Members-Only Club Fined for Unregistered Offering of NFTs
Commentary by Rachael Hashmall
A members-only club settled SEC charges for conducting an unregistered public offering of crypto asset securities in the form of non-fungible tokens ("NFTs").
According to the Order, the firm raised $14.8 million by offering and selling approximately 1,600 NFTs to fund a members-only restaurant in New York City. The SEC found that the firm marketed the NFTs through its website, social media and various public interviews, in which they emphasized that the NFT value would appreciate based on the success of the restaurant. The SEC found that the NFTs were immediately traded on secondary markets, with early resales generating substantial profits for some investors. The SEC said that later, the value of the NFTs had sharply declined, with the price of some NFTs dropping by as much as 74 percent from their original sale price.
The SEC determined that, under the Howey test, these NFTs qualified as investment contracts, and therefore securities, because investors had a reasonable expectation of profits based on the entrepreneurial and managerial efforts of the club and its principals. The SEC cited statements made by the firm, which encouraged investors to expect gains from reselling or leasing their NFTs. As a result, the SEC found that the firm violated Securities Act Sections 5(a) and 5(c) ("Prohibitions relating to interstate commerce and the mails") by failing to register the offering.
To settle the charges, the firm agreed to (i) cease and desist from further violations, (ii) destroy all remaining NFTs under its control, (iii) stop collecting royalties from secondary market sales and (iv) pay a $750,000 civil monetary penalty in installments.
In a dissenting statement, Commissioners Hester M. Peirce and Mark T. Uyeda criticized the Commission for its continued overreach into the cryptocurrency space. The Commissioners argued that "[t]he NFTs here are utility tokens, not securities," characterizing them as a means to provide concrete access to the club, which makes them more akin to membership passes than investments. Regarding the SEC's Howey test analysis, the Commissioners argued that the "holders of [the] NFTs had a reasonable expectation of obtaining in the future wonderful culinary experiences," not profits in the securities sense. They warned that stifling innovation in NFT projects, particularly creative ventures, risks harming the very people the SEC is meant to protect; "creative people should be able to experiment with NFTs without having to consult a high-priced tea-leaf reader—ahem, lawyer."
Commentary
Although Commissioners Peirce and Uyeda point out in their dissent that the NFTs were intended to serve as "utility tokens" (you couldn't eat at the restaurant without one), the point underscores the importance for issuers to monitor communications and public statements closely. The SEC took clear issue here with the various statements made by the issuer regarding the expectation of profits from selling the NFTs, spending 4+ pages of the Order pointing out specific examples of these statements on X, Discord, email, public interviews, etc.