Artists Challenge SEC Over NFT Regulations
In a groundbreaking move, two American artists have initiated legal proceedings against the U.S. Securities and Exchange Commission (SEC) in a Louisiana court. Their lawsuit seeks a declaratory judgment that their upcoming non-fungible token (NFT) projects will not infringe upon U.S. securities laws. This case is particularly notable given the jurisdiction of the notoriously anti-regulatory Fifth Circuit, which is known for its skepticism towards federal regulatory overreach.
The complaint filed by the artists, conceptual artist and law professor Brian Frye and musical artist Jonathan Mann, also known as “Song a Day Mann,” highlights a significant concern regarding the SEC’s recent enforcement actions. The plaintiffs argue that the SEC’s actions against NFT projects such as Impact Theory and Stoner Cats are indicative of the agency’s attempts to assert jurisdiction over the entire NFT industry without clear legislative backing from Congress.
The lawsuit names several key officials as defendants, including SEC Chair Gary Gensler and the four other SEC Commissioners: Hester Peirce, Caroline Crenshaw, Mark Uyeda, and Jaime Lizarraga. The complaint accuses the SEC of adopting an overly broad interpretation of its authority concerning digital assets, which has resulted in considerable ambiguity for NFT creators regarding compliance with securities laws.
The Chilling Effect of Regulatory Ambiguity
According to the plaintiffs, the SEC’s lack of clarity regarding the conditions under which NFTs could be classified as securities has created a chilling effect on artists across the United States. Both Frye and Mann are currently withholding their NFT projects, awaiting legal protection from the “credible threat” of SEC investigations or litigation. Their attorneys have emphasized that any such action by the SEC could be “economically devastating” to their artistic pursuits.
Moreover, this issue transcends individual artists; major corporations involved in the NFT space are also grappling with the uncertainty surrounding regulatory compliance. Just one day after the lawsuit was filed, DraftKings, a prominent American sports betting company, announced the immediate closure of its NFT business, citing “recent legal developments.” DraftKings is currently embroiled in a class-action lawsuit, with investors alleging that its NFT sales violated securities laws. Similarly, Dapper Labs, known for the popular NBA Top Shot digital trading cards, recently settled a $4 million class-action securities lawsuit, further highlighting the precarious nature of the NFT market.
Recent SEC Enforcement Actions
The lawsuit by Frye and Mann draws attention to two specific SEC enforcement actions against NFT projects: Impact Theory and Stoner Cats. In August 2023, the SEC charged Impact Theory with offering and selling unregistered securities through their Founder’s Keys NFTs. This marked the first time the SEC publicly addressed NFTs, yet it did so without prior formal guidance on NFTs, which has created a climate of uncertainty for creators in the digital art space.
As part of its settlement with the SEC, Impact Theory was ordered to pay over $6 million in disgorgement and civil penalties, and it was also required to destroy all remaining Founder’s Keys NFTs. The plaintiffs argue that this directive from the SEC represents an unprecedented overreach, effectively mandating artists to destroy their creations as a punitive measure for alleged regulatory violations.
Two SEC commissioners, Hester Peirce and Mark Uyeda, dissented from the SEC’s actions regarding Impact Theory, expressing concerns that the agency’s approach to NFTs raises broader questions about the application of securities laws to artistic endeavors. They argued that such an application could stifle creativity and innovation within the NFT space.
In September 2023, the SEC continued its enforcement agenda by charging the creators of Stoner Cats, a Mila Kunis-backed animated series funded through NFT sales. The company settled with the SEC by agreeing to pay a $1 million civil penalty and destroy all Stoner Cats NFTs within 10 days of the order. Again, Peirce and Uyeda dissented, expressing that the SEC’s application of securities laws to NFTs lacks logical consistency and could discourage content creators from exploring new ways to engage with audiences through digital platforms.
The Need for Clarity and Guidance
The lawsuit emphasizes that the SEC’s aggressive stance towards NFT projects sends a clear message: the agency is claiming regulatory authority over digital art markets and possibly the broader art market. This creates a precarious environment for artists and innovators like Frye and Mann, who seek legal clarity before proceeding with their projects.
Frye has previously sought a no-action letter from the SEC for two other NFT initiatives but received no response. This lack of engagement from the SEC further underscores the frustrations felt by creators seeking guidance in a rapidly evolving digital landscape.
In conclusion, the legal action taken by Frye and Mann is a significant step in challenging the SEC’s regulatory approach to NFTs. As similar preemptive lawsuits emerge from various entities within the same circuit—such as ConsenSys seeking to prevent SEC action regarding Ethereum and other companies contesting the SEC’s definitions and actions—there is a growing call for clearer regulations that balance the need for oversight with the promotion of artistic innovation.