What does the SEC's historic first accusation of NFTs as "unregistered securities" mean?

Written by: Cookie, BlockBeats

Impact Theory's "Founder's Keys," the first NFT project in history to face SEC "unregistered securities" charges.

On August 28, the SEC (U.S. Securities and Exchange Commission) charged Los Angeles-based media and entertainment company Impact Theory, LLC with conducting an unregistered securities offering of crypto assets in the form of NFTs.

In response to the SEC's charges, Impact Theory, LLC accepted a cease-and-desist order without admitting or denying the findings of the SEC investigation. The order found that it violated the registration provisions of the Securities Act of 1933 and ordered it to pay a total of over $6.1 million in illegal gains, pre-judgment interest, and civil penalties, with the illegal gains to be returned to affected investors through the establishment of a fairness fund. Additionally, Impact Theory agreed to destroy all of their "Founder's Keys" NFTs, issue a public announcement regarding the cease-and-desist order on their official website and social media, and waive any royalty income that may arise from future secondary market transactions involving "Founder's Keys."

Why are "Founder's Keys" facing "unregistered securities" charges?

The SEC determined that the "Founder's Keys" NFTs were offered and sold as investment contracts and securities based on the following facts and circumstances:

From October 13, 2021, to December 6, 2021, Impact Theory raised approximately $29.9 million from hundreds of investors (including investors from across the U.S.) through the issuance of the NFT series "Founder's Keys."

The series was divided into three tiers of rights: "Legendary," "Heroic," and "Relentless," and sold at different prices.

Before the issuance of "Founder's Keys," Impact Theory held several voice live streams on Discord, subsequently uploading recordings of these live streams to their own Discord channel and sharing information about these publicly accessible recordings on their official website and social media. Impact Theory also released recordings of other speaking events on YouTube and participated in public interviews on news media and social media promoting "Founder's Keys."

Through these public promotions, Impact Theory attracted potential investors to view the purchase of "Founder's Keys" NFTs as an investment in their business, stating that if Impact Theory's efforts succeeded, investors would profit from purchasing "Founder's Keys" NFTs. In particular, Impact Theory emphasized that the company was "working to build the next Disney," which, if successful, would bring "tremendous value" to "Founder's Keys" NFT purchasers, with future value far exceeding their purchase price. Impact Theory articulated this in several ways:

"If you pay 1.5 (ETH), you will earn more. So no one would just take a glance at this project and say, 'Sorry, buddy, I think this thing has no value.' I'm very bullish on this, and I will do everything I can to ensure that what I say is right."

"The project is called Impact Theory 'Founder's Keys,' and we like to say it unlocks the future of everything we are currently doing as a company… When I seriously look at NFTs, I realize that what they allow you to do is reward your community. For someone like me trying to build the next Disney, what you need is a thriving community. Therefore, we believe this is a huge way for our community to gain tremendous value from what we are building."

"Now, as we are building this IP, imagine if you could have had the chance to be involved with Disney when they made 'Steamboat Willie'; that’s how we view the legendary tier. Frankly, that's also how we view our first NFT series."

Impact Theory also emphasized that the company's efforts would realize the values they claimed, stating that they would use the proceeds from the sales to "develop," "bring more talent to the team," and "create more projects," as well as:

"But of course, I will ensure that we do something that, by any reasonable standard, people can obtain shocking value from."

"What I want you to take away is that in the next 18 to 24 months, a lot of cool things will happen, and this is just a small part of what will happen in the next five years. The reason we are only selling based on the hype in the next 18 to 24 months is that I want you to capture 90% of the economic value of all the great things we will be doing in the longer future years. The only way to do this is to sell and price based solely on what we are doing in the short term, which will allow you to reap huge gains."

"We will use this money for 'development,' 'bringing more talent to the team,' and 'creating more projects' to ensure we provide amazing value. Until people are laughing and thinking they can't believe they previously spent------you know------whatever value they hold in any tier of NFT will gain all this value------until there is such a feeling------we have been injecting value into the NFTs."

