New York Federal Prosecutors Convict Defendant of NFT Insider-Trading Scheme | Foley Hoag LLP – White Collar Law & Investigations

New York Federal Prosecutors Convict Defendant of 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 purchase and sale of non-fungible tokens (“NFTs”).[1] This historic criminal case represents the first time that federal prosecutors have taken criminal action against 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, allegedly used confidential information about NFTs to be displayed on OpenSea’s homepage for his personal financial gain. Chastain was responsible for selecting the NFTs to display on the OpenSea homepage, and OpenSea kept the NFTs’ distinct identity secret until they appeared on its homepage.[2] After the NFT was featured on the OpenSea homepage, the value of the NFT and other NFTs made by the same creator increased exponentially.[3] The government alleges that Chastain was aware of this fact and used his confidential business information regarding which NFTs would be offered to purchase dozens of NFTs under an anonymous account shortly before they appeared. Once the value of Chastain’s purchased NFTs increases from their exposure on the OpenSea homepage, Chastain will allegedly resell the NFTs for a significant profit.[4]

On August 19, 2022, Chastain filed a motion to dismiss the indictment. Chastain argues that the government’s electronic fraud theory of insider trading does not apply in this context because insider trading requires trading in securities or commodities.[5] Chastain stresses that because they have no connection with financial markets, NFTs are not. Additionally, Chastain argues that the government’s electronic fraud charge cannot succeed because it requires the government to create, Among other thingsor money or property as the object of a fraud scheme or ploy, and the confidential information allegedly misappropriated does not constitute “property,” but instead consisted of a “marketing concept” that was “devoid of any inherent economic value and based on [his] Unspoken personal thoughts.[6] Chastain also argues that the money-laundering case should be dismissed because it requires proof that he tried to conceal the alleged fraud. Here, all movements and transactions were made on the Ethereum blockchain, and thus were visible to the public. According to Chastain, he did nothing more than transfer money in a “obvious and tangible” manner, which does not constitute money laundering.[7]

On August 24, 2022, the New York Board of Defense Attorneys (“NYCDL”) submitted a friendly memorandum in support of Chastain’s motion to reject. In the summary, the NYCDL wrote that it is “deeply concerned about efforts by the Department of Justice to expand mail and telecommunications fraud beyond the limits set by Congress.”[8] The NYCDL Brief focuses primarily on Chastain’s second argument, given the government’s definition of “property,” to broaden the scope of confidential business information that employees receive in connection with their jobs. The NYCDL argues that such a construct “would … capture nearly every case of an employee using internal employer information for non-work-related purposes,”[9] Including, for example, situations where a corporate whistleblower collects information about a company’s wrongdoing and submits it to a journalist who violates company policy.[10]

On September 7, 2022, the government submitted a memorandum of opposition. In refuting Chastain and NYCDL’s arguments, the government claims that the “newness of the NFTs” does not make the case a “new trial,”[11] And the “[t]The misappropriation theory of electronic 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 ‘proprietary’ if the company cannot ‘commercially exploit the information by trading it’.[13] Moreover, the fact that Chastain, rather than OpenSea, profited from the use of confidential business information does not mean that it has no economic value to OpenSea. The government suggests that OpenSea “could have exploited this value by, for example, providing advice on upcoming premium NFTs as benefits to business partners.”[14] Choosing not to take advantage of 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 proposal exploits the alleged incorrect use of the term “insider trading”, Chastain has not in fact been accused of committing insider trading; He was charged with fraud and money laundering.[16] The references to the term “insider trading” in the indictment were appropriate insofar as Chastain’s “use of[d] Confidential and non-public information for trading an asset.”[17]

Regarding the money laundering charge, the government alleges that despite the transactions taking place on the Ethereum blockchain, Chastain took steps to conceal his connection to those transactions using anonymous accounts.[18] Moreover, the Money Laundering Act broadly defines “transaction” to include the “transfer” of funds, which covers Chastain’s movement of assets on the blockchain.[19] The government also argues that Chastain’s appeals to the money laundering charge are all “fact-based arguments for the jury,” and are “not appropriate grounds for dismissal of the accused.” [i]ndictment”.[20]

Afif It highlights the Department of Justice’s growing focus on the emerging digital asset space. The issue will be important to monitor, particularly as we expect to see additional application in this area by the government going forward.

[1] NFTS is “a type of digital asset stored on the blockchain, which is a decentralized digital ledger that stores information, including information about transactions.” United States vs. 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 piece of artwork, and the NFT provides evidence of ownership of that digital object and a license to use it for specific purposes.” ID.

[2] ID. in 1.

[3] ID. in 1-2.

[4] ID. in 4.

[5] United States vs. Chastainmemorandum of law in support of Nathaniel Chastain’s motion to dismiss the indictment, 22-CR-305, ECF No. 19 (SDNY August 19, 2022) at 2.

[6] ID.

[7] ID. at 3 o’clock.

[8] United States vs. ChastainBriefing on Amicus Curiae New York Defense Counsel Board in Support of Dismissal of Indictment, 22-CR-305, ECF No. 20 (SDNY August 24, 2022) at 2.

[9] ID. in 1.

[10] ID. in 5.

[11] United States vs. ChastainGovernment Memorandum Against Defendant’s Request to Reject the Indictment, 22-CR-305, ECF No. 23 (SDNY September 7, 2022) at 1.

[12] ID. in 6.

[13] ID. at 13. See, for exampleAnd the United States vs. Grossman843 F.2d 78 (2d Cir. 1988).

[14] ID. at 15.

[15] ID.

[16] ID. in 1.

[17] ID.

[18] ID. at 26.

[19] ID. at 28.

[20] ID. at 25. In his pleading, Chastain asked for oral arguments to be made, and the next court hearing is scheduled for October 27, 2022.

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