On August 28, 2024, the co-founder and CEO of OpenSea, Devin Finzer, announced via X, formerly known as Twitter, that OpenSea, the widely popular non-fungible token (NFT) marketplace, had received a Wells Notice from the U.S. Securities and Exchange Commission (SEC).[1] According to Finzer, the notice asserted that under existing federal law, the NFTs on OpenSea are securities.[2] As a result, OpenSea was engaged in the offering of unregistered securities. Because OpenSea is the biggest NFT exchange in the world, offering a broad spectrum of NFTs, the issuance of a Wells Notice signals that the SEC may view all NFTs as securities. As a result, this notice raises fundamental questions about how NFTs, a relatively new asset class, fit into the framework of U.S. securities laws and what the future holds for digital assets. What is clear from the notice is that this is a clear attempt by the SEC to expand its jurisdiction to the NFT market.
What Is OpenSea?
OpenSea is a decentralized platform where users can buy, sell, and trade NFTs, which are unique digital assets often tied to art, music, or other media.[3] By facilitating transactions through blockchain technology, OpenSea has become the largest marketplace for NFTs.[4] Its decentralized nature allows users to engage in peer-to-peer trading without intermediaries.[5]
What Is a Wells Notice?
A Wells Notice is a formal preliminary notification by the SEC, signaling that the agency’s enforcement division believes it has enough evidence to bring legal action against a company or individual.[6] Historically, Wells Notices have been an indicator of an impending enforcement action by the SEC.[7] When a Wells Notice is issued, the recipient has the opportunity to respond and argue their case before the SEC decides whether to proceed with any enforcement action.[8] Despite having the opportunity to respond to the notice, an SEC lawsuit is likely inevitable once the notice has been made.[9]
The Howey Test
At the core of the SEC’s argument against OpenSea is the application of the Howey Test, established in the 1946 Supreme Court case SEC v. W.J. Howey Co.[10] The Howey Test is used to determine whether a transaction qualifies as an “investment contract.” If it does, the transaction is considered a security under U.S. law and falls under SEC oversight.[11] The test revolves around a four-part framework which requires: (1) an investment of money, (2) in a common enterprise, (3) with the expectation of profit, and (4) derived from the efforts of others.[12]
The primary issue with the current NFT market is that certain NFTs, including those sold on OpenSea, are traded specifically because of their potential for price appreciation. This may be seen by the SEC as triggering the third prong of Howey.[13] For example, NFTs such as CryptoPunks and Bored Apes Yacht Club, which have been marketed as valuable collectables, have skyrocketed in value since their release due to profit speculation.[14] If these NFTs meet the Howey criteria, OpenSea and other platforms may need to register them with the SEC and comply with extensive regulatory requirements.
OpenSea’s Response and Potential Consequences
Following the SEC’s notification, Finzer responded by expressing surprise and concern over the SEC’s stance, arguing that NFTs are fundamentally creative goods rather than securities.[15] Finzer also vowed to challenge the SEC’s actions and support the regulatory legal battles of NFT creators.[16]
To date, the SEC has brought other enforcement actions against NFT markets, including Stoner Cats and Impact Theory, both of which resulted in settlements.[17] OpenSea, however, seems likely to put up a fight. If the SEC succeeds in a suit against OpenSea and is able to classify NFTs as securities, this could not only increase operational costs but also deter creators and investors from engaging in the NFT space, potentially stifling innovation.[18]
Conclusion
The SEC’s Wells Notice to OpenSea marks a pivotal moment in the regulation of NFTs and digital assets. A potential classification of NFTs as securities could bring about significant changes in how they are regulated. Specifically, NFT platforms like OpenSea may be required to follow the same registration, disclosure, and compliance requirements as major financial institutions. The most important take from this saga is that the SEC’s continued war against the crypto space highlights the urgent need for updated regulatory frameworks that can adequately address the complexities of digital assets while promoting innovation in the space.[19]
As OpenSea prepares for what could be a lengthy legal battle, the world of decentralized finance will be watching closely to see how the SEC’s actions shape the future of digital assets.
[1] See Devin Finzer (@dfinzer.eth), X (Aug. 28, 2024), https://x.com/dfinzer/status/1828791832009953706.
[2] See id.
[3] See Tobi Amure, What is OpenSea? Investopedia (July 7, 2023), https://www.investopedia.com/what-is-opensea-6362477.
[4] See id.
[5] See id.
[6] See Wells Notice, Legal Information Institute, Cornell Law School, https://www.law.cornell.edu/wex/wells_notice (last visited Sept. 13, 2024).
[7] See Mackenzie Sigalos, OpenSea Receives Wells Notice from Sec, Regulator Says NFTs Are Securities, CNBC (Aug. 28, 2024), https://www.cnbc.com/2024/08/28/sec-issues-wells-notice-to-nft-marketplace-opensea.html.
[8] See id.
[9] See Aoyon Ashraf, OpenSea Gets ‘Wells Notice’ from SEC, Calling NFTs Sold on Platform ‘Securities,’ CoinDesk (Aug. 28, 2024), https://www.coindesk.com/policy/2024/08/28/opensea-gets-wells-notice-from-sec-calling-nfts-sold-on-platform-securities/.
[10] 328 U.S. 293 (1946).
[11] See SEC Push to Regulate NFTs Continues with OpenSea Wells Notice, Thomson Reuters Practical Law (Sep. 05, 2024), https://uk.practicallaw.thomsonreuters.com/w-044 3330?transitionType=Default&contextData=(sc.Default)&firstPage=true.
[12] See id.
[13] See Brian Frye, Why I Sued the SEC, Right Click Save (Sep. 11, 2024), https://www.rightclicksave.com/article/why-i-sued-the-sec-law-regulate-art-nft.
[14] See Edmund P. Daley, Cory S. Flashner & Frank L. Gerratana, Could a Bored Ape + CryptoPunk + ApeCoin = Security?, Mintz (Mar. 18, 2022), https://www.mintz.com/insights-center/viewpoints/2301/2022-03-19-could-bored-ape-cryptopunk-apecoin-security.
[15] Finzer, supra note 1.
[16] Finzer, supra note 1.
[17] Frye, supra note 13.
[18] See Katherine Ross, SEC Wells Notice Targets NFTs on OpenSea, Blockworks (Aug. 28, 2024), https://blockworks.co/news/sec-issues-wells-notice-opensea-nfts.
[19] See Attorneys Comment on OpenSea Wells Notice and Potential SEC Enforcement Action: Are NFTs Securities?, Herrick (Sep. 5, 2024), https://www.herrick.com/news/attorneys-comment-on-opensea-wells-notice-and-potential-sec-enforcement-action-are-nfts-securities/.
