Understanding Blue Sky Laws

The OTC equity market operates within a unique, often complex regulatory environment.  While much of the securities industry focuses solely on federal laws and regulation, the companies, broker-dealers, investors and others comprising the OTC market must understand the impact of state “Blue Sky” laws as well. 

What are Blue Sky Laws?

Blue Sky laws are state laws that regulate the offering and sale of securities.  The phrase “Blue Sky law” originated in the early 1900’s as a reference to the empty promises made as part of some fraudulent sales of securities.   Blue Sky laws were designed to help investors make informed decisions by mandating that companies disclose accurate and current information when offering or marketing securities.

How do Blue Sky Laws impact Brokers and Registered Investment Advisors?

Blue Sky laws do not prevent a retail broker from executing a self-directed customer’s buy or sell order.  Rather, they were created to protect the public from the offering and sale of fraudulent securities.  Today, Blue Sky laws regulate companies, brokers and investment advisers when participating in an offering of new stock, sending research reports, or soliciting trades from customers.  Investment professionals across the country must consider Blue Sky laws when determining where they can solicit or recommend securities.

How do Blue Sky Laws impact the average Investor?

Consider the example of John Smith, an investor in the (fictional) state of Ames who is interested in buying stock in ABC Corp.  John has read through ABC Corp.’s Annual and Quarterly reports, recent press and research reports, and feels confident about making a new investment.  However, before he makes a final decision, he wants to check with his broker first.  If ABC Corp. is not in compliance with the Blue Sky laws of the state of Ames, his broker is not permitted to offer John any advice.  Similarly, if John has a managed account in Ames, the account can only hold the securities of companies in compliance with Ames’ Blue Sky laws.

What does this mean for companies that trade on OTCQX and OTCQB?

Companies not listed on a national exchange, must comply with individual state Blue Sky laws.  As each state’s Blue Sky laws may differ, it can be extremely difficult for even the most compliance-focused companies to qualify in all jurisdictions. Regulators and brokers across the country rely on disclosure-based “manual exemptions” from individual state Blue Sky laws.  A manual exemption generally allows for secondary trading of qualifying companies as long as certain financial standards are met and key information about the company is published in a nationally recognized securities manual or its electronic equivalent. Forty-four U.S. states and jurisdictions maintain some form of manual exemption, and each state determines which manuals qualify under its rules.

Manuals have traditionally been printed publications that investors found in their local library or broker’s office.  The manual recognized in the highest number of states was Standard & Poor’s (“S&P”) Corporation Records, which S&P ceased publishing in May of 2016.  As a result of that change, OTC Markets Group began working with the North American Securities Administrators Association (NASAA) and individual state regulators to have our OTCQX and OTCQB Markets, with easily accessible online information, be recognized as the electronic equivalents of securities manuals for the purposes of each state’s manual exemption.

Achieving Blue Sky Recognition:

Over the past year, our legal and issuer compliance teams have worked closely with state regulators to further educate them about the OTCQX and OTCQB disclosure standards and the online, publicly available, current disclosure that these companies are required to provide.  This information fulfills the company disclosure requirements of each state’s manual exemption and provides other information not found in traditional printed securities manuals.  Each state has tailored its approach to granting this exemption, from no-action letters to rule changes and administrative orders.

OTC Markets Group continues to actively reach out to all other states that maintain a Blue Sky Manual Exemption and to engage NASAA and the remaining states to determine how best to qualify OTCQX and OTCQB traded securities based on the easily accessible, robust disclosure OTCQX and OTCQB companies provide.

By recognizing the value of online access to current public information that OTCQX and OTCQB companies offer, and granting these markets status as recognized manuals or markets for Blue Sky secondary trading exemptions, state regulators are supporting more informed and efficient trading that benefits OTCQX and OTCQB companies, brokers, and investors.

Daniel (Dan) Zinn is OTC Markets Group’s General Counsel, Chief of Staff and Corporate Secretary. He leads the Company’s regulatory and policy making efforts and is often a speaker on over-the-counter equity markets. As Chief of Staff, Dan also oversees the company’s Human Resources and Administrative functions. Prior to joining OTC Markets Group in 2010, he served as outside counsel to OTC Markets Group beginning in 2007, as a partner at The Nelson Law Firm LLC. Previously, Mr. Zinn worked in the corporate office of AIG. He received his JD from the Benjamin N. Cardozo School of Law, where he served as Associate Editor of the Cardozo Law Review and received his BS from Pennsylvania State University. He is a member of the American Bar Association.

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