Wire fraud: the most powerful law in crypto right now

23 August 2022 – Regulation and enforcement in the cryptocurrency space are hot topics, with the debate centering around the complex question of whether to classify digital assets as securities, commodities or an asset class of their own. In the midst of this debate, the Department of Justice (DOJ) has sent a message — the classification has no bearing on its purpose. In recent prosecutions, the DOJ has used the wire fraud statute, 18 USC § 1343, a law with origins dating back to the 1800s, to bring innovative cases in the cryptocurrency space that do not rely on how a digital asset is classified.

My previous article in February 2022 highlighted how the DOJ could seek to use the wire-fraud statute to prosecute racketeering (ie, taking the money and running schemes), insider trading, and market manipulation of digital assets. (See McGinley, “Expect Charges in NFT Space Soon,” Reuters Legal News (Feb. 4, 2022)).

Since then, the DOJ has used wire fraud to prosecute the first two wire fraud cases involving NFTs and to prosecute two cases of insider trading in digital assets. The DOJ has not recently used wire fraud in a large-scale market manipulation case, but it is likely to be a next area of ​​focus, given public reports of market manipulation and spoofing (creating orders with the intent to cancel) by crypto whales, which are individuals or entities that own significant amounts of a particular cryptocurrency.

This article examines the DOJ’s use of the wire-fraud statute during the first half of 2022 and what you can expect going forward.

Briefly about the wire fraud act

The wire fraud statute is based on the nearly identical Mail Fraud Act, which was enacted in 1872 to combat fraud committed through the mail. The wire fraud statute expanded the law beyond the mail to include telephone, and now all forms of telecommunications including e-mail, text messages and social media. Generally speaking, the wire fraud statutes prohibit the use of wire communications to obtain money or property through a scheme to defraud, which is often accomplished through misrepresentation or false promises.

The statutes are adaptable; it is not limited by the subject. Prosecutors have used it on insider trading schemes, counterfeiting and other forms of market manipulation. It is a powerful tool for prosecutors. For this reason, Judge Jed Rakoff famously said that for prosecutors, the mail and wire fraud statutes are “our Stradivarius, our Colt 45, our Louisville Slugger, our Cuisinart—and our true love.” (Jed S. Rakoff, “The Federal Mail Fraud Statute (Part 1),” 8 Duq. L. Rev. 771, 771 (1980)). The DOJ’s recent cases in the crypto space only prove Judge Rakoff’s point.

Recent cases

1. Carpet cover

In the first half of 2022, the DOJ charged two innovative NFT carpets using the wire-fraud statutes, both of which are still pending. First, in March 2022, the US Attorney’s Office for the Southern District of New York (SDNY) indicted US v. Nguyen, the first fraud case involving NFTs. SDNY alleged that the creators of the Frosties NFT collection committed a $1.1 million blanket scam by falsely promising buyers that in addition to cartoon-like images, they would receive benefits such as giveaways and access to a metaverse game.

Second, in June 2022, the DOJ Fraud Section in US v. Tuan indicted the second NFT scam against the creator of the “Baller Ape” NFT project, alleging a scam of $2.6 million. The allegations in that case are even more serious: The creators gave nothing to buyers, not even pictures.

In neither case did the DOJ argue that the NFTs in question were securities or commodities, as the classification of NFTs was immaterial to the wire fraud charges. The DOJ charged a basic theory of wire fraud — that buyers of these NFTs did not receive what they were promised.

2. Insider trading cases

The DOJ has adopted a similar approach in the insider trading area, charging cases that do not depend on the complexity of the underlying asset. In June 2022, the SDNY filed the first case of insider trading in digital assets, against Nathanial Chastain, a former OpenSea employee.

The indictment in US v. Chastain alleges that Chastain had advance knowledge of which NFTs would be featured on OpenSea’s website, which generally leads to an increase in the NFT’s price. Chastain bought the NFTs before they went public and sold them after listing for a profit, reportedly around $67,000.

A month later in US v. Wahi, the SDNY filed another digital asset insider trading case – this time against a former Coinbase employee and two others for participating in a similar scheme. The allegation is that Ishan Wahi, a Coinbase employee, knew which tokens the exchange would list and gave this information to his brother and friend, who traded on the information for a $1.6 million profit.

