Bloomberg — By Chris Dolmetsch
As a young rapper, Jay-Z once teamed up with Damon Dash to sell CDs of his music out of a car in the Brooklyn projects. Today, the co-founders of Roc-A-Fella Records are embroiled in a legal fight involving one of the most cutting-edge investments: non-fungible tokens.
The lawsuit is among a flurry involving NFTs as U.S. courts begin to grapple with the novel legal issues surrounding ownership and regulation of the assets, which have recently exploded in value. More than half a dozen suits citing NFTs have been filed in federal courts alone since the start of 2020, as monthly trading volume in the world’s biggest NFT marketplace, OpenSea, soared from $8 million six months ago to more than $1 billion in August.
The dispute began in June, when Roc-A-Fella sued Dash, seeking to stop him from auctioning off the copyright to Jay-Z’s debut album, Reasonable Doubt, as an NFT, which represents ownership of a digital object on a blockchain. Roc-A-Fella says that while Dash holds a one-third stake in the company, it owns the album itself, and he has no legal right to sell the NFT.
The Jay-Z suit should serve as a warning to buyers and sellers of NFTs to make sure both sides know exactly what’s being sold, said Christopher A. Cole, a partner with Crowell & Moring LLP in Washington.
“They need to be very careful up front, when the NFT is created, to ensure that it’s a valid instrument and the creators had the rights they needed to what’s being sold, so that it’s not attacked down the road,” Cole said.
More litigation involving NFTs is likely, from lawsuits on behalf of consumers who didn’t understand the nature of the rights they were acquiring to government enforcement actions to protect them, said Pratin Vallabhaneni, a partner with White & Case in Washington.
“There are all kinds of misunderstandings that consumers have,” Vallabhaneni said. “Whether the disclosures around the product were strong enough and whether the terms were clear enough are the kinds of consumer protection questions that may serve as the basis for lawsuits.”
Dash is just trying to assign the rights to future royalties he’s entitled to as a one-third owner of Roc-A-Fella, as artists have done for a long time, said his lawyer Natraj Bhushan.
“Roc-A-Fella doesn’t understand what’s being minted, and it doesn’t care what’s being minted,” Bhushan said. “I don’t think they understand what we’re trying to do.”
Alex Spiro, a lawyer for Roc-A-Fella and Jay-Z, declined to comment on the dispute.
Some of the cases could help shape the way the industry develops, as the laws surrounding NFTs are unclear and authorities haven’t given specific guidance on how the tokens will be regulated, said Gary DeWaal, a financial markets and regulation attorney in New York and a former trial lawyer with the U.S. Commodity Futures Trading Commission.
“There’s no regulatory guidance coming out that’s meaningful, so if something comes out in a private litigation, that can have an unintended consequence of impacting how future development in this space goes,” DeWaal said. “But there’s nothing unique about NFTs. This whole industry, the whole crypto space, suffers from a paucity of clear regulation, and as a result folks are sort of left on their own to figure it out the best they can.”
One issue that stands out is whether NFTs are securities and therefore subject to regulation by the U.S. Securities and Exchange Commission. Some industry participants are essentially begging for a clue.
In April the broker-dealer Arkonis Capital LLC, a subsidiary of Sustainable Holdings Inc., sent a petition to the agency asking it to clarify how NFTs will be handled, saying they have “tremendous potential to revolutionize industries” but “do not function as traditional securities and do not fit clearly under the existing regulatory framework.”
In one potentially influential case, Dapper Labs, a pioneer in the industry that created the popular Cryptokitties platform, was sued by a customer who alleged that its NBA Top Shot game features unregistered securities and accused it of using its control over the collectibles to prevent investors from withdrawing their funds.
That suit, in which the customer is seeking to represent a class of others, was a “shot across the bow” to NFT developers and the platforms that facilitate sales of the tokens, and probably led some potential issuers to scrap their plans, said Courtney Rogers Perrin, a lawyer with Frost Brown Todd LLC in Nashville.
“I think it’s definitely a developing area, and much like we saw” with initial coin offerings several years ago, “the regulators are still trying to figure out exactly what this is and how it sits in the current regulatory paradigm,” Rogers Perrin said. “In the interim you have some plaintiffs’ lawyers or individuals that feel like it should sit a certain way and are bringing lawsuits.”
Dapper Labs hasn’t responded to the suit. Chief Legal Officer Scott Shipman said the company doesn’t comment on active litigation.
The animosity between Dash and Jay-Z that has built up through years of contention over the management of Roc-A-Fella is evident in their latest clash.
Dash says he never claimed to be selling his interest in Reasonable Doubt and that he never minted an NFT reflecting an ownership stake in the album or his share of the record company. He says the entire suit is part of a campaign by Jay-Z to stop him from selling his Roc-A-Fella stake so he can acquire it for a lower price. Dash alleges Jay-Z has created a “toxic environment” that has made it difficult for him to sell his interest in the company.
Roc-a-Fella, in turn, has accused Dash of launching into an “angry, unprofessional and incoherent rant” at a board meeting while highlighting his lack of income as a motive for selling the rights to the album.
Dash was initially blocked from selling off any rights to the album and later agreed not to transfer an interest in the recording until the lawsuit is resolved. In July he began an auction with a starting bid of $10 million for his share of Roc-A-Fella. The winner will receive a commemorative NFT, “It’s the Roc,” that represents a certificate of ownership.
Jay-Z sold his own NFT celebrating the 25th anniversary of his debut album through Sotheby’s for $138,600.
The case is Roc-A-Fella Records v. Dash, 21-cv-5411, U.S. District Court, Southern District of New York (Manhattan).