Friel v. Dapper Labs, Inc.
Date: February, 22, 2023
Case No: 657 F. Supp. 3d 422
Dapper Labs, the creator of NBA Top Shot, faced legal scrutiny over its sale of digital collectibles in the form of Non-Fungible Tokens (NFTs). The lawsuit argued that NBA Top Shot “Moments” (NFTs featuring NBA game highlights) were sold as investment contracts under the guise of collectibles. The case hinges on the assertion that buyers were led to expect profits from their purchases, based on the efforts of Dapper Labs to maintain the platform, promote the Moments, and develop the market.
Legal Issue
The crux of the case is determining whether NBA Top Shot Moments qualify as "securities" under U.S. federal securities laws, necessitating registration with the SEC. The lawsuit centers on whether the sale of these NFTs meets the criteria set forth by the Howey Test, with a particular focus on the expectation of profits derived from the efforts of Dapper Labs.
Howey Test
Investment of Money: Clearly met, as consumers purchased Moments with money, fulfilling the initial criterion of an investment contract under the Howey test.
Common Enterprise: The lawsuit contends that the buyers’ fortunes were interwoven with Dapper Labs' success in managing the NBA Top Shot platform and the broader market for Moments, indicating a common enterprise.
Expectation of Profits: The plaintiffs argue that Dapper Labs promoted Moments as an opportunity for profit, particularly through the appreciation in value driven by Dapper Labs' efforts in platform development, marketing, and creating scarcity.
Derived from the Efforts of Others: Central to the lawsuit is the claim that any potential profits from holding or trading Moments would primarily result from Dapper Labs’ promotional activities, platform management, and market creation efforts, rather than the actions of the NFT holders themselves.
Key Takeaways and Legal Conclusions
Scope of Howey Test in Digital Assets
This case explores the extension of the Howey Test to the realm of NFTs, questioning when digital collectibles cross the threshold into being securities based on their marketing and the context of their sale.
Marketing and Expectation of Profits
The case emphasizes the role of promotional strategies in creating an expectation of profits among buyers, a pivotal factor in applying the Howey Test to digital assets.
Platform Development and Profit Expectation
Highlighting Dapper Labs’ role in curating and promoting the Moments marketplace, the lawsuit underscores the influence of issuer efforts on the perceived value and profitability of digital assets.
Representations to Investors
Promotion of Value Appreciation
Dapper Labs is accused of promoting NBA Top Shot Moments by emphasizing their scarcity, the potential for future demand, and the company's ongoing efforts to enhance the platform's attractiveness to both current and potential users. Such promotions suggested that Moments were not merely digital collectibles but assets likely to increase in value over time.
Highlighting Growth Potential and Speculative Value
Through various marketing channels, Dapper Labs highlighted stories of significant returns realized by early purchasers of Moments. These narratives served to underscore the speculative value of Moments, drawing parallels with traditional investment opportunities where returns are contingent on the asset's appreciation.
Statements Regarding Platform Development and Expansion
Dapper Labs made explicit references to their plans for expanding the NBA Top Shot platform, introducing new features, and securing additional partnerships within the sports and entertainment industries. These statements were designed to convey a sense of upward trajectory for the platform, further fueling the expectation of increased demand and value for Moments.
Engagement with the Community on Future Projects
Dapper Labs engaged with the NBA Top Shot community, hinting at future projects and collaborations that would bring additional content and exclusivity to Moments holders. This engagement strategy reinforced the notion that Moments were gateways to ongoing value creation, directly tied to the company's efforts.
Economic Inducements and Expectation of Profits
The lawsuit argues that the cumulative effect of Dapper Labs' marketing strategies, coupled with direct communications about the company's future plans, acted as economic inducements. These inducements fostered an environment where purchasers of Moments were led to reasonably expect profits, predicated on factors beyond mere market forces—namely, the managerial and entrepreneurial efforts of Dapper Labs.
Conclusion
The "Friel v. Dapper Labs" case represents a pivotal moment in the legal scrutiny of NFTs, challenging the distinction between digital collectibles and investment contracts. By examining the marketing and sale of NBA Top Shot Moments against the backdrop of the Howey Test, the case probes the nuanced dynamics between consumer expectations, the role of the issuer, and the legal definition of securities. It underscores the necessity for entities offering NFTs to meticulously consider how they present these assets to potential buyers, especially when claims of value appreciation are tied to the efforts of the issuer. This lawsuit signals a growing need for clarity in the regulatory treatment of NFTs, urging a careful balance between fostering innovation in digital assets and protecting consumer interests under established securities law.
