The Securities and Exchange Commission recently brought its first two enforcement actions against issuers of non-fungible tokens (NFTs), resulting in cease-and-desist orders, penalties and other remedies, finding that the NFTs were investment contracts and that each of the issuers had engaged in an offering of securities without registration in violation of Section 5 of the Securities Act of 1933.  These enforcement actions create legal ambiguity and risk for NFT developers regarding the marketing, transferability and royalty generating capacity of NFTs.

What are NFTs?

Non-fungible tokens, often referred to as NFTs, are blockchain-based tokens that each represent a unique asset such as a piece of art, digital content or media. An NFT can be thought of as an irrevocable digital certificate of ownership and authenticity for a given asset, whether digital or physical.

A non-fungible token is created by an artist, creator, or license-holder through a process called minting. Minting involves signing a blockchain transaction that outlines the fundamental token details, which is then broadcasted to the blockchain to trigger a smart contract function which creates the token and assigns it to its owner.

Howey Test

In previous SEC enforcement actions against digital asset sponsors, the SEC applied the standards of the seminal Howey case to determine whether those assets were deemed investment contracts and their distribution a sale of securities.  Under the Howey test, an investment contract exists when the contract, transaction or scheme in question involves (i) an investment of money, (ii) in a common enterprise, (iii) with a reasonable expectation of earning a profit, (iv) primarily through the efforts of others. The definition of a “security” in Section 2(a)(1) of the Securities Act provides a list of instruments or arrangements that includes an “investment contract.”

The NFT Enforcement Actions

Impact Theory

The SEC’s first cease-and-desist order was brought on August 28, 2023 against Impact Theory, LLC, a media and entertainment company, which raised approximately $30 million from the sale of NFTs called “Founder’s Keys” (KeyNFTs). The order found that Impact Theory violated Section 5 of the Securities Act by offering and selling securities without having a registration statement filed or in effect with the SEC or qualifying for an exemption from registration.

In advance of the offering, Impact Theory hosted several live speaking events on Discord, posted recordings of those events on Impact Theory’s Discord channels and shared information on the company’s websites and social media channels. Impact Theory also posted recordings of additional speaking events on YouTube and participated in public interviews on news and social media promoting the KeyNFTs.

The SEC alleged that, through those events and public statements, Impact Theory invited potential investors to view the purchase of a KeyNFT as an investment into the business, stating that investors would profit from their purchases if Impact Theory was successful in its efforts.  Impact Theory emphasized that the company was “trying to build the next Disney,” and, if successful, it would deliver “tremendous value” to KeyNFT purchasers, and that the future value of the KeyNFTs would be significantly greater than their purchase price.

The order required Impact Theory to pay disgorgement of $5,120,718.27, prejudgment interest of $483,195.90 and a civil money penalty of $500,000 as a fund for affected investors, destroy all KeyNFTs in its possession or control, publish notice of the order on Impact Theory’s websites and social media channels, revise the smart contract underlying the KeyNFTs to eliminate any royalty that Impact Theory might otherwise receive from any future secondary market transactions.

Stoner Cats

The SEC’s second NFT cease-and-desist order came on September 13, 2023 against Stoner Cats 2, LLC (SC2), producer of an adult animated television show about house cats that become sentient after being exposed to their owner’s medical marijuana and starring Ashton Kutcher, Chris Rock, Dax Shepard, Jane Fonda, Michael Bublé, Mila Kunis, Seth McFarlane, and Vitalik Buterin.  To finance the production of the show, SC2 offered and sold 10,320 NFTs for 0.35 ETH (approximately $800) each. The offering sold out in 35 minutes and generated gross proceeds in ETH equal to approximately $8.2 million. As in the Impact Theory action, the SEC also found here that SC2 violated Section 5 of the Securities Act by offering and selling securities without registration with the SEC or qualifying for an exemption from registration.

The Stoner Cats NFTs provided holders with exclusive access to view the Stoner Cats series on the internet. SC2 ended up producing six episodes of Stoner Cats, the first of which was released prior to the offering but the next five of which were released afterward, with the final episode airing fifteen months later.

SC2 configured the Stoner Cats NFTs so that it received a 2.5% royalty for each transaction in them on a certain secondary market platform.  According to the SEC, the royalties created incentives for SC2 to encourage individuals to sell and buy the Stoner Cats NFTs in the secondary market. The royalties also helped to assure owners of the NFTs that SC2 would remain committed to the animated show after receiving the Stoner Cats NFT offering proceeds. If the Stoner Cats show was successful, the price of the NFTs could rise in the secondary market and so could the amount of royalties.

On its website, SC2 promised that if 100% of the NFTs were sold (which occurred), 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.”

SC2 engaged in an extensive media campaign to promote the Stoner Cats NFTs both before and after they were sold to the public.  SC2 emphasized that its team had the right credentials to execute the project plan.

