America's financial cops say Impact Theory's NFTs were unregistered securities

Dissenting opinion asserts position is wrong and that many headaches linger

In its first enforcement action concerning the issuance of non-fungible tokens, or NFTs, if you can remember that sad fad, the SEC has declared they should be considered and thus regulated as conventional securities under some circumstances.

That would mean, in those cases, those offering the tokens must follow the rules laid down for securities, including those involving the registration of those NFTs with regulators.

A dissenting opinion within the US financial watchdog argued that logic is wrong.

The SEC's action this week concerns a settlement it reached with media and entertainment company called Impact Theory, which was run by Tom Bilyeu, founder of an outfit called Quest Nutrition. After selling Quest for $1 billion, Bilyeu started Impact Theory “to pull people out of the Matrix, at scale, by giving them an empowering mindset.” The biz does that with podcasts featuring successful entrepreneurs.

Readers may not be surprised to know that in 2021 the Matrix-extraction outfit decided to issue NFTs and, according to an SEC order [PDF] against Impact, raised approximately $30 million (£23.8m).

Without registration, investors of all types are deprived of the protections afforded them

Impact Theory’s NFTs were pushed as a way to obtain a stake in the business in its early days. Company reps told would-be investors this would be akin to buying into Disney while it was working on Steamboat Willie, the short animation that debuted Mickey and Minnie Mouse. "I want you guys to be able to capture 90 percent of the economic value of all the big things that we will do in the coming years beyond that," Impact Theory reps said on Discord and social media.

The SEC on Monday said those offers had all the qualities to be considered investment contracts, that the NFTs were therefore securities, and that those securities had not been registered with the watchdog as required by law. As such, the regulator charged Impact with conducting an unlawful unregistered offering in the US, and hammered out a settlement with the biz.

“Impact Theory violated the federal securities laws by offering and selling these crypto asset securities to the public in an unregistered offering that was not otherwise exempt from registration,” as the SEC put it.

“Absent a valid exemption, offerings of securities, in whatever form, must be registered,” added Antonia Apps, director of the SEC’s New York office. “Without registration, investors of all types are deprived of the protections afforded them by the robust disclosures and other safeguards long provided by our securities laws.”

As the SEC investigated the biz, Impact Theory stopped selling its NFTs, and began a buyback in which it repurchased 2,936 of its Founders Keys tokens and returned approximately $7.7 million (£6.1m) of Ethereum to investors.

Impact Theory has now committed to destroying all of its NFTs that had been repurchased and will modify the smart contract for the remaining Founders Keys such that it won't get any royalty payment from secondary market sales, both of which it committed to doing within 10 days of the SEC's order on Monday.

Impact Theory also agreed to pay $6.1 million (£4.8m) in civil penalties to the SEC. The company didn't immediately respond to questions from The Register, though admits no guilt in its settlement agreement with Uncle Sam.

This means NFTs are automatically securities, right? Not so fast

While the SEC’s actions in this matter are clearly based in the regulator’s belief that Impact Theory was selling securities, two of the org’s commissioners - Hester Peirce and Mark Uyeda - issued a dissenting opinion.

Peirce and Udeya disagreed with the SEC’s application of the Howey test that stems from the 1946 US Supreme Court decision in SEC v. W. J.Howey Co., a landmark case used to determine if a security can be classified as an "investment contract."

According to the SEC, investment contracts exist "when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others." However, Peirce and Uyeda disagreed that the Howey test applies, or that NFTs even belong under SEC jurisdiction.

"We do not routinely bring enforcement actions against people that sell watches, paintings, or collectibles along with vague promises to build the brand and thus increase the resale value of those tangible items," the pair said in their statement.

Along with arguing that the Howey analysis was misapplied, the dissenting commissioners asserted the decision raises questions about whether the commission "generally views previous NFT offerings as securities" or whether securities law is even the best regulatory approach for the digital collectibles.

The duo also took issue with the mandated destruction of Founders Key NFTs, saying it raises questions of precedent for "future cases in which the NFTs at issue represent unique pieces of digital art or music." We think it's worth remembering here that NFTs are nothing but a blockchain entry – a digital receipt, a proof of purchase – and not the actual piece of art or music they represent. If one wishes to prevent an NFT's media from vanishing with its token, all one needs to do is right-click and save.

The dissenting opinion, and the logic on which it rests, suggests the question of whether all NFTs are securities remains open. Peirce and Uyeda wish that weren’t the case.

“The commission should have grappled with these questions long ago and offered guidance when NFTs first started proliferating,” they wrote.

Their dissent also stated: “We share our colleagues’ worry about the type of hype that entices people to spend almost $30 million for NFTs seemingly without having a clear idea about how they will use, enjoy, or profit from them.”

Clearly the pair need to be pulled out of the Matrix.

We asked the SEC about the dissent and what its settlement with Impact Theory meant for the future of NFT law, and haven't heard back.

Bilyeu commented on the settlement on Xitter, where he opined: "Although we are disappointed that the SEC has chosen to broadly question the exciting technical innovations that make digital assets possible through the lens of the securities laws, we remain optimistic for the future of this industry in the United States, and hope we remain the global home of innovation." ®

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