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  • L Misthos and M Bacina

US Regulation by Enforcement takes a Non Fungible Turn

The Securities and Exchanges Commission (SEC) has charged Impact Theory LLC for conducting an alleged unregistered offering of crypto-asset securities in the form of Non-Fungible Tokens (NFTs). Impact Theory sold approximately USD$30 million in Founder's Keys NFTs and agreed to a cease-and-desist deal with the SEC.

Under the announced settlement deal, Impact Theory will pay USD$6.1 million in penalties and other charges to the SEC and will destroy all the NFTs under its control. Additionally, the company will forfeit any royalties it received from the sales of these NFTs on secondary markets.

Interestingly, the SEC has cited the language used by the company as a potential trigger for enforcement. The SEC's press release, referring to the SEC order against Impact Theory from 2021, states that:

The order finds 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

Impact Theory is alleged to have told buyers that it was "trying to build the next Disney" and if successful this would deliver "tremendous value" to NFT purchasers. It appears in this instance that the SEC is sending a message to projects that purport to use puffery or strong language promising financial returns that they will be treated as if they are offering financial investments.

The news appears to be having a serious ripple effect in the NFT world.

Commissioners Hester Pierce and Mark Uyeda, released a dissenting statement disagreeing with the New York SEC's interpretation of the Howey analysis and its use to charge Impact Theory. Ms Pierce and Mr Uyeda argue that the NFTs were not remotely shares in a company and did not pay dividends, such that they should not be treated as securities:

We understand why the Commission was concerned about this NFT sale. Even through we believe strongly that adults should be able to spend their money as they choose, we share our colleagues' worry about the type of hype that entices people...

But that:

This legitimate concern, however, is not a sufficient basis to pull the matter into our jurisdiction.

The dissenting statement refers to companies that sell watches, paintings or collectibles and make vague promises about the increase in value, which are not subject to similar enforcement by the SEC, and rightly infers that NFTs are far more similar to these products than traditional securities.

This dissent shows the difficulty some factions of the SEC are having with the classification of NFTs and the application of the Howey test to them in the US. Importantly, the dissenting Commissioners suggest a discussion about NFTs and recommended 9 questions for exploration:

  1. Non-fungible tokens are not an easy-to-characterize asset class, particularly because they can give the owner a wide array of rights to digital or physical assets. People are experimenting with a lot of different uses of NFTs. Consequently, any attempt to use this enforcement action as precedent is fraught with difficulty. Are there useful ways for the Commission to categorize NFTs for purposes of thinking about whether and how the securities laws apply to offers and sales?

  2. If the Commission were to craft guidance for NFT creators seeking to understand potential intersections with the securities laws, what questions would be helpful for us to address?

  3. How should recent legislative efforts to construct a framework for crypto inform SEC thinking about the application of securities laws to NFTs?

  4. Is a securities law regime best suited to ensure that NFT purchasers obtain the information they need before buying an NFT? What type of information do these purchasers want? Might other regulatory frameworks be more appropriate?

  5. If a securities law regime is best, how could SEC registration requirements be tailored to reflect the unique nature of NFTs? Would compliance with any requirements be prohibitively costly? If so, what alternative approaches would be more workable, but still achieve the Commission’s objectives of protecting investors and the integrity of the marketplace?

  6. Does this action indicate that the Commission generally views previous NFT offerings as securities offerings? If so, will the Commission provide specific guidance to those issuers describing what they need to do to come into compliance?

  7. What, if any, restrictions should apply to secondary market sales of NFTs that the issuer sold as the object of an investment contract?

  8. This settlement includes an undertaking by the issuer to destroy NFTs in its possession. What precedent does this set for future cases in which the NFTs at issue represent unique pieces of digital art or music?

  9. The settlement includes an undertaking to “[r]evise the smart contract(s) or any other programming code(s) or computer protocol(s) underlying the KeyNFTs to eliminate any royalty.” Given that one of the promising features of NFTs is the ability to reward creators with royalties every time an NFT they created is sold, what precedent does this set for future cases?

On that last point, the dissenting Commissioners might need to get up to speed on the issues around royalty enforcement (i.e. it's not occurring on a number of platforms). Many had considered NFTs to be, from a regulatory perspective, a far safer space than token sales, but the SEC appears to be playing some cards which suggest they consider the contrary position to be the case.


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