Dapper Labs has been under fire since Jeeun Friel, a Virginia woman and NBA Top Shot user, filed a putative class action lawsuit against Dapper Labs, Inc., alleging that the technology company violated the Securities Act of 1933 by operating an application called “NBA Top Shot” which promoted, offered and sold securities, known as NBA Top Shot Moments (“Moments”), throughout the United States. Friel alleges that as a result of Dapper Labs’ issuance, promotion and sale of unregistered securities, Plaintiffs and the Class have suffered substantial damages in an amount to be proven at trial.
On August 31, 2022, Dapper Labs filed a motion to dismiss the case, and nearly five months later, on February 22, 2023, the court denied the motion, finding the claim to be plausible. Dapper Labs had to respond to the court’s decision by March 15, 2023.
Dapper Labs, currently valued at $7.6 billion, is a popular and innovative blockchain-focused technology company that was founded in 2018 and is based in Vancouver, Canada. In October 2020, Dapper Labs partnered with the NBA and NBPA to launch NBA Top Shot – an NFT marketplace for the NBA’s greatest plays and players – and has since sold over $1 billion in digital assets to collectors. NBA Top Shot sells digital basketball cards referred to as “Moments”, which are NFTs featuring a short video clip of a play from an NBA game and are accompanied by statistics about the player and the game. Moments are sold in packs, and each card is assigned its own serial number, making each card a unique digital asset sold in the form of a non-fungible token. NBA Top Shot is built on Dapper Labs’ Flow blockchain – a Proof-of-Stake blockchain developed and controlled by Dapper and powered by their original FLOW token. Dapper Labs originally used the public and decentralized Ethereum blockchain, and its smart contract technology, for their early projects, but after their popular NFT project Cryptokitties “broke” Ethereum with its popularity, Dapper Labs developed its own exclusive blockchain with the ability to scale up and meet consumer needs. This has now become a significant factor in the court’s analysis of “Howey Test,” as it privatized the blockchain — giving Dapper significant control over the sales and success of Moments.
The core of Friel v. Dapper Labs depends on whether the court determines that Dapper Labs’ NBA Top Shot “Moments” are considered securities under “Howey Test.” Dapper Labs claims that their Moments are not securities, but simply digital basketball cards using innovative NFT and blockchain technology. Friel rejects this claim, arguing that NBA Top Shot Moments are not standard cardboard basketball cards and are instead securities. If the court finds that these moments qualify as securities, Dapper will have to register with the SEC or operate under a registration exemption.
The Supreme Court’s decision in SEC v. WJ Howey Co . established a three-part test (“Howey Test”) to determine whether a contract or transaction constitutes an investment contract. These three components include: (1) an investment of money, (2) in a joint venture, (3) with the expectation that profit will be derived from the efforts of the promoter or third party. The parties focused only on the second and third elements of “Howey Test, as it is undisputed that collectors pay an investment of money for their moments.
Friel claims that all three of “Howey test prongs are met, and that the court should therefore find that Dapper Labs’ NBA Top Shot Moment NFTs are securities under the Securities Act of 1933. Friel argues that the fact that Dapper Labs hosts its Moments on Flow blockchain directly affects the second and third prongs of “Howey Test” and further claims that NBA Top Shot, Dapper’s Flow blockchain and Dapper’s FLOW tokens are inextricably linked in a way that leads investors to expect profit from the efforts of Dapper Labs’ ability to sustain interest in its Flow blockchain – to create Moments securities.
Dapper Labs rejects this claim, arguing that neither the second nor the third prong of “Howey Test” is met because Moments’ collectors do not claim to have purchased any FLOW tokens, and since there is no legal support for linking FLOW tokens to the digital basketball cards, Friel’s references to the Flow Blockchain and FLOW tokens are merely a attempt at distraction. without any relevant connection.
The court must analyze the importance of Dapper Labs’ Moments residing on their privately owned and operated Flow blockchain powered by their FLOW token and what impact this has on “Howey Test” analysis. Friel claims that Dapper Labs is using NBA Top Shot Moments as a scheme to stimulate activity on the Flow blockchain and prop up the value of the FLOW token – at the expense of innocent investors. Dapper Labs states that Friel’s Flow claims are immaterial because FLOW tokens are entirely separate products that require separate analysis, regardless of the involvement of blockchain technology, and neither Friel nor digital basketball cards have any necessary connection to FLOW tokens. The court stated that this question is fundamental to the conclusion, and that the privatization and restrictions implemented by Dapper Labs are what separate Moments from cardboard basketball cards.”
The court’s denial of Dapper Labs’ motion to dismiss puts NFT sellers on notice that they may be dealing with securities, which will hopefully lead sellers to put more protective measures and policies in place for their consumers. It is important to note that there are other federal agencies outside of the SEC that may have the necessary regulatory authority over these transactions, such as the Commodity Futures Trading Commission (“CFTC”), which regulates commodities including cryptocurrencies.
