“Please set forth as explicitly as possible the actual measures by which competition can be effectively regulated. The more explicit we are on this point, the more completely will the enemies guns be spiked.”
September 27, 1912 Telegram from Woodrow Wilson to Louis Brandeis
During the first two decades of the twentieth century, state efforts to regulate the sale of corporate securities flourished. Motivated by real and spurious complaints from investors about roving financial hucksters, many state legislatures passed laws to stop unscrupulous pitchmen from selling honest investors everything “but the blue sky.”
The first blue sky law passed in Kansas in 1911, but other states soon created commissions to regulate and enforce the myriad of rules imposed on securities dealers by the laws. The rules included licensing, bonding provisions, disclosure regulations, and limitations on who could market securities within any given state.13
The regulations, while generally well-intentioned, often created as many problems as they solved. Because states patterned their blue sky laws after existing state regulations unrelated to the special nature of securities practices -- one state modeled its blue sky law on an existing statute regulating the sale of patent medicine -- they failed to address the specific disclosure requirement inherent in securities trading.14
Many state blue sky laws were narrowly drawn and haphazardly implemented. The increasing complexity of financial regulation and the securities industry practice meant that state legislatures passed a variety of legal reforms which were often inadequate or detrimental to addressing the problems of reforming securities practices.
In response to the blue sky movement, securities interest groups, such as the Investment Bankers Association (IBA), began an assault on the very idea of state securities regulation. Between 1913 and 1917, the IBA drafted a “model securities act” that modeled the fraud act based on the federal postal codes. It then attempted to convince states that its approach limiting the fraudulent acts of “wildcat securities” would sufficiently protect investors.15 Relying on a growing membership to exert political power over state legislatures, the IBA fought New York’s blue sky proposal in 1913. In states where its membership was large, the IBA had political success advocating its agenda.
However, in many smaller states, where many of the securities salesmen were out-of-state vendors, or where the sales of securities came through the mail, state legislatures proceeded with their reform efforts. Ohio, Michigan and South Dakota passed laws patterned after the Kansas statute. The laws required the registration of securities dealers, increased securities disclosure, and provided penalties for violation, such as denial of licensing. Securities firms affected by these reforms fought back, filing cases challenging the state regulations under the interstate commerce clause and due process clauses of the U.S. Constitution.16
(13) Parrish, 6-7.
(14) Jonathan R. Macey and Geoffrey P. Miller, “Origin of the Blue Sky Laws,” 70 Texas Law Review (December 1991): 348-397.
(15) Ibid, 10-11.
(16) Parrish, 10-13.
