Monday, February 29, 2016

Why Haven’t Conservative States Tried to Roll Back State Securities Laws?

Federal and state securities regulation is the personification of what conservatives refer to pejoratively as “big government.” Businesses can’t raise money unless they first get permission from the government and, in many states, that permission turns on a regulator’s determination of whether the offer is fair. The cost of compliance is a serious drag on capital formation, especially small business capital formation. Federal and state securities laws also generate a tremendous amount of plaintiff’s litigation, another conservative bugaboo.

We’ve seen conservative efforts at the federal level to limit securities regulation and litigation—for example, the Private Securities Litigation Reform Act and the JOBS Act. But, unless things are going on at the state level that I’m not aware of, there doesn’t seem to be a corresponding effort at the state level.

That’s surprising, because the Republicans have greater control at the state level than they do at the federal level. There are 31 Republican governors and the Republicans control both chambers of the state legislature in 30 states, plus Nebraska’s unicameral legislature. Republicans control both the governorship and the state legislature in 24 states.

Why hasn’t there been a push to change state securities regulation? Are Republicans satisfied with state regulation? If so, that’s surprising because Rutheford Campbell and others have pointed to state securities regulation as a major drag on small business capital formation. Are politicians at the state level not as anti-government? Or is there something else going on that I’m missing?

I’m not arguing that state securities laws should be limited (at least, not in this post). I’m just curious why it hasn’t happened.

C. Steven Bradford, Securities Regulation | Permalink


I. To answer the question, big business has repealed – indirectly – state merit review regulation, by NSMIA preemption, in 1996. Having won the war, big business may have considered it no longer necessary to fight further battles. And also, because of NSMIA, state securities regulation might not actually be much of a drag on small business capital formation any more.

II. There is hardly any private-plaintiff state securities law litigation, except as an add-on to private-plaintiff federal securities law litigation. Removing the blue sky law from a state’s statute book would have practically no effect upon plaintiff litigation.

III. From my particular conservative viewpoint (raised in red states, living in a blue state):
(1) For most voters most of the time, blue sky laws are invisible.
(2) Blue sky laws are used by (properly) ambitious public officials to prosecute actual fraud in the offer and sale of securities. Republican voters usually do not have a problem with this. The first blue sky law was passed, if memory serves, in Kansas in 1911.
(2a) Wall Street values are not Main Street values. Does this supposed difference have any practical effect? That is a worthwhile political debate. In any event, to the extent the red state voter sees the state securities laws being used at all, they are being used to put fraudsters out of business.
(2b) The North American Securities Administrators Association (NASAA) lobbies hard for the continuing role of state blue sky laws and state blue sky regulators in fighting fraud.
(3) In my experience, a family-and-friends funding will frequently be conducted in perfect ignorance of state blue sky law. If the business succeeds, the offering will enjoy the so-called “good deal” exemption. If the offering fails, and if the offeror has committed fraud, then a blue sky count might be added to the fraud complaint. In practice, the blue sky laws do not actually prevent fundraising from people you know. What they sometimes do prevent is the sale of crummy or fraudulent deals to strangers. This result would not seem outrageous in a red state, a blue state, or any other color state.
(4) The anecdotes out there regarding the stifling of small business by government regulation are seldom anecdotes about the cost of securities law compliance, but are rather anecdotes about taxes, charges, insurance, fees, and paperwork. For a $1 million offering, $60,000 of offering costs is only 6% of the proceeds, while, in contrast, mandatory labor costs imposed by federal and state governments will frequently add 30-50% on top of the amounts the business agrees to pay employees.
(5) Blue sky compliance does not, as far as I can tell in practice, interfere with capital raising. For a start-up business, the initial test for securities law purposes is whether the business has produced a thoughtful business plan. If yes, and if the start-up business has a reasonable chance of success, then it is not the issuer’s blue sky compliance that impedes capital raising. The issuer’s blue sky compliance costs are a small portion of the deal.
The critical cost is at the broker-dealer level. The cliché that “Securities are not bought, they are sold,” carries some truth in the sense that, without a broker who is recommending a particular security to an investor, how is an investor to choose which, out of thousands, of securities to buy? For each start-up securities offering, it is essential to determine how the securities will be offered and sold. Usually, the issuer needs to find a licensed securities broker-dealer that wants to sell the issuer’s securities. When issues of securities total less than a certain number of millions of dollars, then the broker-dealer and the start-up cannot afford each other. In my experience, this is the real problem, not the cost of blue sky law compliance.
This practical conclusion is now being tested by internet crowdfunding. The majority of states, regardless of degree of red or blue, have adopted intra-state crowdfunding, with investor protections more or less similar to the Congressionally-mandated investor protections under Title III of the JOBS Act. One essential characteristic of intra-state crowd-funding regimes is that the investor is only allowed to window-shop: that is to say, the offeror of the securities posts offering information on a web portal along with any number of other offerors. A potential investor can look at whatever offerings the investor chooses. The web portal is prohibited from recommending any particular security or securities out of the various offerings shown on the portal. The question to be answered is how the investor will pick an investment out from the many being offered. Will it be the investment with the most outrageous claims that catches the investor’s attention? Or will the investor have to go hire a broker after all, to pick out a good security?

Anyway, thank you for a thought-provoking, category-busting question.

Posted by: Christopher J. Bonner | Mar 4, 2016 3:27:06 PM

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