INTRODUCTION

The American people have enjoyed a degree of well-being and comfort unknown in history before; their material advantages and wealth have steadily increased throughout the history of the country. The per capita wealth of the average American increased from $514 in 1860, at the beginning of the Civil War, to $2,918 in 1922, four years after the end of the World War, while the best available estimate indicates an annual income of $3,000 for every family in the United States. Both the income and wealth of the American people have been reduced since October 1929, when the decline in the price of stocks brought forcibly to the attention of a wide public the reaction in business and industry which added the United States to that large group of countries in the throes of an economic depression even though the economic advantage of the American people continues unchallenged.

Since the Biblical days of Job times of depression have been considered especially appropriate for reflection and readjustment. If the present depths of misery and economic losses are to be counterbalanced by improvements, epoch-making developments may well be expected. The people generally, both in the United States and throughout the world, have suffered through no fault of their own. They had no part in bringing about the depression which is usually ascribed primarily to the World War.3 Their only mistake might be said to be a too literal adoption of the principle of free spending and investing.

The wide distribution of wealth in the United States has resulted in a large number of investors among the people. The days of restricted ownership of stock are gone forever, many corporations counting their stockholders in the hundreds of thousands and bankers and promoters offering their securities to the general public. There are more than 800,000 individual owners of stocks of the 160 class I railroads of the United States.

In the 13 years from 1919 to 1931, $50,000,000,000 worth of new stocks and bonds were issued in the United States, of which nearly twenty billions were stocks. Unfortunately, a considerable portion of this $50,000,000,000 was invested in securities of little intrinsic value and in some cases of no value whatever.

Since the World War, partly as a result of the wide distribution of bonds among people who had never owned securities before, the number of questionable stock and bond issues has increased markedly. In a report made to Congress under date of December 2, 1918, the Capital Issues Committee of the Federal Government stated:

"At no time has the obligation been so definitely placed upon the Government to protect its public from financial exploitations by reckless or unscrupulous promoters. The field has been greatly enlarged by the wide distribution of Liberty bonds, and the purveyor of stocks and bonds is no longer put to the necessity of seeking out a select list of prospective purchasers with money to invest. He now has the entire American public, and the transaction becomes one of persuasion to trade a Government bond bearing a low rate of interest for stocks or bonds baited with promise of high rate of return and prospect of sudden riches."

Because of the wide extent of the operations of swindlers who were urging the holders of Liberty bonds to exchange them for worthless securities, President Wilson recommended in his message to Congress on August 8, 1919, the passage of a Federal Securities Act which had been proposed by the Capital Issues Committee:

"May I not add that there is a bill now pending before Congress which, if passed, would do much to stop speculation and to prevent the fraudulent methods of promotion by which our people are annually fleeced of many millions of hardearned money."

1 E. Dana Durand, Introduction of American Industry and Commerce.

2 Statistical Abstract, 1931, p. 295.

Edwin F. Gay, The Great Depression, Foreign Affairs, July 1932.

American Telephone & Telegraph Co. stock is owned by 665,000 individuals; General Motors Corporation stock by 263,528; United States Steel stock by 187,409. According to the New York Times of July 7, 1932, "In the first official classification which it has made of its common-stock holders, the United States Steel Corporation showed, in a statement issued yesterday, that 80,309 of its 187,409 holders of common stock own less than 10 shares each."-Regulation of Stock Ownership in Railroads, U.S.H.R. 2789, p. XLIX.

The United States Legion of Capitalists, by Joseph S. McCoy. American Bankers Journal, February 1927, pp. 559-560, 626-628.

The Diffusion of Stock Ownership in the United States, Gardiner C. Means, Quarterly Journal of Economics, August 1930, pp. 561-600.

Commercial and Financial Chronicle, Monthly Statements.

Capital Issues Committee Report to Congress Dec. 2, 1918, Public Document No. 1485.

The author of a recent book entitled "Financial Racketeering" writes as follows:

"A 5-foot bookshelf could without great labor be filled with scandalous volumes if some bold writer should essay to docket and report the cases of all the financial swindles which occurred in the United States in, for example, the last 5 calendar years.'

