Demystifying Private Placement Laws – Part 2: Blue Sky Laws
The term “Blue Sky Laws” refers to the laws of U.S. states that prohibit the fraudulent sale of securities. This post is the second in a two-part series on securities and gives a general overview of some of the state securities laws and regulations that may apply to domestic private investment funds, such as a hedge fund, private equity fund, real estate fund or a venture fund. Please refer to Demystifying Private Placement Laws, Part 1: Reg D and other Federal Laws and Regulations, for a synopsis of federal securities laws and regulations applicable to private investment funds.
This post is an overview only. Fund managers are strongly encouraged to seek advice from securities counsel before offering or selling any fund interests.
Blue Sky Filings
Similar to federal securities laws, Blue Sky Laws generally prohibit any public offering of interests in funds in a state unless either a registration statement is filed with the proper state agency or an exemption from registration applies. Such laws typically require filings to be made to perfect the “private offering” exemption in that state. A private investment fund offering fund interests must comply with the Blue Sky Laws of its home state and in each state in which the fund plans on offering fund interests.
For example, most private investment funds with operations based in California will have language in their offering materials designed to permit the fund to rely on the federal preemption of California securities qualification laws which requires, among other things, that the fund file a signed Form D and a Consent to Service of Process with the California Department of Business Oversight and pay a filing fee, within 15 days of the first sale of one or more fund interests.
If that same California private investment fund offers fund interests outside of California, it will be required to comply with the securities laws of each state where an offeree or fund investor resides. Numerous states have similar regulations as California. Some state laws (such as New York) require that certain filings be made, fees paid or other acts be taken before offers may be made to residents. Other states have self-executing exemptions that do not required a fund to make any filing with a state agency, provided that the sale of fund interests is made to only a select group of investors. The wide variety of approaches to state regulation of securities requires review of each state, on a case by case basis, as a fund offers interests to residents of different states.
Some states limit the effectiveness of Blue Sky filings to only one year. Thus, in addition to filings made prior to or immediately after the first sale of one or more fund interests in a state, fund managers may also need to renew a state filing if an existing investor makes an additional investment a year later or if a new investor from the same state purchases fund interests.
Private investment fund managers should consider each state’s securities laws and regulations and draft the requisite state filings before their first sale of fund interests. Many private investment funds that plan on offering interests in New York file the requisite state filings in New York in advance of launching the fund, while for most other states, the private investment fund may make filings immediately after the sale of fund interests.
It is important to promptly advise a private investment fund’s Blue Sky filer of a new sale of fund interests or of an additional capital contribution by an existing investor to ensure that the particular state’s filing deadline is met. Some states may charge late-filers penalties. For example, penalties can range from $50 for a tardy state filing in Idaho to up to $5,000 in Mississippi. Other states, such as Nebraska and Washington, claim a late filing will void the ability for the fund to take advantage of the exemption from state registration of the securities being offered (although that position conflicts with the federal National Securities Market Improvement Act of 1996, which pre-empts such state laws). Nonetheless, the fund may be subject to a regulatory action by the relevant state agency for failure to comply with an applicable Blue Sky Law and be obligated to return the investor’s capital contribution.
Although not discussed here, other Blue Sky issues that may affect a private investment fund include whether the fund’s activities make it exempt from registration as a broker-dealer under that state’s laws, whether a fund manager or its employees are exempt from registration as an investment adviser or investment adviser representative in a particular state and whether a fund manager must notice file with a state regulatory agency. Fund managers are strongly encouraged to seek advice from counsel on these issues.