Attorneys Comment on OpenSea Wells Notice and Potential SEC Enforcement Action Are NFTs Securities?
Partner and co-chair of Herrick's Securities Litigation and Enforcement Group, Arthur G. Jakoby, spoke with Crowdfund Insider about the Securities and Exchange Commission ("SEC") sending a Wells Notice to OpenSea, a popular non-fungible token ("NFT") marketplace, which is a likely indicator of impending enforcement action against the company.
The article noted that the SEC may deem certain NFTs issued and traded on OpenSea's platform as digital asset securities. Arthur said the test for whether OpenSea is making a market in securities will be whether any of the NFTs they are trading are deemed to be securities. Currently, there is no indication as to which NFTs the SEC will claim are securities. "Once that is known, it will be necessary to examine each NFT, apply the four prongs of the Howey Test, and determine whether a court is likely to find that it is or is not a security."
Is there an argument to be made by the SEC regarding NFTs and fractional holdings?
"Selling fractional units to the public and maintaining a market for secondary purchases of the fractional units is a situation which would clearly be the sale of securities," stated Arthur.
Does this open up far broader interpretations of other collectible/ownership markets (for example, houses)?
Arthur explained that "a ruling by a court with respect to the sale of fractional units would not expand existing law since the Howey Test involved the sale of fractional units in a citrus grove. In other words, the sale of fractional housing units is already a security. That is why when you buy a condominium from a developer, the offering memo you receive states that the sale of the condo or coop is the sale of a security but exempt from registration."
So, where should the line be drawn?
Arthur believes it will be based on the Supreme Court’s 1946 Howey Test ruling. "The NFT and crypto industry is looking for a new set of rules related to the issuance and marketing of digital assets which takes into consideration these 21st-century assets. The security rules were drafted in 1933 and 1934 and the Howey test is based upon an interpretation of these 1930s laws. Congress in 1933 and 1934 could not have imagined – and clearly did not contemplate – that one day there would be an internet or digital assets. The question is whether these ancient laws should apply to digital assets. No one is saying that digital assets should not be regulated. Rather, the argument is that these assets are unique, and, thus, a new body of laws, enacted after congressional, consumer, and industry input, is what is needed to safeguard the public. While the industry is seeking clear laws regulating digital assets, the SEC prefers to maintain its jurisdiction and interpret existing laws, and thereby govern digital assets via enforcement actions."
Arthur anticipates that issuers and exchanges of digital assets will flee the US to operate overseas and then prohibit sales of digital assets to US citizens in order to avoid the uncertainty of U.S. regulations. “That is not a result that benefits the U.S. economy," said Arthur.
He added that the SEC staff is apolitical and that large digital asset cases that have been lost (IE Ripple) were commenced several years ago when no one anticipated that a court decision would be authored in 2024, several months before an election. Arthur believes that politics does not play any role regarding SEC cases or when a Wells Notice is issued.