Although these fraudulent practices are largely made possible through the creation, under legal sanction, of artificial corporate entities which enable individuals to avoid personal responsibility for many of their acts, the sentiment of legislators and law courts was, until recent years, opposed to all measures intended to check these abuses.23 22 Opinion gradually changed, however, and the British Companies Act of 1908 became the basis of a series of additions and amendments that finally resulted in the Consolidated Companies Act of 1929 which requires, among other regulations, that each prospectus inviting the public to purchase the securities of a company or other corporation shall be signed by all its promoters and directors who are held personally responsible for all false statements or misrepresentations which it may contain.23

Blue-sky legislation in the United States.-Statutes attempting to regulate the sale of securities in the United States have been popularly known as "blue sky" laws since an early judicial decision that referred to "speculative schemes that have no more basis than so many feet of blue sky." 24 The first such legislation was enacted by Kansas in 1911 25 and was shortly after followed by similar provisions in West Virginia, Iowa, South Dakota, Ohio, Michigan, and other States until by 1923 only two States, Delaware, Nevada, and the Territories were without some type of law designed to regulate the sale of investment securities.26 Delaware enacted a blue-sky law during 1931 and only Nevada and the Territories are without such legislation at present. The earlier enactments were directed entirely against "speculative" securities but later provisions of the laws of many States have gradually been extended to other issues and the powers of the administrative departments in most States have been increasingly broadened until at present nearly all corporations issuing any form of securities are subject to the provisions of this class of laws.27

Legislation originally held unconstitutional.—A corresponding progressiveness has been shown in the decisions of the courts concerning this type of legislation. The earlier statutes were attacked as unconstitutional almost immediately after enactment on numerous grounds, among the more important being the contentions that they were unlawfully discriminatory contrary to article IV, section 2, of the Federal Constitution, that they impaired the right of contract and confiscated property without due process of law in violation of the fourteenth amendment, that they constituted a burden on interstate commerce, and that they were an unlawful delegation of legislative and judicial power to the executive branch of the Government.28 From the time the first Kansas statute of 1911 was attacked until 1917, the lower Federal courts consistently held that such laws, including those of Arkansas, Iowa, Michigan, West Virginia, Ohio, Oregon, and South Dakota, were unconstitutional,29 the blue sky law of Florida alone being upheld by the supreme court of that State, from which decision no appeal was taken.30 These decisions resulted in legislative revision of the acts in several States and a halting of new enactments in other States that had not already passed such laws.31

Declared constitutional by Supreme Court.-During 1914 and 1915 a series of proceedings were instituted independently attacking the constitutionality of the blue sky law of Ohio and the revised 1915 acts of South Dakota and Michigan.32 After exhaustive hearings, six decisions of the Federal courts held that these statutes were unconstitutional 33 and, during 1917, appeal was taken from each of these decisions to the Supreme Court of the United States. In the Supreme Court the cases were considered together 34 and the decisions of the lower courts reversed in three opinions delivered ad seriatum January 22, 1917, each opinion covering 22 Blue Sky Laws, R. R. Reed, p. 1. 'A special committee of the British Board of Trade in 1895 considered and rejected as futile and dangerous, 'every suggestion for a public inquiry by the registrar or other officials into the soundness, good faith and prospects' of a proposed promotion."

23 Statutes 19 and 20, George V, ch. 23.

24 Hall v. Geiger-Jones, 242 U.S. 339.

25 Session Laws of Kansas, 1911, ch. 133.

26 Cowan's Manual of Securities Laws, 1929 ed.

27 Cowan's Manual of Securities Laws, ed. 1929.

28 Bracey v. Darst, 218 Fed. 482; Hall v. Geiger-Jones, 230 Fed. 233; Caldwell v. Sioux Falls Stock Yard Co., 230 Fed. 236; Merrick v. Halsey & Co., 228 Fed. 805; Alabama & N. Ó. Transport Co. v. Doyle, 210 Fed. 173; Wm. R. Compton Co. v. Allen, 216 Fed. 537.

