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05 September 2023
mayor brown
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In a published settlement of allegations dated August 28, 2023, the U.S. Securities and Exchange Commission (“SEC”) stated that non-fungible tokens (“NFTs”) issued by Impact Theory, LLC (“IMPACT”) were “securities.” The sale of those NFTs without registration under US federal securities law and without or in reliance on an exemption from registration requirements violated federal securities law.
This action highlights the SEC’s continued digital enforcement policy and marks the first time that the SEC has charged an NFT issuer with selling unregistered securities. There was also disagreement over agreement with the SEC’s action, with two SEC commissioners disagreeing with the findings.
What does this mean for NFT issuers and the market? In this legal update, we provide a snapshot of agreement and disagreement and draw some key findings for the NFT market.
background
Pursuant to the agreement, between October and December 2021, Impact will offer and sell NFTs called Founder’s Keys (“KeyNFTs”)1 and, in doing so, will raise approximately $30 million. Some key facts about NFTs and their offering, sales and marketing on a settlement basis:
- KeyNFTs were offered in three tiers (“Legendary,” “Heroic” and “Relentless”), and each tier of NFTs was offered at a different price range and had different features.2
- Impact marketed KeyNFTs through speaking engagements, social media and other channels. The SEC highlighted several Statements of Impact that focus on the potential increase in value and profit from KeyNFTs (more on that below).
- KeyNFTs are traded on various secondary markets, and Impact publicized that KeyNFTs can be bought and sold on two secondary market platforms. Impact received a 10% royalty from each secondary market sale.
Main facts, allegations and settlement
The SEC determined that Impact’s sale and related actions “invited potential investors to view the purchase of KeyNFTs as an investment in the business,” therefore constituting the offering and sale of investment contracts.
be test.3 Specifically, the Settlement Order focuses on a number of events and public statements that Impact anticipates will provide “tremendous value” to KeyNFT purchasers. The SEC cited specific statements and direct quotes from Impact, including the following:
- “If you’re paying 1.5 [ETH], you are going to get a much bigger amount than this. So nobody’s going to walk away saying, ‘Oh man, I don’t think I’ve found any value here.’”4
- “We’re going to invest that money in growth, in bringing on more team, building more projects, making sure that we’re only providing the very minimum of value.”5
- “Our goal is to ensure that as effect theory enriches [its founders] Enriched, just as our team at Impact Theory is enriched, so are you guys.”6
As part of the settlement, Impact accepted the SEC’s findings that the offering and sale of KeyNFTs constituted unregistered investment contracts in violation of Sections 5(a) and 5(c) of the Securities Act of 1933. The settlement includes a payment of more than $5 million. A civil money fine of $500,000, and a requirement to destroy all NFTs in Impact’s possession, and to modify the NFT smart contract to eliminate any future royalties Impact may receive from “future secondary market transactions”. Additionally, the SEC noted that Impact repurchased approximately $7.7 million of KeyNFTs from investors as part of remedial efforts prior to the settlement.9
Dissenting Commissioners’ Viewpoint
The settlement order was decided along party lines, with commissioners Hester Pearce and Mark Ueda refusing to impose a ban and issuing a statement saying that Impact Theory’s offering and sale of NFTs is an investment contract (” did not constitute “disagreement”. 10 Commissioners Pearce and Ueda shared the concerns expressed by other commissioners about the “promotion” in these markets, but also asked questions to both
be analysis in this instance as well as the nature of the penalty imposed. Decent analogized NFTs to the issue of watches, paintings, and other collectibles, arguing that the SEC does not take enforcement action against sellers of those tangible items, even when those sales are made with “vague promises of brand building and thus growth”. be associated with. [the products’]
resale value.”11 Dissent also rejected the commission’s findings regarding Impact’s public statements, stating that “[t]The handful of Company and Buyer statements cited in the order, while related, “are not the type of promises that constitute an investment contract.” 12 Commissioners Pearce and Ueda concluded their statement by calling on the Commission to issue guidance on possible interconnections. NFTs and securities law, in particular with respect to distinguishing between the wide range of rights that various NFT holders provide.13 Commissioners Pearce and Ueda focused on nine specific questions and areas that the SEC needs to address in NFT-related guidance. or should be addressed in making the rules.14
key takeaways
- effect theory This continues a long series of enforcement actions in which the SEC has considered statements made by digital asset teams and issuers in implementing its investment contract analysis. NFT issuers, digital asset protocols and token issuers should be clear that their public statements will be closely scrutinized by regulators – in particular, any reference to investment returns, economic value or profits accruing to token holders.
- The dissenting commissioners raised several open questions facing the NFT industry that they believe the SEC should address. Specifically, the Settlement Order fails to define which NFTs may fall within or outside the purview of the SEC. At this time, it does not appear that the SEC’s current approach will be influenced by the points outlined in the dissent.
footnote
1. Identification. On two
2. Identification.
3. Identification.
4. Identification. 3 o’clock.
5. Identification.
6. Identification. 3-4 hrs.
7. effect theory 7 o’clock; 15 USC § 77b(a)(1).
8. Identification. 6-7 hrs.
9. Identification. at 6.
10. NFTs and the SEC: Statement on the Impact Principle, LLC, sec.gov | NFTs and the SEC: Statement on the Effects Principle, LLC.
11. Identification.
12. Identification.
13. Identification.
14. Identification.
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