Many of those active in the non-fungible token (NFT) market have been nervously anticipating action from the U.S. Securities and Exchange Commission (SEC) regarding whether or not they will categorize NFTs as securities and further regulate them. U.S. regulators have not yet definitely opined on whether NFTs in general are securities. However, a recent ruling, Friel v. Dapper Labs Inc et al, U.S. District Court, Southern District of New York, No. 21-05837, may have set the stage for some much-needed clarity with respect to the legal characterization of NFTs.

Dapper Labs is the creator of the NFT marketplace NBA Top Shot, where you can purchase and own a specific highlight or play from professional basketball games called “Moments.” Dapper Labs faces a securities class action lawsuit alleging that Moments are unregistered securities. On February 22, 2023, the U.S. District Court denied a request by Dapper Labs to dismiss the case. In its ruling, the court referenced the multi-pronged Howey Test, and ruled that it is plausible the NBA Top Shot NFTs could meet the requirements to be considered a security. The court reasoned that the value of Dapper Labs’ Moments is “causally related to the profitability of [Dapper Labs] as a whole”, as the value of such Moments is dependent on the overall success of Flow Blockchain. Further, the court held that social media statements from Dapper Labs confirms an expectation of profits, as such posts used popular emojis representing an upward trending stock chart and a bag of money.

However, the court wanted to make clear that a ruling in this case should not be seen as establishing precedent for all NFTs. The court went on to say “not all NFTs offered or sold by any company will constitute a security, and each scheme must be assessed on a case-by-case basis.” In response to the ruling, a Dapper Labs spokesperson stated that “Courts have repeatedly found that consumer goods—including art and collectibles like basketball cards—are not securities under federal law.” The spokesperson then went on to assert “We are confident the same holds true for Moments and other collectibles, digital or otherwise, and look forward to vigorously defending our position in court as the case continues.”

The ultimate ruling in Friel v. Dapper Labs may prove to be an important inflection point for NFT regulation one way or another. In the interim, this preliminary ruling will likely encourage similar lawsuits against other issuers and sponsors of NFTs, who should understand consider the factors discussed in the Dapper Labs case and risk assess their potential exposure to litigation.