Want to invest in an NBA player’s contract?
This unusual question is the basic premise of Brooklyn Nets guard Spencer Dinwiddie’s plan to convert his employment contract into a tradable financial asset.
As envisioned by Dinwiddie, people could invest in his three-year, $34 million contract, just like they can invest in treasury bonds or corporate bonds. In monthly installments, investors would be paid back their principal, plus interest. Meanwhile, by receiving investors’ funds upfront, Dinwiddie would essentially be paid earlier than he’d be paid by the Nets. He could use those funds to invest in other ventures, ideally earning enough to payback investors and take home a healthy profit for himself.
Everyone wins, right?
Maybe. This is an innovative concept with complex implications for NBA players and the league.
Understanding how an NBA player’s contract could become an investment option
Dinwiddie, 26, details his plan on his DREAM Fan Shares (DFS) website. The plan is to offer “qualified investors”—more on that below—a chance to invest “in the first ever security represented by a Professional Athlete Investment Token (PAInT).” This security would be secured by Dinwiddie’s contract.
Under the current version of the plan, Dinwiddie would convert at least $4.95 million, and up to $13.5 million, of his contract into an investment vehicle. In other words, between 60% and 85% of Dinwiddie’s player contract would remain traditionally configured, with the Nets paying him over the next three years. Still, a sizable portion would become the basis of a security.
This arrangement calls for DFS to serve as a platform for the issuance of securities tied to Dinwiddie’s contract. DFS, to be clear, is neither serving as a broker nor issuing securities. A separate, Utah-based company called North Capital Private Securities is listed as the broker-dealer. Still another company, SD8 LLC, issues the actual securities; Dinwiddie formed SD8 for this very purpose. Meanwhile, Paxos Trust Company would take custody of the securities and manage disbursements of payments. Those payments would utilize Paxos’s system of stablecoin, a form of cryptocurrency pegged to an asset.
As you can tell, there are a lot of moving pieces.
Even if you are Dinwiddie’s number one fan, chances are you don’t have enough money to qualify as a potential investor. To that point, a minimum investment would be $150,000. Funds could be paid through U.S. dollars, BTH (Bitcoin Hot, a form of cryptocurrency) or ETH (Ethereum, a form of cryptocurrency). This arrangement therefore utilizes blockchain, a digital ledger used for financial transactions and other purposes.
A PAInT investment would be abbreviated as a “token” and would, as mentioned above, be backed by Dinwiddie’s contract with the Nets. This arrangement would reflect a debt instrument, meaning an asset that requires fixed and typically scheduled payments to investors. Payments reflect two forms of compensation: payback of the principal investment and interest on the principal.
The interest is crucial to the investor: it reflects the main upside to investing. The interest also represents a key factor in the investment option’s risk/reward profile. Savings and checking accounts, for instance, are extremely safe investments—banks are required to carry FDIC insurance for deposits up to $250,000—but they tend to offer only modest returns, with bank account interest rates generally in the ballpark of just 1% or 2%. Stocks, in contrast, are more volatile but have higher upside. Generally speaking, the safer the investment option, the less upside; the riskier the option, the greater upside. Buying a token in Dinwiddie’s contract, and earning interest on it, would represent another investment choice for qualified investors.
In addition to the prospect of interest payments, investors in Dinwiddie’s contract might also “be entitled to special premiums” based on whether Dinwiddie earns bonuses, negotiates a new contract and other factors. The exact terms of those premiums would be specified in the investor contract. In other words, even if the interest percentage for a token holder is not much higher than what can be found in a bank savings account, the prospect of additional benefits could make the overall investment more appealing.
The details of Dinwiddie’s idea are intricate and rely on terminology unfamiliar to many. The larger picture centers on a much more relatable concept: athletes identifying new ways to maximize their earnings during relatively short and one-injury-away-from-abruptly-ending careers.
