First NFT-based Insider Trading Case Tees Up Important Questions for Digital Asset Fraud Prosecutions | Patterson Belknap Webb & Tyler LLP

This summer time, the US Attorney’s Office for the Southern District of New York broke new floor in its oversight of fraud involving digital belongings when it introduced fees towards Nathaniel Chastain associated to an insider buying and selling scheme involving non-fungible tokens (“NFTs”).[1] NFTs are digital belongings which can be saved on a blockchain, which is a digital, decentralized transaction ledger. Each NFT is usually related to some digital object, reminiscent of a chunk of digital art work or a meme. An NFT supplies proof of possession of the digital object.

Chastain labored as a product supervisor at Ozone Networks, the guardian firm for OpenSea, which is the most important on-line market for the acquisition and sale of NFTs.[2] Since May 2021, OpenSea has positioned “featured NFTs” on the homepage of its web site.[3] According to the indictment, the worth of featured NFTs, in addition to different NFTs by the identical creator, usually appreciated considerably after being featured on the homepage.[4]

One of Chastain’s tasks was to decide on the featured NFTs, which means that he knew which digital belongings can be displayed on the homepage earlier than any members of the general public.[5] The indictment alleges that on quite a few events between June and September 2021, Chastain profited off of this proprietary info by buying NFTs shortly earlier than they have been featured after which promoting them shortly after their characteristic went dwell.[6] He tried to hide these gross sales through the use of nameless OpenSea accounts, relatively than his public account listed in his personal identify, and by routing the cryptocurrency proceeds via a number of Ethereum blockchain accounts.[7]

Interestingly, the indictment fees Chastain with wire fraud and cash laundering,[8] relatively than securities fraud, which is the standard statute for insider buying and selling legal responsibility. This method implies that the Government could not must show that the NFTs are actually “securities” or “commodities.” Additionally, the indictment notes that Chastain signed a written confidentiality settlement as a part of his employment during which he acknowledged his obligation to “preserve the confidentiality of confidential enterprise info acquired in reference to [his] work” and “to chorus from utilizing such info, besides for the good thing about OpenSea,”[9] suggesting that the Government is prepared to look to conventional employment agreements to kind a vital a part of its insider buying and selling circumstances. This prosecution can be according to the Department of Justice’s elevated give attention to cryptocurrency and digital asset markets underneath the Biden administration.[10]

Chastain lately moved to dismiss the indictment towards him.[11] He argues that insider buying and selling fees, even underneath the wire fraud statute, can’t lie the place the securities or commodities markets aren’t implicated. Specifically, he emphasizes that the misappropriation idea of insider buying and selling, which activates using confidential enterprise info as alleged right here, includes a “breach of obligation and using materials personal info in a manner that undermines the integrity of the securities or commodities markets and victimizes the general public.”[12] Because the NFT transactions at subject right here didn’t have an effect on securities or commodities markets, the argument goes, a wire fraud cost can’t stand. He additionally argues that the enterprise info at subject right here—the NFTs to be featured on the OpenSea homepage—shouldn’t be “property” for functions of the wire fraud statute and that, even whether it is, OpenSea was not disadvantaged of something because of the alleged scheme at subject.[13] That is, the knowledge had no inherent market worth to OpenSea.

This line of reasoning is predicated on the Supreme Court’s choice in Carpenter v. United Statesthe place the Court held that the Wall Street Journal had a property proper “in preserving confidential and making unique use, previous to publication, of the schedule and contents” of a selected column relating to the inventory market, and that the defendant violated the mail and wire fraud statutes by “go[ing] alongside to his co-conspirators confidential info belonging to the Journal, pursuant to an ongoing scheme to share income from buying and selling in anticipation of the [] column’s impression on the inventory market.”[14]

Chastain argues that permitting the federal government’s case to go ahead right here would develop wire fraud properly past the confines of Carpenter to succeed in what would usually be business disputes. Chastain supplied two eventualities as examples of how this case would impermissibly broaden insider buying and selling wire fraud:

An artwork gallery worker decides to advertise one portray as a “gallery characteristic” on a distinguished shelf on the entrance of the gallery. She notices that promoted work typically promote quicker and at a better value than un-promoted work. As a end result, she decides to advertise one among her personal work because the “gallery characteristic” throughout a extremely attended silent artwork public sale. One day after the public sale, the best bidder is knowledgeable that they efficiently bid on the worker’s piece and the acquisition is formally transacted and finalized on-line.

A coffeeshop worker decides to advertise a selected bag of espresso beans within the storefront window. Before the promotion, he personally bought a big amount of beans. Immediately after the promotion, he notices a pointy improve in demand. He then sells his baggage on-line at a revenue.[15]

The New York Council of Defense Lawyers lately filed an amicus transient in help of Chastain’s arguments, asserting that the prosecution would “criminalize a broad swath of conduct by no means earlier than thought prison,” together with “just about each occasion worker utilizing inner employer info for non-work functions.”[16]

In his movement to dismiss, Chastain additionally highlights the novelty of the cash laundering fees towards him. He argues that that cost must be dismissed as a result of the Government didn’t sufficiently allege concealment or that there was a “monetary transaction.”[17] First, Chastain asserts that his transactions weren’t “hid,” as a result of all transactions on OpenSea—and all transactions utilizing the Ethereum blockchain—are inherently “recorded and visual to the general public.”[18] Second, he argues that the Government doesn’t allege—and there’s no precedent discovering—that the motion of cryptocurrency from one digital pockets to a different impacts interstate commerce or is in any other case a “monetary transaction” for cash laundering functions.[19] The movement due to this fact raises key questions for blockchain-related circumstances going ahead.

Chastain’s movement to dismiss stays pending earlier than Judge Furman within the Southern District of New York. We will proceed to observe this case for its implications throughout the digital asset house.

[1] See Indictment, United States v. Chastain, no. 22-cr-305 (SDNY May 31, 2022).

[11] See ECF Nos. 17-19, United States v. Chastain (SDNY Aug. 19, 2022).

[12] ECF No. 19 at 9, United States v. Chastain (SDNY Aug. 19, 2022).

[14] 484 US 19, 26-27 (1987); see additionally id. at 28 (noting the “impact on inventory costs” and “chance of benefiting from the knowledge leaked”).

[15] ECF No. 19 at 10, United States v. Chastain (SDNY Aug. 19, 2022).

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

[17] ECF No. 19 at 20, United States v. Chastain (SDNY Aug. 19, 2022).

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