full and complete authority and other areas where both the federal government and the state governments separately regulate securities activity. These state securities laws are called Blue Sky laws, a term said to have been started by an early 20th Century Supreme Court justice who expressed his desire to protect investors from speculative ventures that had “as much value as a patch of blue sky.”
So, what about securities offerings exempted from Federal regulation under Reg D and Reg A? Offerings made under Rule 505, 506 (b or c), and offerings under Tier 2 of Regulation A are exempt from state registration as securities under the National Securities Market Improvement Act. This means that if you are selling securities under those exemptions, you do not need to complete a full registration in each state into which the security is sold (although it is important to note that they may still require you to submit a notice filing and pay a fee). A notice filing generally consists of consent to process in that state, a copy of the Form D previously filed with the SEC, a fee, and, if using the online EFD system (more about this below), some basic information about the offering.
While Reg D and Reg A Tier 2 are exempt from the registration requirements of the various states, the states still retain their power to protect their citizens from harm. In particular, states regulators continue to have the authority to punish issuers, broker-dealers, RIAs, registered representatives, lawyers, etc. for any sort of fraudulent activity in their state. The regulators frequently use this authority to protect investors in their state. For example, in Virginia last year the State Corporation Commission, the state agency charged with enforcing the securities laws and regulations in Virginia, was involved in multiple cases involving investment fund managers defrauding investors, including those detailed here and here.
Historically, a notice filing has consisted of a fee, a paper consent to service of process, and a copy of the Form D (the form filed with the SEC announcing a Reg D offering has commenced). For a few states, paper filing is still required, but in the last few years the vast majority of states have taken their filings online and use the joint Electronic Filing Depository (EFD) to receive filings. The advent of EFD has led to a significantly more efficient way to handle multiple blue-sky filings at one time. This website, managed by the North American Securities Administrators Association, serves as a central location to file and manage State Blue Sky filings nationwide. Through this platform, the issuer, or its representative, provides some minor details (maximum amount of the offering, number of investors in each state, amount invested from each state, and the date of first sale in that state), assents to service of process, and pays the required fees via ACH. Several states required issuers, or their agents, to file using EFD.
As a result of their concern for their investors, many states take a failure to file the required notice filing quite seriously. You should be familiar (or have good counsel that is familiar) with the blue sky laws in any state in which you plan to sell securities, as well as your home state. In most states, failure to file on time, or at all, can result in a fine or even disgorgement. In light of these possible penalties, issuers should make the required filings within the 15-day window after first sale in a state. Other participants in an offering, such as broker-dealers and lawyers, also should make sure these filings are made in a timely manner, as some states, including Virginia, view other participants equally liable for these filings.