Tonya Evans, a former professional tennis player who directs the Blockchain, Cryptocurrency and Law certificate program at the University of New Hampshire Franklin Pierce School of Law, tells Sports Illustrated that Dinwiddie’s approach is innovative and sensibly draws on efforts by other players “to monetize the value of their professional careers by creating a holding company and selling its stock.” Evans highlights former Houston Texans running back Arian Foster, who played a pivotal role in the rollout of Fantax, a company that pays professional athletes money in exchange for a percentage on the player’s future earnings. By directly engaging with investors, Dinwiddie and his business partners would essentially take ownership over some of the functions that Fantax provides.
Evans, who is also an associate dean, professor of intellectual property law and attorney, sees the wisdom in Dinwiddie and other pro athletes “leveraging blockchain and cryptographically-secured tokens to ‘tokenizing’ their contracts or other revenue-generating assets related to their name, image, likeness and careers.” She stresses that individuals tokenizing their brands “is already occurring on the entertainment side of the equation.” Evans also highlights that “giving athletes direct to fan access” would “truly disrupt an industry laden with intermediaries standing between the athlete and the fan.”
Dinwiddie certainly appreciates the fleeting nature of an athlete’s career. In 2014, the Los Angeles native suffered a torn ACL in his left knee while playing for the University of Colorado Buffaloes. The injury contributed to Dinwiddie falling from a projected first round pick in the 2014 NBA Draft to a second rounder. With his plan to tokenize player contracts, Dinwiddie could play a transformative role in athlete empowerment.
Federal securities law governs Dinwiddie’s plan
In the wide scope of legal topics that apply to sports, securities law is seldom mentioned. Securities law consists of statutes, court decisions and regulations that oversee financial markets and investor relations in the United States. On a federal level, the U.S. Securities and Exchange Commission is charged with enforcing securities law. The SEC attempts to ensure that investors possess essential information concerning securities that are offered for public sale. The SEC also tries to prevent various kinds of fraud in the marketing and sale of securities.
Rule 506 of Regulation D of the Securities Act of 1933 would govern the selling of security interests tied to Dinwiddie’s contract. Among other things, Rule 506 would obligate Dinwiddie and his business partners undertake “reasonable steps” to verify that its investors are “accredited investors.”
Under SEC rules, an “accredited investor” is a person or a couple satisfying one of two tests: possess a net worth in excess of $1 million (excluding the investor’s primary residence) or have earned more than $200,000 in annual income ($300,000 for couples) over the last couple of years with a reasonable expectation of earning at least that amount going forward. Alternatively, an accredited investor can be a business with assets exceeding $5 million, among other required characteristics.
As to “reasonable steps” for verification, they often include review of financial statements, including tax returns, credit reports and W-2 wage forms. The legal onus would be on Dinwiddie and his partners to conduct the necessary due diligence.
If the initial offering is a success, Dinwiddie might later utilize offering methods that are not limited to accredited investors. Regulation A of the Securities Act of 1933, for example, permits a limited involvement of non-accredited investors.
Low risk—but not no risk—for prospective investors in Dinwiddie’s contract
No investment is “risk free” and that is true of buying a security interest in an NBA player’s contract. DFS openly acknowledges this point on its website. “Investments in the securities represented by Spencer’s PAInT,” the website cautions, “are illiquid and carry the risk of complete loss of capital . . . investors should review the risk factors within the offering documents before considering an investment.” A separate DFS page for “Private Placement Risks” stresses, in all caps, “INVESTMENTS IN PRIVATE PLACEMENTS ARE HIGHLY SPECULATIVE AND INVOLVE A HIGH DEGREE OF RISK. INTERESTS SHOULD NOT BE PURCHASED BY ANY PERSON WHO CANNOT AFFORD THE LOSS OF ITS ENTIRE INVESTMENT.”
