The legal system is cracking down on NFTs.
Last week a federal judge preliminarily concluded that NFTs of game highlights created by Dapper Labs, a Vancouver-based blockchain company that has partnered with the NBA and NBPA, and sold as NBA Top Shot Moments, are securities and thus subject to federal securities laws.
Judge Victor Marrero of the Southern District of New York denied Dapper’s motion to dismiss a case brought by Virginia resident and Moments purchaser Jeeun Friel. Friel contends that Moments—essentially digital basketball cards that can be bought in packs (like cardboard baseball cards) or in a secondary market and then traded, gifted or sold—are functionally the same as stocks and bonds.
Dapper hasn’t filed a registration statement for Moments with the Securities and Exchange Commission. This is problematic since the Securities Act prohibits offering, selling or delivering “any security” unless a registration is in effect. Purchasers of unregistered securities can sue for damages and raise other claims. The Securities Act defines “security” broadly, with courts focusing on whether individuals invest their money “in a common enterprise” and are led to expect profits.
The denial of Dapper’s motion does not conclusively establish that Moments are securities or that Dapper will lose the case or lose potential appeals to the U.S. Court of Appeals for the Second Circuit or the U.S. Supreme Court. As is often true in litigation, there’s a long road ahead. But the denial does mean the case is on track for pretrial discovery, where Dapper emails can be accessed and sworn testimony taken.
The denial also signals a positive forecast for Friel’s case, which Marrero might later certify as a class action on behalf of “many thousands” of people who purchased Moments between June 15, 2020, and the present. Further, Marrero’s analysis fortifies the broader argument that NFTs function more like securities than collectibles. Dapper disputed the judge’s finding in a statement to Sportico.
“Importantly, the Court’s ruling – which the Court described as a “close call” – only denied the defendants’ motion to dismiss the complaint at the pleading stage of the case. It did not conclude the plaintiffs were right, and it is not a final ruling on the merits of the case. Courts have repeatedly found that consumer goods – including art and collectibles like basketball cards – are not securities under federal law. We are confident the same holds true for Moments and other collectibles, digital or otherwise, and look forward to vigorously defending our position in Court as the case continues,” the company said in the statement.
Friel v. Dapper also presents what is called a case of “first impression.” As Marrero wrote, “no other courts have addressed either the exact substance or posture of the dispute here: whether allegations that an unregistered offer for purchase or sale of, specifically, an NFT constitutes an investment contract.”
Marrero’s opinion stressed several points.
One is that a Moments purchaser does not acquire any intellectual property in the underlying artwork or basketball highlight—such as of a Jayson Tatum shooting a fall away three pointer—or a right to “exploit the highlight without the express permission of the NBA, NBPA, and Dapper.” Ownership is only of the NFT, which is of varying value tied to scarcity and market interest. That arrangement reflects how Dapper, in collaboration with the league and players’ association, “mints” a game highlight into an NFT and attaches a serial number to function as a unique identifier.
Dapper earns revenue from Moments in several ways, such as by keeping a 5% transaction fee on tokens sold via its marketplace and by taking a “cash out fee” when a purchaser transfers their Dapper balance to a bank account. According to Marrero, Dapper’s “combined market capitalization from sales of Moments on the NBA Top Shot application had reached $1.9 billion.”
Purchasers are also restricted in how they convert Moments into financial returns. Those who try to withdraw cash “have not always been able to do so, nor has it been quick.” In 2021, Dapper announced a six-to-eight-week period when withdrawals would first be “enabled” only to then be “processed” over an additional 20 to 40 days (or more).
Pushing in the direction of security recognition, Marrero underscored that the value of Moments is “causally related” to the profitability of Dapper. This is because Dapper generates revenue through the sale and transaction fees. The company also retains the purchasers’ cash after withdrawals are requested, allegedly as a means of “raising money at a high valuation” and “propping up the value” of Dapper’s “Flow Blockchain,” which is used to record transactions.
Marrero also distinguished Moments from baseball cards and other physical collectibles. If Dapper “went out of business and shut down the Flow Blockchain, the value of all Moments would drop to zero,” he wrote. In contrast, “if Upper Deck or Topps, two longtime producers of physical sports trading cards, were to go out of business, the value of the cards they sold would be wholly unaffected, and may even increase, much like posthumously discovered art.”
In addition, Marrero reasoned that Dapper’s “public statements and marketing materials objectively led purchasers to expect profits.” He noted that promotional tweets might not have used the word “profit,” but emojis of rocket ships, stock charts and money bags “objectively mean[t] one thing: a financial return on investment.”
Marrero also unpacked purchasers’ motivations. While many purchasers are NBA fans and enjoy collectibles, some evidence suggests their main motivation is to invest. For example, he references an investor who paid $208,000 for a LeBron James dunk Moment because “it was worth seven figures right away” and that “investing in [Moments] is a lot like investing in stocks. … It’s not only about what the best company or best player is. It’s about understanding what’s baked into the price and what other people aren’t seeing.”
Marrero cautioned that his analysis is limited to Moments rather than NFTs in general. “Not all NFTs offered or sold by any company will constitute a security, and each scheme must be assessed on a case-by-case basis,” he stressed. Still, the ruling will concern any company featuring a similar structure for an NFT.
The judge also noted that “celebrities, influencers, and NBA players” have been gifted Moments. To the extent someone is compensated, either by pay or gifts, to promote Moments or other NFTs, they might eventually face suits like those that have hit Tom Brady, Steph Curry, Naomi Osaka and other stars who have ties to the criminally implicated crypto platform FTX and also, in Curry’s case, ties to the Bored Ape Yacht Club NFT series.
(This story has been updated with a statement from Dapper Labs in the seventh paragraph.)