Web3 powerhouse Dapper Labs is renowned for revolutionising how trading cards can be digitalised and owned on the blockchain, however as per a recent court ruling, the company’s most prized creation- the NBA Top Shot Moments NFT collection- is being faced with scrutiny over stature of its assets being ‘securities’.
Here, the lawsuit alleges Gharegozlu and Dapper Labs of violating federal securities laws by offering the NBA Top Shot Moments NFT collection without first registering the assets with the U.S. Securities and Exchange Commission (SEC).
More specifically, New York District Judge Victor Marrero said:
“The Court finds that Plaintiffs’ allegations render each consideration under Howey facially plausible and survive Defendants’ Motion to Dismiss the alleged violation of Sections 5 and 12 of the Securities Act”.
Here, the use of the word ‘Howey’ relates to the ‘Howey Test’- a process in which the U.S. Supreme Court created for determining what transactions qualify as ‘investment contracts,’ and therefore securities.
For an asset to be deemed an ‘investment contract,’ the Howey Test states that there must be an “investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others”.
Further, if such circumstances are found to be present, the in-question assets are then required to be disclosed and registered under the Securities Act of 1993 and the Securities Exchange Act of 1934.
Given the unavoidable trading/flipping and money-making culture that sits at the very core of many people’s Web3 journeys, such area of law has become synonymous with blockchain residing assets, whether it be those of the non-fungible type such as NBA Top Shot, or cryptocurrencies and initial coin offerings (ICOs).
In the case of Dapper Labs, both types of blockchain assets are involved, as although the ruling doesn’t declare the $FLOW token (of its Dappers’ native Flow blockchain) to be a security, the tokens are still “necessary to the totality of the scheme at issue”.
Staying on such topic, and explaining how $FLOW tokens are bound to the utility of NBA Top Shot Moments, Marrero stated that:
“Plaintiffs have alleged that, without FLOW tokens, no transactions on the Flow Blockchain can be validated. Indeed, the ‘Proof-of-Stake’ mechanism employed by the Flow Blockchain requires FLOW to power it and incentivize miners to validate transactions. In that respect, FLOW’s utility creates value for Moments through the network’s consensus as to ownership and the price of each transaction”.
In response to the lawsuit, Dapper Labs filed a motion back in September 2022, stating that it should be dismissed due to the fact that:
“Basketball cards are not securities. Pokemon cards are not securities. Baseball cards are not securities. Common sense says so. The law says so. And courts say so”.
The Intricacies of the Ruling Against Dapper Labs
However, in today’s ruling, Marrero disagreed with the above statement, meaning that Dapper Labs’ Motion to dismiss the lawsuit has been denied.
In reaching such decision, the ruling went through the three ‘prongs’ involved in the Howey test; ‘investments of money,’ ‘whether there is a common enterprise,’ and ‘whether there is an expectation of profits’.
Whilst the debate around whether ‘investments of money’ have been involved in the collection was ‘adequately pled,’ the second prong of determining whether there’s the involvement of a ‘common enterprise’ required a lot more judicial rigor. This is because the court had to review precedents set out in previous cases in order to look at the definition of ‘pooling of investors’ funds’.
Ultimately, the court ruled that the plaintiff’s complaints survives the Motion to Dismiss, with Marrero adding that “purchasers’ fortunes were tied to the overall success of Dapper Labs” because the company controls both the Flow blockchain and the marketplace in which the NFTs are traded on.
Again, the third ‘prong’- i.e., the expectation of profits- was also satisfied, as the court said that Dapper Labs’ public statements and marketing materials “objectively led purchasers to expect profits”, It also stated that “Moments were primarily purchased for an investment purpose”.
“The allegations that Dapper Labs created and maintains a private blockchain is fundamental to the Court’s conclusion. By privatizing the blockchain on which Moments’ value depends and restricting the trade of Moments to only the Flow Blockchain, purchasers must rely on Dapper Labs’s expertise and managerial efforts, as well as its continued success and existence”.
In conclusion, Marrero wrote that “what Dapper Labs offered was an investment contract under Howey is narrow,” however that it’s “the particular scheme by which Dapper Labs offers Moments that creates the sufficient legal relationship between investor and promoter to establish an investment contract”.
Through this decision, and by way of the Howey Test, NFTs from the NBA Top Shot Moments collection have been deemed as securities. Through this ruling, they are further required to be registered with the SEC.
With such ruling now finalised, Dapper Labs and its legal team has 3 weeks to respond.