With that in mind, when we say that an NBA player contract is “guaranteed”, we use that word loosely. Dinwiddie’s contract with the Nets is “guaranteed” in the sense that he will be owed $34 million regardless of how well he plays and regardless of whether he is traded to another NBA franchise. He’d also likely be owed that amount even if he is released or waived. The same would be true if he is seriously injured in the course of playing basketball.
However, circumstances can arise that convert an otherwise guaranteed NBA contract into one that doesn’t pay a player or is no longer guaranteed. None of those circumstances is likely to occur but each has a greater than 0% chance of occurring.
Risk that a labor dispute suspends player contracts
One investment risk is not about Dinwiddie but about the league in which plays. It’s not inconceivable that the NBA and the National Basketball Players’ Association could become embroiled in labor dispute that triggers the cancellation of games—and the accompanying cessation of player pay. The NBA, for instance, could lock out players. NBA lockouts occurred in 2011 and thrice during the 1990s. Alternatively, NBA players could go on strike or boycott games.
A work stoppage would follow failed negotiations between owners and the union on a new collective bargaining agreement. During a lockout or strike, players would not be paid or receive other employment benefits. They might have access to reserve funds set aside by the NBPA. Those funds, however, would likely reflect only a fraction of players’ salaries and only last for a limited duration.
It’s extremely unlikely that an NBA labor dispute will take place during the course of Dinwiddie’s three-year contract. His contract is structured as a two-year deal for ’19-’20 and ’20-’21, and a player option for ’21-’22. The deal will thus expire in June 2021 or June 2022. The current CBA is set to expire in June 2024. That expiration date fast forwards to June 2023 if either the league or players’ association opts out of the CBA following the ’22-’23 season. Therefore, if an NBA labor dispute is on the horizon, the earliest it would occur would be after Dinwiddie’s contract expires.
Still, the situation becomes more fluid when different possibilities are considered. Imagine that at some point over the next couple of years, Dinwiddie negotiates a new contract with the Nets. If investors to his current contract gain a preferred right to buy into a new contract, there’s at least a theoretical risk of a labor dispute impacting investors’ returns.
Risk that Dinwiddie’s own conduct negates salary guarantees in his contract
Another investment risk is the possibility that Dinwiddie loses guarantees in his contract due to his own conduct. To be sure, this type of possibility seems extremely unlikely. Dinwiddie has avoided any kind of controversy—be it legal, behavioral or drugs—during his five seasons in the NBA. He also impressed during his three seasons at Colorado. Along those lines, Dinwiddie’s 2014 NBADraft.net profile approvingly describes him as “intelligent” and a “high character guy” who is also “likeable” and a team player.
Still, players who seem upstanding occasionally encounter controversy after many years of earning others’ respect. No player—or any human being, for that matter—is a certain bet to avoid being accused of wrongdoing or to engage in wrongdoing.
With that risk in mind, a team can invoke standard language in the Uniform Player Contract to attempt to void a particular contract. Under Paragraph 16, a team can nullify a contract if the player fails to “conform his personal conduct to standards of good citizenship, good moral character, and good sportsmanship.” A team can also terminate a deal if a player neglects to “keep himself in first class physical condition” or “obey the team’s training rules.” Additional grounds for forfeiture include if a player commits “a significant and inexcusable physical attack against any official or employee of the team or the NBA (other than another player), or any person in attendance at any NBA game or event.”
Also, while player injuries generally do not permit a team to withhold base pay, a team can elect to withhold pay when the injuries occurred while a player engaged in contractually prohibited conduct. This is contemplated in Paragraph 12, which contains a long list of prohibited behaviors. Bungee jumping, trampoline jumping, fighting, boxing, wrestling, using fireworks, participating in any activity involving firearms or other weapons, riding on electric scooters, riding on a motorcycle or moped, or four-wheeling/off-roading of any kind are all on the list. A team can also withhold pay when a player is convicted, pleads guilty or pleads no contest to any felony, or participates in “any riot” or “insurrection of war.”
