First NFT-Based Insider Trading Case Begins with Key Questions for Digital Asset Fraud Lawsuits | Patterson Belknap Webb & Tyler LLP

This summer, the US Attorney’s Office for the Southern District of New York broke new ground in its oversight of fraud involving digital assets when it filed charges against Nathaniel Chastain related to 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 usually associated with a digital object, such as a digital artwork or 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, which is the largest online marketplace for buying and selling NFTs.[2] Since May 2021, OpenSea has placed “featured NFTs” on the home page of the website.[3] According to the indictment, the value of featured NFTs, as well as other NFTs of the same creator, typically appreciated significantly after being featured on the website.[4]

One of Chastain’s responsibilities was to select the featured NFTs, meaning he knew which digital assets would be featured on the homepage before any members of the public.[5] The indictment alleges that on several occasions between June and September 2021, Chastain profited from this proprietary information by purchasing NFTs shortly before they were publicized and then selling them shortly after their feature was published.[6] He attempted to hide these sales by using anonymous OpenSea accounts, instead of his public account listed in his own name, and by routing the cryptocurrency proceeds through multiple Ethereum blockchain accounts.[7]

Interestingly, the indictment charges Chastain with fraud and money laundering,[8] rather than securities fraud, which is the typical insider trading liability statute. This approach means that the government may not have to prove that the NFTs are actually “securities” or “commodities.” In addition, the indictment notes that Chastain signed a written confidentiality agreement as part of his employment in which he acknowledged his obligation to “maintain the confidentiality of confidential business information received in connection with [his] work” and “to refrain from using such information except for the benefit of OpenSea,”[9] which suggests that the government is willing to look at traditional employment agreements to form a crucial 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 dismiss the charges against him.[11] He argues that insider trading fees, even under the statute of frauds, cannot lie where the securities or commodity markets are not involved. Specifically, he emphasizes that the theory of insider trading notification, which turns on the use of confidential business information as alleged here, involves a “breach of duty and use of material non-public information in a manner that undermines the integrity of the securities. or raw materials markets and victimizes the public.”[12] Because the NFT transactions at issue here did not affect the securities or commodity markets, the argument asserts that an electronic fraud fee cannot stand. He also argues that the business information at issue here – the NFTs to be displayed on the OpenSea website – is not “property” under the wire-fraud statute, and that even if it is, OpenSea was not deprived of anything as a result of the alleged scheme in question.[13] That is, the information had no inherent market value for OpenSea.

This justification is based on the Supreme Court’s decision in Carpenter v. United Statesin which the court held that the Wall Street Journal had a proprietary right “to hold confidential and exclusive use, prior to publication, of the schedule and content” of a particular column concerning the stock market, and that the defendants violated the mail and wire fraud statutes by “pass[ing] along with his co-conspirators confidential information belonging to the Journal, pursuant to an ongoing scheme to share profits from trading pending [] column’s impact on the stock market.”[14]

Chastain argues that allowing the government’s case to go forward here would expand wire fraud far beyond its borders carpenter to reach what would typically be commercial disputes. Chastain offered two scenarios as examples of how this case would impermissibly expand insider trading fraud:

An art gallery employee decides to promote one painting as a “gallery feature” on a prominent shelf at the front of the gallery. She notices that promoted paintings often sell faster and at a higher price than non-promoted paintings. As a result, she decides to promote one of her own paintings as the “gallery item” during a highly attended silent art auction. One day after the auction, the highest bidder is informed that they have bid on the employee’s chip, and the purchase is officially completed and completed online.

A coffeeshop employee decides to promote a particular bag of coffee beans in the shop window. Before the campaign, 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 at a profit.[15]

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

In the motion to dismiss, Chastain also highlights the novelty of the money laundering allegations against him. He argues that the charges should be dismissed because the government did not sufficiently allege concealment or that there was a “financial transaction.”[17] First, Chastain claims that his transactions were not “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 is not alleging—and there is no precedential finding—that moving cryptocurrency from one digital wallet to another affects interstate commerce or is otherwise a “financial transaction” for money laundering purposes.[19] The proposal therefore addresses key questions for blockchain-related matters going forward.

Chastain’s motion to dismiss remains before Judge Furman of the Southern District of New York. We will continue to monitor this case for its implications across the digital asset space.