Non-Fungible Tokens (NFTs) Often Fall Short of Meeting Securities Standards, According to Hester Peirce
The U.S. Securities and Exchange Commission (SEC) is actively exploring possible frameworks for governing the evolving crypto space, with a particular focus on non-fungible tokens (NFTs). Under the leadership of Commissioner Hester Peirce, the SEC's Crypto Task Force is at the forefront of this initiative.
At a recent SEC Speaks event, Commissioner Peirce noted that NFTs structured to provide ongoing compensation or revenue-sharing to creators could potentially fall outside the purview of federal securities regulations if they do not resemble an investment contract. This is because tokens that offer holders future profit flows derived from the managerial efforts of others may be classified as securities, thus falling under SEC regulation.
The SEC applies the Howey test to determine if digital assets, including NFTs, are “investment contracts” and therefore securities subject to the Securities Act of 1933 and related regulations. NFTs that provide ongoing compensation or revenue-sharing to creators may resemble an investment contract if buyers are led to expect profits derived primarily from the efforts of creators or intermediaries, triggering SEC oversight.
The recent White House Working Group on Digital Asset Markets report recommends a clear taxonomy dividing digital assets into categories including security tokens (those that qualify as securities, offered as investment contracts, or tokenized forms of securities). The SEC is actively modernizing its regulatory approach, developing rulemaking and safe harbors relating to digital assets that might be securities or investment contracts, aiming for clarity and accommodating innovation like tokenized securities and DeFi applications.
However, it's important to note that Commissioner Peirce's statements do not represent the official position of the SEC or her fellow Commissioners. The SEC has yet to issue formal guidance on the regulatory status of NFTs, leaving uncertainty around how these digital assets will ultimately be treated under federal securities laws.
Commissioner Peirce has increased efforts to engage with the digital asset sector since leading the SEC's Crypto Task Force. The Task Force has organized industry roundtables, invited public feedback, and collaborated with legislators to explore possible frameworks for governing the evolving crypto space. The Task Force is part of the SEC's broader initiative to develop clearer regulatory guidelines for the digital asset sector.
Not all NFTs are likely to be considered securities by the SEC. Crypto assets designed solely for use or consumption should not fall under the scope of federal securities laws, according to Peirce. NFTs can be programmed to transmit a portion of the sale price to the creator as a royalty each time the NFT is resold, resembling royalty models used by streaming platforms. However, whether these NFTs are considered securities depends on whether they meet the criteria of an investment contract under the Howey test.
In summary, if an NFT is structured to provide holders with a share of ongoing compensation or profit flows due to the efforts of creators or third parties, the SEC is likely to consider it a security subject to existing securities laws and regulations. Issuers and intermediaries must comply with registration and disclosure requirements unless a valid exemption applies. The SEC is concurrently pursuing regulatory clarity and updated frameworks specific to digital assets, including NFTs, to address these issues comprehensively.
[1] Investor.gov. (2022). SEC's Crypto Assets and Initial Coin Offerings. [online] Available at: https://www.investor.gov/introduction/crypto-assets-and-icos
[2] SEC.gov. (2022). Statement Regarding Frameworks for Crypto-Asset Securities. [online] Available at: https://www.sec.gov/news/public-statement/frameworks-for-crypto-asset-securities
[3] Cointelegraph. (2022). SEC's Hester Peirce: Regulatory Clarity for Crypto Is 'Imminent'. [online] Available at: https://cointelegraph.com/news/sec-s-hester-peirce-regulatory-clarity-for-crypto-is-imminent
[4] SEC.gov. (2021). Statement on Proposed Safe Harbor for Transactions by Venture Capital Funds Investing in Digital Asset Securities. [online] Available at: https://www.sec.gov/news/public-statement/statement-proposed-safe-harbor-transactions-venture-capital-funds-investing-digital-asset-securities
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