Nfts
DraftKings Faces NFT Lawsuit as Judge Says Howey Test Valid
Published on: July 3, 2024, 05:22h.
Last updated on: July 3, 2024, 05:22h.
DraftKings (NASDAQ: DKNG) is facing a class action lawsuit after a federal judge ruled that non-fungible tokens (NFTs) offered on the company’s DraftKings marketplace are considered securities.
On Tuesday, U.S. District Judge Denise Casper ruled that the trial could proceed because the Howey test hurdle had been met regarding digital trading cards sold on Marketplace to participants in DraftKings’ Reignmakers fantasy games.
The Howey test is derived from the landmark 1946 Supreme Court decision, SEC v. W.J. Howey Co. Since then, the Supreme Court has established four criteria for determining whether an asset is a security. Those criteria are investment of money, expectation of profit, common enterprise, and whether the success of the investment is dependent on parties other than the individual investor. Casper held that the plaintiffs met these thresholds in the DraftKings lawsuit.
So while the Howey test remains crucial for distinguishing securities from non-investments, its application varies depending on jurisdiction, the specifics of the case, and changes in the types of financial products offered,” according to Investopedia.
An NFT is a unit of data stored on the blockchain. NFTs can be applied to various digitized items, such as audio and video files and images. The complaint was filed in March 2023 Justin Dufoe, an Illinois resident, filed a lawsuit in U.S. District Court in Boston, claiming he lost about $14,000 on NFTs he purchased on DraftKings Marketplace.
Bad Timing for DraftKings’ NFT Efforts
In mid-2021, as the NFT market was booming, DraftKings unveiled projects for DraftKings Marketplace. Reignmakers, which works on the Polygon blockchainwas the addition of fantasy sports to the Marketplace.
Through Reignmakers, users accumulate collections of gamified NFT cards through auctions, pack drops, and secondary market transactions. Participants then use these cards in NFL, PGA Tour, and UFC fantasy contests during those seasons. However, the timing proved bad for Reignmakers participants hoping to make a profit on their digital trading cards, as shortly thereafter, NFT prices crashed and volumes dried up. Dufoe’s attorney noted in the 2023 legal complaint that his client purchased more than $72,000 worth of NFTs on DraftKings Marketplace and that the value of those tokens has since dropped to $58,000.
The complaint also alleges that during the Class Period, DraftKings failed to register its NFTs as securities with the Securities and Exchange Commission (SEC). If proven, DraftKings could face regulatory scrutiny as the SEC has taken enforcement actions classifying NFTs as securities.
Casper’s ruling indicates that DraftKings Marketplace is more than just a digital equivalent of a trading card store. Instead, the judge said it is a securities exchange, potentially implying that DraftKings is trading securities in an unauthorized manner.
Recent precedents do not favor DraftKings
While NFTs are a young asset classThere is already legal precedent that could favor the plaintiffs in the DraftKings Marketplace case.
In 2023, U.S. District Judge Victor Marrero ruled that NBA trading cards offered by NBA Top Shot — controlled by Dapper Labs — were securities. Dapper has raised a total of $153 million from sales and resales of these NFTs on its platform, and last month, the U.S. District Court for the Southern District of New York ordered the company to pay $4 million to the plaintiffs. The plaintiffs sued Dapper, claiming that the NBA Top Shot NFTs were securities.
Additionally, in 2023, the SEC fined two NFT issuers a combined $1.5 million that the commission found were selling unregistered securities.