Turning On… Crypto Insider Trading Is Targeted – Finally! Part 1 – Cointelegraph Magazine

It took a few years, but the government’s crackdown on “insider trading” involving digital assets has finally arrived. It’s about time! Insider trading occurs frequently in our securities markets, so it was only a matter of time before crypto and other digital assets would be misused by miscreatives for financial gain.

Turn on… is a monthly opinion column from Marc Powers, who spent much of his 40-year legal career working on complex securities-related cases in the United States after a stint at the SEC. He is now an adjunct professor at Florida International University College of Law, where he teaches “Blockchain & the Law.”

Already on June 1, the US attorney for the Southern District of New York announced a criminal indictment against a former product manager for the OpenSea market, Nathaniel Chastain. He is accused of using the confidential information about which non-working tokens were to be displayed on OpenSea’s website to buy them ahead of the event, and then sell them after they were displayed. It is alleged that in order to conceal the fraud, Chastain made these purchases and sales using various digital wallets and accounts on the platform. He is charged with wire fraud and money laundering by making approximately 45 NFT purchases on 11 separate occasions between June and September 2021, selling the NFTs for 2x to 5x their cost.

There are a couple of interesting things to note about the indictment United States v. Chastain. First, the criminal charges do not include securities fraud. Why? Because while there may be occasions when an NFT sale involves the sale of “investment contracts,” which are a type of “security” under the federal securities laws, the NFTs in question do not appear to fall into that category. Also, while some of the NFTs may be “securities,” the US attorney wisely saw no need to pursue the additional charge, given that wire fraud carries a longer prison sentence. Wire fraud is also easier to prove.

Second, the indictment does not indicate how much financial gain Chastain obtained from this alleged scheme. Given this, I can only assume it was a relatively small dollar amount, probably less than $50,000.

Third, although somewhat esoteric, what happened here is not traditionally referred to as “insider trading,” as the United States characterizes it. For most securities lawyers, it is more like a “trading ahead” arrangement. Insider trading usually involves the improper advance purchase or sale of a security. Here, the NFTs in question do not appear to be “securities” and involve exchange participants who trade in front of the market participants.

Finally, it’s worth emphasizing that the Securities and Exchange Commission has not filed a complaint against Chastain for this behavior. This confirms my thinking that the NFTs at issue in the scheme are not “securities”, as the SEC only has jurisdiction over conduct involving securities.

More interesting is the insider trading case against Ishan Wahi; his brother, Nikhil Wahi; and his close friend, Sameer Ramani, i SEC v. Wahi, et al. On July 21, the SEC filed its complaint with the SDNY alleging that the three realized about $1.1 million in ill-gotten gains from their scheme, which ran from June 2021 to April 2022. It fell apart due to Coinbase’s compliance department, from which Ishan — a Coinbase employee — “misappropriated” confidential information about tokens to be listed on the exchange and traded them ahead of listing announcements.

Ishan was called by the compliance department on May 11th to attend an in-person meeting at Coinbase’s office in Seattle, WA the following Monday, May 16th. On the evening of Sunday 15 May, Ishan bought a one-way ticket to India scheduled to leave the following day, shortly before he was due to be interviewed by compliance. In other words, it looks like he was trying to flee the country! Fortunately, Ishan was stopped by police at the airport before boarding and was prevented from leaving, so he will have his day in court here in the US to explain his behavior and prove his innocence.

The SEC complaint alleges that Ishan breached his fiduciary and fiduciary duties owed to his employer, Coinbase. He was a leader in Coinbase’s Assets and Investing Products Group, partly responsible for deciding which digital assets should be listed on the exchange. He traded ahead of 10 listing announcements involving 25 different cryptocurrencies. Ishan was a “covered person” subject to Coinbase’s Global Trading Policy and Digital Asset Trading Guidelines, both of which prohibited the use of token listings for financial gain. It is alleged that Ishan tipped off his brother and close friend with details of which cryptocurrencies would be listed in advance and that they used the material, non-public information to buy those cryptocurrencies.

In other words, the SEC considers the elements of insider trading in the complaint: the purchase or sale of securities based on material, non-public information, in violation of a duty. If the duty of the trader or punter is owed to the issuer of the securities, such as a public company, what has occurred is known as “classic” insider trading. If the duty is not owed to an issuer, but rather to someone else, such as an employer, the insider trading “misappropriation” theory applies. Here what is alleged is the “misappropriation” theory of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 violations.

In the second part of this column next week, I will discuss the legal development of the theory of misappropriation, tipping liability in insider trading, and some of the implications of the Coinbase employee case.

The opinions expressed are the author’s alone and do not necessarily reflect the views of Cointelegraph or Florida International University College of Law or its affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice.