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Yuga Labs Threatened With Possible Class-Action Lawsuit

Legal

decrypt.co 24 July 2022 21:37, UTC
  
Reading time: ~5 m

Last month, Yuga Labs, the $4 billion company behind popular NFT collection Bored Ape Yacht Club (BAYC), generated headlines by suing a prominent artist for trademark infringement

Now, the company may find itself on the other side of the courtroom.

Law firm Scott+Scott is currently organizing a class-action suit against Yuga Labs, according to an announcement from the firm late this week. The lawsuit will allege that Yuga falsely promoted Bored Ape NFTs and ApeCoin, the collection’s native Ethereum token, as securities with guaranteed returns but which in reality plummeted in value over the last three months.

The case’s plaintiffs have not yet filed an official complaint in a federal court. Scott+Scott is still in the preliminary stage of seeking plaintiffs who suffered losses in association with the purchase of Yuga-backed NFTs and tokens from April to June. The firm did not immediately respond to a request for comment on this story.

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Key to the suit’s success, once filed, will be the court’s determination as to whether non-fungible tokens are securities, similar to a share in a company that could appreciate in value. If a court finds the BAYC NFTs to be securities, then Yuga Labs would have failed to make the necessary disclosure and registration obligations that come with offering securities.

But that may be a long shot. 

“I see very, very, very little likelihood that the SEC is going to want to step in there and ... characterize that [Bored Ape NFT collection] as a security,” said Brian Fyre, a professor of law at the University of Kentucky. “I think they’re going to resist that tooth and nail, because that would open up a huge can of worms for them and force them to regulate all manner of other things that they don’t want to be regulating.”

a class action lawsuit against yuga labs has been initiated https://t.co/IfW5YsZvvn i imagine the first of many

— RYDER-RIPPS.ETH 🔜 (@ryder_ripps) July 24, 2022

The Securities and Exchange Commission has thus far refrained from decisively labeling any NFT as a security. That may have something to do with the fact that such a move would likely bring the broader art market under the SEC’s purview, something the agency has long resisted.

“I don’t really get the sense the SEC knows what it wants to do yet. And in fact, in some ways, I fear that they don’t know what’s going on.”

Technically, whether any financial offering constitutes a security is determined by the so-called “Howey Test,” a four-prong evaluation established by the Supreme Court in 1946. But in reality, things aren’t so black-and-white.

“You know when something is a security? When the SEC decides it wants to regulate it—then it becomes a security,” said Fyre. “The real question is, does the SEC want to regulate this particular market? And the reality is, the SEC does not want to regulate the art market.”

The potential class-action suit against Yuga effectively will allege that customers bought artworks, expecting them to increase in value based on an artist’s (or here, collection’s) reputation. If courts found that Yuga Labs is on the hook here, it’s no further a stretch for the SEC to begin regulating the sales of paintings, sculptures, and tapestries—items far different from stocks, the agency’s bread and butter.

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So, classifying Yuga’s NFT collections as securities may pose an uphill battle. But the lawsuit will also allege that BAYC’s native token, ApeCoin, is a security—and that argument could have more traction. 

ApeCoin, a cryptocurrency launched by Yuga in March, grants holders the ability to vote on the governance proposals of ApeCoin DAO, a decentralized autonomous organization that makes decisions related to the Bored Ape Yacht Club ecosystem. The coin’s value tends to fluctuate with the fortunes of BAYC and Yuga Labs.

“Something like ApeCoin, I could definitely see the SEC saying that looks a lot like a share in a business,” Fyre said.

Despite the federal government largely refraining from labeling NFTs as securities, last month the Department of Justice charged a former executive at NFT marketplace OpenSea with insider trading. The charges allege that the executive made trades informed by insider knowledge about which NFT collections would be featured on OpenSea’s homepage.

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“The weirdness about that is, how do you insider trade unless you’re doing it with something that’s a security, trading on a securities markets?” said Fyre.

But despite labeling the executive’s actions “insider trading,” the Department of Justice only charged him with wire fraud and money laundering, avoiding any formal labeling of the items traded—NFTs—as securities.

This suit against Yuga may force the SEC to finally make a commitment as to whether it views NFTs, or even governance tokens like ApeCoin, as securities. Or, the agency may once again elect to punt.

“I don’t really get the sense the SEC knows what it wants to do yet,” said Fyre. “And in fact, in some ways, I fear that they don’t know what’s going on.”


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