NFTs
Are NFTs Securities Offerings? Two Artists Sue the SEC to Find Out
‘Song-A-Day’ Man artist Jonathan Mann and law professor Brian Frye have sued the SEC to help provide regulatory clarity for digital artists using blockchain technology and NFTs.
Posted on July 29, 2024 at 12:26 pm EST.
The cryptocurrency industry has been on the offensive against the SEC lately, and a new lawsuit filed by NFT artists follows suit.
On Monday morning, two artists — musician Jonathan Mann, also known as “Song a Day Mann,” and conceptual artist Brian L. Frye — filed a lawsuit complaint against the SEC wanting to know in advance whether the art they create using NFTs — visual art, music or videos — will be considered a digital asset before incurring prohibitive legal bills, SEC fines or even having to destroy their artwork.
The lawsuit, which seeks declaratory and injunctive relief against “unlawful enforcement actions” by the SEC, aims to stop the agency from doing what it has done so far with cryptocurrencies: bringing enforcement actions against cryptocurrency participants after the fact, rather than setting clear rules of conduct in advance.
“Should artists have to ‘register’ their artwork before selling it to the general public? Should artists be forced to make public disclosures about the ‘risks’ of purchasing their artwork?” the complaint asks. “Should artists be required to comply with the federal securities laws, and the thousands of regulations and reams of interpretive guidance under them, just to offer their works to the public?”
Mann explained the reason for the lawsuit. “From my perspective, it is simply ridiculous to suggest, as I think [SEC Chair] Gary Gensler has, that’s because [my songs] exist on a blockchain, there is some kind of magical, ethereal process that they go through that suddenly turns them into a security.”
Frye agreed: “The SEC has not been adequately challenged… this complaint puts the ball in the SEC’s court and forces it to consider the implications of its arguments.”
Previous SEC Enforcement Actions Against NFT Projects
In late 2023, the SEC investigated whether NFTs could be considered securities. The SEC found in two cease and desist agreement cases—Impact Theory It is Stoner Cat Web Series—that the creators of these projects conducted unregistered offerings of NFTs.
The SEC has announced charges and a settlement with Impact Theory, LLC, a media and entertainment company, for allegedly offering and selling unregistered securities in the form of its Founder’s Keys (“KeyNFTs”) — the SEC referred to them as “purported NFTs.” The SEC’s argument was that Impact Theory made public statements urging potential investors to view the purchase of a KeyNFT as an investment that would increase in value. As part of the settlement, Impact Theory agreed to pay disgorgement of more than $5 million and interest and penalties of approximately $1 million, and to destroy all NFTs in its possession.
The SEC has charged and settled with Stoner Cats 2, LLC for allegedly offering and selling securities in the form of Stoner Cats NFTs that provided exclusive access to the series and future content, with a resale royalty imposed on each trade. The SEC found that the NFTs were offered as investment contracts, again citing the 2.5% royalty as well as statements made by SC2 staff “[tying] the success of the show to the value of the NFTs.” The settlement included a civil monetary penalty and, again, the requirement to destroy all Stoner Cats NFTs in possession.
In both Stoner Cats and Impact Theory, dissenting commissioners Hester Pierce and Mark Uyeda questioned the SEC’s application of the Howey test, writing, in response to Stoner cats“If we applied securities laws to physical collectibles the same way we apply them to NFTs, artists’ creativity would wither in the shadow of legal ambiguity. … The fact that there is money involved does not make NFTs securities.”
Read more: Mila Kunis’ Stoner Cats NFT Project Pays $1 Million to Settle SEC Charges
Seeking Clarity for NFT Artists
The complaint alleges that the Impact Theory It is Stoner cats The cases show that the SEC believes NFT creators are offering and selling securities when they sell NFT art accompanied by marketing and royalty statements, without making clear what circumstances make NFT sales offerings of securities. “Instead, the SEC has continued to obfuscate the issue,” the plaintiffs claim, citing the fact that Gensler himself admitted before the House Financial Services Committee that a physical Pokémon card is not a security, but that an NFT representing a physical card could be.
Watch more about royalties: Are NFT royalties the way forward? How to build a sustainable creator economy
The complaint gives the example of Taylor Swift selling concert tickets, albums, clothing, books, and even guitars that could be bought and sold on secondary markets at higher resale values the more famous she became. However, the complaint states, “It would be completely unreasonable for the SEC to treat Taylor Swift’s tickets or collectibles as securities.” And yet, the plaintiffs say, the SEC’s actions against Impact Theory and Stoner Cats raise questions about the limits of the SEC’s authority in the art world, so “[casting] a shadow over the digital art industry, artistic creation in America, and ultimately the American economy at large.”
Plaintiffs’ attorney Jason Gottlieb, who recently achieved a major turnaround against the SEC in Debt box ruling that required the agency to pay $1.8 million in legal fees, stated: “Art is not just an investment, right? It is literally a reflection of human creativity and the human spirit, and… works of art and artistic expression, of course, are protected by the First Amendment.”
Zack Shapiro, Managing Partner at Rains, commented on the strategy of filing a claim before Mann or Frye issued their NFTs. “This has proven to be, so far, a good strategy for the industry. … I think there’s no excuse for the lack of clarity.” [the SEC has] “The SEC has been very cautious about what has been given so far, and I think it reflects a deliberately hostile stance that the SEC has taken toward the digital asset industry. It has been a huge waste of time and money. They absolutely owe the industry better guidance,” Shapiro said.