You might point out, correctly, that we don’t hear of NBA teams voiding guaranteed contracts. This reflects the fact that players have a right to challenge such a move to a grievance arbitrator, who would be neutral, and the general unwillingness of NBA teams to pursue total discharge of contractual obligations. Indeed, it is rare for a team to escape financial commitments to a player.
But rare is not never.
In 2004, the Boston Celtics and Vin Baker reached a settlement after the Celtics attempted to void the remaining $35 million guaranteed in his contract. Baker had battled alcohol problems and failed to follow team rules. The settlement called for the Celtics to pay Baker $16 million, or a little less than half of what the team contractually owed him.
Four years later, the Golden State Warriors suspended guard Monta Ellis for 30 games, without pay. The Warriors learned that Ellis had suffered a serious ankle injury as a result of a moped accident. As noted above, Paragraph 12 permits teams to withhold pay for injuries caused by prohibited conduct. Driving a moped is on the list.
A player can also lose a substantial amount of money if he tests positive for a “drug of abuse,” such as cocaine, methamphetamine, LSD or heroin. As dictated by Article XXXIII of the CBA, a first-time positive test for a drug of abuse results in an automatic two-year ban. The player’s contract is rendered “null and void and of no further force or effect.” In May, Tyreke Evans was suspended two years for violating this policy.
Testing positive for a steroids, performance-enhancing drugs or diuretics results in a lesser, but still deterring punishment (25 games for a first-time offense). Last month, Phoenix Suns center Deandre Ayton received a 25-game suspension after he tested positive for a diuretic. Also, if a player tests positive for marijuana for a third time, he is subject to a five-game suspension (a first- or second-time marijuana positive result does not trigger a suspension).
Are any of the gloomy scenarios mentioned above likely to apply to Dinwiddie? No. But the same can often be said of players who encounter controversy: usually there is surprise that a particular player somehow got in trouble. For a potential investor in a player’s contract, they should understand that risk and determine how impacts their investment.
NBA has concerns about the securitization of player contracts
For now, the NBA has rejected Dinwiddie’s proposed plan. The league has met with Dinwiddie but remains opposed.
The NBA cites Article II of the CBA, and specifically its prohibition on a player assigning or transferring to a third-party his right to receive compensation under his employment contract. This prohibition does not preclude a player from directing his team to send a player’s paycheck to his agent or attorney. In that situation, the agent or attorney is acting on behalf of the player and is thus not a third-party.
The NBA distinguishes Dinwiddie’s concept because his contract would act as a security interest for another person’s investment. This other person—the investor—would be a third-party from the vantagepoint of the NBA. The league’s position implies that the legal obligation of Dinwiddie and his business partners to pay the investor is tantamount to an assignment or transfer of his right to be paid under the contract.
The NBA likely has specific concerns about player contracts becoming vehicles for securities transactions.
For one, the league has a bargaining interest in enforcing the language of the CBA. If players want the capacity to pursue what Dinwiddie seeks, their union, the NBPA, should negotiate for that capacity in the next CBA. Labor discussions generally represent a series of tradeoffs, with owners and players each giving up preferred terms and gaining others. The league might be open to Dinwiddie’s plan, but only after it has been collectively bargained.
Second, the NBA might be worried about a lack of league ability to monitor and approve financial transactions that stem from NBA player contracts. Dinwiddie’s concept involves a number of companies and investors, and also relies to some degree on blockchain and cryptocurrency. By themselves, none of those features is necessarily problematic. However, the league wouldn’t be directly included in this enterprise of transactions. To that point, the NBA wouldn’t have a chance to evaluate and certify investors and potential investors for dealings that are pegged to league contracts.
Third, the NBA has reason to be risk averse to the possibility of unintended consequences. The league continues to cope with a major, and still unresolved, public relations controversy involving NBA operations in China and protests in Hong Kong. The timing isn’t ideal for a new vehicle of player compensation that, as noted above by Tonya Evans, is fundamentally “disruptive.” This vehicle also depends on emerging technologies and developing forms of business dealings in order for it to succeed.
