In its first enforcement action involving NFTs, the SEC focused on issuer marketing that promised massive returns on investment and platform creation.
On August 28, 2023, the Securities and Exchange Commission (SEC) issued a cease and desist order (the Order) against Los Angeles Media and Entertainment Company (the Company) for an unregistered securities offering related to the sale of $29.9 million. Value of non-fungible token (NFT)[1], The company agreed to a settlement that included paying $5 million in restitution, an additional $1 million in fees and penalties, and ceasing to violate the Securities Act of 1933. Notably, the settlement does not cover allegations of fraud.
Main facts and conclusions
The SEC alleges that from October 13, 2021, to December 6, 2021, the company offered its NFTs (called Founder Keys) to the public. It sold 13,921 NFTs and raised $29,896,237.16 worth of ether (ETH) from hundreds of “investors,” including individuals, across the United States.
Public information about the company and founder’s keys reveals a long list of benefits promised to NFT holders. These benefits included “the right to disseminate a digital collectible that would have additional utility.” [Company’s] ecosystem,” access to future content, the right to purchase other NFTs at discounted prices, access to weekly meetings, and “university” type courses conducted by company representatives. Did the SEC consider any of these proposed benefits in its analysis? It is not clear whether the finding is significant. Rather, the order focused primarily on the following statements by the company or its founder:
- Several media channels (including the company’s Discord, YouTube and other social media channels) pointed to the NFT investment opportunity as having the potential for large “upside for small risk”.[T]There is no investment right now that has such an amazing risk-to-reward ratio”)
- Compare NFTs to “joining” a major media company before the company has created its own globally recognizable intellectual property, or making an early investment in a pioneering social network (“it’s a fast-growing company”). like offering to invest when they’re Series A.”)
- Said buying an NFT was essentially an “investment” [the Company] Team”
- States that it will use the proceeds from the NFT offering to fund platform expansion, project development and hiring additional personnel (“we’ll just keep stocking”) [the NFTs] with value.”)
- It states that these “NFTs are the mechanism by which communities will be able to derive economic value from the development of the company they support”.
- The company’s founder’s own efforts in maximizing economic value and return on investment for buyers are guaranteed (“I would make sure that we make something that, by any reasonable standard, gives people a crush of value.” wali, hilarious amount.”)
Separately, the SEC noted that in December 2021 and August 2022, the company took “remedial actions” — specifically repurchasing 2,936 KeyNFTs, which the SEC said “returned approximately $7.7 million worth of ETH to investors.”
investment contract analysis
According to the SEC, “[b]Based on facts and circumstances. , , KeyNFTs were offered and sold as investment contracts and therefore securities in accordance with the prescribed tests SEC vs. WJ Howe Company328 US 293 (1946) and its progeny.” The SEC appears to have viewed this as a fairly straightforward matter Gary Plastics Wherein the marketing and promises made around the equipment led to the overall arrangement becoming an investment contract.[2] In the SEC’s view, the various statements cited above are due to the Company’s efforts to benefit purchasers.
treatment
The company agreed to the settlement without admitting or disclaiming any violation of (or waiver of) the registration provisions of the Securities Act of 1933. It agreed to pay a $500,000 fine, pay back $5,120,718.27 in ill-gotten gains (through the “Fair Fund” to pay back that money). buyers paid to obtain the NFTs), and pre-judgment interest of $483,195.90. It also further agreed to cease and desist violations of the Security Act and to destroy all contained NFTs in its possession or control.
Disagreement on SEC
Commissioners Hester Pearce and Mark Ueda released a statement following the order, saying they dissented in part because they “disagree with the application of.” be analysis.” The dissent did not specify where it differed from the majority, but emphasized that “the handful of Company and Purchaser statements cited in the order are not the type of promises that constitute an investment contract.” However, the dissenting commissioners focused more on the issue of enforcement priorities and the policy question of how NFTs should be treated generally:[E]Even though NFT sales fit perfectly here [the Howey Test]Does this set of facts warrant enforcement action?
He also asked a series of “tough questions” to spur policy discussion and development within the SEC. For example, given the fact-specific nature of each NFT offering, the dissent questions the value of this order as a precedent in other NFT cases, particularly with respect to the application of securities laws and prescribed remedies. It also asked whether the SEC views all previous NFT offerings as security offerings, and if so, whether the SEC will “provide specific guidance to those issuers on what they need to do to become compliant.” “
key takeaways
The order highlights that the focus will be on marketing and communications for the SEC with respect to NFT issuers, as they have been for other digital assets. As we have discussed earlier, NFTs are marketed as a Investment Because the expected appreciation of the NFT based on the maker’s efforts could affect the nature of the overall transaction and make it more likely that such a sale would be considered a securities transaction (for more information, see this Latham post).
The case was particularly notable in that the value of the NFTs at issue were marketed as being directly linked to the value of the company, which fits more conveniently within the traditional concept of an investment contract in which buyers are typically legally entitled to The unit has authority.
Source: www.lexology.com