29 See cases cited note 1, supra.

30 Ex parte C. H. Taylor, 66 South, 292.

31 Reed and Washburn's Blue Sky Laws.

32 Code of Ohio, 1916, vol. 2, secs. 6373-1 to 6373-24; South Dakota laws, 1915, ch. 275; Michigan Public Acts, 1915, p. 63.

33 Hall v. Geiger-Jones; Caldwell v. Sioux Falls Stock Yard Co.; Merrick v. Halsey, supra.

34 Hall v. Geiger-Jones (242 U.S. 539); Caldwell v. Sioux Falls Stock Yard Co. (242 U.S. 559); Merrick v. Halsey (242 U.S. 568).

the law of one of the three States involved.35 These decisions definitely established the basic constitutionality of State blue sky law provisions generally and overruled the objections on which the earlier contrary opinions of the lower courts had been based. The decisions were unanimous, excepting Mr. Justice McReynolds, who did not deliver an opinion.36 No further cases involving the basic principles of blue sky laws have yet reached the Supreme Court.

Within the few years following these decisions, all States with the exception of Delaware and Nevada, that had not already enacted legislation of this type placed blue sky laws upon their statute books.37 These enactments, although differing considerably in details, followed to a large extent the precedent of earlier acts and, with one notable exception,38 may be divided, according to their basic provisions, into two major types. Although several authors have attempted to classify the legislation of the various States in different ways, the analysis adopted by Forrest B. Ashby in his pamphlet entitled "Economic Effects of Blue Sky Laws" 39 appears to be the least confusing. This analysis divides American securities statutes into two major groups as follows:

41

I. Laws that provide for the punishment of fraud in the sale of securities. II. Laws that attempt to regulate the sale of all but exempted securities. Fraud laws. The blue sky laws of New York,40 New Jersey, Maryland,42 and Delaware 13 are examples of the type of law that becomes operative only when evidence has been presented that a fraud has been, or is about to be, committed." This class of statute empowers the attorney general or other official of the State to investigate, with authority to subpena witnesses and records, whenever it shall appear that any individual or organization has engaged in, or is about to engage in, fraudulent practices in the sale of securities. A temporary restraining order may, in his discretion, be issued against the further sale of the securities involved and, if the results of the investigation appear to warrant such action, the order may be made permanent. Criminal actions may also be brought against fraudulent issuers and dealers when the investigation develops sufficient evidence of an indictable offense. This type of statutes, known as "fraud” laws, are classified as one of the two major groups, not because they are numerous 45 but because the methods they employ differ widely from the characteristic provisions of the statutes of other States which attempt to regulate the sale of securities regardless of whether or not evidence of fraud has been presented.

Regulatory laws.-The group of laws which are intended to regulate the sale or issue of securities, prior to their being sold or issued, comprise by far the greater part of the blue-sky legislation in the United States. 46 Basically, the regulatory type of statute makes it unlawful to issue or sell securities without first obtaining the State's permission. Without further qualification, however, such a provision would place Government bonds in the same category as worthless or highly speculative stock issues, would apply to a private owner of bonds who wishes to sell as well as to the bucket-shop operator, and would in a number of ways unwarrantably hamper the normal course of legitimate business. For these reasons it has been necessary to make numerous exemptions and to devise methods of procedure

35 It is of interest in this connection that Mr. George W. Wickersham, Mr. Robert R. Reed, and Mr. Charles K. Allen were permitted by the court to file briefs as amici curiae (friends of the court), on behalf of the Investment Bankers Association of America, contesting the validity of these statutes, although the association had no direct pecuniary interest in these particular proceedings. Idem.

36 The finality with which these opinions were accepted by opponents of this class of legislation is well indicated in a letter which Mr. Robert R. Reed wrote to his clients, the Investment Bankers Association, concerning the legal effect of the court's decisions. In it he said:

"The net result is (that) the decision and opinion have undoubtedly been fully considered by the court and express its final position, not only as to these statutes, but probably as to a great many similar statutes, actual and possible.

"The most important conclusion which can be drawn with reasonable certainty is that no typical blue sky law, as applied to the business of dealing in securities, violates the Federal Constitution, either the fourteenth amendment or the interstate commerce clause."

