On September 13, 2023, the U.S. Securities and Exchange Commission (“SEC”) brought a settled enforcement action against Stoner Cats 2 LLC (the “Company”) for raising approximately $8 million through an unregistered offering of Non-Fungible Tokens (“NFTs”) that the SEC alleged were securities.  This action is another example of the SEC alleging that crypto assets were securities based on the specific manner in which they were offered.

According to the SEC, on July 27, 2021, the Company offered, and ultimately sold in the span of just 35 minutes, 10,320 NFTS for approximately $800 each.  The NFTs were sold to the public as part of the Company’s marketing campaign for its web series Stoner Cats, and the SEC focused on certain details of the offering.  While the NFTs were essentially collectibles, the Company allegedly promoted the advantages of owning the NFTs as including an option to resell in a secondary market; and the reselling of the NFTs in the secondary market was arranged such that the Company would receive a 2.5% royalty for each transaction.  Buyers were further promised that if 100% of the NFTs were sold, the Company would facilitate and create a decentralized autonomous organization (“DAO”), which would be comprised of NFT holders and develop new animation projects.

The SEC alleged that, through the marketing efforts, the Company “led investors to expect profits from their entrepreneurial and managerial efforts, because a successful web series could cause the resale value of the Stoner Cats NFTs to rise in the secondary market.”  As a result, the SEC claimed that the NFTs were securities, and the Company violated Sections 5(a) and 5(c) of the Securities Act of 1993, which generally prohibits the offering and selling of securities to the public in an unregistered offering.

The Company did not admit or deny the SEC’s allegations but agreed to cease and desist, destroy any NFTs in its possession and pay a civil penalty of $1 million.  The SEC, meanwhile, established a fair fund to provide restitution to allegedly injured investors who purchased the NFTs.

Notably, Commissioner Hester M. Peirce and Commissioner Mark T. Uyeda issued a dissent from the SEC’s decision to bring an action.  They observed that the Company’s campaign was essentially crowdfunding, a common phenomenon among artists, creators and entertainers in our growing digital society.  As such, the Commissioners argued that the Stoner Cats NFTs were no different from other collectibles from the past, like Star Wars collectibles offered and sold in the 1970s.  The Commissioners emphasized that NFT creators “do not get a free pass” from securities laws, but they cautioned that the SEC must set clear guidance for those seeking to experiment with NFTs instead of arbitrarily furthering enforcement actions against NFT projects after the fact.

In the absence of such clear guidance, any company seeking to sell NFTs should proceed very cautiously to ensure that their marketing efforts do not give rise to a claim that the NFTs are in fact securities.