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In a statement before the Committee on the Judiciary of the United States House of Representatives, recommending the passage of a Federal blue sky law of which he was the author, Congressman E. T. Taylor, of Colorado, said: 8 "During the war and ever since, there has been a deluge of mushroom, getrich-quick corporations organized all over the country for the purpose principally of selling stock. Nearly every State has produced some of them. * I learned that something like $500,000,000 of the wildest kind of speculation stock was being flooded over the country every year, and a very large part of it utterly worthless. From every State I think, except California, when these commissions (blue sky) expressed an opinion they urged the passage of a Federal law, and stated the reasons why the State laws were insufficient."

The report of the United States Senate Committee on the District of Columbia on the Prevention of Fraud in Promotion or Sale of Securities in the District of Columbia, contained the following statement: "

"The subcommittee developed the fact that within the past 6 or 7 years there have been issued in or sold from the District a great quantity of these securities, largely consisting of mortgage bonds or notes, in an amount approximating $100,000,000-a very considerable portion of which are of highly dubious value, and in some cases utterly worthless.

"Many of these securities have been distributed to women as safe investments for insurance and savings funds, and to a large class of people who have no detailed knowledge of investment principles.

"The subcommittee discovered in such sales gross misrepresentation of values and concealment of essential facts, as to value amounting to fraud, criminal in character.

"In many instances, investors were induced to exchange hard-earned savings of a lifetime for 'securities' which were not worth the paper on which they were engraved or printed."

In discussing a blue sky law for the District of Columbia, Congressman Daniel A. Reed, of New York, made the following statement in the House of Representatives: 10

"A group of financial bandits, actuated by selfish motives and with no regard for the welfare of the Nation have driven the public into a frenzy of fear and despair for no other purpose than to profit by it. Recent disclosures in financial circles have shaken public confidence to its very foundations. The financial pirates, who have fleeced the public out of billions of dollars, now hope to obscure their iniquities by directing public attention elsewhere."

Estimates of the amount of questionable securities sold to the American public each year vary considerably because of the difficulty of collecting accurate statistics. It is evident, however, that a considerable percentage of new capital issues are fraudulent.

The entrance of the general public, untrained in business principles and perplexed by the magnitude of modern business organizations, into the investment field has brought about some complications of a major character. "Public policy demands that the savings of the poor be secure, because in hard times these savings are the first line of defense against destitution, doles, communist propaganda and many other painful and dangerous effects." 11

The doctrine of caveat emptor (let the buyer beware) of the old common law is not applicable to modern conditions.12 Both the Federal and State Governments protect the public from the unscrupulous by regulating the sale of many articles. As indicated by the common law, from time immemorial, persons with funds to invest were considered capable of determining the soundness of business ventures but recent developments in the field of business have been so rapid and so gigantic that even persons trained in one field are incapable of determining values in a related business. Even trained accountants are unable to determine, without detailed investigation, the intrinsic value of securities of corporations 7 William L. Stoddard, p. 199.

• Hearing before the Committee on the Judiciary, U.S. House of Representatives, 66th Cong., 1st sess., on H.R. 188, p. 7. S.Rept. 412.

10 Congressional Record, May 23, 1932, p. 11262.

11 The Irrepressible Conflict, p. 28, David C. Coyle.

12 London Fiancial News, May 18, 1932, The Law and Holding Companies.

whose property and activities extend into many States and foreign countries. Numerous court decisions have emphasized the need for clear, simple financial statements which may be understood by the layman.13 Banks and bond houses offering securities to the public have felt the need of protecting themselves against loss by including in their advertisements of securities that, while they believe the statements of the issuing company to be correct, they do not guarantee their accuracy.14

Nearly all of the States of the Union have passed laws regulating the sale of securities.15 These laws have resulted in the suppression of many fraudulent securities and have saved the public untold sums of money. There are many differences in the laws, however, and until some general Federal law is enacted unscrupulous persons may continue their dishonest practices in one State or another.16

