On August 28, 2023, the US Securities and Exchange Commission (SEC) charged media and entertainment company, Impact Theory, LLC, with violating the Securities Act of 1933 by making an unregistered offering of securities in the form of non-fungible tokens (NFT). Through the offering, Impact Theory raised roughly $30 million from investors across the country.

This dispute is particularly significant because it focuses on NFTs as opposed to cryptocurrency, which has been the primary focus of SEC enforcement activity in this arena.

SEC Allegations

Impact Theory’s tokens are known as Founder's Key (KeyNFT). As described in the SEC’s order, Impact Theory offered and sold NFTs at three tiers, including “Legendary,” “Heroic,” and “Relentless,” with Legendary being the most expensive of the tiers, costing 1.5-3.0 ether (ETH) per token.

In making this offering, Impact Theory allegedly advertised to KeyNFT purchasers that it would deliver “tremendous value” to their lives, and that the offering proceeds would be put toward “development,” “bringing on more team,” and “creating more projects.” In advance of the relevant offering, Impact Theory hosted publicly available speaking events and participated in interviews on news and social media sites promoting the KeyNFTs. In these promotional speeches, Impact Theory expressed that if one were to pay 1.5 ETH, they would “get some massive amount more than that” in return.

By making these alleged promises and emphasizing the direct connection between the success of Impact Theory and the enrichment of KeyNFT holders, the SEC asserted that Impact Theory gave purchasers in the KeyNFT offering a reasonable expectation of obtaining future profits based on the managerial and entrepreneurial efforts of Impact Theory. For the first time, the SEC has taken the position that by failing to register the Founder’s Keys, Impact Theory violated the Securities Act of 1933.  The focus of the SEC’s contentions were largely the public statements, which they argued were invitations to invest.

SEC Settlement Order

Ultimately, without admitting or denying liability, Impact Theory consented to the SEC’s cease-and-desist order, thereby agreeing to pay a combined total of over $6.1 million in disgorgement, prejudgment interest, and civil penalties. To comply, Impact Theory will post a copy of the order on their website and refrain from committing or causing any future violations of sections 5(a) and 5(c) of the Securities Act.

The order also established a Fair Fund to return monies paid by investors who purchased the relevant KeyNFTs. This buyback program, which was instituted before the SEC acted against Impact Theory, was considered by the SEC when entering the settlement and has already resulted in Impact Theory’s repurchase of approximately $7.7 million worth of ETH. Finally, as part of the settlement order, Impact Theory agreed to destroy all KeyNFTs in its possession or control and eliminate any royalties that they may otherwise receive from secondary market transactions dealing with Founder’s Keys. Notably, Impact Theory was to receive a 10% royalty on each of these secondary market sales, and such sales were alleged to have generated approximately $978,000 worth of ETH in royalties between October 13, 2021, and July 20, 2023.

Takeaways

This SEC action against Impact Theory is far from the first of its kind. Rather, it is part of a string of enforcement actions, including those against Binance, Coinbase, and Ripple, brought under the Howey test against creators and/or sellers of NFTs and cryptocurrencies for their alleged engagement in the unlawful sale of unregistered securities. The SEC again applied the Howey test in its analysis of Impact Theory’s offerings of NFTs. It is worth pointing out that the Commissioners were divided with respect to the applicability of Howey as set forth in the dissenting statement by Commissioners Peirce and Uyeda, who were concerned that Impact Theory’s marketing statements “are not the kinds of promises that form an investment contract.”  Further, Peirce and Uyeda outlined important questions that should be considered by the Commission in their approach to NFTs. 

The question of whether a particular token is a security or a collectible is highly fact-specific, making it difficult to predict how a court might rule from case to case. Further, the questions raised within the Commission and inconsistency within the courts creates uncertainty in the marketplace for marketers of NFTs and suggests a need for careful review of statements connected with NFT sales.