Jury finds former NFT Marketplace Manager guilty of insider trading scheme for fraud and money laundering | Baker Hostetler

Takeaways

• On May 3, 2023, a jury found a former NFT marketplace manager guilty of wire fraud and money laundering for his misuse of “confidential business information” with the intent to profit from the sale of certain NFTs and for his attempts to conceal his illegal actions.
• Although initially termed an “insider trading” digital asset case, the case was not brought under the Securities Fraud Act; Prosecutors relied on a wrongful appropriation theory of wire fraud to allege that the marketplace operator’s misuse of nonpublic information constituted a fraudulent use of company property.
• The case demonstrates the authorities’ ability to hold accountable those who engage in “insider trading” activities without having to claim that the underlying assets qualify as securities.
• In light of the outcome of the case, companies with digital assets should strongly consider reviewing and/or reformulating comprehensive insider trading policies, confidentiality agreements and other policies to prevent fraud, even if the assets in question are not alleged to be financial instruments subject to insider trading . laws, such as those promulgated under US securities laws.

Overview

On May 3, 2023, a jury found Nathaniel Chastain, a former CEO of OpenSea (a major NFT marketplace), guilty of wire fraud and money laundering in connection with his attempts to conceal his use of confidential business information for his own personal gain.[1]

The conviction stems from an indictment brought last year by the United States Attorney’s Office for the Southern District of New York (USAO), which accused Chastain of engaging in (1) wire fraud based on an insider trading scheme involving the misappropriation of confidential information and (2 ) money laundering.[2] Specifically, the USAO accused Chastain of using information about which NFTs were to be featured on the OpenSea website, buying certain NFTs before they were featured on OpenSea, and then selling them when their value increased. He then allegedly tried to hide his behavior by using anonymous Ethereum addresses and OpenSea accounts. In total, he received more than $50,000 in profits through the scheme. By not asserting an “insider trading” cause of action under the Criminal Securities Fraud Act, USAO avoided the significant burden of proving beyond a reasonable doubt that the NFT transactions at issue qualified as offers or sales of securities.

Pre-issues crystallized for trial

In the initial stages of the proceedings, Chastain filed a motion to dismiss the indictment, challenging the validity of both charges.[3] The court agreed that Chastain’s legal arguments had “some force”, but denied his motion to dismiss on the grounds that it was premature and that the government had not yet made “a full offer of the evidence it intended”.[ed] to present at trial.” [4]

Fee for fraud

The government’s wire fraud indictment against Chastain was based on allegations that he knowingly, with intent to defraud, misappropriated “property” in the form of “confidential business information” (non-public information about which NFTs would appear on the market and when) for his own personal gain.[5] The parties argued two main issues with respect to this charge: (i) whether the government’s reliance on a wire fraud misappropriation theory was permissible given that a case with respect to insider trading activities would otherwise require the underlying assets to be considered securities or commodities and ( ii) whether the information in question qualified as property under the federal wire-fraud statute, which prohibits “the use of interstate wires as part of any scheme or art to defraud, or to obtain money or property by means of false pretenses; or fraudulent pretenses, representations or promises.'”[6]

With respect to the first issue, the court ruled that Chastain’s claim that the “abuse theory” of wire fraud requires dealing in securities or commodities transactions was “entirely without merit” since the statute “does not refer to securities or commodities.”[7] However, the court agreed that Chastain’s argument—whether “the mere selection of an object for prominent display” was covered property under the wire-fraud statute—had merit and was a factual dispute to be determined at trial.[8]

Fee for money laundering

The government’s money laundering charge was based on its allegation that Chastain misappropriated confidential business information “knowing that the property involved . . . represented the proceeds of some form of illegal activity” and attempted to “conceal and conceal the nature, location, source, ownership, and control of the proceeds of specified illegal activity.”[9] Chastain moved to dismiss this charge on the grounds that it is impossible to attempt to hide transactions conducted over permissionless blockchains because they are “completely visible to the public.”[10] Conversely, the government argued that public access to blockchain data is immaterial when a defendant engages in a course of action designed to conceal illegal transactions through “anonymous” accounts.[11] The court considered this a question of fact to be decided at trial.

The jury’s consideration

The question of whether the information in question qualified as “confidential business information” appeared to be given great weight by the jury.[12] For example, during its deliberations, the jury requested a copy of the transcript of Devin Finzer, co-founder and CEO of OpenSea, who stated at trial that he “had not thought carefully about which NFTs would be discussed and when were confidential information.”[13] Several hours later, the jury notified the court that it was unable to reach a unanimous verdict before asking the court for clarity on how to analyze the information claimed to be confidential.

Other facts the jury may have considered included Chastain’s claim that his actions were carried out without criminal intent and that his employer failed to provide “specific guidance prohibiting the conduct.”[14] For example, Chastain claimed at trial that after he left OpenSea, the company updated and expanded its internal insider trading policies, in an effort to convince the jury that no company policy in place during Chastain’s employment specifically prevented his conduct.

However, such presentations of Chastain proved unavailable; On May 4, 2023, the jury returned its verdict that Chastain was guilty of wire fraud as well as money laundering.[15]

Conclusion

The outcome of this case shows a skillful approach by the authorities to prevent insider trading in digital assets, while sidestepping the question of whether the underlying asset is a security. For that reason, digital asset companies should consider whether their business model justifies the implementation of insider trading policies and employee training programs designed to prevent digital asset fraud, regardless of how digital assets are classified.

[View source.]