Jonathan Mann and Brian L. Frye have filed a lawsuit against the Securities and Exchange Commission (SEC), seeking to protect their digital artwork, which was sold as non-fungible tokens (NFTs) from being subjected to regulatory oversight.
The lawsuit, filed in the US District Court for the Eastern District of Louisiana, aims to address a particular interpretation of the landmark 1946 Supreme Court ruling in SEC v. W.J. Howey, which has long defined what constitutes an "investment contract" under US securities laws (commonly referred to as the Howey Test).
The artists argue that the SEC’s recent application of the Howey Test to NFTs is an overreach of the SEC's authority. According to the complaint, the SEC has been leveraging the Howey Test to classify the sale of NFTs as securities offerings, which has led to regulatory actions against NFT sellers in the past year.
While a recent report found that US intellectual properties law is adequate in categorising and dealing with NFTs, the same certainty does not apply to sales of artist's NFTs. The plaintiffs contend that the SEC has not provided clear guidance on when sales fall under its jurisdiction and that a song sold as an NFT is not within the SEC's wheelhouse.
Mann, who holds the Guinness World Record for most consecutive days writing a song plans to sell over 10,000 NFTs, each featuring a unique remix and a digital image of one of his songs, while Frye creates artwork based on legal scholarship and plans to sell 10,000 digital editions of conceptual artwork. Both hope to make royalties on each resale of the NFTs.
The lawsuit seeks a declaratory judgment that their upcoming NFT projects do not violate the SEC's rules and asks the court to preemptively block the SEC from taking enforcement action against them for not registering their NFT projects as securities.
This legal battle could have far-reaching implications for the NFT market, which saw explosive growth in 2021, including high-profile sales like the $69 million NFT artwork auctioned by Christie’s, before succumbing to a market slump. The outcome may set a precedent for how digital assets are regulated in the future, providing much-needed clarity for artists, creators, and investors alike.
The SEC has yet to comment on the lawsuit, and there is no guidance available, nor any practical or affordable way, for any artist to seek to sell their art based NFTs as a financial product or security, so if these artists are not successful and the SEC continues to assert that art based NFTs are securities/financial products, artists will not enjoy the same tech-neutrality that applies to selling their artwork in other formats, and will lose out on the potential automation of royalty collection offered currently by blockchain and token based smart contracts.
By Michael Bacina and Luke Misthos
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