Original author: Will Awang
On September 13, 2023, the SEC accused Stoner Cats 2 LLC (SC 2) of selling unregistered securities. SC 2 raised approximately 8 million dollars by selling NFTs of an animated web series from investors.
This is the SEC's second major action in the NFT industry since last month's regulatory enforcement against Impact Theory NFT. This regulatory enforcement action is likely to affect the entire NFT industry because the operational paths of 99% of NFT projects are similar to Stoner Cats.
Here I will outline the SEC's regulatory enforcement approach towards Stoner Cats and compare it with Impact Theory NFT to identify similarities and differences in the SEC's regulatory actions towards NFTs.
Reference article: SEC issues first fine to NFT industry, what kind of NFTs are considered securities?
1. Stoner Cats NFT case details
(https://prestonbyrne.com/2023/09/13/a-short-note-on-the-absurd-stoner-cats-settlement/)
Stoner Cats is an animated series that tells the story of a group of adorable cats who behave strangely after their owner, Grandma, smokes marijuana. SC 2 is the production company behind the animated series, and they aimed to raise funds for the production of the Stoner Cats web series through the sale of NFTs.
The SEC points out that before and after the NFTs were offered to the public, SC 2 extensively promoted the sale of NFTs through their official website and social media channels (such as podcasts, YouTube, Twitter, Instagram, Discord, as well as interviews on television and the internet). They highlighted the benefits of owning NFTs, including the unique opportunity to participate in the web series, access to an online member community, future entertainment content, and the right to resell the NFTs in the secondary market.
In its marketing campaign, SC 2 emphasizes their skills from Hollywood producers, experience in cryptocurrency projects, and the participation of renowned artists in web dramas, all of which lead investors to expect success in web drama operations by the SC 2 team and bring them profits from the resale of their NFTs.
Because the resale of NFTs can bring SC 2 a 2.5% royalty income, SC 2 has the motivation to encourage investors to engage in secondary market transactions, such as through guidance provided by SC 2's official Twitter content. Additionally, most NFTs are resold on the secondary market in the following months (not held as collectibles).
SEC officials stated, "Whether packaged as beavers, Totoro, or other animal NFTs, under the Securities Act, if they constitute an 'investment contract' based on economic substance, such NFTs will be included in the definition of 'securities.' In this case, the Stoner Cats NFTs led investors to believe that they could profit from the resale of NFTs through the aforementioned marketing campaign."
In the end, SC 2 reached a settlement with the SEC, which includes (1) agreeing to pay a $1 million civil penalty, (2) establishing a fair fund to compensate harmed investors, (3) destroying all NFTs under their control, and (4) publishing the regulatory enforcement order on their official website and social media.
II. Dissenting Statements from SEC Commissioners
Similar to the Impact Theory NFT case, SEC Commissioners Hester Peirce and Mark Uyeda immediately released dissenting statements, stating that the SEC's decision will target all NFT projects. The SEC needs clear regulatory guidance on NFTs to avoid stifling innovation by creators using NFTs.
Hester Peirce and Mark Uyeda believe that SC 2's behavior should be called "fan crowdfunding," and this digital-era crowdfunding method is similar to the 1970s crowdfunding of Star Wars collectible cards, which brought significant success to the project. This approach from Star Wars is equally applicable to creators today.
III. Logic behind SEC's Regulatory Enforcement
The logic behind the SEC's regulatory enforcement in this case is similar to the Impact Theory NFT case, both applying the Howey test to determine the existence of an "investment contract" and include it in the definition of "securities."
We can see that Stoner Cats NFTs on the surface do meet the standards of the Howey test: (1) investors make a monetary (ETH) investment; (2) the purchased NFTs are for a "common enterprise," where the investor's wealth is closely tied to the SC 2 producers' wealth; (3) investors expect to profit from the resale of NFTs through SC 2's efforts to achieve success in the Stoner Cats web drama.
Among them, SC 2's market promotion and commitments made to investors through public channels are key to determining it as a "security".
Due to Stoner Cats NFT's broader definition of "security" compared to Impact Theory NFT, this regulatory enforcement is likely to affect the entire NFT industry. The frightening thing is that 99% of NFT projects have a Roadmap to inform NFT investors about the future development path and the project owners' experience and resources. After the project is launched, the project owners will promote the NFT through various social media platforms, and the NFT's royalty will be much higher than 2.5%.
Preston Byrne, a partner at Brown Rudnick, said: "The Impact Theory case is clearly a story of an entrepreneur packaging investment contracts as NFTs, while the Stoner Cats case is a story of the SEC packaging collectibles as securities."
But I think differently. These financing-oriented projects, whether NFTs or not, need to be regulated. With so many rug events and so many worthless pictures in your hands, can't they convince you?
IV. Conclusion
In fact, when Azuki launched the Elementals series, I stated at the SeeDAO investment research sharing session that Azuki NFT would clearly be considered a "security": (1) monetary investment (2 ETH); (2) a common endeavor with the investors' wealth closely linked to the wealth of the Azuki NFT project owners (not necessarily, their wealth has been directly withdrawn to Coinbase for cash-out); (3) expecting to profit from the resale of NFTs through the efforts of the Azuki NFT project owners.
What's more important is the strong correlation between the project owners and the price of NFTs, to the extent that the Azuki NFT project owners can single-handedly crash the entire Azuki NFT price with the Elementals series.
So, which NFT project owners will be the next target of the SEC? Former blue-chip projects A (Azuki), B (BAYC), C (CloneX), and D (Doodles) are all trembling.
Only the Mfers say: We are so Back!
（https://twitter.com/unofficialmfers）
Mfers is an NFT project with built-in memes. Founder Sartoshi publicly declared these works to be in the public domain through a CC0 license at the beginning of the project. After handing the project's smart contract over to the community, Sartoshi "disappeared" until he was abandoned and reviled by the community as a "scumbag". In this completely decentralized, roadmap-less mfers open community, anyone can use these NFT characters to create any form of item, just as Sartoshi said at the very beginning: "Plant the seeds and let them grow wild".
REFERENCE:
[1] SEC Charges Creator of Stoner Cats Web Series for Unregistered Offering of NFTs
https://www.sec.gov/news/press-release/2023-17
[2] Collecting Enforcement Actions: Statement on Stoner Cats 2, LLC
https://www.sec.gov/news/statement/peirce-uyeda-statement-stonercats-091323
