A Swing and a Miss
By James Rathmell and Rodrigo Seira
One of the most clickworthy clips from the recent congressional hearing with the five SEC commissioners was Rep. Ritchie Torres grilling SEC Chair Gensler on whether the secondary sale of a baseball ticket could constitute an investment contract. In isolation, this seems like an outlandish question: What could securities laws have to do with Yankees tickets? But Rep. Torres’ line of questioning was timely, following OpenSea’s late August announcement that it had received a Wells notice from the SEC threatening the company with a lawsuit. While the SEC’s specific allegations against OpenSea remain undisclosed, we can deduce the SEC’s reasoning based on settlements last year with Impact Theory and Stoner Cats, and just a few weeks ago with Flyfish Club: “We believe NFTs are the subject of a number of investment contracts, and targeting one of the largest NFT marketplaces is the most efficient way to curb this activity.”
Yet the SEC’s gambit to regulate NFTs seems poised to fail.
NFTs are unique collectibles with consumptive uses, ranging from fine art to in-game items and, yes, even event tickets. As a practical matter, purchases for consumption are not investment contracts, since—to use Rep. Torres’ example—the buyer of a baseball ticket will ultimately exchange it for entry to a Yankees game.
But this is equally true as a legal matter.
In United Housing Foundation, Inc. v. Forman, the U.S. Supreme Court held that shares of “stock” representing ownership in a low-cost housing development were not investment contracts because of the obvious “consumptive use for the apartment and [the fact that] there was no reasonable expectation of profit in the form of either capital appreciation or participation in earnings.”
Notably, no court has yet ruled that the offer and sale of NFTs constitutes an investment contract. While the SEC might point to its settlements with Impact Theory, Stoner Cats, and Flyfish Club, these settlements do not create legal precedent and bind only the parties involved. The closest a court has come to addressing this issue was in the class action involving Dapper Labs, creators of the NBA Top Shot NFTs. There, the court denied Dapper Labs’ motion to dismiss, concluding only that the plaintiff had sufficiently alleged (not proven) that the sale of NBA Top Shot NFTs constituted an investment contract. Even then, the court emphasized that its decision was “narrow,” “a close call,” and that whether particular NFT offerings qualify as securities must be decided on a “case-by-case basis.” The case ultimately settled before final judgment.
The settlements and cases, which provide the shaky foundations underpinning the SEC’s claim over NFTs, all relate to original sales by the token creators (i.e., “primary issuances”). None have considered the extension of securities laws to secondary marketplaces. And this has important implications. In SEC lawsuits against crypto exchanges, federal courts have repeatedly found that securities laws should be applied on a transaction-by-transaction basis. Therefore, even if certain tokens may have originally been sold in securities transactions, secondary sales of those tokens do not necessarily constitute securities transactions.
The SEC’s argument is even weaker in the context of NFTs, since secondary transactions in NFTs fail the Howey test prima facie. Consider for example that Fidenza #49 by Tyler Hobbs was sold on March 5, 2024 for 496 ETH ($1.2M at the time), while Fidenza #112 was sold that same day for only 65 ETH ($164K at the time). Where is the expectation of profits based on the efforts of others? Where is the investment of money in a common enterprise?
Rep. Torres’ line of questioning is powerful because it illustrates the potentially boundless reach of the SEC’s conception of its authority. There is a hair’s breadth between regulating the market for Fidenzas and regulating the marketplace around America’s pastime. And it should be clear that the SEC lacks the authority to regulate either.
