Investor Protection: State And Federal Securities Regulation

AuthorJames D. Cox/Thomas Lee Hazen
ProfessionProfessor of Law at Duke University/Professor of Law at the University of North Carolina, Chapel Hill
§ 27.1 Securities Regulation—Overview
State corporate laws are geared to the chartering funct ion and, for the
most part, do not concern themselves wit h investor protection. The great
problems caused by stock watering and other fraudulent promotional
schemes at the turn of the century did not result in adequate common
law safeguards. The courts’ inability to prevent or redress t hese frauds
led to the passage in 1911 of the first state securities reg ulatory scheme,
or blue sky law.1 Despite the growth of t hese statutes, frauds conti nued
to flourish in the wake of the Great Crash of 1929. Congress realized
that there was a gap in the protect ion investors needed and accordingly
responded by enacting the Securities Act of 1933 and the Securities
Exchange Act of 1934.2 The importance of the state statutes has been
dwarfed to a large extent by the impact of federal reg ulation. Yet, the
state laws provide significa nt protection for investment schemes that
are either small or essentially local in nature, as well as supplementing
federal law for more widely offered issues. The topic of securities
regulation consumes several treatise volumes and thousands of pages in
law reviews. What follows is but a general introduction and overview.
§ 27.2 History, Policy, and Purpose
of State Securities Laws
The Kansas legislatu re in 1911 passed the first American securities act.3
The law, popularly called a “blue sky law,” attracted wide attention.
Similar legislation has now been adopted in every st ate.
§ 27.3 Preemption of State Registration
Ever since the enactment of the Securities Act of 1933, Congress
preserved the power of the states to regu late securities transactions,
notwithstanding the coverage of the federal securities laws. In 1996,
however, Congress substantially reversed its position by expressly
preempting the field with regard to most registration requirements.
The National Securities Markets Improvement Act of 19964 took
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away from the states the power to impose reg istration and report ing
requirements with regard to a large number of securities transactions.
As amended by the 1996 legislation, Section 18 of the 1933 Act precludes
the imposition of registration and reporting requirements in many
securities transactions, including securities listed on the New York
Stock Exchange, the American Stock Exchange, or the Nasdaq Stock
Market.5 The federal act, however, expressly preserves the states’ right
to require fil ing of documents solely for notice purpose,6 which in effect
preserves a state’s ability to require reg istration by coordination with the
federal registration. The preemption of state registration and repor ting
requirements is not limited to publicly traded secu rities.7
§ 27.4 Preemption of State Securities
Fraud Class Actions
Federal preemption has continued. Congress largely eliminated the use
of state courts for securit ies class actions when it enacted the Securities
Litigation Uniform Standards Act of 1998, which mandates that class
actions involving publicly traded securities be brought in federal court.8
Class actions involvi ng state securities law and common law class actions
with regard to these sec urities are preempted. The Uniform Standards
Act is not complete in its elimination of state court class actions, since
the Act preempts only t hose actions involving publicly traded securit ies.
It is important to note further that the Uniform Standards Act applies
only to class actions and t hus not to individual or derivative suits. There
also is an exclusion for actions brought in the state of incorporation
involving certain corporate transactions.
The preemptive provisions apply only to “covered securities.” Cov-
ered securities under the Uniform Standards Act are secu rities regis-
tered with the SEC and traded on t he New York Stock Exchange, Amer-
ican Stock Exchange, t he Nasdaq National Market, or other national
markets designated by the Commission, as well as securities issued by
investment companies registered under the Investment Company Act
of 1940.9 The preemption applies to any class action with more than 50
members involving misrepresent ations, omissions, deception, or manip-
ulation in connection with the purchase or sale of a covered securit y.10
The Act does not preempt individual actions, derivative suits, or suits
brought on behalf of 50 or fewer persons from being brought in state
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