Does the SEC Have the Authority To Regulate Digital Art?

Should artists have to file paperwork with the Securities and Exchange Commission (SEC) just to sell their own creations? Should they be required to warn buyers that art values might fluctuate? Should the SEC get to say if art sales count as an “investment”? Does the SEC have the regulatory authority to police art sales? The SEC seems to think it does—if the art is a nonfungible token (NFT).

As a federal lawsuit against the SEC explains, NFTs are digital tokens stored on a blockchain that “can give the owner a wide array of digital and/or physical rights.” Think of an NFT as a digital collector’s item, designed to be one of a kind.

The plaintiffs in that lawsuit, musician Jonathan Mann (known online as 
songadaymann) and conceptual artist Brian L. Frye, want to continue selling NFTs, but they worry that the SEC under Chairman Gary Gensler will try to stop them. Mann and Frye, who filed their lawsuit last July in the U.S. District Court for the Eastern District of Louisiana, were alarmed by recent SEC actions against other NFT artists that resulted in punishing settlements. They are seeking an injunction barring the SEC from bringing similar enforcement actions against them, which they argue would exceed the agency’s legal authority.

Mann and Frye say they “justifiably fear” the SEC will punish them for future NFT sales, declaring them “unregistered securities offerings.” Under the Securities Act of 1933, the U.S. Supreme Court ruled in the 1946 case SEC v. Howey, a “security” includes “a contract, transaction or scheme whereby a person [1] invests his money [2] in a common enterprise and [3] is led to expect profits solely from the efforts of the promoter or a third party.” But under the SEC’s expansive definition, artists who even hint that their work might become more valuable risk transforming it into a “security,” making it subject to SEC regulation.

In 2023, the SEC fined two companies, Stoner Cats and Impact Theory, based on that understanding of the law. The cases resulted in settlements totaling $1 million and more than $6 million, respectively.

Since those companies were being punished for selling digital artwork to the general public, Mann and Frye argue, the SEC’s enforcement actions went beyond its statutory powers. “The NFTs were not shares of a company and did not generate any type of dividend or ongoing commitment to generate profits for the purchasers,” their lawsuit notes.

Aside from the digital nature of the art, Mann and Frye aver, there is little difference between their work and an Andy Warhol or a Pablo Picasso—or, indeed, any other piece of art. While artists often continue to build up their careers or reputations in ways that benefit previous purchasers of their art, the lawsuit argues, that does not mean they have a “contract, transaction, or scheme” to do so, such that the SEC can demand registration and other regulatory hoop jumping.

In addition to fining Stoner Cats and Impact Theory, the SEC demanded that they destroy existing NFT art. Two of the SEC’s five commissioners questioned whether the agency was in the right, noting that “we do not routinely bring enforcement actions against people that sell watches, paintings, or collectibles along with vague promises to build the brand.” The dissenters warned that the SEC’s settlements in these cases “create a precarious situation for artists and innovators—who regularly use the money from sales of their art to monetize new projects, and often publicize their work or take other roles to raise the commercial value of their art.”

The SEC has not engaged in any formal rulemaking to delineate its asserted authority over NFTs. Mann and Frye just want to know: Can they sell their art without risking an SEC crackdown? They are requesting “federal court intervention to be able to offer and sell their prospective art projects without facing an enormously expensive SEC investigation.”

The SEC moved to dismiss the case in October. Since the agency so far has not made any demands on Mann and Frye, it said, they do not have standing to sue. The agency also claims that “sovereign immunity” bars the lawsuit because “enforcement actions are within the express discretion of the Commission.”

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