On August 28, the SEC announced its first enforcement action targeting Non-Fungible Tokens (NFTs) in a matter settled with Impact Theory, the issuer of such NFTs.

According to the SEC’s Order Instituting Cease-and-Desist Proceedings, Impact Theory marketed and sold NFTs called “Founder’s Keys,” raising approximately $29.9 million worth of ether (ETH) from purchasers without registering the NFTs as securities.

Leading up to fundraising, Impact Theory publicly stated that it would ensure “people got a crushing, hilarious amount of value” from the Founder’s Keys, and that it would use the sale proceeds for “development,” “bringing on more team,” and “creating more projects.” Impact Theory also made statements tying its prospective fortunes to those of the purchasers, such as: “Our goal is to make sure that as Impact Theory is enriched, as [its founders] are enriched, as our team here at Impact Theory is enriched, that you guys also are enriched.”

Against the backdrop of these and other marketing statements, the SEC found that prospective and actual purchasers viewed the Founder’s Keys as investments, the value of which depended on Impact Theory's success. The SEC found that this sentiment was evidenced by statements in Impact Theory’s Discord channel, such as: “Buying a founders key is [l]ike investing in Disney, Call of Duty, and YouTube all at once”; and “[T]here is at this point in time no investment that has such an amazing Risk to Reward Ratio. You are not investing in some key or PNG, you are investing in [the Impact Theory] team and regarding this is an opportunity that has never been there its like handing 20$ to Mark Zuckerberg in his dorm room.”

And, notably, Impact Theory tapped into the value that its purchasers had touted by programming the applicable smart contract so that the company received a 10% royalty on each secondary market sale of the NFTs.

As a result of these and other findings, the SEC concluded that the NFTs at issue were securities under the federal securities laws, and that Impact Theory violated federal securities laws by offering and selling the NFTs publicly without registering them as securities or an exemption from the registration requirements. Accordingly, and taking into account Impact Theory’s remedial efforts in buying back approximately $7.7 million worth of the NFTs at issue, the SEC has required Impact Theory to (among other things) destroy all of the Founder’s Keys, pay disgorgement of $5,120,718.27, pay prejudgment interest of $483,195.90, and pay a civil money penalty of $500,000.

In a dissenting statement issued when the SEC announced the Impact Theory settlement, Commissioners Uyeda and Peirce questioned the propriety of charging Impact Theory absent fraud despite its rescission efforts. They questioned more broadly the SEC’s perceived shoehorning of NFTs into the federal securities regime without the Commission having “offered guidance when NFTs first started proliferating.” Among other things, Commissioners Uyeda and Peirce stated that even the legitimate concerns over the “hype” that had enticed Impact Theory purchasers to spend nearly $30 million were “not a sufficient basis to pull the matter into [the SEC’s] jurisdiction,” explaining that “[w]e do not routinely bring enforcement actions against people that sell watches, paintings, or collectibles along with vague promises to build the brand and thus increase the resale value of those tangible items.”

These statements exemplify the digital asset industry’s long-held concerns that fractured views among the Commissioners leave unanswered many important questions concerning, e.g., the classification of NFTs, the need for investor protection and a tailored legislative framework, and secondary market transactions.

Notwithstanding these dissenting views, given the Impact Theory settlement and related commentary from certain of the SEC’s Commissioners, NFT industry participants purchasing management or directors’ and officers’ (D&O) liability insurance could face heightened scrutiny at upcoming renewals. It is important for companies to start D&O underwriting meetings early and have direct dialogue with underwriters, differentiating your company’s marketing strategy for NFT projects from the adverse findings in Impact Theory. In addition, these companies should work with an experienced broker to optimize coverage.

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