Does the SEC Really Have Jurisdiction Over NFT Art? Two Artists Sue SEC to Get an Answer

• Two artists have filed a lawsuit against the U.S. SEC in a Louisiana court to get a declaratory judgement that would protect their forthcoming NFT projects from regulatory action from the SEC.

• They say the SEC has set a concerning precedent of potential regulatory overreach by filing charges against two other NFT art projects.

Two American artists filed suit against the U.S. Securities and Exchange Commission (SEC) on Monday, seeking a declaratory judgment from a Louisiana court that their forthcoming non-fungible token (NFT) projects would not violate U.S. securities laws.

The scathing complaint, filed in the jurisdiction of the notoriously anti-regulatory state Fifth Circuit, accuses the SEC of using two 2023 enforcement actions against NFT projects – Impact Theory and Stoner Cats – to stake its jurisdictional claim over the entire NFT industry without authorization from Congress.

SEC Chair Gary Gensler and the four other SEC Commissioners – Hester Peirce, Caroline Crenshaw, Mark Uyeda and Jaime Lizarraga – as well as Eric Bustillo, regional director of the SEC’s office in Miami, Florida are all named as defendants in the suit.

Under Gensler, the complaint argues, the regulatory agency has “taken an extremely expansive view of its own authority in the context of digital assets” and failed to provide clarity to NFT artists about the circumstances in which the offer and sale of NFTs could constitute securities offerings or sales.

And, in sucking NFTs into its regulatory orbit via enforcement actions, the SEC has failed to meaningfully grapple with the potentially far-reaching implications of applying securities laws to art, the complaint alleges.

The specter of potential enforcement actions against NFT projects has “unleashed a chilling effect over NFT artists across the [U.S.],” according to the complaint. The plaintiffs in the case, conceptual artist and law professor Brian Frye, and musical artist Jonathan Mann, also known as “Song a Day Mann,” are each holding back a ready-to-go NFT project until a court grants them protection from the “credible threat” of a future investigation or litigation by the SEC, which their lawyers claim would be which would be “economically devastating to [their] artistic endeavors.”

But it’s not just small artists that are impacted by potential threat of SEC action – major companies offering NFT artwork have also struggled with the lack of regulatory clarity surrounding NFTs.

Just one day after Mann and Frye’s suit was filed, American sports betting company DraftKings announced it was shuttering its NFT business, effective immediately, citing “recent legal developments.” DraftKings is currently facing a class action lawsuit from investors claiming that its NFT sales violated securities laws. Last month, Dapper Labs – the company behind the popular digital trading card NBA Top Shot “Moments” – paid $4 million to settle its own class action securities lawsuit.

Concerning regulatory precedent

Frye and Mann’s lawsuit points to two recent SEC enforcement actions against other NFT projects, Impact Theory and Stoner Cats.

As part of its settlement with the SEC, Impact Theory agreed to pay more than $6 million in disgorgement and civil penalties, as well as to destroy all of the remaining Founder’s Keys NFTs in its possession.

“The SEC literally demanded that artists destroy their art, as punishment for violating its unprecedented diktat that art was a security,” lawyers for the plaintiffs argued. “That’s right: the United States federal government demanded that an artist destroy their art, because an agency of the federal government decided that it was being offered or sold contrary to federal law.”

Two SEC commissioners, Pierce and Uyeda, issued a dissent against the SEC’s Impact Theory action, arguing that the NFT sales did not constitute an investment contract and raised larger questions about NFT art that the SEC “should grapple before bringing additional NFT cases.”

But a month later, in September 2023, the SEC announced charges and a settlement with another NFT project: this time, the company behind Stoner Cats, a Mila Kunis-backed animated web series funded by NFT purchases, agreed to pay a $1 million civil monetary penalty to the SEC to settle the charges. Like Impact Theory, the company also had to agree to destroy “all Stoner Cats NFTs in [its] possession, custody or control” within 10 days of the order.

Pierce and Uyeda again dissented, writing “Were we to apply the securities laws to physical collectibles the same way we apply them to NFTs, artists’ creativity would wither in the shadow of legal ambiguity…the Commission’s application of securities laws here makes little sense and discourages content creators from exploring ways to harness social networks to create and distribute content.”

In going after Impact Theory and Stoner Cats, plaintiffs argue, the SEC has “sent a message…that it regulates the digital art markets, and perhaps, even the art market as a whole,” thus creating a “precarious situation for artists and innovators” like Frye and Mann.

“Accordingly, Mann and Frye require federal court intervention to be able to offer and sell their prospective art projects without facing an enormously expensive SEC investigation, or an administrative or court action that might require them to—as the Stoner Cats and Impact Theory settlements did—literally destroy their own digital art in order to satisfy the SEC’s wrath.”

According to court documents, Frye has, in the past, reached out to the SEC to request a no-action letter for two of his other NFT projects. He received no response.

A number of other companies and entities have recently filed similar preemptive suits against the SEC, largely within the same circuit. ConsenSys sought injunctive relief to prevent the SEC from suing it and declaring Ethereum a security; the Blockchain Association sued over the SEC’s definition of a “dealer”; a company called Beba and the DeFi Education Fund sued for relief against possible SEC action and a crypto company sued to launch a trading platform called “Legit.Exchange.”