On September 13, 2023, Stoner Cats, the popular animated series centered around five cannabis-loving cats, voiced by an A-list cast of celebrities, became the latest digital asset company targeted by the Securities and Exchange Commission (“S.E.C.”) for allegedly offering unregistered securities.[1]
In its Press Release, the S.E.C. charged Stoner Cats 2 L.L.C. (“SC2”) for allegedly offering unregistered digital asset securities as non-fungible tokens (“NFTs”).[2] While SC2 did not admit any guilt regarding the S.E.C.’s order, it agreed to pay a one-million-dollar fine and destroy all NFTs in its possession.[3] In 2021, SC2 raised over eight million dollars when it sold around ten thousand NFTs to fund its web series.[4]
The basis of the S.E.C.’s order derives from the Supreme Court’s Howey test for determining whether an asset qualifies as an “investment contract.”[5] Under Howey, an investment contract “requires an investment of money in a common enterprise, where buyers have a reasonable expectation of profit derived from the efforts of others.”[6] Applying Howey to the 2021 offering, the S.E.C. asserts that the company led “investors to expect profits because a successful web series could cause the resale value of the Stoner Cats NFTs in the secondary market to rise.”[7]
Why it Matters
While the S.E.C. has previously enforced against cryptocurrencies and token sales, SC2 is only the second instance where the agency has gone after NFTs. In August 2023, the S.E.C. charged Impact Theory for Section 5 violations, resulting in unregistered sales of NFTs known as Founder Keys.[8] As the second case by the S.E.C. regarding NFTs, the SC2 order can potentially shake up the industry. According to Hermine Wong, a former S.E.C. regulator and Head of Policy at Coinbase, the S.E.C.’s orders on Stoner Cats and Impact Theory are likely to “have a chilling effect on the industry.”[9] Additionally, the S.E.C.’s order directs attention to royalties, which many NFT projects center their business model around.[10] Stoner Cats NFTs operate under the agreement that whenever the NFTs are resold, the company receives a royalty of 2.5 percent.[11] Royalties incentivize individuals to buy and sell the NFTs in the secondary market.[12]
Further, the NFT price and royalties would increase if the show became a hit. Royalties are also significant because they draw in artists who may otherwise struggle in the ordinary market and would receive no money for the resale of their creations.[13] However, artists and creators are now left confused about how to interpret royalties as the S.E.C. “didn’t issue guidance about what royalties might count as a violation of securities law, so a reasonable person might assume all royalties are in violation.”[14]
The Dissent
Not all of the S.E.C. Commissioners support the Stoner Cats order. Hester Pierce and Mark Uyeda dissented, demanding that the S.E.C. provide further clarity to artists and companies.[15] They also criticized the agency’s Howey analysis, saying it “lacks any meaningful limiting principle.”[16] According to the Dissent, the Stoner Cats NFTs are akin to “crowdfunding,” which is common among creators, artists, and entertainers.[17] Analogizing the Stoner Cats NFTs to Star Wars collectibles, the Dissent furthered their point by stating the NFTs are similar to the “I.O.U. certifications” that Star Wars fans were allowed to redeem in the 1970s for action collectibles that were not unregistered securities.[18] While Pierce and Uyeda agreed that NFTs should be subject to some security regulation, they vehemently criticized the S.E.C. order for further cementing the legal ambiguity faced by creators seeking to build a loyal following.[19]
Conclusion
Ultimately, this action signals the potential for further enforcement in the digital assets industry, especially of NFTs, by the S.E.C.
[1] See Gibson Dunn Digital Assets Recent Updates – September 2023, Gibson Dunn (Sept. 18, 2023), https://www.gibsondunn.com/gibson-dunn-digital-assets-recent-updates-september-2023/.
[2] See id.
[3] See Press Release, U.S. Sec. Exch. Comm’n, SEC Charges Creator of Stoner Cats Web Series for Unregistered Offering of NFTs (Sept. 13, 2023), https://www.sec.gov/news/press-release/2023-178.
[4] See Elizabeth Lopatto, Mila Kunis and Ashton Kutcher’s Stoner Cats NFTs must sober up, SEC orders, The Verge (Sept. 13, 2023, 2:55 PM), https://www.theverge.com/2023/9/13/23872048/stoner-cats-nft-sec-mila-kunis-ashton-kutcher.
[5] See Eric Hall, SEC settlement with Stoner Cats may signal agency’s intent to assert its authority over unregistered securities in the NFT space, DLA Piper (Sept. 26, 2023), https://www.dlapiper.com/en/insights/publications/intellectual-property-and-technology-news/2023/sec-settlement-with-stoner-cats-may-signal-agencys-intent-to-assert-its-authority.
[6] Id.
[7] Id.
[8] See id.
[9] Lopatto, supra note 3.
[10] See id.
[11] See id.
[12] See id.
[13] See id.
[14] Id.
[15] Collecting Enforcement Actions: Statement on Stoner Cats 2, LLC, U.S. Sec. Exch. Comm’n (Sept. 13, 2023), https://www.sec.gov/news/statement/peirce-uyeda-statement-stonercats-091323.
[16] See id.
[17] See id.
[18] See id.
[19] See id.
