Artists and the SEC: A Bleak View for NFT Creators
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Artists and the SEC: A Bleak View for NFT Creators

Brownstein Client Alert, Sept. 14, 2023

Yesterday, in another blow to the viability of NFTs and crypto, the Securities and Exchange Commission (SEC) released a settlement with Stoner Cats 2, LLC, an NFT project designed to raise money to cover some production costs for a cartoon series under the same name. We have previously written on the topic of the SEC’s investigation and anticipated enforcement actions against NFT (nonfungible token) projects. See previous articles here, here and here.

The background of this project is straightforward. In July 2021, Stoner Cats sold 10,320 NFTs to the public for ether valued up to $8.2 million. The purpose of the NFT offering was to promote an animated series about an elderly woman with a cancer diagnosis who lived in NYC and used medical marijuana in connection with her treatment. Her five cats—the Stoner Cats—were the main feature of the show. The series featured animations from Chris Cartagena and voiceovers from celebrities like Jane Fonda, Mila Kunis, Ashton Kutcher, Dax Shepard, Chris Rock and Seth McFarlane. The purpose of the NFT was to promote the show and to provide a sort of memorabilia for its fans.

The SEC alleges that the NFTs, which contained reproductions of the Stoner Cats’ images, was an investment contract. The SEC cites tweets from the show’s promoters during that time suggesting that “the smartest thing to do during a dip in the crypto markets would be to

‘Buy more ETH & sweep the Stoner Cats floor.’” Order, 5, ¶ 21. This created an expectation of profit for the NFT collectors, according to the SEC. Id. at 5, ¶ 19.

In connection with the settlement, Stoner Cats agreed to a civil monetary penalty of $1 million, in addition to destroying any Stoner Cat NFTs it still has in its possession. Id. at 8, ¶ C. The company also agreed to work with the SEC to distribute the penalty as monetary relief to “affected investors.” Id. at 7, ¶ 26(c).

Perhaps more interesting is the dissent from Commissioners Hester Pierce and Mark Uyeda. They argue the SEC has failed to distinguish between ordinary memorabilia and promotional material from blockchain-based collectibles:

Whether an artist is selling numbered versions of physical prints for fans to display on their walls or NFTs for fans to display on social media, she deserves clear guidance about whether and how the securities laws apply. Artists of all kinds have long struggled to support themselves, and NFTs offer a potentially viable way for them to monetize their talents. The fact that money is involved does not transform NFTs into securities.

They further draw an analogy between the limited edition tokens that were released on the heels of the Star Wars 1977 release, which were redeemable for future editions Luke Skywalker, Princess Leia, and R2-D2 action figures to be the equivalent to the modern day NFT. They argue:

In applying the securities laws in this space…, the Commission must take care to preserve the ability of artists to sell their work, build a fan base, and involve that fan base in future creative endeavors. That is what was happening in the 1970s with Star Wars, and that is what was happening here with Stoner Cats. …The 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. More generally, it contributes to the legal ambiguity facing artists, writers, musicians, filmmakers, and others seeking to build a loyal, engaged following.

With public reports of other high-profile NFT investigations, one can expect this may be the first of several enforcement actions in this space. Following SEC Chair Gary Gensler’s testimony to the U.S. Senate on Sept. 12, 2023, in which he said he would seek additional funds for increased crypto enforcement, the next few months may be a challenging period for NFT artists, creators and projects.

This document is intended to provide you with general information regarding SEC enforcement against cryptocurrency and NFTs. The contents of this document are not intended to provide specific legal advice. If you have any questions about the contents of this document or if you need legal advice as to an issue, please contact the attorneys listed or your regular Brownstein Hyatt Farber Schreck, LLP attorney. This communication may be considered advertising in some jurisdictions. The information in this article is accurate as of the publication date. Because the law in this area is changing rapidly, and insights are not automatically updated, continued accuracy cannot be guaranteed.

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