The Securities and Exchange Commission (SEC) recently brought its first enforcement action involving non-fungible tokens or NFTs. The charges signal that the SEC is likely ramping up its efforts to police the marketplace.
Explosion of NFT Marketplace
The popularity of NFTs has skyrocketed in recent years. NFTs are generally defined as unique digital identifiers that cannot be copied, substituted, or subdivided and are recorded in a blockchain. They can be used to certify the authenticity and ownership of various digital assets, each with specific rights associated with it. Once created, NFTs are listed on an NFT marketplace where they can be sold or traded under “smart contracts” that govern the transfers. NFTs are non-distributable and can’t be shared by multiple owners. NFTs have diverse applications due to their distinctive attributes. One of these applications is granting owners access to specific digital content linked to the NFT. They are particularly popular among collectors of art and memorabilia, with rare NFTs being auctioned for millions of dollars.
SEC Alleges NFTs Are Unregistered Securities
In its enforcement action against Impact Theory, LLC (Impact), the SEC alleged that NFTs issued by the media and entertainment company were “securities” under federal securities law. According to the SEC’s order, from October to December 2021, Impact Theory offered and sold three tiers of NFTs, known as Founder’s Keys, which Impact Theory called “Legendary,” “Heroic,” and “Relentless.” The SEC maintains that Impact Theory encouraged potential investors to view the purchase of a Founder’s Key as an investment into the business, stating that investors would profit from their purchases if Impact Theory was successful in its efforts.
According to the SEC, Impact Theory claimed that it was “trying to build the next Disney,” and, if successful, it would deliver “tremendous value” to Founder’s Key purchasers. Statements made to purchasers also included the following: “We’re going to be investing that money into development, into bringing on more team, creating more projects, making sure that we’re delivering just an obscene amount of value”; and “Our goal is to make sure that as Impact Theory is enriched, as [its founders] are enriched, as our team here at Impact Theory is enriched, that you guys are also enriched.”
SEC Rules NFTs as Securities: Impact Theory Faces $6.1 Million Penalty
Based on the foregoing, the SEC concluded that Impact “invited potential investors to view the purchase of a KeyNFT as an investment into the business,” thereby constituting the offer and sale of investment contracts under the Supreme Court’s test outlined in SEC v. W.J. Howey Co., 328 U.S. 293, 301 (1946). In Howey, the Court defined “investment contract” as a contract, transaction, or scheme in which (i) a person invests money in a common enterprise; (ii) with a reasonable expectation of profits; (iii) to be derived from the entrepreneurial or managerial efforts of others. The SEC has routinely applied this broad test to a wide range of investment schemes, including the sale of digital assets.
Under the SEC’s latest order against Impact, the agency found that the NFTs offered and sold to investors were investment contracts and therefore securities. Accordingly, Impact Theory violated federal securities laws by offering and selling these crypto asset securities to the public. Their offering was unregistered and did not qualify for an exemption from registration.
Impact Theory’s SEC Consent Order and Penalties
Impact Theory, without admitting guilt, consented to a cease-and-desist order issued by the SEC. The order established that Impact Theory had violated registration provisions outlined in the Securities Act of 1933. This violation led to a substantial financial penalty exceeding $6.1 million, encompassing disgorgement, prejudgment interest, and a civil penalty. The SEC order also establishes a Fair Fund to return monies that investors paid to purchase the NFTs. Impact Theory has also committed to three significant actions: First, they will destroy all Founder’s Keys they possess or control. Second, they will publish an order notice on their websites and social media channels. Lastly, they will forgo any royalties they might have received from future secondary market transactions involving the Founder’s Keys.
Notably, not all of the SEC’s commissioners supported the decision to bring an enforcement action against Impact. As Commissioners Hester Peirce and Mark Uyeda wrote in their dissent, the SEC doesn’t “routinely bring enforcement actions against people that sell watches, paintings, or collectibles along with vague promises to build the brand and thus increase the resale value of those tangible items.”
What’s Next?
The SEC’s broad interpretation of securities is guiding its efforts to set boundaries within the NFT market. This approach aligns with the agency’s regulatory stance. It comes as no surprise given the agency’s expansive perspective on securities. Expect more NFT enforcement actions soon. Understanding when federal securities laws require registration is crucial. As highlighted by its first enforcement action, entities should be particularly cautious when promoting NFTs as “investments” rather than products.
At this point, it is unclear whether the SEC will ultimately consider a rulemaking regarding NFTs. Entities and NFT investors should remain vigilant in monitoring this dynamic legal landscape. For any inquiries, it’s advisable to seek guidance from experienced legal counsel.
Stay ahead of NFT regulations! Stay informed and consult with our experienced counsel to navigate the evolving NFT landscape effectively.
What Business Owners Get Wrong Before Meeting a Litigation Attorney
What should you expect when meeting a litigation attorney about a business dispute? You should expect to describe the dispute in your own words, hand over the most important documents, flag any deadlines or immediate threats, and leave with a clearer picture of the problem, what information is still needed, and the likely next steps. […]
Arbitration vs. Litigation vs. Mediation: What New Jersey Businesses Should Know Before Signing a Contract
Arbitration resolves disputes privately before an arbitrator whose decision is usually final, while litigation resolves them in court with full rights of appeal. Whether a business ends up in arbitration or litigation is often decided when it signs the contract, long before any dispute arises. Key Takeaways When facing a contract dispute, carefully consider your […]
Can You Own Part of a New Jersey Business Without a Written Agreement?
Can you own part of a business in New Jersey without a written agreement? Yes, it is possible. Under New Jersey’s Uniform Partnership Act, a partnership can arise when two or more people carry on a business as co-owners for profit, whether or not they ever intended to form one. Ownership doesn’t necessarily depend on […]
Crisis-Proofing Your New Jersey Business: Building a Crisis Response Plan Before You Need One
For New Jersey businesses, crisis preparedness should be viewed as a legal and operational function, not simply an emergency-management exercise. A well-designed crisis response plan can help preserve evidence, protect confidential communications, meet reporting obligations, limit unnecessary exposure, and prevent an already difficult situation from becoming a larger legal problem. Key Takeaways A serious crisis […]
Monmouth County's Next Development Wave: What Developers and Investors Need to Know
Monmouth County is entering a significant new phase of development. For those looking to acquire property or undertake a new project, understanding the market opportunity is only the beginning. The more important question is whether a particular property can actually be developed as contemplated and what approvals, agreements, and other conditions will be required to […]
Are Your Conversations with AI Shielded from Discovery? Courts Are Split
Whether a client’s prompts to a generative AI tool and the documents it produces are protected from disclosure depends on the case type, who claims protection, and whether counsel was involved. In United States v. Heppner, a New York federal judge ruled that a criminal defendant’s communications with an AI platform were protected by neither […]
No Aspect of the advertisement has been approved by the Supreme Court. Results may vary depending on your particular facts and legal circumstances.
Sign up to get the latest from our attorneys!
Explore What Matters Most to You.
Consider subscribing to our Firm Insights mailing list by clicking the button below so you can keep up to date with the firm`s latest articles covering various legal topics.
Stay informed and inspired with the latest updates, insights, and events from Scarinci Hollenbeck. Our resource library provides valuable content across a range of categories to keep you connected and ahead of the curve.
Let`s get in touch!
Sign up to get the latest from the Scarinci Hollenbeck, LLC attorneys!
