On Aug. 28. 2023, the SEC issued a settled Order against Impact Theory, LLC in connection with its offer and sale of non-fungible tokens (NFTs). It was the first SEC enforcement action involving NFTs.
According to the Order, from October to December 2021, the Los Angeles-based media and entertainment company offered and sold NFTs it called Founder’s Keys (“KeyNFTs”) in three tiers, “Legendary,” “Heroic,” and “Relentless,” based on the purchaser’s level of investment. In total, Impact Theory sold 13,921 KeyNFTs, raising $29.9 million for the company. The KeyNFTs immediately began trading on various secondary markets, including two such platforms to which Impact Theory directed purchasers. Impact Theory programmed the smart contract for the KeyNFTs so that it would receive a 10% royalty on each secondary market sale.
The SEC’s Order charged Impact Theory with the unregistered offer and sale of securities, in violation of §§ 5(a) and 5(c) of the Securities Act of 1933; required the company to destroy all KeyNFTs in it possession within 10 days and revise the relevant smart contract(s) for the KeyNFTs to eliminate any royalties the company might otherwise receive from future secondary market transactions; and pay $5.1 million in disgorgement, prejudgment interest, and a $500,000 civil penalty.1
The SEC gets to say it brought its first NFT case but, in our view, the technology was kind of beside the point.
Instead, the Order strings together all of the promises of “massive” profits Impact Theory made to investors and potential investors in public fora,2 some of which are definitely worth repeating as things not to say if you decide to mint a bunch of NFTs that look an awful lot alike then sell them to the public:
If you’re paying 1.5 [ETH], you’re going to get a massive amount more than that. So no one is going to walk away, saying, ‘Oh man, I don’t think I got value here.
Now as we’re building out this IP, imagine that you could’ve gotten in on Disney when they were doing Steamboat Willie, and that’s how we think of the Legendary tier. That’s how we think of this whole first drop quite frankly.
But yeah, I will make sure that we do something that by any reasonable standard, people got a crushing, hilarious amount of value.
And just in case, you’re looking for a sentence that comes as close as possible to checking all the boxes of the Howey test at once, there’s this:
We’re going to be investing the money into development, into bringing on more team, making sure that we’re delivering just an obscene amount of value. Until people are giggling thinking that they can’t believe that they paid – you know – whichever tier they come in on and are getting all this value – until that’s the sentiment – we will just keep stocking it with value.
In short, it would not have mattered whether the investments were represented by the KeyNFTs sold, old fashioned fungible tokens in an ICO, paper stock certificates, or some other form, the SEC would have found a security.
There was nothing about the fact that NFTs were involved that complicated the securities law question. This is not a case that should concerns artists, the art market, or those engaged in the creation or sale of NFT collectibles.3
As we have discussed, there are times when the creation of a secondary market can turn a nonsecurity into a security, so the Order’s focus on the secondary market and resale royalties here gives us pause, but only for a moment. In our reading, the point is clearly to deprive the company of future revenue from its violations, not that any particular features of the secondary market transactions involved were otherwise concerning from a securities law perspective.
1 It is not clear why the disgorgement was $5.1 million when the company raised $29.9 million from the program, but the Order does reference repurchase programs, in December 2021 and August 2022, through which Impact Theory bought back 2,936 KeyNFTs it had sold, returning approximately $7.7 million in ETH to investors.
2 The Order attributes the statements to the company, not any specific individuals, and no individuals were charged.
3 For that concern, see here.