The District Court refuses to dismiss the NFT “insider trading” charge against a former OpenSea employee Proskauer – Blockchain and the Law

The District Court refuses to dismiss the NFT “insider trading” charge against a former OpenSea employee  Proskauer – Blockchain and the Law

In late October, a New York district court refused to dismiss the Department of Justice’s (DOJ) indictment against defendant Nathaniel Chastain, who was charged with fraud and money laundering related to his use of insider knowledge to purchase non-fungible tokens (NFTs) in the past. that they were displayed on OpenSea, an online NFT marketplace, and later sell them for a profit. (United States v. Chastain, No. 22-cr-305 (SDNY Oct. 21, 2022)). Despite the headlines and the fact that the DOJ’s press release labeled this enforcement as charges brought in “the first digital asset insider trading scheme,” the Chastain indictment was not actually based on the typical insider trading statutes involving securities law violations, but instead federal wire fraud statute. Despite having an insider trading flavor, the word “security” does not appear in the indictment, and the court, in refusing to dismiss the DOJ’s wire fraud claim, ruled that the government’s wire fraud claim does not require the presence of a “security.”

As we previously reported in a previous post on the matter, Chastain, a former product manager at OpenSea, was indicted in New York in June 2022 for his NFT profiteering scheme. As part of his role, Chastain was responsible for selecting NFTs to be featured on OpenSea’s website; OpenSea kept these particular NFT picks confidential until they were published, as a main page entry often translated into a jump in prices for the featured NFTs and others by the same creator. During a period from June 2021 to September 2021, Chastain pre-purchased these NFTs to be displayed (or others by the same creator) and then sold them at a substantial profit. To hide the alleged fraud, the DOJ claimed Chastain conducted these transactions using anonymous digital cryptocurrency wallets and OpenSea accounts. The DOJ asserted one count of wire fraud (18 USC § 1343) and one count of money laundering (18 USC § 1956(a)(1)(B)(i)) against Chastain.

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Chastain then moved to dismiss the indictment, arguing, among other things, that: (1) the wire fraud count should be dismissed because the information he allegedly misappropriated was not “property” under the Act (a position supported by one amicus brief filed in the case ); (2) the money laundering count was defective because the government failed to sufficiently allege two elements of the crime (namely, concealment and financial transaction elements) and sought to criminalize only the movement of money; and (3) the wire fraud count was insufficiently pleaded because an “insider trading” wire fraud charge requires the presence of a trade in securities or commodities.

The court declined to dismiss the indictment (citing the high standard for dismissal at the Rule 12(b) stage), characterizing Chastain’s point as “about the sufficiency of the evidence, not the sufficiency of the indictment” which is better left to the jury. Still, the court noted that “Chastain’s first two arguments have some force,” depending on what the evidence in the case ultimately shows:

  • The court found that the indictment was sufficient at this point, but stated that the government may not be able to prove beyond a reasonable doubt that the relevant information with respect to wire fraud counts (ie, which NFTs will be discussed and when on the OpenSea website) constituted “confidential business information” and thus “property” under the Act. (18 USC § 1343: “Whoever devises or intends to devise a scheme or artifice to defraud, or to obtain money or property by means of false or fraudulent pretenses, representations or promises ….” [emphasis added]).
  • Similarly, regarding the money laundering charge, the court noted that “given that the Ethereum blockchain is public, the government may have difficulty proving beyond a reasonable doubt that the transactions at issue were “designed in whole or in part” . . . to conceal or disguise the nature, place, source, ownership or control of the proceeds.'”
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The court was more emphatic on Chastain’s last point, finding no merit in his argument that the government’s “abuse theory” of wire fraud requires trading in securities or commodities. As previously discussed, while the government’s indictment statements referred to “insider trading,” the court clarified that Chastain “was not charged with insider trading, at least in the classic sense of the term as a means of engaging in securities fraud in violation of section 10 (b) in the Securities Exchange Act of 1934 and [SEC Rule 10b-5].” The court added that unlike an insider trading claim in section 10(b), which is limited to fraud “in connection with the purchase or sale of securities,” section 1343 does not refer to securities or goods, and no court has any once held that a conviction of this type required trading in securities or commodities, the court suggested that perhaps the “insider trading” label was “misleading,” but such an issue could be dealt with separately by striking it from the pleadings or excluding it at trial.

The final part of the ruling emphasizes how federal prosecutors can broadly apply the wire fraud statute (and corollary fraud) to a variety of conduct, including more modern activities in the digital asset space and beyond, without having to lay out or describe how property or assets that revolves around is a “security”. Using this statute arguably gives the DOJ more flexibility than the SEC, which is responsible for enforcing potential violations of federal securities laws and regulations.

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