Why the SEC Is Declaring War on OpenSea

The Securities and Exchange Commission may have only recently hit NFT exchange OpenSea with a Wells notice, but in many ways their war started more than a year ago.

SEC Chair Gary Gensler has purposefully avoided answering questions in Congressional hearing after Congressional hearing to avoid providing any regulatory clarity that could help industry players.

Just as with crypto in general, Gensler’s SEC has overstepped and laid the groundwork to elbow out other regulatory agencies to ensure they stay in the driver seat. The agency has baffled industry watchers for years by attempting to classify NFTs as both collectibles and securities.

Take for example that one time Congressman Ritchie Torres (D-NY) pressed Chair Gensler last year to answer whether a tokenized Pokemon card would be a problem in the SEC’s eyes:

REP. TORRES: Suppose I would have purchased a Pokémon card. Would doing so constitute a security transaction?

MR. GENSLER: You could purchase a Pokémon card. I don’t know what the context is, but if you’re just purchasing a Pokémon card…

REP. TORRES: If I purchase a Pokémon card, is that a security transaction?

MR. GENSLER: That’s not as secur—

REP. TORRES: Okay, if I were to purchase a tokenized Pokémon card on a digital exchange via a blockchain? Is that a security transaction?

MR. GENSLER: I’d have to know more.

At the same time, SEC lawyers in their case against Coinbase recently backed down from saying they would ever try to go after collectibles. The Judge in that case, Judge Failia, rightfully attempted to clarify how the SEC is even attempting to draw the line. 

SEC Lawyer: “We are not contending that collectibles are securities.”

Judge Failia: No one is actually suggesting that you are. We're all just afraid that you have so little limitation on your standard that that some really thoughtful attorney is going to bring the Beanie Baby class action [lawsuit.] 

And look, there are some NFT cases the SEC has pursued in the past that had merit. Entertainment company Impact Theory was charged by the SEC and paid more than $6 million in fines last year after the agency alleged they sold NFTs in an “unregistered offering.” The company promised NFT buyers it would deliver “tremendous value” to purchasers. And, without an exemption, selling $30 million in NFTs for upside in what was advertised as “the next Disney” may very well fall in a gray area.

That same year, the SEC also went after the Mila Kunis-backed animated series Stoner Cats, which had sold NFTs representing the characters in the series. 

“Regardless of whether your offering involves beavers, chinchillas or animal-based NFTs, under the federal securities laws, it’s the economic reality of the offering – not the labels you put on it or the underlying objects – that guides the determination of what’s an investment contract and therefore a security,” said Gurbir S. Grewal, Director of the SEC’s Division of Enforcement. 

But going after OpenSea for selling potentially problematic NFTs seems like another missed opportunity to provide clarity on where the SEC specifically sees where a project might be stepping over the line.

Or, perhaps, the NFT industry is simply focusing too much on the wrong question. At this point, the first question anyone in the space ever asks is always, “Why is that not a security?” 

The problem is – and where the agenda of the SEC’s war on NFTs becomes clear – is that it assumes everything is usually a security. And it’s unfortunate, because it shows the SEC is winning.

It’s worth noting that even in the enforcement action against Impact Theory, the SEC noted there are important exemptions. 

“Absent a valid exemption, offerings of securities, in whatever form, must be registered,” said Antonia Apps, Director of the SEC’s New York Regional Office. And that begs the right question that hopefully will soon be answered whether the SEC wants to or not. We’ll eventually get an important ruling in the Coinbase case, but other projects are also actively exploring some of those valid exemptions.

Coinage, for example, has been pioneering the first DAO/Cooperative model in the U.S. — just as Spork DAO, the organizers behind the ETH Denver conference, have. We’re hopeful to eventually show there is a path to provide real value to NFT holders outside the scope of the SEC’s reign of terror.

Until then, it’s clear the SEC is content to continue having projects operate from a place of fear under the lack of clarity they’ve enjoyed to their benefit.

If there is one silver lining, it’s also equally clear judges are starting to become slightly annoyed with the SEC’s interest in NFTs. Last year, the agency went after an OpenSea employee in what was trumpeted as the first NFT insider trading case. That employee was convicted for buying NFTs ahead of them being profiled on OpenSea’s site. And while that was a win for the SEC, even the judge noted he couldn’t help but see the case as somewhat of a waste of time.

Judge Furman questioned if the government would have even tried the case if it didn’t involve NFTs. “In another arena the defendant may not have been charged with a crime,” he said as he read his ruling at the sentencing.

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