The order required SC2 to pay a penalty of $1,000,000 as a fund for affected investors, destroy all Stoner Cats NFTs in its possession or control and publish notice of the order on SC2’s website and social media channels.  Interestingly, SC2 posted both the order and the dissenting statement by Commissioners Pierce and Uyeda (see below) on its website.

SEC’s Application of Howey to Impact Theory and Stoner Cats

According to the SEC, Impact Theory’s and SC2’s media campaigns created reasonable expectations on the part of purchasers of obtaining a future profit based on the sponsor’s managerial and entrepreneurial efforts, a key prong in the Howey test.

The SEC asserts in the order that Impact Theory sought to convince investors that the potential increase in value to be created would be derived from the company’s efforts, quoting Impact Theory as telling prospective investors: “We’re going to be investing that money into development, into bringing on more team, creating more projects, making sure that we’re delivering just an obscene amount of value.” Numerous prospective and actual purchasers of KeyNFTs stated on Impact Theory’s Discord channels that they viewed KeyNFTs as investments into the company and understood Impact Theory’s statements to mean that the company’s development of its projects could translate to appreciation of the KeyNFTs’ value over time.  Impact Theory also programmed the smart contract for the KeyNFTs so that the company received a 10% royalty on each secondary market sale, which presumably would incentivize the company to engage in efforts to build post-offering value in the KeyNFTs.

SC2’s media campaign highlighted the special skills and experience the SC2 team brought to the project. It emphasized their expertise as Hollywood producers as well as the reputations of the animators, writers, and editors, whose credits included highly-regarded animated films. It publicized the deep knowledge certain of them had regarding crypto projects, especially NFTs.  SC2’s right to the 2.5% royalty and commitment to the creation of a DAO consisting of Stoner Cats NFT holders to develop future animation projects if 100% of the NFTs were sold sent strong signals to Stoner Cats NFT holders that SC2 would remain committed to the animated show after receiving the Stoner Cats NFTs offering proceeds.

Dissents by SEC Commissioners Hester Peirce and Mark Uyeda

In their statement dissenting from the Impact Theory order, SEC Commissioners Pierce and Uyeda shared their colleagues’ concern about “the type of hype that entices people to spend almost $30 million for NFTs seemingly without having a clear idea about how they will use, enjoy, or profit from them”, but asserted that this legitimate concern is not a sufficient basis for the SEC to bring an enforcement action, and that the company and purchaser statements cited by the order are not the kinds of promises that form an investment contract. They maintained the SEC doesn’t routinely bring enforcement actions against people that sell watches, paintings or collectibles along with vague promises to build the brand and thus increase the resale value of those tangible items.  Moreover, even if the facts satisfy Howey, rescission has been the traditional remedy (Impact Theory actually did offer rescission and repurchased $7.7 million of the NFTs).  Finally, Commissioners Peirce and Uyeda maintained that, rather than regulate this innovative market through enforcement, it would be preferable for the SEC to study the unique attributes of NFTs and issue clear guidelines.

In their statement dissenting from the Stoner Cats order, Commissioners Pierce and Uyeda again called for the SEC to offer clear guidance to NFT promoters.  They suggested that the activity in question here constitutes fan crowdfunding, a common phenomenon in the world of artists, creators and entertainers, and that the Stoner Cats NFTs are similar to Star Wars collectibles sold in the 1970s. They noted that NFTs offer a potentially viable way for artists of all kinds to monetize their talents, and that the application of the securities laws to NFTs could discourage content creators from exploring ways to harness social networks to create and distribute content and could mean that artists’ creativity will “wither in the shadow of legal ambiguity”.   


As Commissioners Pierce and Uyeda point out in their dissenting statements, the SEC has thus far chosen not to provide clear guidelines regarding the application of the securities laws to NFTs.  Both Impact Theory and SC2 encouraged secondary trading, emphasized upside potential and promoted their expertise and ongoing commitment.  That made the NFTs look less like utility tokens on fully developed blockchain networks and more like an investment in an enterprise in which the expectation of profit was dependent on the efforts of others. 

Until the SEC gets around to developing guidelines, NFT sponsors will need to be extremely careful in their public statements and marketing materials to avoid creating the impression that any increase in value of the underlying asset will be dependent on their ongoing entrepreneurial efforts, as opposed to the general forces of supply and demand in the secondary markets.  In the case of production of a television series or similar content, sponsors might consider employing the conservative approach to digital token development funding: effecting a conventional capital raise of securities under an appropriate exemption (e.g., Rule 506(b) or 506(c)) to fund the completion of the production, and then selling NFTs without registration or exemption after the production is complete and at a point when arguably any value fluctuation is not due to managerial efforts but rather market forces.  Another safeguard could be building into the smart contract a stop-transfer mechanism that would prevent any resales for some period of time.