New York federal prosecutors indicted defendants in connection with NFT insider trading scheme | Foley Hoag LLP – White Collar Law & Investigations

Federal prosecutors from the Southern District of New York recently charged Nathan Chastain with wire fraud and money laundering in connection with an alleged scheme to illegally profit from the sale and purchase of non-fungible tokens (“NFTs”).[1] This landmark criminal case marks the first time federal prosecutors have pursued criminal action against police insider trading in the NFT market.

Chastain is a former employee of Ozone Networks, Inc. d/b/a OpenSea (“OpenSea”), the largest online marketplace for buying and selling NFTs, and allegedly used confidential information about which NFTs to display on OpenSea’s website for his personal financial gain. Chastain was responsible for selecting NFTs to appear on OpenSea’s website, and OpenSea kept the identity of featured NFTs confidential until they appeared on the website.[2] After an NFT was featured on OpenSea’s website, the value of that NFT, and other NFTs created by the same creator, usually increased significantly.[3] The government alleges that Chastain was aware of this fact and used her confidential business information about which NFTs to display to purchase dozens of NFTs under an anonymous account shortly before they were featured. Once the value of the NFTs Chastain purchased had increased from the exposure on OpenSea’s website, Chastain would allegedly resell those NFTs for a substantial profit.[4]

On August 19, 2022, Chastain filed a motion to dismiss the indictment. Chastain argues that the government’s theory of insider trading does not apply in this context because insider trading requires trading in securities or commodities.[5] Because they have no connection to financial markets, Chastain argues, NFTs are neither. In addition, Chastain argues that the government’s fraud charge cannot succeed because it requires the government to establish, bluemoney or property as the subject of a scheme or artifice to defraud, and the confidential information he allegedly misappropriated did not constitute “property” but instead consisted of a “marketing concept” that was “free of any inherent economic value and based on [his] unspoken personal thoughts.”[6] Chastain also argues that the money laundering count must be dismissed because it requires a showing that he attempted to conceal his alleged fraud. Here, all movements and transactions were carried out on the Ethereum blockchain, and were thus visible to the public. According to Chastain, he did nothing more than move money in an “obvious and noticeable” manner, which does not amount to money laundering.[7]

On August 24, 2022, the New York Council of Defense Lawyers (“NYCDL”) filed an amicus brief in support of Chastain’s motion to dismiss. In the brief, the NYCDL writes that it is “deeply concerned about efforts by the Department of Justice to expand the scope of mail and wire fraud beyond the limits set by Congress.”[8] NYCDL’s brief focuses primarily on Chastain’s second argument, taking issue with the government’s definition of “property” to extend to any confidential business information received by employees in connection with their employment. The NYCDL asserts that such a construction “would … capture virtually all instances of an employee using internal employer information for non-work purposes,”[9] including, for example, situations where a corporate whistleblower collects information about corporate wrongdoing and provides it to a journalist in violation of company policy.[10]

On 7 September 2022, the government submitted its opposition statement. Refuting Chastain’s and the NYCDL’s arguments, the government argues that the “novelty of NFTs” does not make the case “a new prosecution.”[11] and “[t]The theory of misappropriation of wire fraud is not limited to cases involving traditional securities or commodities.”[12] The government further argues that the Second Circuit has previously rejected the argument that confidential business information is not “property” if the company cannot “commercially exploit the information by acting on it.”[13] Moreover, the fact that Chastain, rather than OpenSea, profited from the use of the confidential business information does not mean that it had no economic value to OpenSea. The government suggests that OpenSea “could have leveraged that value by, for example, tipping off upcoming NFTs as benefits to business partners.”[14] Choosing not to exploit the information’s potential “was a business decision, not a sign that the information was worthless.”[15] The government also argues that while Chastain’s motion raises the allegedly incorrect use of the term “insider trading,” Chastain was not actually charged with insider trading; he was charged with wire fraud and money laundering.[16] The references to the term “insider trading” in the indictment were nevertheless appropriate to the extent that Chastain “uses[d] confidential, non-public information to trade an asset.”[17]

With respect to the money laundering charge, the government alleges that although the transactions took place on the Ethereum blockchain, Chastain took steps to conceal her connection to those transactions by using anonymous accounts.[18] Furthermore, the Money Laundering Act broadly defines “transaction” to include a “transfer” of funds, which covers Chastain’s movement of assets on the blockchain.[19] The government also argues that Chastain’s challenges to the money laundering charge are all “fact-dependent arguments for a jury” and are “not a proper basis for the dismissal of [i]indictment.”[20]

Chastain highlights DOJ’s increased focus on the emerging area of ​​digital assets. The case will be important to watch, especially as we expect to see further enforcement in this area by the government going forward.

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[1] NFTS is “a type of digital asset stored on a blockchain, which is a digital decentralized ledger that stores information, including information about transactions.” United States v. ChastainIndictment, 22-CR-305, ECF No. 1 (SDNY May 31, 2022) at 2. “Each NFT is typically associated with a digital object, such as a work of art, and the NFT provides evidence of ownership of the digital object and a license to use it for specific purposes.” ID.

[2] ID. at 1

[3] ID. on 1-2.

[4] ID. at 4 o’clock.

[5] United States v. ChastainMemorandum of Law in Support of Nathaniel Chastain’s Motion to Dismiss the Indictment, 22-CR-305, ECF No. 19 (SDNY Aug. 19, 2022) at 2.

[6] ID.

[7] ID. 3 ‘o clock.

[8] United States v. ChastainBrief of Amicus Curiae, New York Council of Defense Lawyers in Support of Dismissal of Indictment, 22-CR-305, ECF No. 20 (SDNY Aug. 24, 2022) at 2.

[9] ID. at 1

[10] ID. 5 o’clock.

[11] United States v. ChastainGovernment’s Memorandum of Law in Opposition to Defendants’ Motion to Dismiss the Indictment, 22-CR-305, ECF No. 23 (SDNY Sept. 7, 2022) at 1.

[12] ID. 6 o’clock.

[13] ID. at 1 p.m. See e.g, United States v. Grossman843 F.2d 78 (2d Cir. 1988).

[14] ID. at 3 p.m.

[15] ID.

[16] ID. at 1

[17] ID.

[18] ID. on the 26th.

[19] ID. at 28.

[20] ID. at 25. In her motion, Chastain has requested oral arguments, and the next hearing before the Court is scheduled for October 27, 2022.