The SEC’s First NFT Enforcement Action: SEC v. Impact Theory | Akin Gump Strauss Hauer & Feld LLP

Key Factors

• On August 28, 2023, the SEC charged Influence Concept, LLC, a media firm with an unregistered securities providing by way of its sale of NFTs. This marks the primary time that the SEC has introduced an enforcement motion involving the sale of NFTs as unregistered securities. This will sign a brand new effort by the SEC to carry the NFT market, which has exploded in reputation lately, into its jurisdiction.
• As a part of the settlement, the corporate agreed to pay $6.1 million in disgorgement and penalties. The corporate additionally dedicated to a number of noteworthy undertakings, together with the destruction of remaining NFTs inside its management and the revision of the code for the NFTs to forestall it from receiving any future royalties from secondary market transactions. The settlement doesn’t embrace admissions of fraud.
• Two Commissioners issued a written dissent to the settlement and inspired the SEC to supply the market with higher steerage on NFT regulation.

The Order

On Monday, August 28, 2023, the U.S. Securities and Change Fee (SEC) entered right into a settled enforcement motion (the “Order”) with Influence Concept, LLC, a media and leisure firm, charging it with violating Part 5 of the Securities Act in reference to its unregistered sale of “KeyNFTs.”¹ Influence Concept provided three “tiers” of non-fungible tokens (NFTs): “Legendary,” “Heroic” and “Relentless,” and every KeyNFT contained a digital graphic that featured a mix of 4 (out of fifty potential) symbols.² The Order doesn’t present element on whether or not KeyNFTs have the attributes of collectibles—a typical characteristic of NFTs. Somewhat, the SEC refers back to the KeyNFTs as “purported NFTs,” indicating that the KeyNFTs could also be completely different in type from others NFTs in the marketplace.³

The SEC discovered that Influence Concept bought the KeyNFTs to traders throughout america, elevating roughly $30 million of Ethereum in trade for the NFTs. The settlement is notable as a result of it marks the primary time that NFTs have been discovered as “funding contracts” underneath the check set forth by the Supreme Court docket in SEC v. W.J. Howey Co., 328 U.S. 293 (1946).⁴ Underneath the Howey check, an funding contract is any “contract, transaction or scheme whereby an individual [1] invests his cash [2] in a typical enterprise and [3] is led to count on earnings [4] solely from the efforts of the promoter or a 3rd get together.”⁵

The Order quoted greater than a dozen public statements by Influence Concept in assist of its discovering that KeyNFTs happy every component of the Howey check. For instance, the SEC discovered that:

• Aspect 1: Funding of Cash in a Enterprise. Traders understood that by way of their buy of the KeyNFTs they have been investing in Influence Concept’s enterprise. Influence Concept acknowledged its intention to develop into “the subsequent Disney,” telling potential traders that by buying the KeyNFTs that they had the equal alternative to getting “in on Disney once they have been doing Steamboat Willie.”⁶
• Aspect 2: Widespread Enterprise. Influence Concept publicly shared its view that KeyNFT traders, Influence Concept and Influence Concept’s founders would all be “enriched,” and that their potential earnings have been “all linked collectively.”⁷
• Aspect 3: Expectation of Income. Statements from the corporate and potential and precise purchasers of KeyNFTs mirrored that they clearly believed there could be a “affordable expectation of earnings” from their buy of the KeyNFTs. For instance, traders acknowledged that the explanation they purchased KeyNFTs was the expectation of future earnings, equal to “investing in Disney, Name of Obligation, and YouTube abruptly” or “handing 20$ [sic] to Mark Zuckerberg in his dorm room.”⁸
• Aspect 4: Income Derived from Efforts of the Firm. Influence Concept informed traders that the worth from the KeyNFTs could be derived from the corporate’s efforts and that it might use the proceeds from the KeyNFT providing for “improvement,” “bringing on extra workforce” and “creating extra tasks.”⁹

Previous to the settlement, as a part of remedial efforts, Influence Concept repurchased roughly $7.7 million price of KeyNFTs from traders.¹⁰ And as a part of the settlement, Influence Concept agreed to pay an extra roughly $5.6 million in disgorgement and prejudgment curiosity alongside a $500,000 penalty. As an additional remedial measure, Influence Concept has dedicated to “destroy” all KeyNFTs underneath its management and to take steps to make sure it doesn’t obtain any future royalties arising from secondary market transactions of those NFTs.¹¹

Commissioners Hester Peirce and Mark Uyeda dissented to the appliance of the Howey check to the KeyNFTs. The dissent posed 9 questions referring to the rationale behind the SEC’s resolution to say jurisdiction over NFTs by way of an enforcement motion. The dissenting Commissioners agreed there was a authentic concern concerning the hype across the KeyNFTs but in addition discovered that was “not a ample foundation to tug the matter into [the SEC’s] jurisdiction.” They acknowledged, “We don’t routinely carry enforcement actions towards people who promote watches, work, or collectibles together with imprecise guarantees to construct the model and thus enhance the resale worth of these tangible objects.” The dissenting Commissioners additional famous that as the primary NFT settlement this enforcement motion “elevate[d] many troublesome questions.” From the dissent’s perspective, “[t]he Fee ought to have grappled with these questions way back and provided steerage when NFTs first began proliferating.”

Takeaways

• With the SEC engaged in excessive profile litigation throughout the nation concerning the standing of digital property as securities, this case marks the primary time the SEC has prolonged its jurisdictional attain additional into the NFT house. This isn’t shocking, given remarks from Chair Gary Gensler final yr, which indicated that the SEC’s broad studying of the Howey check may carry a numbers of NFTs into the SEC’s purview.
• The settlement exhibits that the SEC is paying shut consideration to statements and representations made to traders, together with by way of social media websites, concerning how the NFT issuer intends to make use of proceeds from NFT gross sales. As a media and leisure firm, Influence Concept’s enterprise might operate in a different way than conventional NFT marketplaces, which may clarify why the SEC recognized a number of public statements made by the corporate.
• The settlement might have implications for ongoing federal securities class motion lawsuits, akin to the continued litigation towards Dapper Labs, by which plaintiffs have alleged that NFTs, akin to NBA Prime Shot “Moments,” are securities.

^{1 SEC v. Influence Concept, LLC, No. 3-21585 (Aug. 28, 2023).}

^{2 Id. ¶ 4.}

^{3 Id. ¶ 1.}

^{4 Id. ¶ 2.}

^{5 SEC v. W.J. Howey, 328 U.S. at 298–99.}

^{6 Order, ¶ 6.}

^{7 Id. ¶ 8.}

^{8 Id. ¶ 9.}

^{9 Id. ¶ 1.}

^{10 Id. ¶ 16.}

^{11 Id. ¶ 17.}