First NFT-Based Insider Trading Case Raises Important Questions for Digital Asset Fraud Law Enforcement – JD Supra | Jewelry Dukan

This summer, the US Attorney’s Office for the Southern District of New York broke new ground in its oversight of digital asset fraud when it filed charges against Nathaniel Chastain in connection with an insider trading scheme involving non-fungible tokens (“NFTs”).[1] NFTs are digital assets stored on a blockchain, which is a digital, decentralized ledger of transactions. Each NFT is generally associated with a digital object, such as a B. a piece of digital artwork or a meme. An NFT provides proof of ownership of the digital object.

Chastain worked as a product manager at Ozone Networks, the parent company of OpenSea, the largest online marketplace for buying and selling NFTs.[2] Since May 2021, OpenSea has placed “featured NFTs” on the homepage of its website.[3] According to the indictment, featured NFTs, as well as other NFTs by the same creator, are typically valued significantly after being featured on the home page.[4]

One of Chastain’s duties was to select the featured NFTs, meaning he knew which digital assets would be displayed on the homepage in front of all members of the public.[5] The indictment alleges that Chastain benefited from this proprietary information on numerous occasions between June and September 2021, buying NFTs just before they were unveiled and then selling them just after their feature went live.[6] He attempted to hide these sales by using anonymous OpenSea accounts instead of his public account, which operated under his own name, and by routing cryptocurrency proceeds through multiple Ethereum blockchain accounts.[7]

Interestingly, the indictment charges Chastain with wire fraud and money laundering,[8] and not securities fraud, which is typical legal liability for insider trading. This approach means that the government may not have to prove that the NFTs are in fact “securities” or “commodities”. In addition, the indictment notes that as part of his employment, Chastain signed a written nondisclosure agreement acknowledging his obligation to “maintain the confidentiality of confidential business information obtained in connection with [his] to work” and “not to use this information except for the benefit of OpenSea”,[9] This suggests that the government is willing to consider traditional labor contracts as an essential part of its insider trading cases. This prosecution is also consistent with the Justice Department’s increased focus on cryptocurrency and digital asset markets under the Biden administration.[10]

Chastain recently moved to have the charges against him dismissed.[11] He argues that insider trading charges, even under the Remittance Fraud Act, cannot be brought unless the securities or commodity markets are involved. In particular, he emphasizes that the insider trading embezzlement theory, which relates to the alleged use of confidential business information here, “involves a breach of duty and the use of material nonpublic information in a manner that undermines the integrity of securities or commodity markets and bullies the public.”[12] Since the NFT transactions at issue here had no impact on the securities or commodity markets, there can be no charge of wire fraud. He also argues that the business information at issue here – the NFTs intended to appear on the OpenSea home page – is not “property” within the meaning of the Wire Fraud Act and that even if it were, OpenSea has not been deprived of it alleged scheme that is at stake.[13] That is, the information had no inherent market value to OpenSea.

This reasoning is based on the decision of the Supreme Court in Carpenter vs United Stateswhere the court found that the Wall Street Journal had a proprietary right “prior to publication to maintain confidential and exclusive use of the schedule and contents” of a particular column relating to the stock market and that the defendants breached the email has and wire fraud laws through “pass[ing] along with his co-conspirators’ confidential information owned by the Journal, according to an ongoing plan to share profits from the pending trade [] Impact of the column on the stock market.”[14]

Chastain argues that it would allow the government’s case to advance the government’s case here, which would extend wire fraud far beyond the borders of Carpenter to achieve typical commercial disputes. Chastain offered two scenarios as examples of how this case would improperly expand insider trading fraud:

An art gallery employee decides to advertise a painting as a “gallery feature” on a prominent shelf at the front of the gallery. She notes that advertised paintings often sell faster and at a higher price than unadvertised paintings. Because of this, she decides to advertise one of her own paintings as a “gallery feature” during a busy silent art auction. A day after the auction, the highest bidder is notified that they have successfully bid on the employee’s piece and the purchase is officially processed and completed online.

A coffee shop employee decides to advertise a specific bag of coffee beans in the window. Before the action, he personally buys a large amount of beans. Immediately after the promotion, he notices a sharp increase in demand. He then sells his bags online for a profit.[15]

The New York Council of Defense Lawyers recently filed an amicus brief in support of Chastain’s arguments, claiming that prosecutors would “criminalize a wide range of conduct never before considered criminal,” including “virtually all employees who use internal employer information for non-work purposes.”[16]

In his motion to dismiss, Chastain also highlighted the novelty of the money laundering allegations against him. He argues that these charges should be dismissed because the government has not made sufficient allegations that it was a case of deception or a “financial transaction”.[17] First, Chastain claims that its transactions have not been “hidden” because all transactions on OpenSea — and all transactions using the Ethereum blockchain — are inherently “recorded and visible to the public.”[18] Second, he argues that the government does not claim – and there is no precedent – that the movement of cryptocurrency from one digital wallet to another affects interstate commerce or otherwise constitutes a “financial transaction” for money laundering purposes.[19] The motion therefore raises key questions for future blockchain-related cases.

Chastain’s motion to dismiss remains pending with Judge Furman in the Southern District of New York. We will continue to monitor this case for its impact on the digital assets space.

[1] See Accusation, United States vs. ChastainNo. 22-cr-305 (SDNY May 31, 2022).

[11] See ECF No. 17-19, United States vs. Chastain (SDNY August 19, 2022).

[12] ECF #19 at 9, United States vs. Chastain (SDNY August 19, 2022).

[14] 484 US 19 , 26-27 (1987); see also id. at 28 (noting the “impact on stock prices” and the “likelihood of benefiting from the leaked information”).

[15] ECF #19 at 10, United States vs. Chastain (SDNY August 19, 2022).

[16] See ECF No. 20, United States vs. Chastain (SDNY August 24, 2022).

[17] ECF #19 at 20, United States vs. Chastain (SDNY August 19, 2022).

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