The rapid growth of investment trusts, industrial holding companies, and similar financial supercorporations has accentuated the need for some Federal legislation of a general character which, while in no way interfering with sound honest financing of business enterprises, will protect the investing public.17 Although such protection will require legislation somewhat divergent from laws now on the statute books there is ample precedence for such a measure.18

The enactment of the Sherman Act to prevent agreements in restraint of trade by gigantic corporations, the various transportation acts to hold in check the railroad systems of the country and secure equality of benefits to all users, the regulation of banks and savings institutions by such measures as the McFadden Act limiting branches to the municipal homes of parent corporations, the regulation of public utilities, all have had to be added to the law to meet changing conditions.19 According to two recent writers,20 the translation of perhaps two thirds of the industrial wealth of the country from individual ownership to ownership by the large, publicly financed corporations vitally changes the lives of property owners, the lives of workers, and the methods of property tenure.

LEGAL ASPECTS OF BLUE SKY LAWS

Early abuses of corporate privileges.—The abuse of the privileges and immunities created by incorporation, in using them to mulct an uninformed public through the sale of shares in enterprises of little or no value, is by no means of recent origin though the methods employed have undergone considerable change and the magnitude of the operations has increased many times. As early as 1720 the prospectus of the South Sea boom in England advertised a company organized "for carrying on an undertaking of great advantage but nobody to know what it is". More than 200 years later, supposedly sophisticated Americans are wasting billions of dollars in the purchase of shares in enterprises with no more information concerning the important facts than those earlier British "investors" had concerning the South Sea project.

13 "I am further of opinion that directors, shareholders, and incidentally, courts, should have a clear, explicit presentation of the accounting facts relating to a corporation in form and language, which in accord. ance with common sense, will enable the ordinary reader without hiring a technical interpreter, to determine the actual state of the company's business, prospects, and value."-Common Pleas Judge David G. Jenkins, Youngstown, Ohio; Youngstown Sheet & Tube Co. v. Bethlehem Steel Co. National Petroleum News, Jan. 7, 1931.

14 Senator Hiram Johnson, Congressional Record, Mar. 15, 1932. 15 Manual of Securities Laws and Service, Leonard L. Cowan. by National Conference on State Laws. See prefatory note, p. 3. 16 Congressman E. T. Taylor, of Colorado: Hearings before the 188, proposed Federal blue sky law, p. 7.

Uniform Sales of Securities Act drafted
Blue Sky Laws, Reed and Washburn.
Committee on the Judiciary on H R

17 The investment trust and those kindred financial organizations usually grouped under that headholding and finance and security companies of all sorts-are reaching out in all directions for the posession of industrial and financial securities and they will, unless checked, take American industry out of the hands of its industrial leaders and put it into the hands of promotors.-John T. Flynn, Investment Trusts Gone Wrong, p. 11. Regulation of Stock Ownership in Railroads, H.Rept. 2789, p. 10, testimony of Interstate Commerce Commissioner Joseph B. Eastman.

18 Felix Frankfurter, The Public and its Government, pp. 49–51.

19 F. M. Sackett, Senator from Kentucky, Exploitations of Finance Which Call for New Line of Legislative Defense, Trust Companies, November 1929.

20 Berle and Means, The Modern Corporation and Private Property.

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21 Finlason's Report of the Case of Twycross v. Grant, published in London during 1877, contains the following interesting comments: "When, half a century ago, the principle of association was largely applied to commercial enterprises, it became, as all good things are liable to be, grossly and lamentably abused, and the first fault was excess. * 'However absurd', observes the historian, 'many of these schemes to were, the shares of some enormous premiums, especially in foreign mines,' 'People had so much money they did not know what to do with it and so fell an easy prey to artful schemes.' It seems incredible, but such was the fatuity of a reformed Parliament in dealing with such subjects, the Joint Stock Companies Act positively allowed a company to be formed, registered, and incorporated by the mere subscription of seven persons for a single share each". Blue Sky Laws. R. R. Reed, p. 1.

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169692-33-21

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.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 Árkansas, 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.2 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.

TYPES OF BLUE SKY LAWS

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:

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 43 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.

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