For the first time, the Securities and Exchange Commission has levied enforcement action against a company's sale of non-fungible tokens.
On Monday, the SEC fined Impact Theory, a Los Angeles-based entertainment company, $6.1 million, alleging the NFTs sold by the company were unregistered crypto asset securities, per an August 28 press release.
The NFTs, called Founder's Keys, were sold between October and December 2021. The SEC alleges Impact Theory told investors who purchased them that they would "profit from their purchases" if the company was successful down the road. Impact Theory reportedly raised about $30 million through its NFT sales.
Because of this promise to deliver "tremendous value" to Founder's Key buyers, the SEC says the NFTs count as investment contracts and are therefore securities, which must be registered with the agency before being offered to the public.
To establish whether something counts as an investment contract, the SEC uses the "Howey test," which includes the following criteria:
- There is an investment of money;
- in a common enterprise;
- in which the investor expects a profit; and
- the profit is derived solely from the efforts of others.
Impact Theory hasn't admitted or denied the SEC's allegations, but has agreed to a cease-and-desist order. The company will also destroy any remaining NFTs in its possession and return funds to investors who purchased NFTs, according to the SEC's press release.
What the SEC's first NFT-related enforcement action means for investors
So what does this mean for everyday NFT investors? Not much just yet.
The SEC's order may not have much of an impact on the broader NFT market because there are still many questions the agency and Congress need to settle about securities registration for crypto and NFTs, says Kathy Kraninger, vice president of regulatory affairs at crypto security firm Solidus Labs. Kraninger is also the former director of the Consumer Financial Protection Bureau.
"It seems like a fairly open and closed investment contract Howey test analysis," Kraninger tells CNBC Make It. "I don't think this order adds much clarity to the overall marketplace where the majority of crypto assets and NFTs are not securities."
While it's pretty clear that the NFTs offered by Impact Theory were investment contracts, the SEC can't and probably doesn't expect investors to conduct their own Howey test analysis before purchasing crypto or NFTs, says Kraninger.
Instead, investors should consider why they're buying a particular digital asset and what they're hoping to gain.
"With any collectible, it's really buy what you like and hope for the best," says Kraninger. "The bigger thing for investors to be looking out for is that they aren't being brought into a fraud or a scam as they consider what they want to buy."
An easy way to spot a potential scam is if there's a promise of a high return on your investment with little to no risk, the SEC warns.
"Every investment carries some degree of risk and the potential for greater returns comes with greater risk," the SEC says. "You should be skeptical of any investment that is said to have no risks."
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