Dude, where’s my enforcement action?

According to the SEC’s order, the sale of more than 10,000 NFTs for approximately $800 each represented an unregistered offering of securities.

The regulator said the promotional campaign leading up to the offering touted the ability of investors to profit by selling their NFTs in the secondary market, and that the tokens paid a 2.5% royalty to the company for each secondary market trade.

“Regardless of whether your offering involves beavers, chinchillas or animal-based NFTs, under the federal securities laws, it’s the economic reality of the offering — not the labels you put on it or the underlying objects — that guides the determination of what’s an investment contract and therefore a security,” said Gurbir Grewal, director of the SEC’s enforcement division, in a release.

“Here, the SEC’s order finds that Stoner Cats marketed its knowledge of crypto projects, touted that the price of their NFTs could increase and took other steps that led investors to believe they would profit from selling the NFTs in the secondary market. It’s therefore hardly surprising, as the order finds, that Stoner Cats sold its entire supply of NFTs in just 35 minutes, generating proceeds of over $8 million, most of which were then resold — not held as collectibles — in the secondary market within months,” he added.

Without admitting or denying the SEC’s findings, Stoner Cats agreed to a cease-and-desist order and to pay a civil penalty of US$1 million. It also agreed to destroy all NFTs in its possession.

The regulator’s action was criticized by a couple of the SEC’s commissioners, Hester Peirce and Mark Uyeda.

In a joint statement, they dissented from the settlement, suggesting that applying the investment contract test in this case represents regulatory overreach.

“Were we to apply the securities laws to physical collectibles in the same way we apply them to NFTs, artists’ creativity would wither in the shadow of legal ambiguity. Rather than arbitrarily bringing enforcement actions against NFT projects, we ought to lay out some clear guidelines for artists and other creators who want to experiment with NFTs as a way to support their creative efforts and build their fan communities,” they said.

They suggested that the activity is akin to crowdfunding, rather than an issuance of securities.

“While updated for the digital age, the Stoner Cats NFTs are not that different from Star Wars collectibles sold in the 1970s,” they said.

Peirce and Uyeda said some NFTs may represent securities, but in applying securities laws, the commission must take care to preserve the ability of artists to sell their work, build a fan base, and involve that fan base in future creative endeavours.

“That is what was happening in the 1970s with Star Wars, and that is what was happening here with Stoner Cats,” they said.

“The Stoner Cats NFT purchasers received what they paid for — a still image of a character from the series, access to all six episodes of the Stoner Cat series, and the excitement of being part of a popular phenomenon. The commission’s application of the securities laws here makes little sense and discourages content creators from exploring ways to harness social networks to create and distribute content,” they said. “More generally, it contributes to the legal ambiguity facing artists, writers, musicians, filmmakers, and others seeking to build a loyal, engaged following.”

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