39 The Economic Effect of Blue Sky Laws. Forrest Bee Ashby, Philadelphia 1926.

40 New York General Business Law, art. 23- (A) (secs. 352-359g), as amended in 1921, 1923, 1925, 1926, 1927, and 1928. New York added a "dealer licensing" law July 1, 1932.

41 New Jersey, Laws of 1920, ch. 234; Laws of 1927, ch. 79.

42 Annotated Code of General Public Laws of Maryland, art. 32 (A), secs. 11-14.

43 Revised Code of Delaware, No. 3845 (A), sec. 2 (A), ch. 117.

44 Colorado, in 1931, supplemented its Securities Act of 1923 with a Fraudulent Practices Act.

45 New York, New Jersey, Maryland, and Delaware.

48 Forty-two States, including Connecticut, which regulates oil and mining issues only. Economic Effects of Blue Sky Laws (Ashby).

that will obtain the desired results insofar as concerns fraudulent or worthless issues without, at the same time, unduly burdening honest transactions. It has been the diverse methods employed by the various States in their efforts to obtain these results that has caused the divergence in the character of regulatory laws enacted. Most blue-sky legislation of the regulatory type, however, has the following characteristics in common:

(a) The classification of securities and the exemption of some of them. (b) The classification of transactions and the exemption of some of them. (c) The requirement that detailed information be filed concerning nonexempt issues and that permission to sell the issue be obtained from the State.

(d) The requirement that dealers secure licenses dependent on good character, responsibility, and continued honesty.

There are, naturally, a great variety of other conditions and requirements that occur with more or less frequency in the various acts, but the four characteristics mentioned are so nearly universal that special mention has been made of them before proceeding with a more detailed classification of regulatory laws.

Classes of regulatory laws.-1. Dealer licensing laws: A few States seek to regulate the sale of securities solely through control of the dealers who are required to obtain licenses which may be revoked at any time for cause.47 Under these statutes, a licensed dealer may sell securities at his discretion without the necessity of separate approval by the State of each specific issue, subject to revocation of his license in the event of fraud or gross negligence. The issuer of securities himself, however, is not ordinarily permitted, under this type of statute, to sell his own securities until they have been definitely approved by the State.

2. Specific issue permit laws: The usual type of regulatory laws is that which prohibits the sale of a security issue until permission to sell that specific issue has been granted by the State.48 The requirements under these statutes also vary widely. Ordinarily, these enactments classify securities according to their inherent qualities and transactions according to their character. In some States securities are divided into two classes only, speculative and nonspeculative, with an exemption in favor of the nonspeculative issues and a requirement that speculative securities comply with prescribed regulations.49 These are known as "speculative" statutes but efforts to define in the law itself just what issues are to be so considered have ordinarly been found to be very difficut and complicated in actual practice.50 Other acts make much more elaborate classifications, the Michigan act, for example, exempting 10 classes of securities and 8 classes of transactions.51 The proposed Uniform Sales of Securities Act designated 12 types of securities and 9 groups of transactions that are to be exempt.52 tween the two extremes there are many variations including statutes that provide different types of regulations for different groups of securities.

Be

Exemptions.-These various exemptions are, naturally, included in blue-sky laws for the purpose of leaving the channels of legitimate business as free as practicable from unwarranted obstruction by statutes intended only to regulate or prevent speculative and fraudulent transactions. It would serve no useful purpose here to list the various exemptions made in the 43 States but those most usually occurring are found in the Michigan law and may be summarized as follows:

SECURITIES

(a) Securities issued or guaranteed by the United States Government, its territories, or by any State or political subdivision thereof.

(b) Issues guaranteed by friendly foreign governments.

(c) Issues of banks or corporations supervision by the United States Government.

(d) Issues of public utility companies supervised by the State or Federal Government and secured railway equipment trust securities.

(e) Issues of educational and eleemosynary corporations.

(f) Issues of banks under State or Federal control and of building and loan associations organized under the laws of the State.

(g) First mortgage bonds and notes secured on property within the State.

