United States:

SEC Targets NFTs


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For some time now we have cautioned companies to seek legal
advice for certain business models relating to NFTs. According to a
recent report, the SEC is now targeting certain NFT
uses. According to the report, the SEC is probing whether NFTs are
being utilized to raise money like traditional securities. The SEC
has reportedly sent subpoenas related to the investigation and is
particularly interested in information about fractional NFTs.
Fractionalization allows multiple people to hold (and trade) a
share of an asset. Each share is represented by an NFT that
represents a fraction of the ownership of or revenue rights
associated with the asset. In some cases, this may meet
the Howey  test, which is one of the primary
tests the SEC uses to assess whether a digital asset is a
security.

Each matter is fact-specific, but there are at least specific
three scenarios with NFTs where you absolutely should seek
securities advice:

1. fractionalization

2. where NFTs represent a right to revenue stream (e.g., buy a
tokenized song and get a share of future revenue from the
song)

3. pre-sale of NFTs that have no current use (e.g., presale of game
NFTs where the game is not built and funds are used to raise money
to build the game).

If you are jumping into the NFT space, seek counsel before you
launch to avoid the likelihood of having the SEC come after you. If
it’s too late because you launched without advice and you
receive a subpoena we can help.

Securities issues are just one potential legal concern. Each
different NFT model can present unique legal issues. We strongly
encourage companies who plan to enter into the NFT space to seek
competent legal advice early in the planning phase to obtain a
comprehensive legal review. Spending an hour or so up front to vet
the legal issues can avoid subpoenas and legal issues down the
road.

We are tracking a host of NFT lawsuits and legal disputes. Here
are just some examples of the issues that are involved.

License Uncertainty –  some NFTs
were launched without clear license terms and now there are
disputes as to what NFT owners can and cannot do with their NFT

IP Ownership –  a number of
disputes stem from uncertainty over ownership of IP upon which NFTs
are based – Quentin Tarantino was sued based on Pulp
Fiction 
NFTs alleging he did not own the NFT rights

Trademark Infringement  – various
lawsuits have been filed alleging the NFT used a trademark within
the work without authorization

Copyright Infringement –  various
lawsuits have been filed alleging the NFT used copyrighted material
within the work without authorization

Title Slander, Deceptive and Unlawful Trade
Practices
– at least one lawsuit was filed against an
auction house for misrepresentation of ownership of the work
underlying an NFT.

Unjust Enrichment –  A number of
celebrities have been sued for allegedly promoting a crypto
“scam”

Insider trading –  a high level
executive at an NFT exchange was called out (and resigned) for
trading NFTs on non-public information – while no charges were
fled, it prompted the exchange to adopt an NFT insider trading
policy (which we strongly suggest companies in the space consider
adopting)

Money Laundering –   a US
Treasury Department report warns that NFTs are being used to
conduct money laundering, including “self-laundering”
where criminals purchase an NFT with illicit funds, transact with
themselves to create records of sales on the blockchain, then sell
to another party using clean funds.

Sanctions –   OFAC
Sanctioned a Latvia-based exchange, Chatex, for facilitating
financial transactions for ransomware actors and designated Chatex
and 57 cryptocurrency addresses (associated with digital wallets)
as Specially Designated Nationals (SDNs). This was the first time
NFTs have been publicly impacted as “blocked property” as
one of the designated cryptocurrency addresses owns non-fungible
tokens (NFTs). U.S. persons are prohibited from transacting with
the individuals and entities associated with the designated
cryptocurrency addresses or dealing in those NFTs

Gambling – some NFTs are acquired by or
used in connection with gambling.

These are just the tip of the iceberg. As more creative business
models are developed for NFTs, more legal issues will arise. Seek
legal counsel to avoid the icebergs!

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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