SEC vs BAYC? Here’s what legal experts say it means for NFTs

Last week some news leaked from an unknown source NFT world in upheaval.

An anonymous source tipped it off Bloomberg at the Securities and Exchange Commission currently investigating whether NFTs sold by Yuga Labs, the $4 billion company behind Bored Ape Yacht Club, violated security registration laws. The SEC did not deny the report.

Depending on who you ask, the news confirmed a possibility either once unthinkable or inevitable: the U.S. government may be trying to regulate the nascent multibillion-dollar NFT industry like a securities market.

More legal experts to talk to Decrypttook the development as a clear signal that the SEC—which has aggressively increased its stance on crypto regulation in recent months—is taking unprecedented steps to assert its dominance over the virtual art market. Other legal minds dismissed the move as loud but empty political jockeying on the part of the SEC — one that is unlikely to lead to any dramatic changes in regulation.

Across that spectrum of opinion, however, there was agreement that if the SEC chose to escalate its current investigation into Yuga Labs into litigation, the implications would be seismic.

“The potential for regulatory enforcement is greater than I would have expected, even with respect to NFT collections where each digital asset is unique,” said Alfred Steiner, an artist and lawyer who specializes in NFTs. Decrypt. Steiner currently represents Ryder Ripps, a conceptual artist and provocateur who is currently the target of a Yuga Labs Lawsuit over trademark infringement.

Before Monday’s news, Steiner believed the SEC was unlikely to ever go after a blue chip NFT collection like BAYC, simply because most of the 10,000 Bored Ape NFTs in circulation are distinguished by various visual characteristics (eg. an earring or another colored background ). These differences, Steiner believed, would make these NFTs look less like securities and more like works of art.

“My impression before this news had been that the kind of diversity you have among digital resources in a collection like BAYC would be sufficient to keep regulatory actions at bay,” Steiner said. “I don’t know of any previous signal that they were going to do what they’ve done.”

However, other legal experts disagreed, saying they have been anticipating this escalation for some time.

“I’m not surprised. I’ve seen this coming for the last two years,” said Brian Fyre, a law professor at the University of Kentucky. Decrypt.

“What are all the various NFT collections that Yuga Labs sells, other than functionally investments in the future value of the Bored Ape Yacht Club brand?” said Fyre. “That’s all they really are, at the end of the day.”

For the law professor, it makes perfect sense that the SEC would target a major NFT brand to initiate efforts to regulate the NFT space. People buy into blue chip NFT collections like Bored Apes because of their collective reputation, Fyre said, not because of the artistic value of individual NFTs. And it is very similar to buying shares in a company, argued the professor.

“What you’re buying is a piece of Bored Ape Yacht Club, and the value of your NFT rises or falls with the value of the Bored Ape Yacht Club brand,” Fyre said.

Steiner agreed. “I don’t think there’s much doubt that the vast majority of people who buy very expensive NFTs expect a profit,” he said.

But moving into regulating the NFT space by starting with the biggest NFT brand of them all seems to go against the SEC’s modus operandi, said Jeremy Goldman, a lawyer who specializes in NFTs.

“It seems much more likely that if the SEC is going to go after somebody, they’re going to go after projects that fit much more easily into the framework of what the SEC thinks is a security,” Goldman said Decrypt. Goldman previously represented Yuga Labs, although he does not currently; he has also represented Decrypt.

Goldman believes that there are other NFT projects besides Bored Ape Yacht Club that much more clearly check the boxes for appearing as securities. He’s sure the SEC would almost certainly go after those projects first — if it went after any.

“The SEC usually starts by going after lower-hanging fruit. Think of a project where the marketing said, ‘This is going to be a big investment,’ ‘We’re going to 10x what you put in and take you to the moon,'” ” Goldman said. “It’s very easy for them to prove that it falls within their purview as a security. And I just don’t see BAYC in that category.”

Goldman believes it is highly unlikely that the SEC will ever actually sue Yuga Labs for securities violations. He believes Yuga has only gotten involved here to help the SEC in a publicity-oriented battle for sovereignty over regulation of the crypto space. Goldman went so far as to suggest that the leak may have been planted by the SEC itself.

“To me, it’s a bit suspicious. All of a sudden an anonymous source says, ‘Oh, yeah, Yuga is on the list,’ and then it makes headlines,” Goldman said. “I just wonder if this is part of the government’s fight for control. They put it out there, ‘We’re already looking into this,’ and they want to put a big name out there so it gets the attention of the public.”

Other sources familiar with the matter, who did not want to be named, agreed that the SEC could use Yuga Labs as a pawn in a larger game intended to fend off competing regulators, including the Commodities Future Trading Commission (CFTC), the Treasury Department, and the judiciary .

“The SEC is very clearly committed to turf protection,” Fyre said. “Whichever agency enters this arena first will ultimately be the one most likely to take it on long term. And I don’t think the SEC wants to cede the regulatory path to competing agencies.”

Whatever the underlying motivation, what would happen if the SEC went forward with a case against Yuga Labs and won?

“That would be a problem for the entire industry,” Goldman said. “Launching an NFT would be like going public with a share. It would require an enormous amount of legal work and accounting work and disclosures and registration […] it’s just not feasible or practical for the vast majority of startups.”

Fyre does not believe a scenario where NFTs are legally treated as securities would be so disastrous for NFT creators, since much necessary disclosure information would already be publicly available on the blockchain. However, he believes that such a scenario would quickly become a nightmare for the SEC.

“The NFT market is just a radically transparent, radically efficient, radically reduced version of the art market,” Fyre said. “But the economic logic of both is exactly the same. I don’t know how the SEC goes about separating NFTs [profile picture] market from the art market.”

Guys have, for yearsinsisted that the SEC should regulate NFTs, but that it would open a Pandora’s Box that would logically oblige the agency to regulate the art market, a complicated headache it has avoided for decades.

For that reason, the SEC has potentially found itself between a rock and a hard place for years, eager to go after crypto — a new and volatile financial sector that has won and lost investors billions — but also wary of setting an explosive precedent with thought of the art market.

In the meantime, however, flashy NFT companies like Yuga have been acquiring huge amounts of capital, loads of headlinesand lots of celebrity endorsementsit may now be too difficult for the SEC to remain inactive.

“The more impact they see Yuga having on the markets, the more likely they are to see it as something they want to regulate,” Fyre said. “The question is not whether BAYC is a security. The only real question here is, what does the SEC want to regulate?”