47 Kentucky, Maine, Montana, Massachusetts, New Hampshire, Pennsylvania, Rhode Island, Vermont, and California for foreign issues. New York added such a provision during 1931.

48 Alabama, Arkansas, Florida, Idaho, Iowa, Mississippi, Missouri, Ohio, Oregon, North Carolina, South Dakota, Tennessee, Texas, Wisconsin, Illinois, Georgia, etc.

40 Kansas, New Mexico, Oklahoma, Virginia, Wyoming, and others.

50 Economic Effects of Blue Sky Laws, p. 12, Ashby.

61 Michigan Act 20, P.A., 1923.

62 Uniform Sales of Securities Act approved by the National Conference of Commissioners on Uniform State Laws, Aug. 11-16, 1930, and by the American Bar Association, Aug. 20-22, 1930.

(h) Short-term negotiable paper.

(2) Capital stock of domestic trust companies.
(Securities listed on approved stock exchanges.53

(a) Judicial sales.

TRANSACTIONS

(b) Sales of mortgages in liquidation of debts.

(c) Bona fide isolated transactions by individuals.

(d) Distribution of stock dividends to stock holders.

(e) Purchases for investment, and not for resale, by banks, investment and insurance companies.

(f) Subscriptions to capital stock, necessary for incorporation by the incorporators.

Action on applications.-The extent of the investigation made by State authorities upon receipt of an application for permission, when required, to sell designated securities within the State, necessarily depends upon a variety of circumstances. At the outset, the amount of information which the issuer of securities is required to submit, varies in different States, either under the statute itself or under authorized regulations, and the effectiveness with which the statutes are administered frequently differs because of the comparative qualifications or zeal of the officials charged with the law's enforcement.

Ordinarily, a prescribed application form, which is usually under oath and requires certain basic information, must be filed, accompanied by various documents, including the articles of incorporation and bylaws, financial statement and property appraisals, abstracts of title covering real estate, insurance carried, samples of advertising matter, organization expenses, commissions paid, and a number of other items that, in the opinion of the legislators or enforcement officials, are needed for an intelligent investigation of the merits of the issue concerned.54 After the application and supporting documents have been filed and examined, the State is ordinarily empowered to require still further information if this appears to be desirable. In the event the State officials refuse to permit the sale of a designated issue, the applicant may appeal to the courts for redress. In no instance is the State's permit to sell securities to be construed as an official endorsement of those securities and some States 55 refuse to give the applicant any documentary evidence, whatever, such as a receipt, that the sale of an issue has been permitted. This refusal is made on the theory that such evidence might be wrongfully used to induce prospective purchasers to believe that the State had officially endorsed the merits of a project.

In addition to the usual provisions of the typical blue-sky law described in the foregoing paragraphs, the laws of many States also include special provisions to cover situations that the legislators feel are not adequately covered by the usual statute. The securities commissions of some States, for example, control the sale of real estate issues based on property located without the State 56 and the Michigan statute also includes control of transactions in real property located within the State. Some commissions require that applicants deposit promoters' stock in escrow until the corporations are firmly established, limit the commissions that may be paid, require bonds of dealers and issuers, and evaluate patents or other property exchanged for corporate stock. A few States continue their supervision far past the promotional period,57 and the Michigan commission sometimes insists on countersigning all checks drawn by corporations whose prospects are based on new inventions. There is also a fairly recent tendency to include a provision for temporary approval of issues pending investigation and final report 5 or for registration of the issue by notification.59

Penal and civil liabilities.-Violators of blue-sky laws are ordinarily subject to both a civil action on the part of a dissatisfied purchaser of securities and a penalty in criminal proceedings instituted by the State. Many statutes specifically declare that all contracts or sales made in violation of their terms shall be void but, even in the absence of such a provision, contracts in violation of the terms of the statute would doubtless be considered illegal by most courts because of the penal feature, and for this reason void or voidable.60 Although 53 Not in Michigan law, but found in many others.

