SEC became a defendant in the NFT classification lawsuit

Law professor and filmmaker Brian Frye and songwriter Jonathon Mann have filed a lawsuit against the U.S. Securities and Exchange Commission.

Advocates argue that the SEC’s approach to regulation threatens the livelihoods of artists and creators experimenting with NFTs.

I am proud to represent my client and friend Jonathan Mann @songadaymann In his brave and unfortunately necessary lawsuit against the SEC.

Art is not a security, and digital musicians shouldn’t have to hire expensive securities lawyers just to release their music. https://t.co/FBYL9FZZfG

— Jason Gottlieb (@ohaiom) July 29, 2024

What does the lawsuit say?

According to the document, the plaintiffs are seeking to determine whether NFTs fall under the regulator’s jurisdiction. The lawyers have asked the SEC to answer what actions could lead to securities laws being applied to creating and selling NFTs. The lawsuit also seeks information about registering NFTs before they can be sold.

“Two recent administrative actions taken by the SEC demonstrate that the SEC is entering the art industry and determining when works of art must be registered with the federal government before they can be sold.”

The authors of the document liken non-fungible tokens to Taylor Swift concert tickets, which are often resold on the secondary market. Mann and Frye are in exactly the same position in this case. The lawyers argue that it would be absurd for the SEC to classify such tickets or collectibles as securities:

“They are artists and they want to create and sell their digital art without the SEC investigating or suing them.”

SEC’s first lawsuit against NFTs

In 2021, media company Impact Theory released its Founder’s Keys NFT collection. The company promoted the project from October to December 2021. The collection included tokens of three different rarity levels.

As a result, the SEC charged Impact Theory with promoting securities without registration in August 2023. The company used NFTs to attract investors and raised around $30 million. This was the regulator’s first case against NFTs.

Today, we accused Impact Theory LLC, a Los Angeles-based media and entertainment company, of conducting an unregistered cryptocurrency securities offering in the form of so-called NFTs. Impact Theory raised approximately $30 million from hundreds of investors.

— U.S. Securities and Exchange Commission (@SECGov) August 28, 2023

The SEC believes that the company positions the project as a business investment. In particular, it guarantees high profits to its owners and promises comprehensive prospects.

Therefore, the regulator deemed the NFTs mentioned to have the characteristics of an investment contract and were consequently classified as securities. By promoting collectibles, the company violated federal laws in this sector.

Impact Theory agreed to pay a $6.1 million fine without admitting or denying guilt, and they also agreed to destroy tokens and references from their website and social media.

What is considered a security according to the SEC?

The Commodity Futures Trading Commission considers cryptocurrency a commodity. The regulator proposes to apply the tax regime developed for goods to cryptocurrency and consider the actions of issuers as producers of goods. However, there are no rules in the US that force issuers to register tokens as goods.

The SEC uses the Howey test when evaluating the status of cryptocurrencies.

The regulatory body considers the new financial instrument to have security features and believes that cryptocurrency falls within its legal domain.

According to the SEC, all tokens somehow meet various criteria set by the agency: pre-sale or fundraising, promises of improving the project through ongoing business and marketing development, and use of social media to showcase the project’s capabilities and benefits.

But no arbitration body has been able to resolve the dispute between the two American regulators, so each agency is acting according to its own vision of the situation.

Merchants Are Losing Interest in NFTs, Contrary to Regulators

Despite regulators’ interest in non-fungible tokens, excitement around NFTs continues to wane. According to CryptoSlam, sales volume in the NFT sector reached $395.5 million in July, a new minimum since November 2023.

The NFT industry has been in a downward trend for a long time, with sales volume and the number of unique buyers and sellers falling steadily since March 2024.

Source: CryptoSlam

Moreover, sales volume in Q2 2024 fell by 45% compared to Q1: from $4.1 billion to $2.2 billion.

The decline in July began in the middle of the month. At the same time, early July saw signs of a recovery in sales volume after a significant decline in June. At the same time, July became the third largest month in terms of trading volume in 2023.

During this period, 9.9 million transactions were recorded, compared to 5.7 million in June. However, this cannot be a positive sign as the average sales price in July reached a new minimum since September 2023 – $39.56.

What threatens NFT: SEC or falling interest?

The status of non-fungible tokens has yet to be determined, according to a recent lawsuit filed against the SEC, but the regulator is paying less attention to the space as excitement around NFTs wanes.

In any case, the SEC’s approach to regulation threatens NFTs, which were initially conceived as a catalyst for creativity across the blockchain and cryptocurrency space.