The Stoner Cats Case: A Look into the SEC’s Regulatory Approach and its Impact on NFTs

Stoner Cats
Stoner Cats

Stoner Cats is an animated series launched as a Non-Fungible Token (NFT) project by Stoner Cats 2 LLC (SC2). By purchasing one of the 10,000 NFTs, initially sold for approximately $800 each, you could gain access to exclusive animated episodes. The project was an immediate success, selling out in just 35 minutes and generating around $8 million in proceeds. In addition, SC2 configured the Stoner Cats NFTs to provide SC2 with a 2.5 percent royalty for each secondary market transaction, encouraging individuals to buy and sell the NFTs. This led purchasers to spend more than $20 million in at least 10,000 transactions. With backing from Hollywood celebrities like Ashton Kutcher, Mila Kunis, Chris Rock, Jane Fonda, Michael Buble, and Seth McFarlane, the project looked promising and garnered significant attention.

It’s worth noting that anyone investing in a project named Stoner Cats might have been “stoned” themselves but to each their own.

On September 13, 2023, the SEC formally charged SC2, resulting in a cease-and-desist order and a $1 million fine. According to Gurbir S. Grewal, Director of the SEC’s Division of Enforcement:

“Regardless of whether your offering involves beavers, chinchillas, or animal-based NFTs, under the federal securities laws, it’s the economic reality of the offering – not the labels you put on it or the underlying objects – that guides the determination of what’s an investment contract and therefore a security.”

Gurbir S. Grewal, Director of the SEC’s Division of Enforcement

To put it in simpler terms, imagine a lemonade stand. If you buy a glass of lemonade, you’re just purchasing a product. But if you’re buying shares in the lemonade stand with the expectation of future profits based on the efforts of others, you’re buying a security. Essentially, anything of potential value that people purchase either for pleasure or speculatively could be considered a security, necessitating compliance with securities laws.

While the SEC argues that the economic reality of an offering trumps its label, this approach can be seen as undermining the fundamental principles of creativity, entrepreneurship, and self-expression. How creators label their projects should hold significant weight because it outlines the intent and purpose of the offering. If a creator labels a project as an “NFT-based animated series,” then that should be the lens through which it is viewed, rather than retroactively classifying it as a security because it was successful or because it involved financial transactions.

This perspective raises an important question: how many times have big institutions labeled products or derivatives in a way that best serves their interests, only for the SEC to give them a nod of approval? For example, mortgage-backed securities were often portrayed as low-risk investments before the 2008 financial crisis, despite their complicated and risky nature. If these institutions are allowed such leeway with labeling, why shouldn’t the same courtesy extend to individual creators or smaller enterprises?

That being said, the SEC maintains that it’s the economic reality of the offering—not the labels you put on it—that guides the determination of what’s an investment contract and therefore a security. But this approach can sometimes stifle innovation and limit the creative freedom that the digital age has provided.

By giving more weight to how creators label their projects, we would be embracing a future that respects the diverse ways in which people can contribute to the economy, rather than pigeonholing them into outdated regulatory frameworks.

The Stoner Cats case serves as a warning to current and future NFT creators. Creating JPEG images or other digital assets for sale could get you into legal trouble if not appropriately managed.

The existing framework for securities laws, instituted in the 1930s, is increasingly viewed as outdated. These laws primarily benefit deep-pocketed institutions and often create barriers for individuals.

In an age where blockchain technology allows peer-to-peer transactions without a third party, and where people should have the ability to raise funds or transfer money globally 24/7, the regulatory landscape must adapt. Cutting through red tape should be as straightforward as filling out a government form that outlines the project’s risks and rewards.

Rather than stifling innovation and protecting traditional banking institutions, the SEC should focus on evolving its laws and regulations to meet the realities of today’s technological advancements. The Stoner Cats case is not just about one NFT project falling afoul of old laws; it’s a call to action for a broader change in how we regulate the economic activities of the digital age.