NBA-branded ‘Top Shot’ Moment NFTs can be securities, judge rules in Dapper Labs case

The offering of Dapper Labs’ NBA-branded “Top Shot” non-fungible tokens can be securities, a federal judge ruled Wednesday.

The rejection decision comes a year and a half after a class-action lawsuit was filed against Dapper Labs and its CEO Roham Gharegozlu in New York, alleging that Gharegozlu and Dapper Labs violated federal securities laws by offering a non-fungible token (NFT) collection— NBA Top Shot Moments – without first registering with the US Securities and Exchange Commission (SEC).

“The Court finds that Plaintiffs’ allegations make each consideration under Howey facially plausible and survive Defendants’ motion to dismiss the alleged violation of Sections 5 and 12 of the Securities Act,” ruled District Judge Victor Marrero, of the Southern District of New York.

According to the ruling, Dapper Labs’ FLOW tokens—while not necessarily securities in themselves—are “necessary to the entirety of the scheme in question.”

“Plaintiffs have alleged that without FLOW tokens, no transactions on the Flow Blockchain can be validated. In fact, the ‘Proof-of-Stake’ mechanism used by the Flow Blockchain requires FLOW to power it and incentivize miners to validate transactions. In that regard, FLOWs create utility to Moments through the network’s consensus of ownership and the price of each transaction,” the judge said.

Dapper Labs asked to dismiss the lawsuit last September, arguing that its collection of digital basketball cards were not securities.

“Basketball cards are not securities. Pokemon cards are not securities. Baseball cards are not securities. Common sense says so. The law says so. And the courts say so,” argued lawyers for Dapper Labs.

However, Judge Marrero disagreed in his Wednesday ruling, which denied Dapper Labs’ motion to dismiss the lawsuit.

In the ruling, the judge went through the ramifications of the Howey test, a Supreme Court case commonly used as the standard for measuring whether something is a security or not.

The judge said he found the first prong, an investment of money, was “sufficiently pleaded,” noting that neither party objected to that prong.

On the second prong, whether it is a joint venture, the judge looked at the definition of “pooling” of investors’ funds, pointing to precedents such as the Securities and Exchange Commission’s lawsuit against Kik Interactive and Telegram, and the US Department of Justice v. Maksim Zaslavsky.

“The court is satisfied that AC sufficiently alleges joinder to survive the motion to dismiss,” the judge wrote.

Marrero added that “the buyer’s fortunes were tied to the overall success of Dapper Labs,” because Dapper Labs controlled the Flow Blockchain as well as the online marketplace where Moments were sold and traded.

The judge also pointed to claims by the plaintiffs that Dapper Labs had funds from the sale of Moments for the purpose of raising money and maintaining the value of the FLOW token.

“The reasonable inference to draw from these claims is that the capital Dapper Labs raises through the offering of Moments is used to develop and maintain the Flow Blockchain”

Other considerations further bolster the judge’s conclusion, Marrero wrote.

On the third point, whether there is an expectation of profit, the judge begins by saying that Dapper Labs “misstated” the law by saying there had to be a “continuing” promise of profit, which appeals courts have said is not the case. .

“As to the allegations here, the court finds that defendants’ public statements and marketing materials objectively led buyers to expect profits,” the judge wrote, using screenshots of Top Shot tweets as examples.

He went on to add, “Plaintiffs’ allegations, including those set forth above, are sufficient to support a finding that Moments was purchased primarily for an investment purpose.”

The final prong of the test, the effort of others, also appears to be met, the judge said.

“As described above, it is likely that Moments’ value is derived almost entirely from the continued operation by Dapper Labs of the Flow Blockchain, which enables price transparency (thus affecting value) but, perhaps more critically, appears to give buyers the ability to act at all. Defendants’ failure to acknowledge the blockchain technology underlying Moments is fatal to their motion in this regard,” he wrote.

The judge also said the existence of a secondary marketplace controlled by Dapper Labs supports his conclusion.

“The allegations that Dapper Labs created and maintains a private blockchain are fundamental to the Court’s conclusion. By privatizing the blockchain upon which Moments’ value depends and limiting trading of Moments to Flow Blockchain only, buyers must rely on Dapper Labs’ expertise and management efforts, as well as as its continued success and existence,” the judge wrote.

The judge also cautioned that his conclusion “that what Dapper Labs offered was an investment contract under Howey is narrow,” and that other NFTs may not be securities.

“Rather, it is the particular arrangement that Dapper Labs offers Moments that creates the sufficient legal relationship between investor and promoter to establish an investment contract, and thus a security, under Howey,” he wrote.

Dapper Labs now has three weeks to respond to the case.

UPDATE (February 22, 2023, 18:15 UTC): Adding additional information, changing the heading.