Bloomberg News has reported that the Securities and Exchange Commission (SEC) is investigating whether some non-fungible tokens (NFTs) and, possibly, ApeCoin offered by Yuga Labs, LLC, were securities.
Yuga Labs has a complex set of products, including the profile picture (PFP) projects such as Bored Ape Yacht Club, Mutant Ape Yacht Club, Meebits and CryptoPunks; the digital currency “ApeCoin;” and land in its new metaverse, Otherside. It is not clear which of the Yuga Labs projects are under investigation. The SEC has not commented on the press report and has not publicly filed any charges.
However, the SEC has been clear that NFTs are not exempt from the securities law and the manner in which they are offered can make them securities. In fact, Commissioner Hester Peirce discussed NFTs in in a speech in March 2021 and warned that the “definition of security can be pretty broad.” She expressed particular concern about fractionalized NFTs and “NFT baskets.”
The SEC is analyzing the Yuga Labs products and the manner in which they are marketed using the Howey test based on a Supreme Court decision from 1946. The Howey test has four requirements to find that an offering is a security: (i) an investment of money, (ii) in a common enterprise, (iii) with a reasonable expectation of profits, (iv) derived from the efforts of others. If all four prongs are reasonably satisfied, then the offering or arrangement constitutes an “investment contract” which is a security under US law. If only one of the prongs is not reasonably satisfied, then the offering or arrangement is not deemed to be an investment contract and, thus, not subject to regulation by the SEC.
The SEC and the courts have emphasized that the Howey test is flexible and reaches “novel, uncommon, or irregular devices, whatever they appear to be.” The Howey test “embodies a flexible rather than static principle, that is capable of adaptation to meet the countless and variable schemes devised by those who seek to use of money of others on the promise of profits.” In other words, the SEC and courts are likely to be expansive in their interpretation of facts to determine whether the offering or arrangement may meet the requirements of each prong of the Howey test.
The SEC investigation, if it is ongoing, may not result in any charges against Yuga Labs, but is a reminder that the offer and sale of NFTs can be conducted in a manner which makes the offering an investment contract, and thus a security regulated by the SEC.