N.J. State Regulators Have Authority to Block Out-of-State Sales of Non-N.J. Registered Securities
Ruling on the constitutionality of the state regulation of the sale of securities, the Third Circuit Court of Appeals held that the enforcement of a New Jersey Blue Sky law to prohibit an in-state broker from selling securities to out-of-state customers was not an excessive burden on interstate commerce and thus did not violate the dormant commerce clause of the United States Constitution. In so holding, the Third Circuit joined the overwhelming majority of courts that have upheld state Blue Sky laws against challenges under the commerce clause.
Factual Background
In 1996, A.S. Goldmen & Co. ("Goldmen"), a New Jersey broker-dealer with its sole office in New Jersey, underwrote the initial public offering ("IPO") of Imatec, Ltd. ("Imatec"), a Delaware Corporation located in New York. According to the prospectus, Goldmen also owned the Imatec shares that would be offered to the public. Goldmen filed a registration statement for Imatec with the Securities and Exchange Commission, and also attempted to register the offering in New Jersey. The New Jersey Bureau of Securities (the "Bureau"), however, expressed its intent to block the offering in New Jersey because of Goldmen's past questionable business practices and the riskiness of the investment, which it believed could lead to abusive and manipulative business practices. Goldmen then entered into a Consent Order with the Bureau, pursuant to which Goldmen was permitted to sell the securities from New Jersey either on an unsolicited basis or to certain financial institutions or other broker-dealers. Under the Consent Order, however, Goldman was denied an exemption under the New Jersey Securities Act (the "Act") that would have allowed it to solicit members of the public to purchase Imatec in the secondary market. Goldmen thus withdrew its application to register the Imatec offering in New Jersey.
After registering the offering in 16 other states, Goldmen commenced the IPO of Imatec securities and solicited sales only from individuals outside of New Jersey, using the telephone from Goldmen's New Jersey office. After the entire offering had been sold, Goldmen then continued to buy and sell the securities in the interdealer market from its New Jersey office. When the Bureau learned of the IPO, it notified Goldmen that the sales violated both the Consent Order and Section 60 of the Act, which makes it unlawful for any security to be offered or sold in New Jersey unless the security is registered with the state authorities, is exempt under that Act or is a "federal covered security" as defined under the Act. The Bureau issued a Cease and Desist Order prohibiting Goldmen from selling Imatec securities "in or from the State of New Jersey to any members of the public."
Goldmen immediately sought declaratory relief in United States District Court for the District of New Jersey, claiming that Section 60 violated the commerce clause of the United States Constitution by authorizing the Bureau to block the sale of securities to non-New Jersey purchasers. The district court decided in favor of Goldmen, holding that "[t]o allow the Bureau to preclude consumers in other states from receiving solicitations to purchase securities which their own state regulators have deemed appropriate for purchase is, in essence, to allow the Bureau to substitute its own regulatory judgment for that of other states." The district court thus concluded that the New Jersey law imposed an excessive burden on interstate commerce -- especially in the absence of any allegations of fraud on the part of Goldmen.
The Third Circuit's Ruling
On appeal, the Third Circuit reversed. The Third Circuit acknowledged that the commerce clause authorizes courts to invalidate state regulations when the extraterritorial impact of those regulations has the practical effect of controlling conduct beyond the boundaries of the state. The Third Circuit also recognized, however, that states are permitted to regulate the in-state components of interstate transactions when the regulation furthers legitimate state interests. In light of these two competing considerations, the Court conducted a two-part inquiry into the constitutionality of the New Jersey regulation.
Territoriality
The Third Circuit first addressed the "territorial scope of the transaction that the state law seeks to regulate" to determine whether such transaction occurred "wholly outside" of New Jersey. The Court found that the telephone solicitations and sales by a broker located within New Jersey to customers located out-of-state could not be said to occur "wholly outside" of New Jersey. Rather, "elements of the transaction occur in each state, and each state has an interest in regulating the aspect of the transaction that occurs within its boundaries." The Court thus reasoned that Section 60 allows New Jersey to regulate its "half" of the transaction.
Legitimate In-State Interests
The Third Circuit next considered whether the statute reasonably furthered a legitimate state interest. The Court rejected Goldmen's claim that New Jersey did not have a legitimate interest in regulating non-fraudulent sales of securities to out-of-state residents. First, the Third Circuit held that New Jersey has an interest in protecting the reputations of legitimate New Jersey securities issuers. As the Court noted, such issuers would suffer by association if "suspect" firms selling securities to out-of-state buyers were allowed to operate within the state. Second, the Court held that "[r]egulating in-state offers to out-of-state buyers also serves New Jersey's interests by protecting New Jersey residents from dubious securities that enter the state in the secondary market." Because secondary transactions are not subject to a filing requirement, the Court reasoned that the state's most effective means of preserving the integrity of its secondary markets would be to prevent questionable IPOs.
Since at least part of the securities transaction occurred within New Jersey, and since Section 60 was furthering legitimate state interests, the Third Circuit held that New Jersey's Blue Sky law did not violate the commerce clause of the United States Constitution. In dissent, Judge McKee countered that in the absence of fraud, New Jersey's interest in regulating a dealer that sold securities exclusively to out-of-state customers was not sufficiently grave to survive scrutiny under the commerce clause. Unproven and unalleged conduct on the part of Goldmen, the dissent continued, could not serve as a justification for burdening interstate commerce.
A.S. Goldmen & Company, Inc. v. New Jersey Bureau of Sec., 163 F.3d 780 (3d Cir. 1999).