Financial advisors should wait for regulations to emerge around crypto assets called non-fungible tokens before recommending them to clients, experts said following the SEC’s first enforcement action involving NFTs.
The Securities and Exchange Commission ordered Impact Theory, a Los Angeles media and entertainment company, to pay $6,103,913 to settle charges that it sold Founder’s Keys in the form of NFTs from Oct. 13, 2021, to Dec. 6, 2021, without registering them as securities.
The agency said the firm raised almost $30 million in a cryptocurrency known as Ether through sales of KeyNFTs to hundreds of investors. Buying the NFTs was portrayed as an investment in the business — which aspired to be “the next Disney” — that could result in a profit for the purchasers, according to Monday’s SEC order. That made the NFTs investment contracts, the SEC alleged. Impact Theory did not admit nor deny the SEC's findings.
The enforcement action was the SEC’s first related to an NFT. The products are tokens created through blockchain technology with unique characteristics that usually depict real-world assets.
The case demonstrates that financial advisors should tread carefully around NFTs, said Ric Edelman, founder of the Digital Assets Council of Financial Professionals.
“This is further indication that NFT trading by advisors is not ready for prime time,” said Edelman, founder of Edelman Financial Engines. “There is lack of clarity regarding the regulatory status of NFTs and the compliance procedures advisors need to follow in order to operate in a proper way.”
The SEC has been filing cases against cryptocurrency providers and platforms for months. With the Impact Theory case, it’s expanding into the NFT space.
That activity should give advisors pause, said Brandon Zemp, CEO of BlockHash, a blockchain consulting firm.
“Sitting back and waiting is the best thing at the moment, not jumping in too fast,” Zemp said. “With the SEC being so aggressive, that’s a risk you have to consider.”
Advisors contemplating NFT recommendations need to make sure they understand the applicable securities laws and potential regulatory pitfalls, said Max Schatzow, founder of RIA Lawyers. If an NFT investment goes south, a client could claim a breach of fiduciary duty or an unsuitable investment, among other causes of action.
“You’re opening yourself up to risk from a client complaint,” Schatzow said.
Alternative investments are good for diversifying portfolios, but Jonathan Ford Jr. said NFTs don’t rank highly among them.
“I feel there is a wide selection of alternatives that better serve client needs,” Ford, president and chief compliance officer at JFJ Advisory Services, wrote in an email. “I think NFTs as a technology could have a use in the future if they provide a utility to those purchasing them. I question how well NFTs can function as a store of value.”
The SEC split, 3-2, on the enforcement actions against Impact Theory, with the Democratic majority — Chair Gary Gensler and commissioners Caroline Crenshaw and Jaime Lizarraga — voting in favor and the Republican commissioners, Hester Peirce and Mark Uyeda, voting against.
Peirce and Uyeda questioned whether the Impact Theory NFT sales warranted an enforcement action.
“The handful of company and purchaser statements cited by the order are not the kinds of promises that form an investment contract,” Peirce and Uyeda said in a joint statement. “We do not routinely bring enforcement actions against people that sell watches, paintings, or collectibles along with vague promises to build the brand and thus increase the resale value of those tangible items.”
Not many advisors are dabbling in NFTs, and it should stay that way, Edelman said.
“Don’t be the first kid on the block to engage in this,” he said. “When we have clarity of rules, it will be easy for advisors to engage in a completely compliant manner.”
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