We recently reported about the pre-emptive lawsuit that Consensys Software Inc., brought against the United States Securities and Exchange Commission over the regulation of Ethereum. We also previously reported on the SEC’s first NFT enforcement action, against Impact Theory, LLC, a media and entertainment company. The SEC’s second NFT enforcement action, against Stoner Cats, was brought a few weeks later, in September 2023. These two actions by the SEC were a big part of the impetus behind another pre-emptory lawsuit, this one that conceptual artist Brian Frye and musician Jonathan Mann filed against the SEC on July 29, 2024 with respect to NFTs.
An NFT (non-fungible token) can be thought of as a unique cryptographic key contained within a digital token on the blockchain that verifies the corresponding content file as genuine. It is most often used with music or art. The first two paragraphs of the Complaint frame the issue in the lawsuit thus:
This case is about art. More specifically, should art be regulated by the Securities and Exchange Commission? Should artists have to “register” their artwork before selling it to the general public? Should artists be forced to make public disclosures about the “risks” of buying their art? Should artists be required to comply with the federal securities laws, and the thousands of regulations and reams of interpretive guidance thereunder, just to offer their works to the public? Or can artists simply create, and sell, art?
The answers to these questions seem obvious. It would have been ridiculous to require great American visual artists like Lichtenstein, Basquiat, Warhol, O’Keeffe, Rockwell, Pollock, Frankenthaler, or Wyeth to “register” their paintings, or offer them under some exemption in the securities laws, just because they sold multiple copies of their artworks, or made art in a series of related topics. It would be crazy to think that Bob Dylan, Janis Joplin, the Rolling Stones, Ray Charles, Jimi Hendrix, Madonna, or Louisiana’s own Louis Armstrong should have retained attorneys to examine the SEC’s Form S-1 to see how to register their music for sale to the general public, or scour the exemptions of Regulation D and sell only to “accredited investors,” or plumb the depths of Regulation S to sell their tunes only to overseas “investors.” None of that would make any sense whatsoever. And requiring such nonsensical barriers would have strangled the production of some of the greatest American artists, and the greatest American art.
According to the Complaint, however, that is what the SEC is now trying to do. Plaintiffs Frye and Mann, unlike artists in earlier days, create digital art in the form of NFTs. Frye seeks to protect from the SEC a set of 10,320 NFTs called Cryptographic Tokens of Material Financial Benefit, which will be sold by the business entity he formed for the project, Securities Art LLC. These names were obviously chosen with the lawsuit in mind because, as the prospectus notes, the project is “intended to illustrate the absurdity of the SEC’s claim that it has the authority to regulate NFTs that represent ownership of artworks.”
Mann – who the Complaint says is known as “Song a Day Mann,” who has written and released one song every day since January 1, 2009 — plans to release a set of 10,420 NFTs, each composed of unique remixes of his song “This Song Is a Security.”
The Complaint notes that the SEC charged Impact Theory and Stoner Cats with “conducting an unregistered offering of crypto asset securities in the form of purported nonfungible tokens,” but those cases involved simply the sale of art. Both of those parties settled with the SEC.
According to the Complaint, there is no basis for applying securities law to NFTs under the seminal Supreme Court Howey decision (which sets forth the definition of an investment contract). The Plaintiffs allege that the relationship between a creator of digital artwork and a NFT holder is not meaningfully different from the relationship between any other type of artist and art owner. The purchaser possesses and holds the asset outright and, even if he has a subjective hope or belief that the asset will increase in value (as is the case with non-digital art work as well), there is no investment contract that exists under the test established by Howey.
In the words of the Complaint, because of the SEC’s recent conduct with respect to NFTs, artists “are suddenly faced with a bizarre question: do they need to hire a securities lawyer just to sell their art?” The SEC is asserting of jurisdiction over NFTs without properly considering the many open questions raised by applying the securities laws to art. As a result, the Plaintiffs allege they justifiably fear that they will be subject to the SEC’s aggressive tactics and that their upcoming offer and sale of NFTs will be deemed to be unregistered securities offerings.
The Complaint therefore seeks a declaration that that the Plaintiffs’ proposed NFT projects do not violate U.S. securities laws, as well as an injunction preventing the SEC from bringing an enforcement action against the Plaintiffs premised on their failure to register with the SEC in relation to their proposed projects.
