Selling Fractionalized NFTs Could Break The Law, Says SEC Commissioner

Non-fungible tokens (NFTs) are becoming increasingly popular nowadays, but their popularity may impose issues as NFTs can be considered as investment contracts under U.S. securities law. The SEC Commissioner Hester Pierce warned NFT issuers of fractionalized non-fungible tokens and NFT index baskets about the threat. The announcement was made at Draper Goren Holm’s Security Token Summit on March 25.

During the summit, Pierce noted that the concept of NFTs is to be non-fungible, which “in general, it’s less likely to be [considered as] a security.” Also, Pierce added that NFT issuers are becoming more and more creative in the type of NFT they are issuing.

However, the Crypto mom warned NFT issuers to take caution when they are selling fractional interest in NFTs or NFT baskets.

“You better be careful that you’re not creating something that’s an investment product — that is a security,” Peirce stated.

One of the biggest issues with NFTs is the increasingly high prices per token, which made several companies develop ways to fractionalize NFTs to gain exposure to a portion of the NFT token. For example, Digital artist Mike Winkelmann, also known as Beeple, sold his latest artwork “Everydays: The First 5000 Days,” on Christie’s for over $69 million in the form of an NFT. Furthermore, several celebrities and sports clubs are among the early adopters of NFTs – one of which is the NBA’s Top Shot NFT.

Peirce also made a critique about the usage of the Howey Test, which determines if a given asset can be called a security. The test itself is derived from a 1946 court case about real estate contracts being issued by a business individual to gain exposure to fresh funds.

In order to combat the Howey Test and aid the crypto sector, Peirce noted that she hopes for a collaboration with SEC chairman Gary Gensler in the development of a “safe harbor plan” for cryptocurrencies, which would reduce the regulatory scrutiny over new blockchains.

The plan includes a three-year window in which new token issuers have to build decentralized networks and prove that securities laws do not apply to their projects. However, token issuers would have to provide detailed roadmaps, token sale information, and data about the investors and individuals behind the project.

“You have three years to develop the network so that the token is actually usable or the network is decentralized — and at that point, it's clear the securities laws don't apply. And everything that you say will be covered by the anti-fraud laws under the securities laws,” Peirce concluded.