Moreover, Impact Theory publicly shared the view that the wealth of "Founder's Keys" NFT purchasers, Impact Theory, and the founders of Impact Theory are intertwined:

"Our goal is to ensure that as Impact Theory becomes richer, as the founders of Impact Theory become richer, and as the members of Impact Theory become richer, you, the NFT purchasers, also become richer. That’s why we are so actively supporting NFTs."

"NFTs are a mechanism that allows the community to gain economic value from the development of the companies they support."

These statements led many "Founder's Keys" NFT purchasers to express in their Discord that they viewed the purchase of "Founder's Keys" NFTs as an investment in Impact Theory, believing that as Impact Theory progresses in developing its projects, it would bring appreciation to "Founder's Keys" NFTs:

"It's like being invited to invest in a thriving company that is just in its Series A funding."

"It's like investing $10,000 with $300,000 of upside potential while only taking a little risk."

"Everyone here is a crab eater! Buying 'Founder's Keys' NFTs is like investing in Disney, Call of Duty, and YouTube at the same time."

"Currently, there is no investment with such an incredible risk-reward ratio. You are not investing in some 'Founder's Keys' NFTs or PNG images; you are investing in the Impact Theory team, and this unprecedented opportunity is like handing $20 to Mark Zuckerberg in a dorm."

Veteran NFT players reading the above content might just smile helplessly------"Promising to build a brand with the proceeds from NFT sales," "NFTs are a way for the community to benefit from the team's efforts," "Building the next Disney," "Buying NFTs is like investing in a startup/ nascent brand" … It's not about how many NFT projects have said these things, but how many NFT projects haven't said these things…

Will NFTs face significant downturns?

Two SEC commissioners, Hester M. Peirce and Mark T. Uyeda, expressed dissent regarding the SEC's historic enforcement action against NFTs, partly due to disagreement with the application of the Howey analysis. These two commissioners emphasized that NFTs are not company stocks and do not generate any type of dividends for purchasers. Additionally, Impact Theory established a buyback plan in December 2021 and August 2022, proposing to buy back "Founder's Keys" NFTs purchased in the primary or secondary market, having repurchased a total of 2,936, returning approximately $7.7 million worth of ETH to investors. Even if the NFT sales here fully comply with the Howey analysis, it seems feasible for the project party to continue buying back the NFTs from purchasers; is it really worth executing such an enforcement action?

@Orlando_btc believes that the SEC had reasons for allowing Impact Theory to settle without admitting or denying the charges. Compared to FT, NFTs are more like collectibles such as Pokémon cards, sneakers, or watches, thus potentially having stronger arguments regarding membership rights, consumption, and utility, which will still bring many complex issues related to securities law.

Impact Theory is a company primarily focused on Crypto. They have a mainstream brand that is completely separate from Crypto/NFT, so they might be willing to pay hefty fines without admitting wrongdoing and then walk away. This is where the SEC is clever------choosing a defendant with little motivation for fierce resistance, avoiding tackling hard cases like Yuga Labs, while easily claiming a victory in regulating NFTs. However, it can also be said that the SEC has finally started taking action against NFTs, and Yuga Labs may gradually encounter troubles similar to Coinbase.

For most NFT teams, please stop promoting projects as if you are selling equity. Although many lawyers should have already advised NFT projects against this, for many NFT project founders, such advice may still be news.

While this may be the biggest NFT news of the year, the market currently shows little reaction… There is not much panic in the short term, nor is there much optimism in the long term. Commissioners Hester M. Peirce and Mark T. Uyeda raised nine questions about NFTs in their dissenting statement, indicating that the road to NFT regulatory compliance has just begun.

Conclusion

Impact Theory founder @TomBilyeu has tweeted announcing that the company has reached a settlement with the SEC, expressing happiness to conclude the investigation from the SEC so that they can focus on the future of the business and community, even promoting their own NFT project "Kyzen." Tom seems to share a similarity with Su Zhu, both being eternal optimists.

The SEC's shotgun has finally aimed at NFTs, and big players like @garyvee and @frankdegods are likely to be sneezing non-stop today…