On May 3, 2023, Nathaniel Chastain, the former chief product officer of NFT marketplace OpenSea, was convicted by a federal jury in the Southern District of New York of what is being called the first insider trading conviction in the digital asset space.
The premise of the case is that insider trading occurs when the trader acquires significant non-public information in breach of the duty of confidentiality and uses the records or wires to profit from a purchase or sale. The news is that in this case the purchase was of an NFT – which is not necessarily a security or a commodity. As a result, the prosecution avoided taking action on whether the NFTs in question would constitute securities or commodities. “Nathanial Chastain leveraged his advanced knowledge of which NFTs would be featured on OpenSea’s website to make profitable trades for himself,” U.S. Attorney Damian Williams said in a statement. “Although this case involved new trades in cryptoassets, there was nothing particularly innovative about his behavior – it was fraud.” The DOJ’s theory focused on Chastain’s conduct and general principles of fairness. He misused OpenSea’s confidential business information which he obtained only by virtue of his position with the company in breach of a duty he owed to OpenSea, acted on this confidential knowledge and gave himself an unfair advantage over others and profited from his actions.
As part of his responsibilities as Product Manager at OpenSea, Chastain was responsibility to choose which digital art will be displayed on OpenSea’s website. He was also required to keep this information confidential under an employee non-disclosure agreement. Chastain’s fraud conviction was based on his misuse of the confidential information to purchase the NFTs in front of OpenSea with them on the home page, knowing that the NFTs would increase in value from this advantageous position. He then sold them for up to 5 times the price he paid, pocketing roughly $57,000 in profit. The money laundering charge stemmed from Chastain’s attempt to hide his scheme by using multiple anonymous wallets and OpenSea accounts to make purchases and sales and transfer the illegal proceeds back to his own wallet. This conviction demonstrates how robust the application of federal anti-fraud statutes can be to address alleged misconduct in the digital asset market. It reinforces how the DOJ will apply insider trading liability in any situation where material, non-public information gives the seller an advantage, regardless of whether the object being sold is a security, commodity or something else. It should be a warning to traders and operators of NFT and cryptocurrency marketplaces that regardless of how an NFT is characterized, trading and dealing in NFTs will be subject to well-understood principles of fairness and fraud. The industry is learning that US regulators won’t wait for new regulations if they can use existing rules to hold bad actors accountable. The open question is whether, as the SEC and other regulators increase their focus on NFTs and other digital assets, the SEC will seek to expand the argument that NFTs are also securities subject to the anti-fraud provisions of the securities laws.
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