DraftKings NFT Class Action – A Sequel to a Dapper Labs Trial? | ArentFox Schiff
On March 9, 2023, a putative class action lawsuit was filed against DraftKings Inc. for alleged violations of federal securities laws in the United States District Court for the District of Massachusetts. The class, if certified, will include those who purchased or otherwise acquired DraftKings NFTs between August 11, 2021 and today.
As emphasized in our recently published Dapper Labs Alertwhether NFTs are securities is a fact-specific inquiry, so companies should exercise caution when developing new platforms and collections.
SEC v. WJ Howey, 328 US 293 (1946)
Under Howey test, used by the courts when considering whether a financial instrument qualifies as an “investment contract” and thus a security under the Securities Act of 1933, the courts consider the following elements to determine whether a scheme is a security: (1) an investment of money . , (2) in a joint enterprise, (3) with the expectation of profit from the essential entrepreneurial or managerial efforts of others. The Howey The test applies to any contract, arrangement or transaction, regardless of whether it has any of the characteristics of typical securities. The focus to Howey analysis is not only on the form and terms of the instrument itself (in this case the digital asset) but also on the circumstances surrounding the digital asset and the manner in which it is offered, sold or resold (which includes sales on the secondary market). Thus Howey test embodies a flexible approach that can be adapted to different arrangements in which purported investment contracts may arise and takes into account the “totality of the circumstances.”
DraftKings Inc. Class Action Complaint
In their complaint, which is consistent with the reasoning behind the court’s order denying a motion to dismiss in Dapper Labs,[1] the plaintiff class alleges that DraftKing’s NFTs constitute investment contracts under Howey test.
While the allegations against DraftKings reflect those at issue Dapper Labs case, there is at least one notable difference between the NFT collections. While Dapper Labs’ NFTs are minted on Dapper Labs’ private blockchain, Flow, DraftKings’ NFTs are minted on Polygon, a public, Ethereum-based blockchain. The use of a private blockchain was a significant, but not the only, factor in the court’s conclusion that Dapper Labs and consumers engaged in a “joint enterprise” under Howey test. Whether the same reasoning will extend to NFTs minted on a public blockchain remains to be seen.
The plaintiff class also alleges that the third Howey test prong is met because DraftKing’s NFT buyers are dependent on the substantial management efforts of DraftKings to achieve and maintain profits. In support, the complaint alleges that DraftKings NFTs and DraftKings Marketplace satisfy a number of factors identified by the US Securities and Exchange Commission (SEC) as indicative of an expectation of profit from the efforts of others.
Next step
As in all litigation, DraftKings will evaluate a strategy for responding to the complaint, which may include a motion to dismiss. Our team will also monitor this matter Dapper Labs when both unfold.
[1] Friel v. Dapper Labs, 21 Civ. 5837, 2023 WL 2162747 (SDNY Feb. 22, 2023).
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