In recent weeks, the SEC announced two separate enforcement actions against creators of non-fungible token (NFT) projects, alleging that the offering and sale of their NFTs violated the registration requirements under applicable securities laws. This marks the first (and second) time that the SEC has charged a company with securities violations in connection with the unregistered sale of NFTs as opposed to fungible tokens such as cryptocurrencies.

First, on August 28, 2023, the SEC brought charges against Impact Theory, LLC, which sold over 12,000 NFTs known as “Founder’s Keys” to hundreds of purchasers from October to December of 2021. In taking the position that Founder’s Keys are “crypto asset securities,” The SEC focused on the fact that Impact Theory “encouraged potential investors to view the purchase of a Founder’s Key as an investment into the business,” including by stating it was “trying to build the next Disney” and would deliver “tremendous value” to Founder’s Key purchasers if successful. Impact Theory agreed to a settlement whereby, among other things, it will pay over 6 million dollars in penalties, establish a “Fair Fund” to return monies to aggrieved NFT purchasers, destroy all Founder’s Keys in its possession, and eliminate any royalty that it may otherwise receive from future sales of Founder’s Keys on the secondary market.

Next, on September 13, 2023, the SEC charged Stoner Cats 2, LLC (SC2) with conducting an unregistered securities offering after selling 10,420 Stoner Cats NFTs in July of 2021 to finance an animated web series. The Commission highlighted that as part of SC2’s marketing campaign, SC2 touted “specific benefits” of owning the NFTs, including the option to resell them on the secondary market, and “emphasized its expertise as Hollywood producers, its knowledge of crypto projects, and the well-known actors involved in the web series” (which include Ashton Kutcher, Mila Kunis, and Chris Rock, among others). According to the SEC, these actions lead “investors” to “expect profits because a successful web series could cause the resale value of the Stoner Cats NFTs on the secondary market to rise.” As part of its settlement with the Commission, SC2 agreed to pay a penalty of one million dollars, establish a “Fair Fund” to return monies to aggrieved NFT purchasers, and destroy all Stoner Cats NFTs in its possession.

In an obvious swipe at the profile-picture NFT (or PFP) craze of recent years, Director of the SEC’s Division of Enforcement, Gurbir Grewal, stated in connection with the action against SC2 that, “Regardless of whether your offering involves beavers, chinchillas or animal-based NFTs, under the federal securities laws, it’s the economic reality of the offering – not the labels you put on it or the underlying objects – that guides the determination of what’s an investment contract and therefore a security.”

Dissenting statements from Commissioners Hester Pierce and Mark Uyeda in both cases, however, showcase internal conflicts within the SEC and the possibility that the Commission may take a different stance in the future.

For example, Commissioners Piece and Uyeda note that Founder’s Keys “were not shares of a company and did not generate any type of dividend for the purchasers.” They further pointed out that Impact Theory had already offered to repurchase Founder’s Keys from unhappy consumers in December 2021 and August 2022, and questioned whether an enforcement action was warranted under these circumstances “even if the NFT sales fit squarely within” the definition of an investment contract or security.

Regarding the action against SC2, the dissenting Commissioners argue that “Stoner Cats NFTs are not that different from Star Wars collectibles sold in the 1970s” (i.e., “Early Bird Certificate Packages” redeemable for future Star Wars action figures and membership in the Star Wars fan club). They caution that the SEC “must take care to preserve the ability of artists to sell their work, build a fan base, and involve that fan base in future creative endeavors.” Finally, they claim that Stoner Cats NFT purchasers received exactly what they paid for—“a still image of a character from the series, access to all six episodes of the Stoner Cat series, and the excitement of being part of a popular phenomenon.”

Importantly, neither Impact Theory or SC2 admitted any wrongdoing, and neither of these cases were adjudicated. This means there is still uncertainty surrounding whether and when the sale of NFTs constitutes an illegal unregistered securities offering. As we’ve blogged about previously, at least one class action lawsuit against NFT creators Dapper Labs may shed light on this issue in the near future.

Overall, in the meantime, these enforcement actions highlight that the ways in which NFTs are marketed may be the determining factor in whether they are securities subject to registration with the SEC. Going forward, NFT creators should avoid marketing campaigns and other public statements suggesting that the value of their NFTs may increase as the company becomes more successful.

You can read the SEC’s press releases on Impact Theory here and SC2 here.