Analysis of Resale Royalties in NFTs within SEC Securities Law Context

Up until fall 2023, there were minimal SEC enforcements or litigations concerning securities issues with non-fungible tokens (NFTs). However, a significant shift has occurred since then. Last fall, the SEC took action against two NFT projects for alleged violations of securities laws. Despite this, the SEC has not issued specific regulatory guidance or rules on how to treat NFTs as securities. Instead, the agency has opted for targeted enforcement against NFT projects. This year, the SEC has increased its enforcement efforts against digital asset marketplaces selling NFTs and other digital assets that are considered securities. In these cases, the SEC has pointed to the use of smart contracts triggering resale royalty payments to the NFT issuer as evidence supporting the classification of NFTs as securities.

In response to these actions, some potential targets for SEC enforcement have preemptively filed lawsuits challenging the agency’s jurisdiction over digital assets and seeking declarations that their digital assets are not securities. Additionally, private plaintiffs have also initiated civil lawsuits against NFT issuers and marketplaces.

Despite these challenges, the crypto industry is optimistic due to the anticipated increase in pro-crypto legislators in Congress under the new administration. Key appointments of pro-crypto individuals to leadership roles are seen as positive developments within the industry. Furthermore, a bill has been introduced in Congress to provide clarity on legal issues surrounding NFTs.

While waiting for further developments, individuals issuing NFTs or operating NFT marketplaces should remain vigilant in light of the recent regulatory and litigation activities. Evaluating potential risks and taking proactive measures can help avoid becoming the next target of an enforcement action or lawsuit.

For more in-depth information on recent developments and key takeaways, continue reading below.

Recent SEC Enforcements

On August 28, 2023, the SEC initiated cease-and-desist proceedings against Impact Theory, LLC, for alleged violations of registration requirements under the Securities Act of 1933. Impact Theory had sold $30 million worth of NFTs, making promises of value appreciation, leading the SEC to classify the NFTs as securities. Similarly, on September 13, 2023, Stoner Cats 2, LLC was charged with conducting an unregistered offering of crypto asset securities through NFT sales. The SEC also brought enforcement actions against Flyfish Club, LLC on September 16, 2024, over restaurant-related NFTs that were deemed securities.

NFT Artists File Preemptive Lawsuit Against the SEC

In July 29, 2024, two artists filed a lawsuit against the SEC challenging the agency’s authority to regulate NFTs. The artists sought a declaration that NFTs representing ownership of their works are not securities to prevent future enforcement actions.

The SEC Targets Digital Asset Marketplaces and the Marketplaces Fight Back

OpenSea and Crypto.com are among the platforms targeted by the SEC for allegedly selling NFTs that are considered securities. Legal actions have been taken by these platforms to challenge the SEC’s jurisdiction over their secondary-market sales of NFTs.

Class Action Lawsuits Alleging NFTs are Securities

Users have filed class action lawsuits against OpenSea and Nifty Gateway, claiming that their NFT listings misled buyers into purchasing unregistered securities. The SEC’s reliance on resale royalties as a factor in defining NFTs as securities has raised concerns in the industry.

The SEC’s Reliance on Resale Royalties in Finding NFTs to be Securities

The recent wave of SEC enforcements against NFT projects has highlighted the agency’s scrutiny of NFTs. The SEC’s analysis, particularly regarding resale royalties, has been met with criticism within the NFT community.

The NFT Act

In September, Congressman William Timmons introduced the New Frontiers in Technology Act (NFT Act) to address the legal and regulatory treatment of NFTs. The Act aims to provide clarification and guidance on the legal status of NFTs, offering a potential solution to the industry’s legal challenges.

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