It likely will not be long before the first enforcement action against a Non-Fungible Token (NFT) issuer is announced by the Securities and Exchange Commission. Many NFTs will be deemed to be securities, and therefore, a compliant means of satisfying both Federal and State securities laws is required. A technology roadmap exists that includes creating an NFT, securitizing it, qualifying it via an exemption from registration with the Securities and Exchange Commission, issuing it on the blockchain, meeting secondary trading compliance requirements, then listing it on an Alternative Trading System.
The Securities and Exchange Commission is watching. It likely will not be long before the first enforcement action against a Non-Fungible Token (NFT) issuer is announced. The 80+ enforcement actions the regulators have taken to date on cryptocurrency, digital assets, and Initial Coin Offerings (ICO) only stand to prove the point.
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The story is familiar: XYZ issuer peddles a digital asset, investors buy it with an eye on return, investors may or may not lose some or all their investment, regulators storm in, and facts and circumstances drive the path of their enforcement action. Punishment can be as painful as rescission and loss of license or as severe as jail time. Either way, the legal expense, and reputational risk are significant.
“The variety of use cases for NFTs, combined with rapid and significant growth in the number of offerings, and in some cases the promise of a large potential upside for investors, have made NFTs increasingly popular,” says Doug Ellenoff, Partner at Ellenoff Grossman & Schole, LLP. “This increased interest from the public at large, especially from would-be investors, could very likely be followed by increased scrutiny from regulators.” According to DappRadar, NFT sales volume scaled to $24.9 billion in 2021, compared to just $94.9 million in 2020. With such rapid growth, it should be no surprise that SEC Chair Gary Gensler recently said at an Investor Advisory Committee hearing, “… this is an asset class that belongs inside public policy frameworks of looking after investors, guarding against the illicit activity, and protecting our financial stability.” While discussing the broader token marketplace, NFTs are part of this by default.
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“We believe that many, not all NFTs, like ICOs, will be deemed to be securities, and therefore, a compliant means of satisfying both Federal and State securities laws is required,” says Ellenoff. “This means instead of acting outside securities laws; one finds a way to do it within them.”
Luckily such a roadmap exists. It consists of creating an NFT, securitizing it, qualifying it via an exemption from registration with the Securities and Exchange Commission, issuing it on the blockchain, meeting secondary trading compliance requirements, then listing it on an Alternative Trading System (or a public stock exchange if you like).
Dalmore Group, a broker-dealer, specializing in helping companies raise capital online and having over 150 Regulation A+ issuers under its belt, is one player focused on this solution. Etan Butler, Chairman of Dalmore Group, said, “NFT issuers have a choice; they can either go at it alone with all of the regulatory and enforcement risks inherent in a developing marketplace selling unregistered securities. The other option for NFT issuers is to choose a more conservative and relatively cost-effective approach to vehicles like Regulation A+. In today’s market, the choice really should be easy.”
GUARDD is a technology solution provider that allows issuers to comply with their state Blue Sky requirements. With GUARDD, an issuer provides current and ongoing company and financial disclosures that are published in a National Securities Manual, qualifying for what is known as the Manual Exemption. “By using GUARDD to file disclosures, NFT issuers can qualify for exemption from registration in almost every state,” says Sherwood Neiss, CEO of GUARDD. “We also help our clients with the last mile: what they need to do to be compliant in the remaining states so that their NFTs can trade anywhere in the USA.”
Satisfying regulatory requirements allow exempt issuers to approach the secondary trading platform themselves. The PPEX ATS, operated by North Capital Private Securities, is one such provider with over 640 listed securities. PPEX offers both a lit market, where bids and offers are displayed for the ATS’s institutional participants, as well as a dark pool for buyers and sellers who wish to transact anonymously without broadcasting their interest. The PPEX ATS contains a central limit order book to monitor and match orders, report trades to regulators, and transmit transaction details to executing brokers, settlement agents, and custodians. All in a compliant manner.
Jim Dowd, the CEO of North Capital, said, “Public blockchain technology creates an immutable, public record of NFTs, but our API stack offers tools to facilitate compliance with securities laws, along with access to our regulated trading venue.” North Capital has been involved in digital assets for over four years. “We were involved in some of the first offerings of what we now call digital asset securities, so we have an appreciation for the regulatory complexity associated with NFTs.”
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