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SEC Brings First NFT Enforcement Action; Court Dismisses Class Action Against Uniswap Labs

SEC Brings Its First NFT Enforcement Action

What happened?

Last week the Securities and Exchange Commission (SEC) settled its first enforcement action against a creator of non-fungible tokens (NFTs). Impact Theory, a media and entertainment company, agreed to settle the matter with the SEC without admitting or denying the allegations.

According to the SEC, Impact Theory offered and sold crypto asset securities known as Founder’s Keys (“KeyNFTs”) in the form of NFTs, raising around $29.9 million worth of ETH in 2021. Impact Theory publicly stated that it would deliver “tremendous value” to the KeyNFTs purchasers by using the proceeds collected to fund development and recruitment. As a result, the SEC found that the KeyNFTs were offered and sold as investment contracts, and therefore securities, pursuant to the Howey test (finding that an investment contract constitutes a security when there is an investment of money in a common enterprise with profits to come solely from the efforts of others). Before the settlement, Impact Theory engaged in “remedial” efforts by repurchasing NFTs from investors, returning $7.7 million worth of ETH.

Commissioners Hester Pierce and Mark Uyeda dissented, arguing against the application of the Howey test in this action because “this matter raises larger questions with which the SEC should grapple before bringing additional NFT cases.” They suggested that instead of bringing an enforcement action against a company that had taken remedial steps such as the repurchase program (the typical cure for a registration violation), the SEC should create more concrete guidance for NFT creators and purchasers. The two commissioners listed out questions that would be helpful for the SEC to answer and expressed hope that having a discussion about NFTs now could help the SEC “to approach the topic sensibly.”

What does this mean?

Although Impact Theory settled the case, NFTs “are not an easy-to-characterize asset class” and as noted by the dissenting commissioners, clear SEC guidance on NFT sales is still missing. For people who are experimenting with different uses of NFTs, there still remains significant uncertainty when it comes to compliance.

Court Dismisses Class Action Against Uniswap Labs and Investors

What happened?

Last Thursday, U.S. District Judge Katherine Polk Failla dismissed a class action lawsuit against Uniswap Labs and its investors. Individuals who had used Uniswap decentralized exchange protocols to purchase alleged “scam tokens” initiated the suit in an effort to hold Uniswap Labs liable for the money plaintiffs lost when those tokens dropped in value.

In addressing the issue of liability against the protocol’s developers, the court ruled that the lawsuit “stops short of the line between possibility and plausibility of entitlement to relief,” dismissing claims that Uniswap Labs was responsible for investor losses. The court pointed out that the real parties responsible for any investor losses were the issuers of the "scam tokens," not Uniswap protocol or its developers. Contrary to the plaintiffs’ theory of liability, the court found that “this is less like a manufacturing defect, and more like a suit attempting to hold an application like Venmo or Zelle liable for a drug deal that used the platform to facilitate a fund transfer. There, as here, collateral, third-party human intervention causes the harm, not the underlying platform. In this regard, the Court sees merit in Defendants’ counterpoint that this case is more like an effort to hold a developer of self-driving cars liable for a third party’s use of the car to commit a traffic violation or to rob a bank.” (emphasis added). In a key part of the opinion, the Court emphasized that the law in crypto is developing and that it is for Congress to create law in this area: “the Court declines to stretch the federal securities laws to cover the conduct alleged, and concludes that Plaintiffs’ concerns are better addressed to Congress than to this Court.” What does this mean?

Had this ruling been written and published by someone in crypto, the SEC would claim that its findings blatantly contradict the crystal clear securities laws and therefore evidence that the author must be a crypto-criminal and/or scofflaw intent on breaking the law and otherwise advancing the Devil’s designs. We are glad to welcome Judge Failla to our ranks, although she might be surprised to find out how the SEC would characterize her interpretations of the law. However, as she is also the judge assigned to the SEC v. Coinbase case, she will find out soon enough.

In all seriousness, this is a landmark case that represents an inflection point in DeFi’s odyssey. A federal judge appointed by President Obama in the district that oversees the financial services industry in this country endorsed several of the core legal ideas foundational to DeFi—ideas that are applicable in many contexts beyond those immediately at issue in this case. Moreover, the Court endorsed the common sense idea that Congress should write laws, not the Courts, the SEC, or anyone else.

The Court correctly identified the limit of liability of software developers who publish open-source, autonomous code for others to use at their own discretion. As the Court stated, “it defies logic that a drafter of computer code underlying a particular software platform could be liable… for a third-party’s misuse of that platform.”

Moreover, the Court’s comments underscore that the responsibility, and power, to establish a regulatory framework for this space lies only with the legislature, even if one assumes—as the opinion does—all the assets at issue were securities. Regulating this space more effectively lies with legislative bodies, not the courts, and while the court acknowledges the plaintiff’s assertions that the tokens are bona fide securities, it decided not to make a definitive or formal ruling on the matter in this case.

Overall, the ruling is a landmark in the evolving regulatory landscape for cryptocurrencies and DeFi, offering some immediate relief but also signaling the need for legislative action to provide long-term clarity.

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