No Slam Dunk For Plaintiffs In NBA Top Shot Moments Class Action Lawsuit

As if on cue, just as we were bidding adieu to a wave of class action lawsuits stemming from the initial coin offering (ICO) boom of 2017-2018, we see a class action complaint based on allegations that certain NFTs (non fungible tokens) are actually unregistered securities.

The lawsuit was filed against Dapper Labs, Inc and Roham Gharegozlou, the founder and Chief Executive Officer of Dapper Labs, in New York State’s trial court, making them the first defendants in what could turn into an onslaught of lawsuits brought against issuers of NFTs. The gravamen of the complaint is that NBA Top Shot Moments — which are a type of NFT —  are securities, which the defendants “promoted, offered and sold” in violation of federal securities laws.

The plaintiffs assert that Dapper Labs teamed up with the NBA and the NBA Players Association to launch NBA Top Shot. NBA Top Shot Moments depict video clips of highlights from NBA games. The NFTs exist on the Flow blockchain, created by Dapper Labs.  NBA Top Shot sells digital packs of Moments, the prices of which vary based on scarcity. Moments can also be purchased in the Marketplace created by Dapper Labs, where buyers and sellers of Moments come together.

Unlike other lawsuits concerning whether certain digital assets violate U.S. securities laws, this one stands out because it involves the purchase of something that can be considered a collectible. 

But before diving into the question of whether a collectible can also be a security, there are several other items to consider:

First, why didn’t the plaintiffs sue the NBA and the NBA Players Association? Certainly, the NBA has deep pockets. So why not include them as defendants?


Second, the plaintiffs chose to file their lawsuit in New York state court as opposed to federal court. Why sue in state court when the plaintiffs’ claims are based on allegations of violations of federal law? This is particularly perplexing given the novelty of the claims alleged. That is, these claims involving digital assets on a blockchain will likely raise issues of first impression. Why not file in the court best able to address these issues of first impression? 

Daniel Alter, partner at Yankwitt LLP, and former General Counsel at New York State Department of Financial Services, notes that bringing the lawsuit in state court could be problematic from the perspective of developing consistent law. He explains that New York State Courts construing state securities law have a long history of defining securities very broadly. He suggests, “this could take the Howey test in new directions,” which could be helpful to the plaintiffs.

David Silver, founder of the Silver Miller law firm, expects that the defendants will move to dismiss for jurisdictional reasons. He says, “the nexus between the NFTs and New York is questionable as the complaint is written right now.”

Third, the plaintiffs do not allege that the defendants promoted the NFTs as an investment. To the contrary, the plaintiffs concede that in their Service Terms of Use,  the defendants required users to agree that they “are using NFTs primarily as objects of play and not for investment or speculative purposes.” Nonetheless, they allege that Moments were sold with the expectation of profit, and quote both an investor, and a former SEC regulator to buttress their assessment: 

“The reality is that the growing fanatical NBA Top Shot database is all about the investment, speculation and appreciation of the Top Shot NFTs and the NBA Top Shot Marketplace. . . .”

Silver notes that “quotes by third parties to substantiate claims against a defendant are always tricky. The preference is always to directly quote the defendant” which was not done here.

So, the question comes down to whether Moments are more like digital Beanie Babies (which gave rise to the Beanie Baby craze of the 1990s ). Or, are they more like the bank certificates of deposit (CDs) in the seminal case, Gary Plastic Packaging Corp. v. Merrill Lynch, where the Court found that a broker dealer’s scheme to market high-yielding bank CDs to their clients satisfied the Howey test.

In Gary Plastics, the defendants marketed negotiable, insured, and liquid CDs that they had purchased from various banks. In their marketing materials, the broker dealer promised to monitor the creditworthiness of the issuing banks and maintain a secondary market to guarantee purchasers liquidity.

The Second Circuit’s Howey analysis found that the plaintiff had invested $1,200,000 in the CDs offered by the broker dealer, that the broker dealer had engaged in a common enterprise by investigating issuers, and marketing and creating a secondary market for the CDs, and, finally, that the plaintiff expected profits solely from the efforts of the broker dealer. Accordingly, the Court found that the CDs were investment contracts and, thus, securities.   

Here, however, the defendants did not promote or market the Moments as an investment. They expressly disclaimed that the Moments were being sold for investment purposes.

Alter observes that a key component of Gary Plastics was the fact that the broker dealer created and maintained the sole marketplace for trading the CDs. Alter emphasizes that the broker dealer’s oversight and maintenance of the marketplace transformed a non-security into an investment contract. In essence, it was the CDs combined with the program that constituted a security.  

And that’s the nub of it. 

Are the plaintiffs here investors within the meaning of Howey, or are they mere collectors? Have the defendants simply provided basketball enthusiasts with an opportunity to purchase collectibles in the form of a video clip. Or, did they knowingly offer the plaintiffs an investment opportunity by creating and maintaining a marketplace for their Moments. 

Lewis Cohen, co-founder of blockchain-focused boutique law firm, DLx Law noted, “Dapper Labs appear to have been extremely cautious with their marketing of Moments, but they may be a victim of their own success. In a torrid market for non-security assets like their Top Shot Moments, it is inevitable that some buyers will seek a speculative profit, hoping to ride the coattails of the seller’s hot product. If this is the new standard for ‘investment contracts’ there are many other businesses out there that should start worrying.”  

Alter has a different take, insisting the defendants’ disclaimer may not be a silver bullet. He warns Gary Plastics could be a serious threat.


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