DraftKings Faces NFT Securities Lawsuit as Judge Validates Howey Test Application

DraftKings facing an NFT securities lawsuit
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DraftKings Faces NFT Securities Lawsuit as Judge Validates Howey Test Application

DraftKings (NASDAQ: DKNG) must contend with class action litigation after a federal judge ruled that the non-fungible tokens (NFTs) offered on the company’s DraftKings Marketplace qualify as securities. On Tuesday, US District Judge Denise Casper determined that the lawsuit can proceed because the NFTs, sold on the Marketplace for DraftKings’ Reignmakers fantasy games, meet the criteria established by the Howey Test.

The Howey Test, originating from the landmark 1946 Supreme Court case SEC v. W.J. Howey Co., defines what constitutes a security. The four criteria are the investment of money, expectation of profits, common enterprise, and reliance on the efforts of others for investment success. Judge Casper ruled that the plaintiffs met these thresholds in their complaint against DraftKings.

“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, applicable to various digitized items such as audio, video files, and pictures. The lawsuit, filed in March 2023 in US District Court in Boston by Illinois resident Justin Dufoe, claims he lost approximately $14,000 on NFTs purchased on DraftKings Marketplace.

Challenges for DraftKings NFT Ventures

In mid-2021, amidst the booming NFT market, DraftKings launched DraftKings Marketplace with Reignmakers, a fantasy sports addition functioning on the Polygon blockchain. Reignmakers allows users to collect gamified NFT cards through auctions, pack drops, and secondary market transactions, which are then used in NFL, PGA Tour, and UFC fantasy contests.

However, the timing proved unfavorable for participants hoping to profit, as NFT prices plummeted and trading volumes dried up shortly after the launch. Dufoe’s legal complaint notes that he purchased over $72,000 worth of NFTs on DraftKings Marketplace, whose value had since decreased to $58,000.

The lawsuit also alleges that DraftKings failed to register its NFTs as securities with the Securities and Exchange Commission (SEC). If proven, this could attract regulatory scrutiny, as the SEC has previously taken enforcement actions classifying NFTs as securities.

Judge Casper’s ruling suggests that DraftKings Marketplace functions as more than a digital trading card shop, potentially operating as a securities exchange without authorization.

Legal Precedents and Implications

While NFTs are a relatively new asset class, there are legal precedents that could support the plaintiffs in the DraftKings case. In 2023, US District Judge Victor Marrero ruled that the NBA trading cards offered by NBA Top Shot — controlled by Dapper Labs — were securities. Dapper Labs raised a combined $153 million from the sales and resales of these NFTs on its platform. Subsequently, the US District Court for the Southern District of New York ordered Dapper to pay plaintiffs $4 million.

Additionally, in 2023, the SEC imposed combined fines of $1.5 million on two NFT issuers for selling unregistered securities. These precedents highlight the legal challenges DraftKings may face as it navigates the lawsuit and potential regulatory actions.