Ex-OpenSea employee’s NFT handling runs into DOJ’s ‘Stradivarius’

When federal prosecutors charged a former OpenSea employee with insider trading, they did not charge him with securities fraud. They turned to the Louisville Slugger instead.

Nathaniel Chastain, who allegedly bought and sold non-fungible tokens (NFTs) on the OpenSea app with secret information, was charged in June with wire fraud. The Act, along with the related Mail Fraud Act, is broad, adaptable and powerful. They are federal prosecutors’ “Stradivarius, our Colt 45, our Louisville Slugger, our Cuisinart — and our true love,” federal judge and former prosecutor Jed Rakoff once said.

True love or not, wire fraud is not the typical approach in an “insider trading” case, which often involves securities fraud charges. But online fraud can give Justice Department prosecutors an important advantage in digital asset cases: the ability to avoid the knotty question of whether the asset is a security.

Chastain argued in court filings that an “insider trading” fraud charge” requires “the existence of trading in securities or commodities.” Judge Jesse Furman in Manhattan rejected the argument last week and declined to dismiss the indictment.

Furman’s ruling confirms the Justice Department’s approach. It also underscores the flexibility the DOJ has in policing markets for digital assets such as NFTs and crypto-tokens, compared to regulators at the Securities and Exchange Commission. The SEC’s jurisdiction is limited to enforcing securities laws.

The DOJ, which has taken an increased focus on digital assets under the Biden administration, can crack down on conduct that might fall outside the SEC’s reach. The Chastain case is likely to be a model for prosecutors in similar cases, lawyers say.

“The decision opens up the possibility of future ‘insider trading’ actions in digital assets without having to address the hotly debated question of whether a digital asset is a security,” said Evershed’s Sutherland (US) LLP attorney Andrea Gordon. “They don’t even have to to go into it.”

“Real Estate Fraud”

Wire fraud is a broad statute, and prosecutors have used it in a number of high-profile cases. Elizabeth Holmes, the founder of the failed blood start-up Theranos, and Trevor Milton, the founder of the electrical trick maker Nikola, were both convicted of wire fraud.

Federal prosecutors also relied on the statute to charge New Jersey officials in the “Bridgegate” scandal that blocked traffic on the George Washington Bridge, and in cases related to the Varsity Blues college admissions scandal.

Chastain’s case is “an ideal illustration of the breadth of mail and wire fraud principles,” said Robert Anello, a partner at Morvillo Abramowitz Grand Iason & Anello PC.

Chastain was responsible for selecting NFTs to appear on OpenSea’s website, a placement that tended to increase the NFT’s value. Prosecutors allege he secretly bought dozens of NFTs shortly before they were publicized and then sold them at a profit.

When the DOJ announced the charges in June, it called it the “first ever digital asset insider trading scheme.” He was also charged with money laundering. The SEC has not filed a parallel case against Chastain.

Chastain says the NFTs he bought and sold are not a security or commodity. He argued that it is a prerequisite for insider trading costs. After all, the foundation of insider trading case law is the protection of financial markets, he said.

Furman, of the Southern District of New York, said in his order that the argument was “entirely without merit.”

Chastain was not charged with insider trading in the classic sense, which involves fraud under securities laws, the judge said. Chastain was instead charged with wire fraud, under section 1343.

“Section 1343 does not refer to securities or commodities,” the judge said. “To accept Chastain’s argument would be to read an additional element into the wire-fraud statute, which the Court cannot do.”

Chastain’s attorney, David Miller of Greenberg Traurig LLP, declined to comment.

The DOJ may have muddied the waters by referring to the case as “insider trading,” but the legal theories in the indictment are sound, lawyers said.

“It’s straight-up real estate fraud,” said George Washington Law School professor Randall Eliason. “Calling it insider trading is just kind of a way to make a splash. But it’s not really, strictly speaking, insider trading.”

Prosecutors used the wire fraud approach in another digital asset-related case, against Ishan Wahi, a former product manager at crypto exchange Coinbase. Wahi is accused of leaking secret information to help his brother and his friend buy crypto tokens before they were listed on the stock exchange.

Wahi’s brother, Nikhil, pleaded guilty to a fraud charge last month.

Furman’s decision makes clear that the DOJ can still pursue insider-trading-like offenses involving digital assets using the wire-fraud statute when it is not clear whether the assets are governed by the federal securities laws, said H. Gregory Baker, head of the Securities Litigation group at Patterson Belknap Webb & Tyler LLP and a former SEC attorney.

Wild West

This is in contrast to the SEC.

The agency filed its own insider trading case against the Wahi brothers and their friend Sameer Ramani. The SEC’s complaint alleges securities fraud, meaning the agency must prove that the relevant assets are securities.

To determine whether something is a security, regulators and courts use the so-called Howey test, derived from a 1946 Supreme Court ruling. SEC Chairman Gary Gensler has said he believes most digital coins are securities, though much ambiguity remains .

“It’s kind of the Wild, Wild West,” Gordon said.

Others argue that crypto functions more like a commodity, such as oil or grain. Coinbase, the crypto exchange platform, has insisted that it does not list securities. The issue is also being raised in various lawsuits filed by investors. The DOJ, for now, can steer clear of that debate.

“If I’m the DOJ, I say let the CFTC, the SEC and the rest of the world fight out whether it’s a security, a commodity or neither,” Anello said. “I don’t need to know because I can prosecute people for fraud.”

The SEC is in the middle of the trial of a closely watched case accusing Ripple Labs of misleading investors about its XRP cryptocurrency. A central question in the case is whether XRP is a security, subject to SEC jurisdiction.

“If the SEC makes bad decisions about whether cryptocurrencies are securities or not, they could really be degraded, while the DOJ is going to have a much better tool to police fraud in this area,” said Ballard Spahr LLP attorney David Axelrod, a former federal prosecutor . and SEC counsel.

What is property

Wire fraud has its own complications for prosecutors, as proving it requires the defendant to “deprive another of money or property.”

Furman said there was “some force” to Chastain’s argument that information on OpenSea’s website listings does not constitute property.

These questions – what is or is not property – can be difficult in themselves.

In the Bridgegate case, the United States Supreme Court ruled that the Port Authority’s interest in controlling the George Washington Bridge was not a sufficient property interest.

The U.S. Court of Appeals for the First Circuit will hear arguments next month, related to the Varsity Blues investigation, that an offer of admission to a college is not property.

“If you had a case alleging someone took NFTs from their employer, that’s property,” Eliason said. “But if you argue these internal business decisions about what we put on the site next week [are] property, it is much more difficult.”