As if on cue, we are currently seeing a wave of class action lawsuits arising from the first Coin Offering (ICO) boom of 2017-2018, a class action lawsuit based on allegations that certain NFTs (non-fungible tokens) are, in fact, unregistered Securities.
The lawsuit has been filed in New York State Court against Dapper Labs, Inc and Roham Gharegozlou, the founder and chief executive officer of Dapper Labs. This made them the first to be accused in a rush of lawsuits against NFT issuers. The main criterion of the complaint is that NBA Top Shot Moments – a type of NFT – are securities that the defendants “advertised, offered and sold” in violation of federal securities laws.
Plaintiffs allege Dapper Labs partnered with the NBA and the NBA Players Association to launch NBA Top Shot. NBA Top Shot Moments show video clips with highlights from NBA games. The NFTs are present in the flow blockchain created by Dapper Labs. NBA Top Shot sells digital packs of moments, the prices of which vary depending on the scarcity. Moments can also be bought on the marketplace created by Dapper Labs, where buyers and sellers of moments come together.
Unlike other litigation about whether certain digital assets violate US securities laws, this one stands out because they involve the purchase of items that could be considered collectibles.
Before we get into the question of whether a collector’s item can also be a security, however, a few other points should be considered:
First, why didn’t the plaintiffs sue the NBA and the NBA Players Association? The NBA certainly has deep pockets. Why not include them as defendants?
Second, plaintiffs chose to file their lawsuit in federal court in New York, rather than in federal court. Why sue in a state court when plaintiffs’ claims are based on allegations of violations of federal law? This is particularly confusing given the novelty of the alleged claims. That said, these claims about digital assets on a blockchain are likely to pose first impression problems. Why not file with the court for the best solution to these first impression issues?
Daniel Alter, a partner at Yankwitt LLP and former general counsel of the New York State Department of Financial Services, notes that filing a lawsuit in a state court could be problematic from the point of view of developing uniform law. He explains that the New York State courts, which interpret state securities law, have a long history of defining securities very broadly. He suggests “this could take the Howey test in new directions” which could be helpful to plaintiffs.
Silver Miller law firm founder David Silver expects the defendants to be released on legal grounds. He says, “The connection between the NFTs and New York is debatable as the complaint is being written.”
“In reality, the fanatical growing NBA Top Shot database is all about investing, speculating, and appreciating the Top Shot NFTs and the NBA Top Shot marketplace. . . . ”
Silver notes that “Quoting third parties in support of claims against a defendant is always difficult. It is always preferred to quote the accused directly, “which is not what happened here.
So the question is whether moments are more like digital beanie babies (which sparked the beanie baby craze of the 1990s). Or are they more similar to the certificates of deposit (CDs) in the landmark case of Gary Plastic Packaging Corp. v Merrill Lynch, where the court found that a broker-dealer system of marketing high-yield bank CDs to its customers passed the Howey Test.
In Gary Plastics, the defendants marketed tradable, insured, and liquid CDs that they had purchased from various banks. In their marketing materials, the broker-dealer promised to monitor the creditworthiness of the issuing banks and maintain a secondary market to ensure buyers liquidity.
The Second Circuit’s Howey analysis found that Plaintiff had invested $ 1,200,000 in the CDs offered by the broker-dealer, that the broker-dealer had formed a joint venture by investigating issuers, marketing a secondary market for the CDs, and created and eventually that the plaintiff expected profits solely from the efforts of the broker-dealer. Accordingly, the court found that the CDs were investment contracts and therefore securities.
Here, however, the defendants did not advertise or market the moments as an investment. They specifically declined to have the moments sold for investment.
Alter notes that a key component of Gary Plastics was the fact that the broker-dealer created and maintained the only marketplace for trading CDs. Alter emphasizes that the broker-dealer monitoring and maintaining the market has turned a non-security into an investment contract. Essentially, it was the CDs in combination with the program that provided security.
And that’s the gist of it.
Are the plaintiffs here investors in the manner of Howey, or are they just collectors? Let the accused simply give basketball enthusiasts the opportunity to purchase collectibles in the form of a video clip. Or, did they knowingly offer plaintiffs an investment opportunity by creating and maintaining a marketplace for their moments.
According to Alter, the defendants’ disclaimer may not be a silver bullet. He warns that Gary Plastics could pose a serious threat.
Lewis Cohen, co-founder of blockchain-focused boutique law firm DLx Law, noted, “Dapper Labs seem to have been extremely cautious about marketing Moments, but they may be a victim of their own success. In a hot market for non-security assets like their Top Shot Moments, it is inevitable that some buyers will seek a speculative profit in hopes of riding the tails of the seller’s hot product. If this is the new standard for “investment contracts,” there are many other companies that should be concerned. “