In both cases, the DOJ charged wire fraud, not securities fraud, the typical charge in insider trading cases. Although this theory is likely to be challenged in court and the defendants have pleaded not guilty, the use of wire fraud to prosecute insider trading has a long history, dating back to the 1987 Supreme Court case Carpenter v. United States, (484 US 19 ) (1987). This case involved a Wall Street Journal columnist, who wrote about new stocks in his column. This information was considered confidential business information belonging to the newspaper. The columnist abused this information by giving advance notice of the stocks he wanted to point to. his friends at a brokerage firm, who used the information to trade the shares. The DOJ relied on Carpenter because the notification was strikingly similar to the alleged notification in Chastain and Wahi.

Relying on wire fraud provides additional benefits for the DOJ. First, the DOJ can avoid burdensome and complicated litigation over whether the underlying assets are securities. Second, it allows the DOJ to act unilaterally. In the typical securities fraud case, for example, the DOJ and SEC work in parallel and conduct concurrent cases. Although there are advantages to this coordination, it also takes time. When the DOJ only charges wire fraud, there is less coordination because the SEC cannot charge wire fraud. Instead, the SEC can only bring enforcement actions when the underlying asset is a security.

What will be next

1.Disclosure/misrepresentation cases

In both NFT cases, the DOJ focused on representations made to purchasers of the respective NFTs. While these were not large-scale frauds, they underscore the DOJ’s focus on the accuracy of the statements and disclosures defendants made to purchasers of digital assets — regardless of the identity of the underlying asset.

Going forward, we can expect the DOJ to focus on larger disclosure issues, likely at the corporate level. Crypto companies often communicate with the public over various forms of social media. Companies often react in real time to market events. While communicating quickly and frequently with your audience has commercial benefits, it can also lead to inaccuracies. The DOJ has already used wire fraud to prosecute alleged misrepresentations made over social media in other contexts (see US v. Milton, SDNY 2021), and it may seek to do so in the crypto space as well.

2. Major insider trading cases

The first digital asset insider trading case charged a defendant with allegedly profiting less than $100,000. The second, just one month later, charged three defendants with approximately $1.5 million in profits. This trend in complexity and dollar value is likely to increase, especially given reports of greater insider trading problems in this area. (See Foldy and Ostroff, “Crypto Might Have an Insider Trading Problem,” Wall Street Journal (May 21, 2022)).

Insider affairs in a particular industry often start relatively small and involve those closest to the source of the information. Over time, they evolve to focus on downstream tippees – that is, individuals at trading firms who are a few steps removed from the information but are able to make larger trades. I expect the DOJ will focus next on investigating insider trading by major market participants and crypto-focused trading firms.

3. Market manipulation cases

Finally, we can likely expect the DOJ to use the wire-fraud statute to prosecute market manipulation in the digital asset space. The media has long reported suspected manipulative trading practices in the cryptocurrency markets, including wash trading and spoofing. (See, e.g., “In Crypto, Market Manipulation Remains a Problem,” PYMTS.com (1 Aug. 2022)).

In terms of counterfeiting, the practice of crypto whales using buying and selling “walls” has attracted attention. These “walls” are essentially price points created by entering large volumes of buy or sell orders, with the idea of ​​artificially inflating the price of a token to sell high, or reducing a token’s value to create a buying opportunity.

In 2018, the DOJ investigated apparent price manipulation in the crypto markets. (Robinson and Schoenberg, “US Launches Criminal Probe into Bitcoin Price Manipulation,” Bloomberg (May 24, 2018)). Given the rise in the prominence of crypto in our economy since 2018, it is only logical that the DOJ would tighten its focus on this practice.

Although the DOJ’s track record in using wire fraud to prosecute spoofing cases has been mixed (and beyond the scope of this article), the DOJ recently prevailed in a spoofing case involving precious metal futures before the 7th US Circuit Court of Appeals at to use a wire-fraud theory. (See, e.g., United States v. Chanu, (7th Cir. July 6, 2022)). This success will likely encourage the DOJ to use wire fraud for crypto market manipulation.

Conclusion

As crypto becomes mainstream, prosecutors have responded with one of the DOJ’s oldest tools – wire fraud. In the first half of 2022, the DOJ prosecuted cases under the wire fraud statute, and we can expect this trend to continue and expand into other areas of financial fraud traditionally prosecuted by the DOJ, including corporate disclosure and market manipulation cases.

The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed under its fiduciary principles to integrity, independence and freedom from bias. Westlaw Today is owned by Thomson Reuters and operates independently of Reuters News.