Media Company Fined for Unregistered NFT Offering
Commentary by Steven Lofchie
A media company settled charges for failing to register the sale of non-fungible tokens ("NFTs") under the Securities Act.
In an Order, the SEC stated that the company raised approximately $29 million from its sale of NFTs to "hundreds" of investors, some of whom were U.S. persons. The SEC found that the sales of NFTs were investment contracts that constituted securities pursuant to the test laid out in Howey. The SEC reasoned that the NFT purchasers had a reasonable expectation of receiving a future profit based on the company's "managerial and entrepreneurial efforts." The SEC concluded that the sale of the NFTs violated Securities Act Sections 5(a) and 5(c) ("Prohibitions relating to interstate commerce and the mails") "by offering and selling these securities without having a registration statement filed or in effect with the Commission or qualifying for an exemption from registration."
To settle the charges, the company agreed to (i) cease and desist from further regulatory violations, (ii) comply with the various undertakings set forth in the Order, (iii) disgorge $5,120,718 plus prejudgment interest of $483,196 and (iv) pay a civil money penalty of $500,000. The undertakings included that the company must (i) destroy any NFTs in its possession and (ii) eliminate any royalty from the NFTs.
Commissioner Statement
SEC Commissioners Hester M. Peirce and Mark T. Uyeda dissented, both as to the enforcement action and as to the remedies imposed. Ms. Peirce and Mr. Uyeda argued that the reliance of the SEC majority on Howey went beyond the bounds of the precedent. The Commissioners said that even if the company's NFT sales "fit squarely within Howey," an enforcement action is not warranted based on the fact that the "typical cure for a registration violation is a rescission offer."
In light of the enforcement action being the first NFT settlement for the SEC, the dissenting Commissioners questioned the logic of the undertakings in the settlement. They said that "this matter raises larger questions with which the Commission should grapple before bringing additional NFT cases." These include questions on:
- how to categorize NFTs for the purposes of applying securities laws to offers and sales;
- NFT-related guidance on securities laws;
- how recent legislative efforts to establish a crypto framework should inform the SEC's application of securities laws to NFTs;
- whether a securities law regime is suitable to ensure purchasers obtain necessary information before buying an NFT and, if it is, ways in which SEC registration should be curtailed to the "unique nature" of NFTs; and
- what restrictions should apply to secondary market sales of NFTs.
Commentary
The SEC enforcement action and the Commissioners' dissent raise fundamental questions on the appropriate use of regulatory power.
In this case, Commissioners Peirce and Uyeda appear to agree with the majority that the investors likely made an unwise investment decision and based that decision on inadequate information. They part ways with the majority when asserting that regulators should not exercise their power to correct misdeeds if the relevant laws do not give the regulators that authority.
One may presume that the SEC majority feels more comfortable in stretching the boundaries of the SEC's authority if it means serving the good (however the majority defines it). This view of the proper exercise of governmental power is by no means limited to the SEC majority. (See, e.g., "CFPB Director Chopra Previews Plans to Regulate Data Brokers," linking to a speech by the CFPB Director that suggests that the CFPB was open to being clever or aggressive in expanding its authority to right a wrong.) It's hard not to be sympathetic to this viewpoint. Who wants to say that an investor or consumer was wronged, but there is nothing to be done about it? Even if this position can be morally defended for a period, however, that period should not be indefinite.
Crypto assets are no longer novel products. The arguments that the SEC lacks the authority that it now routinely asserts are very reasonable. Further, it is very clear that the SEC has made no effort to answer the very reasonable questions that the dissenting Commissioners have posed, even though these questions (or ones like them) have been on the table for years.
If the SEC really wants to do the "right" thing as to digital assets, it must give real consideration as to whether it is accomplishing that goal by its current approach.