Dapper Labs agrees to settle NBA NFT allegations

Dapper Labs (Dapper) has agreed to pay a putative class action brought by private plaintiffs, subject to court approval, ending allegations that its NBA-endorsed non-fungible tokens (NFTs) were offered and sold as unregistered investment contract securities. The terms of the settlement, including the actions taken by Dapper to decentralize its network, may provide a model for third parties who wish to avoid securities liability in connection with the offering of collectible NFT assets digital.

Dapper, also the creator of CryptoKitties, sells NFTs called NBA Top Shot Moments (Moments) that are minted and traded on the Flow blockchain, which was originally owned and operated by Dapper as a private blockchain. Moments are NFTs that represent notable highlights from the NBA game, such as a three pointer by Steph Curry. These NFTs are tradable like physical trading cards. However, the trial alleged that these collectible NFTs were securities because, according to the plaintiffs, Moments satisfied the Howey test and constituted “an investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of [Dapper].”

Dapper argued that Moments are collectibles and that buying and selling them does not constitute the sale of unregistered securities. Dapper argued that collectors obtain Moments for consumption purposes similar to traditional sports trading cards, based on their personal preferences, as opposed to potential investment purposes, and that the value of a Moment is not not directly correlated to Dapper’s profitability, the value of Flow tokens, or the value of other Moments. Instead, factors such as player popularity, performance, type of play, and player injuries determine the value.

In deny In Dapper’s initial motion to dismiss, the court focused on: Dapper’s (1) control over the then-private Flow blockchain; (2) market control for sales of Moments; and (3) marketing efforts. The court, admitting that it was a “close match,” found that since Moments were traded on the blockchain and the Flow marketplace, which Dapper privately controlled, the buyers relied on “the expertise and management efforts of Dapper Labs, as well as its continued success and existence,” thus fulfilling the “joint enterprise” and “efforts of others” prongs of Howey. In terms of Dapper’s marketing, the court also focused on tweets leading to reasonable expectations of profits: “the ‘rocket’ emoji, the ‘stock chart’ emoji, and the ‘money bags’ emoji objectively mean one thing: a return on financial investment. » These facts were sufficient to deny Dapper’s motion to dismiss.

Although it does not address the merits of the sale of the Moments as securities, the parties’ settlement stipulation, which includes the payment of US$4,000,000, describes the business changes already made and to be made by Dapper:

1. Dapper no longer has control over the Flow blockchain, which is now completely permissionless and decentralized;
2. Moments can now be viewed, bought and sold in other marketplaces;
3. Dapper has addressed withdrawal delays, including updating its customer wallet, improving AML/KYC protocols, increasing withdrawal limits, and partnering with new payment and custody providers;
4. Dapper and co-founder and CEO Gharegozlou will relinquish control of Flow reserve tokens to the Flow Foundation; And
5. Dapper will train key personnel in marketing in accordance with securities laws.

The court initially approved the settlement, which now faces a final hearing on September 17, 2024.

The private settlement of a civil dispute has no precedential value. Likewise, enforcement regulations, while they may reveal the inclinations of the regulator, do not set a precedent. However, after this class action settlement and two other Securities and Exchange Commission (SEC) commissions colonies When it comes to NFT securities, industry players can begin to develop some “rules of the road.” In other settlement orders with the SEC (Regarding the impact theoryAnd In the case of Stoner Cats 2), the SEC focused on public statements suggesting buyers should expect asset appreciation and the issuer’s use of revenue from sales and key entrepreneurial efforts to develop NFT projects (which the Dapper court also emphasized).1

After “read tea leaves» (as SEC Commissioner Hester Peirce says), NFT issuers should be careful about:

1. Technical or managerial control over the native blockchain of an NFT,
2. Create an exclusive marketplace for NFTs;
3. Use sales revenue to develop a project or service for a product; And
4. Marketing suggesting investment value or returns on investment.

Based on these factors, NFT projects should be evaluated regarding their structure, technological decisions and marketing in order to assess the level of risk created.

Please contact a member of our team for more information as we continue to closely monitor NFT regulatory and enforcement considerations.

1 The SEC’s Division of Enforcement was reportedly engaged in an enforcement investigation into Dapper, but closed its investigation without recommending enforcement action to the Commission in late September 2023, following settlements with Impact Theory and Stoner Cats 2. It is unclear whether, or to what extent, changes implemented by Dapper and planned changes to the operation and control of the Flow blockchain may have factored into the Division’s decision of Enforcement.

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