Blue sky laws

Blue sky laws are each state's own set of rules for regulating securities. They work together with federal regulations to protect investors from fraudulent investment schemes. The name "blue sky" comes from an old court case where a judge criticized certain speculative investmentsHigh-risk investments that rely on market sentiment and price appreciation rather than fundamental business value, often characterized by significant potential for both gains and losses. as having "no more basis than so many feet of blue sky."

For hedge fund managers, these state laws create ongoing compliance requirements. Even though hedge funds are primarily regulated at the federal level, they must still follow certain state rules in every state where they have investors. This means fund managers often need to deal with dozens of different state requirements simultaneously.

The way hedge funds are regulated changed dramatically in 1996 with a law called the National Securities Markets Improvement ActFederal legislation that created the qualified purchaser standard and Section 3(c)(7) exemption for private funds. (NSMIA). Before this law, each state could conduct detailed reviews of private investment offerings like hedge funds. State regulators could examine investment terms, evaluate fund managers' qualifications, and even reject offerings they deemed unsuitable for their residents.

NSMIA changed this system by limiting what states could do. The law removed states' ability to block or substantially review hedge fund offerings that follow federal Rule 506 under Regulation D Regulation D Regulation D provides exemptions from SEC registration requirements for private placements of securities, with hedge funds typically relying on Rule 506(b) for traditional private offerings or Rule 506(c) for offerings involving general solicitation. . This meant states could no longer conduct "merit reviewsState regulatory evaluations that assess whether an investment offering is suitable or appropriate for investors, prohibited for certain federal securities under NSMIA." where they decided whether an investment was good or bad for investors.

However, NSMIA did not eliminate all state authority. States kept the right to require basic paperwork filings and collect fees from funds that sell to their residents. This created the current system where hedge funds face streamlined federal oversight but must still handle administrative requirements in multiple states.

Today, hedge fund sponsors must file paperwork in every state where they accept money from investors. Each state has its own forms, deadlines, and fees. This creates a complex administrative task that funds must manage carefully.

Most states require funds to submit their federal Form D Form D Form D is an SEC filing required when a company relies on Regulation D exemptions from securities registration, used by hedge funds to notify regulators of exempt private offerings and containing basic information about the fund, its managers, and the offering. filing along with additional state-specific forms. The timing varies by state, but most require these filings within 15 days of accepting the first investment from a resident of that state. Fees typically range from $100 to $500 per state, though some states like New York charge more and have additional requirements.

Fund managers usually handle this through systematic compliance policiesWritten procedures that must be reasonably designed to prevent violations of applicable laws and regulations. that track filing requirements across all relevant states. Missing a filing or deadline can result in penalties or complications for the fund's operations.

While NSMIA simplified securities registration, it left broker-dealerA person or firm engaged in the business of buying and selling securities for the account of others or for its own account. licensing rules unchanged. Most states require anyone selling securities to state residents to either register as a broker-dealer or qualify for specific exemptions. This requirement creates complications for hedge fund managers who use their own employees for marketing.

Fund sponsors must check each state's rules about who can sell securities without a broker-dealer license. Most states allow fund managers and their officers, directors, and partners to market without registration, but these exemptions often come with conditions. Some states require additional filings or limit how these employees can be compensated for marketing activities.

The rules vary significantly from state to state. What works in one jurisdiction may not be allowed in another, requiring fund managers to understand the specific requirements in each state where they plan to raise capital formationThe process by which businesses and other entities raise funds from investors to finance their operations and growth..

When hedge funds hire third-party placement agents to help raise money, coordinating state compliance becomes even more important. Fund sponsors should get written confirmation that placement firms and their employees will meet broker-dealer registration requirements in all states where they plan to market the fund.

For funds that use their own employees for marketing, the compliance analysis becomes more complex. Fund managers must understand that state exemptions from broker-dealer registration are not always automatic. They may need to meet specific conditions or file additional paperwork in certain states.

This intersection of federal and state authority requires careful planning. Fund managers must ensure full compliance while managing the administrative costs and complexity of dealing with multiple regulatory jurisdictions. The key is developing comprehensive compliance frameworks that can address the specific requirements of each state where the fund seeks investors.