"Ultimately, the Court’s conclusion that what Dapper Labs offered was an investment contract under Howey is narrow," the judge wrote.

Court Says That NBA-Branded "Top Shot Moments" NFTs May Be Securities in Dapper Labs Lawsuit

NBA Top Shot NFTs (Dapper Labs)

The offering of Dapper Labs’ NBA-branded “Top Shot” non-fungible tokens might be securities, a federal judge ruled Wednesday.

The ruling on a motion to dismiss comes a year and a half after a class-action lawsuit was filed against Dapper Labs and its CEO, Roham Gharegozlu, in New York. The lawsuit alleges Gharegozlu and Dapper Labs violated federal securities laws by offering a non-fungible token (NFT) collection – the NBA Top Shot Moments – without first registering with the U.S. Securities and Exchange Commission (SEC).

“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,” ruled District Judge Victor Marrero, of the Southern District of New York. The Howey Test mentioned by the judge was created by the U.S. Supreme Court for determining whether certain transactions qualify as "investment contracts."

According to the ruling, Dapper Labs’ FLOW tokens – while not necessarily securities themselves – are “necessary to the totality of the scheme at issue.”

“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,” the judge said.

Dapper Labs filed a motion to dismiss the lawsuit in September, arguing its collection of digital basketball cards are not securities.

“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,” lawyers for Dapper Labs argued.

However, Judge Marrero disagreed in his Wednesday ruling, which denied Dapper Labs’ motion to dismiss the lawsuit.

In the ruling, the judge went through the prongs of the Howey Test.

The judge said he found that the first prong, an investment of money, was “adequately pled,” noting neither party had an objection to that prong.

With regard to the second prong, whether there is a common enterprise, the judge looked at the definition of “pooling” of investors’ funds, pointing to precedents such as the Securities and Exchange Commission’s lawsuits against Kik Interactive and Telegram, and the U.S. Department of Justice’s case against Maksim Zaslavskiy.

“The Court is persuaded that the [plaintiff's complaint] adequately alleges pooling to survive the Motion to Dismiss,” the judge wrote.

Marrero added that the “purchasers’ fortunes were tied to the overall success of Dapper Labs,” because Dapper Labs controlled the Flow Blockchain as well as the online marketplace where the Moments were sold and traded.

The judge also pointed to claims from the plaintiffs that Dapper Labs held funds from the sale of Moments for the purposes of fundraising and maintaining FLOW tokens’ value.

“The reasonable inference to draw from these allegations is that the capital Dapper Labs raises through the offer of Moments is used to develop and maintain the Flow Blockchain,” said the judge.

Other considerations further reinforce the judge’s conclusion, he wrote.

On the third prong, whether there is an expectation of profits, the judge said Dapper Labs “misstated” the law in saying there needed to be a “‘persistent’ promise of profit,” which appeals courts have said is not the case.

“As to the allegations here, the Court finds that Defendants’ public statements and marketing materials objectively led purchasers to expect profits,” the judge wrote, using screenshots of Top Shot tweets as examples.

He added, “Plaintiffs’ allegations, including those detailed above, are adequate to support a finding that Moments were primarily purchased for an investment purpose.”

The final prong of the test, the efforts of others, also appears to be met, the judge said.

“As detailed above, it is plausible 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. Defendants’ failure to acknowledge the blockchain technology that underlies Moments is fatal to their Motion in this respect,” he wrote.

The judge also said the existence of a secondary marketplace controlled by Dapper Labs supports his conclusion.

“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,” the judge wrote.

The judge said his conclusion “that what Dapper Labs offered was an investment contract under Howey is narrow,” and other NFTs may not be securities.

“Rather, it is the particular scheme by which Dapper Labs offers Moments that creates the sufficient legal relationship between investor and promoter to establish an investment contract, and thus a security, under Howey,” he wrote. "... In sum, Plaintiffs adequately allege that Dapper Labs’s offer of the NFT, Moments, was an offer of an 'investment contract' and therefore a 'security,' required to be registered with the SEC."

Dapper Labs now has three weeks to respond to the lawsuit.

 

By Nikhilesh De, Cheyenne Ligon | Original link