Investor Protection: State And Federal Securities Regulation

• Author: James D. Cox/Thomas Lee Hazen
• Profession: Professor of Law at Duke University/Professor of Law at the University of North Carolina, Chapel Hill
• Pages: 604-632

§ 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.

PART A. STATE BLUE SKY LAWS

§ 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

Requirements

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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