DraftKings Faces NFT Securities Suit as Judge Rules Howey Test Is Valid

Posted on: July 3, 2024, 05:22h. 

Last updated on: July 3, 2024, 05:22h.

Todd Shriber @etfgodfather Read More
Expertise: Financial, Gaming Business, Mergers and Acquisitions.

DraftKings (NASDAQ: DKNG) must face class action litigation after a federal judge ruled the non-fungible tokens (NFTs) offered on the company’s DraftKings Marketplace pass muster as securities.

DraftKings Marketplace
An add for DraftKings Marketplace. A federal judge ruled the company can face litigation because its NFTs qualify as securities. (Image: DraftKings Marketplace)

On Tuesday, US District Judge Denise Casper ruled that the suit can proceed because the Howey Test barrier was met regarding the digital trading cards sold on Marketplace to participants in DraftKings’ Reignmakers fantasy games.

The Howey Test is derived from the landmark 1946 Supreme Court case SEC v. W.J. Howey Co. Since then, the high court set forth four criteria to determine whether or not an asset is a security. Those benchmarks are the investment of money, expectation of profits, common enterprise, and investment success dependent upon parties beyond the individual investor. Casper ruled that plaintiffs met those thresholds in the complaint against DraftKings.

Thus, while the Howey test remains crucial in discerning the line between securities and non-investments, its application has varied based on jurisdiction, the specifics of the case, and changes in the types of financial products being offered,” according to Investopedia.

An NFT is a unit of data stored on the blockchain. NFTs can be applied to various digitized items, such as audio and video files and pictures. The suit was filed in March 2023 in US District Court in Boston was brought by Illinois resident Justin Dufoe. He claims he lost approximately $14,000 on NFTs he bought on DraftKings Marketplace.

Bad Timing for DraftKings NFT Efforts

In mid-2021 as the NFT market was booming, DraftKings unveiled plans for DraftKings Marketplace. Reignmakers, which functions on the Polygon blockchain, was the fantasy sports addition to Marketplace.

Through Reignmakers, users accumulate collections of gamified NFT cards via auctions, pack drops, and secondary market transactions. Participants then use those cards in NFL, PGA Tour, and UFC fantasy contests over those seasons. However, timing proved poor for Reignmakers participants hoping to turn profits on their digital trading cards because soon thereafter, NFT prices collapsed and volumes dried up. Counsel for Dufoe noted in the 2023 legal complaint that their client purchased more than $72,000 worth of NFTs on DraftKings Marketplace and that the value of those tokens had since declined to $58,000.

The suit also contends that during the class period, DraftKings failed to register its NFTs as securities with the Securities and Exchange Commission (SEC). If that is proven, DraftKings could draw regulatory scrutiny because the SEC has taken enforcement actions in which it classifies NFTs as securities.

Casper’s decision indicates that DraftKings Marketplace is much more than a digital equivalent of trading card shop. Rather, the judge said it’s a securities exchange, potentially implying DraftKings is allegedly dealing securities in unauthorized fashion.

Recent Precedent Doesn’t Favor DraftKings

While NFTs are a young asset class, there is already some legal precedent that could favor the plaintiffs in the DraftKings Marketplace case.

In 2023, US District Judge Victor Marrero ruled the NBA trading cards offered by NBA Top Shot — controlled by Dapper Labs — were securities. Dapper raised a combined $153 million from the sales and resales of those NFTs on its platform and last month, the US District Court for the Southern District of New York ordered the company to pay plaintiffs $4 million. Those plaintiffs sued Dapper claiming NBA Top Shot NFTs are securities.

Additionally in 2023, the SEC garnered a combined $1.5 million in fines from two NFT issuers the commission said were selling unregistered securities.