Legal Foundations
Securities Laws
This presentation provides an in-depth exploration of securities laws, focusing primarily on private offerings relevant to startups and emerging companies and emphasize the critical nature of securities regulation, a highly regulated area often overlooked in startup discussions, and underscores the evolving landscape shaped by regulatory changes and enforcement trends.
Starting with the foundational Securities Act of 1933, which was enacted to prevent fraud and ensure transparency in securities transactions, the program explains the central legal framework governing securities sales in the U.S.: every offer and sale must be either registered with the Securities and Exchange Commission (SEC) or qualify for an exemption. Registration involves detailed disclosures and ongoing reporting, primarily for public offerings, whereas private offerings rely heavily on exemptions such as Regulation D, Regulation CF (crowdfunding), and others.
Regarding the definition of a security, the Howey Test determines whether a transaction involves a security based on four factors: investment of money, common enterprise, expectation of profit, and reliance on the efforts of others. There has been a broad and sometimes ambiguous application of this test, especially in the context of emerging asset classes like cryptocurrencies.
The presentation then outlines key exemptions under Regulation D, notably Rule 506(b) (no general solicitation, accredited investors plus up to 35 sophisticated non-accredited investors) and Rule 506© (permits general solicitation but requires all investors to be accredited and verified). Royse also discusses Regulation CF, which allows companies to raise capital from the general public through SEC-registered crowdfunding portals, albeit with investment limits and disclosure requirements.
State securities laws, or “blue sky” laws, add another layer of complexity, as states often require notice filings, fees, and impose anti-fraud provisions even when federal exemptions apply. California’s 25102(f) exemption is highlighted as an example of a state-level accredited or sophisticated investor exemption with specific conditions.
Royse addresses other crucial topics including broker-dealer laws, which regulate who can be compensated for raising money, resale restrictions like Rule 144, tender offer rules, and specific exemptions that allow private companies to issue stock or options to employees (Rule 701).
The evolving regulatory approach to cryptocurrencies and digital assets is a significant focus. Royse discusses the SEC’s recent three-prong framework for determining whether crypto tokens are securities, contrasting decentralized cryptocurrencies like Bitcoin with tokens controlled by a founding team. He notes enforcement actions and the potential impact of pending legislation such as the Clarity Act, which may reclassify many digital assets as commodities rather than securities, providing regulatory clarity.
Finally, Royse underscores the importance of avoiding securities fraud under Rule 10b-5, emphasizing the high standard of disclosure required to protect investors and avoid legal liability. He concludes by reminding startups to take securities laws seriously, as violations can result in severe consequences including criminal penalties.
Highlights
[04:00] Overview of the Securities Act of 1933 and its role in preventing fraud and promoting transparency in securities transactions.
[06:00] Explanation of the Howey Test for defining a security and its broad application, especially relevant to crypto assets.
[09:30] Key exemptions under Regulation D, focusing on Rule 506(b) and 506©, including accredited investor definitions and solicitation rules.
[12:00] Discussion on Regulation CF (crowdfunding), its evolution, and how startups can raise capital through online platforms with public participation.
[21:40] Detailed criteria for accredited investors and proposed legislative changes to expand investor access through financial sophistication exams.
[30:40] Broker-dealer law challenges related to finders and transaction-based compensation, including ongoing regulatory proposals to ease restrictions.
[53:50] SEC’s new framework for cryptocurrency regulation and the ongoing evolution of crypto assets under securities laws.
Key Insights
[04:09] Securities Act of 1933: Foundational Protection Against Fraud
The 1933 Act created the foundation for modern securities regulation, addressing the information asymmetry between issuers and investors by mandating detailed disclosures. This historical context highlights why transparency remains central to securities law, especially critical in startup financing where investors rely heavily on issuer-provided information.
[06:00] Howey Test: A Flexible but Broadly Applied Security Definition
The Howey Test’s four-part criteria provide a flexible framework for determining what constitutes a security. Its broad interpretation allows regulators to classify unconventional investments—including many crypto tokens—as securities, underscoring the test’s continuing relevance and the need for startups to carefully evaluate their offerings under this standard.
[09:30] Regulation D Exemptions Balance Investor Protection and Capital Formation
Rule 506(b) allows private placements with no general solicitation but permits some sophisticated non-accredited investors, emphasizing a cautious approach to investor inclusion. Rule 506© permits general solicitation but requires strict accredited investor verification, reflecting a regulatory balance between broader fundraising access and investor protection.
[12:00] Regulation CF Democratizes Startup Investment but Imposes Limits
Crowdfunding under Regulation CF opens startup investing to the general public, lowering the barrier for small investors to participate. However, investment caps and required disclosures prevent abuse, while the growth of crowdfunding platforms demonstrates the maturation of this capital-raising avenue, now a viable complement to traditional funding rounds.
[21:40] Accredited Investor Definition: Wealth as a Proxy for Sophistication, but Change is Coming
The current reliance on income and net worth as proxies for investor sophistication is outdated, excluding many financially savvy individuals. The proposed Equal Opportunity for All Investors Act (2025) aims to modernize this by allowing investors to qualify through a financial literacy exam, potentially broadening access and reducing reliance on wealth-based criteria.
[30:40] Broker-Dealer Restrictions on Finders: A Significant Compliance Challenge
Strict rules requiring broker-dealer registration for anyone receiving transaction-based compensation create barriers for startups seeking capital introductions. The ongoing regulatory review and potential tiered exemptions could ease this burden, but for now, companies must navigate these complex rules carefully to avoid enforcement risk.
[53:50] SEC’s Crypto Framework: Toward Regulatory Clarity in a Rapidly Evolving Market
The SEC’s three-prong test for crypto tokens—considering investment intent, utility, and control—reflects an effort to provide clearer guidelines after years of enforcement uncertainty. The pending Clarity Act signals a potential shift by treating many digital assets as commodities, offering startups and investors a more predictable regulatory environment.
[57:00] Anti-Fraud Provisions and Disclosure Obligations Are Paramount
Rule 10b-5 imposes a low bar for liability, requiring issuers to disclose all material facts to investors. This “seller beware” principle is critical for startups to understand, as failure to disclose relevant information can lead to rescission rights or lawsuits, even absent intentional fraud.
[42:00] State Blue Sky Laws Remain an Important Consideration Despite Federal Preemption
Even when federal exemptions apply, states retain anti-fraud enforcement and require filings and fees. California’s rigorous enforcement and filing penalties exemplify the ongoing risks startups face in multi-jurisdictional offerings and the importance of compliance beyond federal law.
[40:00] Integration Rules Prevent Circumvention of Offering Limits
Multiple simultaneous offerings can be “integrated” for regulatory purposes, potentially invalidating exemptions if not carefully structured. Startups must plan timing, investor types, and solicitation methods to avoid unintended aggregation of offerings that could trigger registration requirements.
[50:00] Rule 701 Enables Equity Compensation Without Full Registration Burdens
To incentivize employees and service providers, Rule 701 offers a streamlined exemption for issuing stock or options. While limits and disclosure requirements exist, this rule facilitates startup growth by enabling equity-based compensation without triggering complex securities registration.
Conclusion
This presentation provides a comprehensive, practical guide to navigating the complex world of securities laws applicable to startups. It emphasizes regulatory compliance as both a legal obligation and a strategic necessity to protect investors, ensure fundraising success, and avoid costly enforcement actions. The discussion of exemptions, investor classifications, broker-dealer rules, and the evolving treatment of digital assets equips founders, investors, and advisors with critical knowledge to operate effectively within the securities regulatory framework.