On August 16, 2024, a federal district court judge in Florida denied in large part the motion to dismiss brought by basketball legend Shaquille O’Neal in the case in which he was sued for his role in Astrals Project, concerning 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. One part of the Astrals Project is a collection of 10,000 NFTs 3D avatars, which Plaintiffs alleged was aimed to promote investment in a virtual world in which users could socialize, play, and interact with other users. Another critical pillar of the Astrals Project was the creation of a decentralized autonomous organization (DAO) for “incubating innovative projects.” The Galaxy token is the governance token of this DAO.
In the wake of the FTX collapse, O’Neal, on the community message board Discord, sent a graphics interchange format (gif) from The Wolf of Wall Street that read, “I’M NOT F^ING LEAVING.” Plaintiffs allege that O’Neal then fled the project and the value of the Astrals Financial Products plummeted.
The first cause of action was for the offer and sale of unregistered securities in alleged violation of Sections 5 and 12(a)(1) of the Securities Act. A “seller” in this context is defined to include a “person who successfully solicits the purchase, motivated at least in part by a desire to serve his own financial interests or those of the securities owner.” “Solicitation,” as so used, according to the court, is an active act (from a person working for another) urging or persuading a consumer to buy or purchase something. The court held that O’Neal did in fact urge people to purchase. He also personally invited fans to an Astrals Discord channel, where he interacted directly with them on a daily basis, reassuring investors that the project would grow. O’Neal’s own financial interests were in mind because he was one of the founders. And, the Astrals Project was his brainchild that he personally developed, and his son was named head of “Investor Relations.” The court thus held that seller alleged enough to state a Section 12 claim against the defendants.
A second issue was that, to allege a securities law violations, it was necessary that the Galaxy token be a “security.” The court relied on the Supreme Court’s Howey test that has been used by the SEC for decades to determine whether something is a security, including digital tokens. Howey defines an investment contract as “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or third party.”
Plaintiffs alleged they invested money into Astrals Financial Products. That was enough to satisfy the “investment of money” prong at the motion to dismiss stage.
As to “common enterprise,” one pillar to Astrals was a story-driven, play-to-earn role-playing game. The court said that, if this were the only main purpose, then Defendants would be correct in arguing that there is no common enterprise when applying the broad vertical commonality test. The court the explained: “However, apart from the story-driven game, the creation of the Astrals metaverse depended on initial funding from the tokens. While there seems to be an aspect of control that Plaintiffs were set to have in the gameplay, it is still clear that the success or failure of the overall investment lies in the hands of Defendants. . . . While the community and investors own a specific NFT within the project (and can increase that specific NFT’s value through gameplay), the investors and players have no control over the success of the investment into the Astrals metaverse. . . .Plaintiffs’ fortunes were still directly tied to the success of the Astrals metaverse and the Astrals group overall.” Thus, the court found Plaintiffs met the “common enterprise” prong of the Howey test.
In order to meet the “reasonable expectation of profit” prong of Howey, investments must be substantively passive and depend on the “entrepreneurial or managerial efforts of others.” There seemed to be no disputing the fact that Plaintiffs engaged (or looked to engage) in some level of effort to increase their Astrals value. The Project in fact discussed increasing the value of an individual Astrals NFT by “levelling up, improving mutable characteristics, and purchasing add-ons.” However, the question was not whether the investors put in any of their own effort, but whose effort (promoter or investor) forms the essential managerial efforts which affect the failure or success of the enterprise. The court said: “Here, Plaintiffs allege that Defendants controlled both the website and marketplace where Astrals products are bought or sold, and the ownership interest in all intellectual property and other ownership rights in the Astrals NFTs. Further, it was clear that Defendants were looking to develop and grow the entire operation, which could lead an objective investor to see a possibility of investment income. . . . It was [also] clear that Defendants were reinvesting into the business and committing to growing the project for the long term.” This satisfied Howey’s expectation of profit prong.
Because the Howey test was satisfied and O’Neal was a “seller,” the court refused to dismiss the claim for the offer and sale of unregistered securities.