Fourth, the league could worry about potential liability to it and the Nets—and also, by extension, other teams that employ players who pursue tokenized contracts. If an investor has a dispute with Dinwiddie and his business partners, the investor could eye the league and Nets as “deep pocket” co-defendants. Often in litigation, plaintiffs gravitate towards potential defendants with substantial financial resources to pay civil judgments or arbitration awards. Contract disclaimers and indemnity clauses might, to some degree, extinguish potential exposure for the NBA and teams. However, the league probably doesn’t see the upside in taking that chance.
Fifth, it’s not clear how the NBA and owners would stand to gain from allowing player contracts to secure investments. It does not appear that the league would be paid as part of the transactions related to Dinwiddie’s concept. Also, if NBA executives perceive potential league value in what Dinwiddie proposes, those executives might propose their own competing plan for tokenized contacts—one that would add to the total amount of basketball related income, which, per the CBA, owners and players share evenly.
A potential legal battle between Dinwiddie and the NBA
In public comments, Dinwiddie suggests that the NBA misunderstands what he is trying to do. He flatly rejects the contention that there would be an assignment of his right to be paid under his Nets contract.
Dinwiddie’s point of view isn’t without merit. As he stresses, he doesn’t intend to transfer a right to be paid—he would instead use that right to secure an investment. Investors, then, wouldn’t technically obtain rights related to the Nets or NBA; their rights would seemingly be limited to the value of a contract owed to Dinwiddie. Article II doesn’t explicitly prohibit what he is trying to accomplish. However, as detailed above, it could be interpreted to impose a prohibition.
Dinwiddie hoped to launch his tokenized contracts plan in October and begin monthly payments in early December.
Dinwiddie would take on legal risk by moving forward without the NBA’s blessing.
The league, for example, could petition a federal judge to temporarily enjoin Dinwiddie and his business partners from offering securities that are tied to NBA contracts. If an injunction or restraining order were granted, Dinwiddie and the NBA would develop legal arguments that could eventually lead to a trial.
The league could also fine or suspend Dinwiddie. Under Article 35 of the league constitution, commissioner Adam Silver is authorized to punish players for “conduct that does not conform to standards of morality or fair play, that does not comply at all times with all federal, state, and local laws, or that is prejudicial or detrimental to the NBA.” This language is explicitly referenced and incorporated into the Uniform Player Contract. The NBA might reason that Dinwiddie betraying an NBA edict would clearly constitute conduct “prejudicial or detrimental to the NBA” and possibly prove in breach of contract, too.
Dinwiddie, meanwhile, has his own potential legal strategies. For instance, he could retain attorneys to repel any attempt by the NBA to gain a court-ordered injunction. Also, if the NBA suspends Dinwiddie for more than 12 games, he would have the collectively bargained right to appeal to a neutral grievance arbitrator. There are still other possible legal avenues, including Dinwiddie and the NBPA pursuing remedies before the National Labor Relations Board. Section 7 of the National Labor Relations Act guarantees union members the right to engage in concerted activity; perhaps Dinwiddie would argue that he and other players intend to use tokenized contracts as a collective expression of their identities as NBA players.
Odds are that Dinwiddie and the NBA will eventually resolve this dilemma in a way that both sides find acceptable. The NBA, for instance, might permit tokenized contracts on a temporary and monitored trial basis, with the NBPA understanding that it would need to collectively bargain a more lasting arrangement. The NBA might also develop protocols to ensure that the league obtains some direct value from tokenized contracts.
Until then, Dinwiddie will continue to plead his case to the league and continue to pursue a pathbreaking model of player compensation.
Michael McCann is SI’s Legal Analyst. He is also an attorney and Director of the Sports and Entertainment Law Institute at the University of New Hampshire Franklin Pierce School of Law.