With the onset of the crypto winter, the Securities and Exchange Commission is continuing to bring cases against crypto companies. The latest is against a funding model for animated series: Stoner Cats. The producers wanted to try finding a crypto method to fund the production.
It started off as Kickstarter mixed with Non-Fungible Tokens. The tokens were digital pictures of the animated characters on the production. I think that’s okay and the tokens would not likely to be securities. You initially buy the NFT from producer to be able to watch the series. That’s like buying a movie ticket. That funds the production of the series.
Then the producers added in a royalty feature. When the NFT is traded from the initial buyer to secondary user, the producers take a 2.5% fee that gets passed to the actors and producers. I still that’s okay and doesn’t move the tokens into the treatment as a security.
Under the Howey test, it’s clearly a pooled investment and it’s success is clearly due to the efforts of the production team. The question is there an expectation of profits required by the third prong of the Howey test?
The cash flow from re-sale fee goes to the producers, not the token holders. So, the expectation of profits does not flow directly from the success of the production.
The SEC focused on the potential increase in value of the tokens.
“[I]t led investors to expect profits from their entrepreneurial and managerial efforts, because a successful web series could cause the resale value of the Stoner Cats NFTs to rise in the secondary market.” …
“Investors were also told that “the more successful the show, the more successful your NFT” will be.”
There are plenty of securities offerings that investors look to an increase in value and not to a payment of dividends. Those equity offerings still offer investors a residual claim on the business, even if they don’t get cash flow.
The SEC seems to hang it’s charges on the marketing efforts of the producers that the NFTs could increase in value if there is demand for the series. But of course that is part of the pitch to token holders and the whole NFT eco-system. Buy these tokens and they will increase in value. NFTs occupy this space between commodities and securities.
There is probably an interesting legal analysis and this could be an interesting court case. However, the producers settled with the SEC, agreed to return funds and destroy the NFTs.
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