54 A detailed list of the usual requirements may be found on p. 21 of Ashby's Economic Effect of Blue Sky Laws.

55 Illinois, for example.

56 Ohio, Wisconsin, Iowa, Mississippi, New Mexico, and others.

57 Illinois, Wisconsin, and Michigan.

58 Illinois, Georgia, Wisconsin, and Missouri. Economic Effect of Blue Sky Laws, Ashby.

69 Indiana, Minnesota, Utah, and West Virginia.

60 Edward v. Ioor, 205 Mich. 617. Blue Sky Laws, Reed & Washburn, p. XIX.

it is a general rule of the common law that an illegal contract, if executory, cannot be enforced and if executed cannot be complained of by either party, yet "if the illegality results from a statute directed against only one party and designed for the protection of the other party, the latter may enforce an executory contract and obtain relief from the executed transaction." 61 There appears to be little or no doubt that a dissatisfied purchaser of securities, sold to him in violation of a securities law containing a penal clause, can maintain an action to nullify the contract of sale and recover the purchase price, even though the statute contains no clause specifically declaring such contracts void or voidable. Prosecutions under the penal provisions of blue-sky laws, which vary considerably in severity and usually provide for both fine and imprisonment, are instituted by the appropriate State officers 62 and it is well settled law that trial or conviction under the penal clause constitutes no bar to the civil action and that acquittal on the criminal charge is not evidence of innocence in a civil proceeding.63

Summary. Summarizing the foregoing broad analysis of American blue-sky laws, they may be classified as follows:

I. Fraud laws, such as exist in three States, and which are not set in motion until evidence is presented that fraud in the sale of securities has been or is about to be committed.

II. Regulatory laws, existing in 43 States, which attempt to regulate the traffic in securities by forbidding their sale until an application has been filed and permission granted by the State. This type of laws may be further classified as follows:

(a) Dealer licensing laws, which seek to exercise the desired control through dealers, by requiring that they obtain licenses under which they are held responsible for fraud or gross negligence in their transactions.

(b) Specific issue permit laws, which prohibit the sale of any security unless a permit has been granted by the State for the sale of each specific issue. Such permits are granted only after the applicant has filed more or less detailed information concerning the issue offered. This group of regulatory laws may be further subdivided, in accordance with their classification of securities, as follows:

(1) Speculative laws which treat all securities as either "speculative" or "nonspeculative" and apply the provisions of the statutes to speculative issues only. (2) The typical blue-sky laws that divide securities into several different groups, exempting the sounder issues and applying the regulations to others. Some transactions also, such as judicial sales, isolated sales by individuals, and sales to satisfy mortgages are usually exempted.

In addition, some statutes contain certain special clauses such as those providing for temporary permits pending investigation, registration by notification, requirements that promoters deposit stock or file bonds until the corporation is well established and other measures, intended to facilitate the sale of legitimate securities or to restrain fraudulent or speculative issues. These features are usually supplemental to the characteristic provisions of this type of statute.

The law of Colorado, which differs widely from all other American securities legislation, will be described in connection with the proposed Federal law.

LIMITATION OF STATE LAWS

There is no way of estimating even approximately the actual savings to American investors as a result of the various blue-sky laws. Reports from State enforcement officers cover only those applications filed for permission to sell such securities as the applicants believe have sufficient merit to pass inspection. Naturally, there can be no record of the far greater number of projects which never materialized because of the exactions of these laws or for which no applications were filed because of possible evasions discovered by clever promoters and shrewd attorneys. It has already been stated that there is a great difference in the effectiveness of the legislation in the various States and in the qualifications and zeal of the enforcement officers, and promoters quickly discovered and took advantage of these differences by operating in States where the statute or its enforcement was lax and

61 Blue Sky Laws, Reed & Washburn, p. XXI. Bowditch v. New England Mut. Ins. Co., 141 Mass. 292; Sav. Bank of San Diego v. Burns, 104 Cal. 473; Cashin v. Pliter, 168 Mich. 386.

62 Securities Commission, Attorney General, Superintendent of Banking, Secretary of State, etc.

63 Stone v. U.S., 167 U.S. 178; Coffey v. U.S., 116 U.S. 436; Wilkes v. Dinsman, 7 How. 89; U.S. v. Donaldson-Schultz Co., 148 Fed. 581, and many others. See Corpus Juris, judgments.