A federal judge ruled that the once-hugely-popular NFT video clips known as Moments are likely enough to be securities that a class action lawsuit can go forward.
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Dapper Labs has lost its bid to have a class action lawsuit dismissed that claims NBA Top Shot NFTs are securities.
The suit accuses the company behind the pioneering CryptoKitties NFT collection and its CEO, Roham Gharegozlu, of selling the non-fungible tokens containing brief highlight reel video clips of NBA stars without registering them as securities.
"Moments" were the first NFT collection to really break into the mainstream, attracting basketball fans as much as crypto buyers in 2020, with almost 21 million sales and resales bringing in $982 million since 2020.
Dapper Labs argues that they are not securities but collectibles akin to cardboard basketball cards, and asked that the case be tossed.
Federal District Judge Victor Marrero didn't agree. While not a definitive decision, the preliminary ruling on Feb. 22 found — and enumerated — the ways in which the Top Shot met the four-part definition of a security found in the Supreme Court Howey test.
That defines a security as an investment contract in which there is an "(1) investment of money (2) in a common enterprise (3) with a reasonable expectation of profits (4) to be derived from the efforts of others."
A key part of the judge's ruling is based upon the collection's use of the Flow blockchain created by Dapper Labs for its NFT projects. While Dapper argued that Flow is now a community-controlled, permissionless blockchain, the judge didn't buy it.
The legal relationship that makes Moments an investment contract "is derived primarily from the plausible allegations that Dapper Labs maintains private control over the Flow blockchain," he said.
Dapper Fights Back
While it is believed to be the first case looking at whether NFTs in particular are securities, Judge Moreno warned that his ruling was too narrowly based on the specifics of the NBA Top Shot line to be a definitive precedent.
Securities and Exchange Commission Chairman Gary Gensler has argued that virtually all cryptocurrency tokens — likely including NFTs — are securities.
"Importantly, today's order — which the court described as a 'close call — only denied the defendants' motion to dismiss the complaint at the pleading stage of the case," Dapper Labs told CoinMarketCap Academy via email. "It did not conclude the plaintiffs were right, and it is not a final ruling on the merits of the case."
The company added:
"Courts have repeatedly found that consumer goods — including art and collectibles like basketball cards — are not securities under federal law. We are confident the same holds true for Moments and other collectibles, digital or otherwise, and look forward to vigorously defending our position in Court as the case continues."
The Four Prongs
There wasn't any disagreement about the first part of Howey, that the Moments NFTs represent an investment of money. Aside from all the sales and resales, the NFTs are broken into four classes of rarity, with progressively fewer of each — intended to make them more or less valuable.
The common enterprise is passed because the "purchasers' fortunes were tied to the overall success of Dapper Labs," which controls the Flow blockchain and the sale of FLOW tokens to maintain it.
For the expectation of profits, the judge mined Dapper Labs' own marketing material and tweets, saying they "objectively led purchasers to expect profits."
The fourth prong, the effort of others, comes from the judge's acceptance of the argument that:
"Moments' value is derived almost entirely from the continued operation by Dapper Labs of the Flow Blockchain, which enables price transparency (and thus influences value) but, perhaps more critically, appears to provide purchasers with the ability to trade at all."
He added that Dapper Labs "failure to acknowledge the blockchain technology that underlies Moments is fatal" to its argument for a dismissal of the charges. Without that, the FLOW token, and the Dapper Labs-controlled marketplace that is the only place to trade the NFTs, Judge Marrero found, it is plausible to assert that "Moments would have no value."
However, Judge Marrero also concluded that "not all NFTs offered or sold by any company will constitute a security. He said:
"Each scheme must be assessed on a case-by-case basis."
And given the importance placed on his belief that Dapper Labs controls the Flow blockchain, it's easy to see how the case could fail to set a precedent for NFTs on Ethereum, Solana or other more widely used public blockchains.
