The SEC’s Second NFT Enforcement Action: SEC v. Stoner Cats 2

Key Point

• Just over two weeks after the SEC announced the settlement of its first NFT enforcement action against Impact Theory, on September 13, 2023, the SEC announced its second NFT enforcement action against SC2, the creator of a popular, celebrity-backed animated web series. The SEC charged SC2 with conducting an unregistered offering of digital assets in the form of non-fungible tokens called “Stoner Cats.”

SEC v. Stoner Cats, LLC

On July 27, 2021, Stoner Cats 2, LLC (SC2) sold 10,320 non-fungible tokens called “Stoner Cats” (hereinafter “Stoner Cats NFTs” or the “NFTs”), then valued at around $8.2 million, to fund the production of an animated series through an unregistered offering.¹ The Stoner Cats NFTs are tokens recorded on the Ethereum blockchain, which are each linked to a uniquely-generated image of one of the Stoner Cats characters.² The NFTs were sold for about $800 each and sold out in 35 minutes.³ SC2 promised that if all the NFTs were sold, it would facilitate the creation of a decentralized autonomous organization (DAO) comprised of Stoner Cats NFT holders and that it would commit to working with the DAO to “develop at least one new animation project a year for the next three years.”⁴

The U.S. Securities and Exchange Commission (SEC) charged SC2 with violating section 5 of the Securities Act in connection with its unregistered public offering for the sale of the NFTs.⁵ In the settlement, SC2 agreed to pay a $1 million civil penalty, along with other undertakings, including destruction of the NFTs. In remarks about the settlement, Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, stated: “Regardless of whether your offering involves beavers, chinchillas or animal-based NFTs, under the federal securities laws, it’s the economic reality of the offering – not the labels you put on it or the underlying objects – that guides the determination of what’s an investment contract and therefore a security.”

As they did in Impact Theory, Commissioners Hester Peirce and Mark Uyeda dissented to the application of the Howey test in SC2. They specifically focused on how the sale of Stoner Cats NFTs constituted crowdfunding. The dissenting Commissioners emphasized how the NFTs were more similar to collectibles than securities, remarking: “the Stoner Cats NFTs are not that different from Star Wars collectibles. . .[t]he Commission’s application of the securities laws here makes little sense and discourages content creators from exploring ways to harness social networks to create and distribute content.” However, they also noted that “[i]n some instances, sales of NFTs may implicate our securities laws.”

Takeaways

• The SEC is focusing on statements made to investors on social media to promote NFTs. These statements tie to investors’ “expectations of profit” under Howey. SC2 made statements to investors promoting the NFTs on social media both before and after the offering, including touting the sale of the NFTs on the secondary market to encourage the public to buy them.
• In both the SC2 and Impact Theory settlements, the SEC focused on how the NFTs were programmed so that the issuer received royalties from resale transactions, which created incentives for the market to buy and sell the NFTs in the secondary market.
• Both the SC2 and Impact Theory settlements contained similar remedial measures, including the requirement that the companies destroy all NFTs at issue in their possession or control within 10 days of the settlement. This may become a standard remedial measure in any future NFT settlements with the SEC.

^{1 SEC v. Stoner Cats 2, LLC, No. 3-21655 (Sept. 13, 2023).}

^{2 Id. ¶ 8.}

^{3 Id. ¶ 1.}

^{4 Id. ¶ 11.}

^{5 Id. ¶¶ 23-25.}