NSMIA Preemption of Blue Sky Qualification Requirements
In 1996, Congress enacted the National Securities Markets Improvement Act ("NSMIA"), which established the exclusive federal authority (and thereby also redefined the boundaries of state regulatory authority) over securities offerings in order to facilitate national securities markets.
The federal legislators who adopted NSMIA found that state securities laws were an impediment to the national capital markets and supplanted them with a uniform federal rule in order to foster improvement in the capital market. In particular issuers' had difficulties complying with up to 50 blue sky qualification requirements or respective applicable exemptions.
NSMIA preempts states from applying their own registration and qualification requirements of blue sky laws to securities offerings and transactions in NSMIA “covered securities.” Where covered securities are involved, NSMIA realigned state and federal roles in securities regulation. The U.S. Securities and Exchange Commission the exclusive regulator of offerings. State authority to impose registration and qualification requirements on these offerings under their blue sky laws, or to impose any limits or conditions on the use of offering documents prepared by or on behalf of the issuer in such offerings, was eliminated by NSMIA for "covered securities".
As a result of NSMIA, states retain registration authority only if the securities are not "covered securities". "Covered securities" exclude securities sold in reliance on the intrastate offering exemption (Rule 147), offerings under Regulation D Rule 504 or 505, offerings under Regulation A, and any other offerings which are not deemed offerings of "covered securities".
State securities regulators, additionally, retain full authority under blue sky laws to investigate and bring enforcement actions with respect to fraud or deceit.
What are NSMIA “Covered Securities”?
Congress concluded that offerings of securities defined as covered securities in NSMIA are inherently national in character, and should therefore be subject to exclusive federal regulation.
NSMIA covered securities include:
- Nationally traded securities: securities listed or authorized to be listed for trading on the New York Stock Exchange and the current equivalent of the National Market System tier of the Nasdaq Stock Market, or other exchanges with comparable listing standards, as designated by the SEC by rule or otherwise. The SEC has designated several successor and other national securities exchanges as falling within this NSMIA covered security category, which also includes all securities equal in seniority to or senior to those listed securities; and Securities issued by an investment company registered under the federal Investment Company Act of 1940, as amended. This category of covered securities encompasses the offer and sale of mutual fund shares.
- NSMIA covered securities also include securities offered and sold to persons who meet criteria established by the SEC as “qualified purchasers.” The SEC has proposed, but not adopted, a definition for the term "qualified purchaser" under the Securities Act of 1933, as amended (the “Securities Act”) to implement this provision of NSMIA. The proposed definition mirrors the definition of “accredited investor” under Regulation D of the Securities Act.
- NSMIA also includes as covered securities certain offerings that are exempt from federal registration requirements under the Securities Act: (a) §§4(a)(1) or 4(a)(3) (15 USCS §77d) of the Securities Act when the issuer is a reporting company under the Securities Exchange Act of 1934; (b) §4(a)(4) (15 USCS §77d) of the Securities Act (brokers transactions); (c) certain offers and sales of securities exempt under §3 (15 USCS §77c) of the Securities Act; and (d) securities offered and sold in transactions exempt under SEC rules issued under §4(a)(2) (15 USCS §77d) of the Securities Act. The most prominent example of NSMIA covered securities falling within this category is an offering carried out in reliance on Rule 506 of Regulation D under the Securities Act, the safe harbor exemption from federal registration requirements.
Rule 506, adopted by the SEC under authority granted in §4(a)(2) of the Securities Act, is the mainstay of private securities offerings today. It permits offerings in unlimited amounts to an unlimited number of “accredited investors,” and up to 35 nonaccredited investors, when certain conditions are satisfied.
Notice Filing Requirements for Covered Securities
Although NSMIA preempts state registration and qualification requirements for the offer and sale of covered securities, states are permitted to impose notice filing, consent to service, and fee requirements. Many states have done so.
The required notice filing generally consists of a copy of Form D as filed by the issuer with the SEC pursuant to the Securities Act, together with a report of the value of securities sold or offered to be sold to persons located in the state.
Notice filing for the sale of securities pursuant to Rule 506 (17 CFR 230.506) of Regulation D under the Securities Act is made using Form D, as prescribed by Rule 503 (17 CFR 230.503) of Regulation D. Although Rule 506 of Regulation D does not itself make filing Form D a condition to availability of the exemption, state securities regulators view the filing of Form D, as provided in Rule 503, as a requirement for the validity of the Rule 506 exemption, and thus for the securities offered and sold to be NSMIA covered securities for which state registration and qualification authority is preempted.
Blue Sky Regulation of Offerings After NSMIA
After the enactment of NSMIA, state securities administrators have focused their attention on smaller offerings having a local or regional character. Administrators continue to be empowered under blue sky laws to require registration and make determinations, with or without exercising merit review, that are particularly suited to such offerings. Based on the definition of “covered security” in NSMIA, offerings remaining within the scope of registration and qualification requirements in blue sky laws without being preempted by NSMIA consist of
- “Intrastate offerings” (sometimes in reliance upon the Rule 147 safe harbor) as provided in §3(a)(11) (15 USCS §77c) of the Securities Act;
- Offerings carried out pursuant to Rules 504 (17 CFR 230.504) and 505 (17 CFR 230.505) of Regulation D under the Securities Act, permitting offerings up to $1 million and $5 million, respectively;
- Offerings carried out pursuant to Regulation “A” of the Securities Act, which permits a public offering of securities in an amount up to $50 million under a limited form of federal registration; Offerings of securities by qualifying not-for-profit or charitable issuers in reliance upon the federal exemption in §3(a)(4) (15 USCS §77c) of the Securities Act;
- Offerings made through certain judicially or administratively approved proceedings in reliance upon the federal exemption in §3(a)(10) (15 USCS §77c) of the Securities Act where a fairness hearing is conducted by teh Department of Corporations; Municipal securities offerings in the state in which the issuer is located; and
- “Private” offerings made pursuant to the exemption in §4(a)(2) of the Securities Act, made outside of Rule 506 of Regulation D.
Retained State Enforcement Authority
The NSMIA expressly preserves state authority to investigate and bring enforcement actions with respect to fraud or deceit. There are no limitations imposed on states’ preserved anti-fraud enforcement authority, and, as some courts have held, the scope of that authority may be such as to permit challenges to the adequacy of disclosures made in offering documents used in an offering of covered securities in spite of the NSMIA preemption of state authority to impose limits or conditions on the use of disclosure documents prepared by or on behalf of an issuer. Moreover, numerous courts considering the question of state authority to determine the validity of covered securities — specifically the validity of a claimed federal exemption under Rule 506 of Regulation D — have concluded that states may exercise such authority and, in effect, determine the limits of NSMIA preemption in regard to these offerings. These courts have rejected the notion that NSMIA preempts states from examining Rule 506 offerings for compliance with the federal exemption simply because the issuer has attempted to qualify, or purports to make the offering pursuant to the Rule 506 exemption.