In a significant move aimed at clarifying the regulatory landscape for digital artists, musician Jonathan Mann, known as “Song-A-Day Mann,” and law professor Brian L. Frye have filed a lawsuit against the U.S. Securities and Exchange Commission (SEC). The lawsuit seeks to determine whether the art they create using non-fungible tokens (NFTs) will be classified as securities, a designation that could impose heavy legal burdens on artists.
The complaint, filed on July 29, 2024, comes amid growing tensions between the crypto industry and the SEC. Artists Mann and Frye are pushing back against what they perceive as the SEC’s vague and reactive enforcement actions regarding NFTs. They argue that the agency has not provided clear guidelines on how NFTs should be treated under securities law, leaving artists in a precarious position.
The lawsuit requests both declaratory and injunctive relief, aiming to prevent the SEC from continuing its pattern of pursuing enforcement actions without first establishing clear rules. The artists question whether they should be required to register their artwork, disclose potential risks to buyers, or comply with extensive federal securities regulations simply to sell their creations.
Mann expressed his frustration with the SEC’s stance, particularly comments made by SEC Chair Gary Gensler. He stated, “From my perspective, it’s just ludicrous to suggest that because my songs exist on a blockchain, there’s some kind of magical, ethereal process that they go through that suddenly makes them into a security.” Frye echoed this sentiment, emphasizing that the SEC has not faced adequate challenges regarding its interpretations of the law.
The SEC’s recent actions have raised alarms within the NFT community. In late 2023, the agency began scrutinizing whether NFTs could be classified as securities. This scrutiny led to enforcement actions against projects like Impact Theory and Stoner Cats, where the SEC determined that the creators had conducted unregistered offerings of NFTs.
In the case of Impact Theory, the SEC charged the media and entertainment company for allegedly selling unregistered securities in the form of their “Founder’s Keys” or “KeyNFTs.” The SEC argued that the company’s public statements suggested that purchasing a KeyNFT was an investment opportunity. As part of the settlement, Impact Theory agreed to pay over $5 million in disgorgement and penalties and was required to destroy all NFTs in its possession.
Similarly, the SEC took action against Stoner Cats 2, LLC, for offering NFTs that provided exclusive access to a web series and future content. The SEC’s findings indicated that these NFTs were offered as investment contracts, particularly due to the resale royalty imposed on each trade. The settlement included a civil monetary penalty and the destruction of all Stoner Cats NFTs held by the company.
In both cases, dissenting SEC commissioners Hester Pierce and Mark Uyeda criticized the agency’s application of the Howey test, which is used to determine whether an asset is a security. They argued that applying securities laws to NFTs in the same manner as physical collectibles could stifle artistic creativity and innovation.
The lawsuit filed by Mann and Frye highlights the confusion surrounding the SEC’s stance on NFTs. The plaintiffs assert that the SEC’s actions suggest that NFT creators are offering securities when they market their art with statements about royalties and potential value increases. However, the SEC has not clearly defined the circumstances under which NFT sales would be classified as securities offerings.
For instance, the complaint points out the inconsistency in the SEC’s reasoning. Gensler has acknowledged that a physical Pokemon card is not a security, yet he suggested that an NFT representing that card could be. This ambiguity creates uncertainty for artists who wish to explore the NFT space without facing potential legal repercussions.
The plaintiffs draw parallels to traditional artists and entertainers, such as Taylor Swift, who sell concert tickets, albums, and merchandise that can appreciate in value. They argue that it would be nonsensical for the SEC to classify these items as securities, yet the agency’s actions against NFT projects raise questions about the boundaries of its authority in the art world.
Jason Gottlieb, the plaintiffs’ attorney, emphasized the importance of artistic expression, stating, “Art’s not just an investment; it is literally a reflection of human creativity and spirit, and artwork and artistic expression are protected by the First Amendment.” This assertion underscores the need for regulatory clarity that respects the rights of artists while addressing the SEC’s concerns about investor protection.
Zack Shapiro, a managing partner at Rains, commented on the strategic decision to file the lawsuit before either Mann or Frye launched their NFTs. He noted that this approach has proven effective for the industry, as it compels the SEC to provide clearer guidance. Shapiro criticized the agency’s lack of clarity, suggesting that it reflects a hostile stance toward the digital asset industry and has resulted in unnecessary costs for artists and creators.
The lawsuit filed by Mann and Frye represents a pivotal moment for artists navigating the evolving landscape of NFTs and blockchain technology. As the SEC continues to grapple with how to regulate this burgeoning sector, the outcome of this case could have far-reaching implications for the future of digital art and the rights of creators.
In conclusion, the legal battle initiated by Mann and Frye seeks to establish a clearer framework for NFT artists, ensuring that they can create and sell their work without the looming threat of regulatory penalties. The case highlights the urgent need for the SEC to provide definitive guidance on the status of NFTs as securities, allowing artists to thrive in a rapidly changing digital economy.
Source: Various news outlets
