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

DraftKings (NASDAQ: DKNG) is required to confront class action lawsuits after a federal judge determined that the non-fungible tokens (NFTs) provided on the company’s DraftKings Marketplace qualify as securities. 

On Tuesday, US District Judge Denise Casper decided that the lawsuit can move forward since the Howey Test requirement was satisfied concerning the digital trading cards offered on the Marketplace to players in DraftKings’ Reignmakers fantasy games. 

The Howey Test originates from the pivotal 1946 Supreme Court case SEC v. W.J. Howey Co. Since that time, the court established four criteria to assess if an asset qualifies as a security. Those benchmarks include the outlay of funds, anticipation of returns, shared venture, and the success of the investment reliant on entities outside the individual investor. Casper determined that the plaintiffs satisfied those criteria in the lawsuit 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 piece of information recorded on the blockchain. NFTs can be utilized for a range of digital items, including audio and video files as well as images. The lawsuit was initiated in March 2023 in the US District Court in Boston by Justin Dufoe, a resident of Illinois. He asserts that he lost around $14,000 on NFTs he purchased through DraftKings Marketplace. 

Inopportune Moment for DraftKings NFT Initiatives 

In the middle of 2021, as the NFT market surged, DraftKings announced its intentions for DraftKings Marketplace. Reignmakers, operating on the Polygon blockchain, was the fantasy sports component of Marketplace. 

By using Reignmakers, users gather sets of gamified NFT cards through auctions, pack releases, and transactions in the secondary market. Participants subsequently utilize those cards in fantasy competitions for the NFL, PGA Tour, and UFC throughout those seasons. Nevertheless, the timing was unfavorable for Reignmakers participants aiming to make profits from their digital trading cards, as shortly after, NFT prices fell sharply and trading volumes decreased significantly. In the 2023 legal complaint, Dufoe's counsel mentioned that their client acquired over $72,000 in NFTs on DraftKings Marketplace, but the worth of those tokens had dropped to $58,000. 

The lawsuit also claims that throughout the class period, DraftKings did not register its NFTs as securities with the Securities and Exchange Commission (SEC). If that is established, DraftKings may face regulatory examination as the SEC has implemented enforcement actions classifying NFTs as securities. 

Casper’s choice shows that DraftKings Marketplace represents far more than a mere online version of a trading card store. Instead, the judge indicated it’s a securities exchange, potentially suggesting DraftKings may be engaging in securities transactions without proper authorization. 

Recent Rulings Are Not in Favor of DraftKings 

Although NFTs are a relatively new asset class, there are already legal precedents that might benefit the plaintiffs in the DraftKings Marketplace lawsuit. 

In 2023, US District Judge Victor Marrero decided that the NBA trading cards provided by NBA Top Shot — managed by Dapper Labs — were considered securities. Dapper generated a total of $153 million through the sales and resales of those NFTs on its platform, and last month, the US District Court for the Southern District of New York directed the company to compensate plaintiffs $4 million. The plaintiffs filed a lawsuit against Dapper, asserting that NBA Top Shot NFTs qualify as securities. 

Furthermore, in 2023, the SEC collected a total of $1.5 million in penalties from two NFT issuers that the agency stated were offering unregistered securities.