SEC opens investigation into Bored Ape Yacht Club creators — their NFTs and ApeCoin may be equated to securities

Yuga Labs, creator of the popular non-fungible tokens or NFTsNFTs are digital assets that can denote ownership of items such as paintings or sports memorabilia. Tokens can also serve as certificates of authenticity.) collection Bored Ape Yacht Club, is having a tough time. In July, the company was sued for allegedly pumping NFTs and ApeCoin using celebrities in advertisements. 

And as early as October 11, the U.S. Securities and Exchange Commission (SEC) began investigating Yuga Labs for suspected violations of federal laws in the sale of digital assets.

imo the sec probe of @yugalabs is a necessary step in the overall adoption of #NFTs and #web3. i expect their brand to come out of this stronger once this business wraps up.

— j1mmy.eth (@j1mmyeth) October 11, 2022

What’s happened? 

According to Bloomberg’s source, the financial authority checks whether some NFT Yuga and cryptocurrency ApeCoin are similar to securities. A Yuga Labs spokesman said the company assists the SEC in the investigation.  

I am happy to announce my new partnership with the U.S. Securities and Exchange Commission.

This is the first step in doing what is best for web3.

It’s not pretty right now, but I speak for everyone here, when I say we will stand for what’s right.

— illaDaProducer (ex yugalabs) (@huckleberrygump) October 11, 2022

Because of this, the value of ApeCoin, Bored Ape Club’s native token, fell -8.68% (according to Coinbase and as of October 12). The coin price was $4.71 at the time of writing (it was $5.16 the day before). In addition, OpenSea, the largest NFT exchange, has taken down the RR/BAYC NFT collection. 

hey @opensea it seems weird you took down RR/BAYC because of a pending lawsuit from a corporation, but BAYC is still up with pending investigation of fraud from the US government… one pending thingy seems a bit more severe no? please let me know asap why BAYC is still up, thnks

— RYDER-RIPPS.ETH 🔜 (@ryder_ripps) October 11, 2022

The status of the NFT in many countries is in limbo. As for the SEC’s treatment of NFTs and other similar digital assets, Coinbase asked the SEC to set rules for them back in a July petition.

What is Yuga Labs? 

Yuga Labs was founded in 2021 and has quickly become one of the most famous brands in the crypto sphere thanks to its NFTs in the form of cartoon primates, which can cost hundreds of thousands of dollars. Among the customers are celebrities such as Jimmy Fallon and Madonna. 

When Yuga Labs introduced ApeCoin this March as a claim for owners of the Bored Ape Yacht Club, Mutant Ape Yacht Club and Bored Ape Kennel Club NFTs, the company attracted media attention. 

Later, the coin (equal to $305 APE) was needed to purchase the Otherdeed NFTs for Yuga Labs’ Otherside meta-universe game. A collection of 55,000 Otherdeeds sold out in just two hours, bringing the business over $300 million. 

Subsequent and spin-off projects, the Mutant Ape Yacht Club and the Otherside metaverse, earned $96 million and $319 million, respectively. 

The bloodhounds from SEC 

The SEC has recently been actively studying the market for NFTs and cryptocurrencies and the exchanges on which they are traded. 

In July, the SEC had already equated nine cryptocurrencies with securities: AMP (AMP), Rally (RLY), DerivaDEX (DDX), XYO (XYO), Rari management token (RGT), LCX (LCX), Powerledger (POWR), DFX Finance (DFX) and Kromatika (KROM). 

Last week, SEC Chairman Gary Gensler (it was under him that the regulator became so active in the Web3 company) suggested that Ethereum’s switch to Proof-of-Stake (PoS) protocol would profit from other parties’ efforts, which means that Ethereum inherently acts as a security. 

In early October, the SEC fined model Kim Kardashian $1.2 million for illegally pumping EthereumMax (EMAX) coins via social media advertisements.

If NFTs become securities… 

The SEC has not yet decided about NFTs as an asset class. Each will likely be considered case-by-case until practices are developed for categorizing these products.  

Looking at similar financial products may explain how the SEC will move forward with NFTs and their status.  

The SEC’s guidance on celebrity approval of initial coin offerings (ICOs) for cryptocurrencies (which monetize NFTs) and the court investigation of Ripple Labs may shed some light on this. 

Interestingly, lawyer Kevin Koo discerned several tricky moments in ApeCoin that make it very difficult to recognize tokens as securities. 

“First, the sale of the NFT collections (BAYC / MAYC / BAKC) has long ended, so there is no way an allegation can be made that the NFT was sold with the promise of a free token. Second, they took steps to set up a DAO, a foundation, and a board of trustees/advisors/governors, possibly in an effort to claim sufficient distance from Yuga Labs LLC and establish sufficient decentralization,” he wrote. 

Therefore, lawyers recommend that NFT issuers avoid marketing their products as investments that might reward holders with valuations, profits, or dividends. It’s also worth walking away from: 

• NFT sales marketing as an attempt to raise funds to build a platform for future sales; 
• engaging promoters, sponsors, or third parties whose marketing efforts are designed to increase recognition of NFT; 
• giving NFT buyers the impression that they can reasonably expect to increase the value of or profit from a digital asset due to the efforts of the creator or any third party. 

Update from our expert, lawyer Kevin Koo:

If you look at the SEC’s guidance on digital assets, it goes back to the Howey Test. I think you have to see what was the promise that was made to buyers at the point of mint. That would give rise to the expectation of profit and hence give rise to the investment contract. So the factual finding must come first. Were BAYC sold with an expectation of profits from the efforts of others? If yes then maybe there’s an investment contract. Maybe, they would also consider whether the NFTs which were sold on the secondary, with the expectation of an airdrop, were sold on an expectation of profit from the efforts of others.

In our story below, you can learn more about what it’s like to own an NFT. 

https://buidlbee.com/owning-an-nft-is-like-having-a-pokemon-q-a-with-eddie-omega-founder-of-bot-buddyz/