What an SEC lawsuit against OpenSea could look like

The SEC may be looking to take OpenSea to court. 

Though, to be clear, nothing’s set in stone yet. And it’s not clear what the SEC would target. All we know right now is that OpenSea received a Wells notice (essentially telling them that an investigation has been completed and that warning that an enforcement action could be on the horizon). 

Now, if the SEC chooses to file a lawsuit it wouldn’t necessarily be the first time that the regulator tries to claim that NFTs also count as securities (alongside a long list of tokens, though — as we’ve discussed — they’ve gotten plenty of pushback against that). 

But how likely is a lawsuit? That’s still up in the air.

“Although we have certainly seen some counter examples, it can be difficult to talk the SEC staff out of bringing charges once a matter has reached the Wells stage.  That is particularly true in a case like this,” Pillsbury Winthrop Shaw Pittman partner David Oliwenstein told Blockworks. 

“In light of the high-profile nature of this matter and the fact that digital assets are Chair Gensler’s top enforcement priority, an enforcement recommendation is almost certainly socialized within the highest levels of the Division of Enforcement before the issuance of a Wells notice.”

It would, however, be the first time that the SEC encounters resistance in pursuing securities allegations against NFTs.

Both Impact Theory and Stoner Cats settled with the SEC after the regulator claimed they violated securities laws with their NFT projects. 

In another case, the Department of Justice went after a former employee for insider trading, which could perhaps also imply that the things, aka NFTs, he was trading were, well, securities. 

But, despite the use of the term insider trading — Oliwenstein doesn’t expect the SEC to try to use the DOJ case against OpenSea unless it shows “compliance failures by the exchange.” 

He does, however, believe the agency will fall back on the settlements if they bring a case against the NFT exchange.

“It is likely that the SEC will rely on the Impact Theory and Stoner Cats matters to bolster their argument that — depending on how the Howey analysis applies to a particular asset — NFTs may constitute ‘investment contracts’ under the federal securities laws. It will certainly use those enforcement actions to counter any argument by OpenSea that the exchange lacked ‘fair notice’ that the SEC views NFTs as securities,” he told me. 

Jason Gottlieb, who’s representing Jonathan Mann and Brian Frye in their case against the SEC (in which they’re trying to suss out regulatory clarity around NFTs), agreed with Oliwenstein.

“Where I think this precedence gets dangerous is the SEC has this immense power where it can come in against smaller projects or artists, and say, ‘we think that you’re violating the securities laws, we’re going to sue you, and if you want to fight us, you’re going to spend millions of dollars, and you’re going to spend the next few years locked in litigation.’ And frankly, most people can’t afford to do that,” Gottlieb explained. 

It seems that OpenSea is aware of its beneficial position in comparison to smaller NFT projects. Buried in the Wells notice disclosure from yesterday was a pledge from the platform to aid NFT projects facing SEC action. The company says it has allocated $5 million to that fight, as it prepares its own legal battle. 

Gottlieb pointed out that there’s mud in the water when it comes to a potential case. 

So far, the SEC hasn’t been necessarily winning on its arguments that secondary market trading of the tokens it has alleged are securities. In the Kraken case, as we discussed earlier this week, the judge allowed the case to stand based on some of the securities claims, but also showed a fair bit of skepticism. 

Judge William Orrick said that the SEC had an “inconsistent manner” when discussing digital assets, and tacked on that the agency sometimes “confuses” its case with the claims it’s making. 

Add to that, Gottlieb said, the fact that NFTs don’t have the same argument as, say, the tokens mentioned in some of the previous cases brought by the SEC. 

Potentially claiming that there’s a difference between digital art and what we’ll call real world art (the OG RWA, if you will) enough to call the former a security is a “really troubling precedent,” Gottlieb explained. 

The SEC, if it wanted to pursue this argument, could have feasibly alleged that all art transactions are securities, going back so far as the regulator’s inception. But it hasn’t, he noted. 

“So for the staff of the SEC to be threatening charges against OpenSea both lies in the face of what judges have said about secondary market trading of tokens, but is also flying in the face of 90 years of history where the where the SEC does not regulate art markets,” Gottlieb told me. 

Reed Smith partner Jonathan Ammons thinks that the SEC could be targeting fractional NFTs. 

“OpenSea is not the creator or seller of the NFTs, but merely provides information about the NFTs and provides a marketplace for their purchase and sale. OpenSea provides information about historical purchases and values, but does not (to my knowledge) tout the investment returns that buyers are likely to achieve. This seems like a more difficult argument for the SEC to make, and could potentially be applied more broadly to the NFT market than the Impact Theory matter if it is not based on specific actions OpenSea took to market NFTs purchased on its platform,” Ammons said.

“We do not know all of the facts yet, but it is possible that the SEC is focused on fractional NFTs, where investors can buy a fraction of an NFT. These are sometimes called “shares” of an NFT, and some commentators have believed that the SEC would claim that selling such “shares” is equivalent to selling a security (even if the NFT itself were not a security).”

Part of his theory comes from the aforementioned Impact Theory settlement. 

“Much of the SEC’s enforcement order against Impact Theory focused on the ways in which Impact Theory touted the investment returns that buyers would achieve from its NFTs, and how Impact Theory would use the proceeds from the offering to develop the company in ways that would make the purchased NFTs even more valuable. Rightly or wrongly, these types of promises likely made it easier for the SEC to claim that Impact Theory was selling investment contracts, but that is not the case here,” he said. 

To add to this, OpenSea’s been operating without SEC fanfare since 2017.

It won’t be publicly clear what wrongdoing the SEC is accusing OpenSea of until or unless a lawsuit is filed, but a lawsuit against an NFT exchange could open up further securities arguments. 

A modified version of this article first appeared in the daily Empire newsletter. Subscribe here so you don’t miss tomorrow’s edition.

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