US DOJ Files First-Ever Insider Trading Lawsuit Involving Digital Assets | Insights and Events

The Department of Justice (DOJ) continues to position itself as the primary law enforcement agency focused on the investigation and enforcement of digital asset offenses with its first-ever insider trading prosecution involving assets digital. On June 1, 2022, the U.S. Attorney’s Office for the Southern District of New York (SDNY) released an indictment charging a former employee of a non-fungible token (NFT) marketplace called OpenSea with insider trading in connection with the employee’s alleged use of confidential NFT information that was to appear on the OpenSea homepage for his own personal financial gain.1

Background

An NFT is a tradable digital asset in the form of an original digital image, sound, or other artifact whose ownership is recorded on the blockchain. Following the skyrocketing popularity of cryptocurrency, the NFT market has also seen explosive growth since 2021, with sales up 21,000% in just one year to over $17 billion.2 OpenSea was at the heart of this massive expansion. The first and largest marketplace for NFTs, OpenSea bills itself as a platform that has sold over 80 million NFTs, including art, photography, music, sports memorabilia, and domain name NFTs.3 OpenSea says it has made $20 billion in revenue since its inception in 2017.4

SDNY-assigned OpenSea employee Nate Chastain was the product manager and responsible for selecting NFTs to be displayed on the OpenSea homepage.5 OpenSea treated this information as confidential until the NFT appeared on its homepage.6 Once an NFT appeared on the OpenSea homepage, the price buyers were willing to pay for the NFT usually increased significantly, as did the price of other NFTs made by the same creator.seven

In September 2021, allegations surfaced on Twitter linking Chastain to leading NFTs (i.e. purchases based on prior non-public information).8 After learning of this behavior, OpenSea ordered an internal investigation and strengthened its internal controls to prevent similar behavior by other employees.9 Subsequently, Chastain resigned.

The indictment

SDNY’s indictment alleges that, over a period of approximately three months in 2021, during the extraordinary explosion in NFT sales noted above, Chastain allegedly used confidential NFT information that would be featured on the OpenSea homepage to buy dozens of NFTs.ten Once the NFTs were featured on the OpenSea homepage and their value skyrocketed, Chastain would sell the NFTs with profits that were two to five times the original purchase price.11 Chastain surreptitiously made these sales by creating anonymous digital currency wallets and anonymous accounts on OpenSea.12

For this alleged conduct, the SDNY charged Chastain with one count of wire fraud and one count of money laundering.13 Notably, while the SDNY charged this is a case of “insider trading” because NFTs are not generally classified as securities, prosecutors did not rely on Section 10 ( (b) the Securities Exchange Act of 1934 and Rule 10b-5, the generally preferred law and regulation in matters of insider trading.14 Instead, prosecutors relied on wire fraud law with respect to Chastain’s purchase and resale of NFTs in violation of the duties Chastain owed to OpenSea as an employee and the money laundering for the use of anonymous wallets to conceal ill-gotten resale profits.15

Carry

Companies and investors trading digital assets such as NFTs should be aware of SDNY lawsuits. This lawsuit shows that the lack of clarity in regulations governing the digital asset space will not be a safe harbor, and the government’s drive to “regulate by enforcement” appears to be continuing unabated. In the absence of more specific legislation or regulatory guidance, law enforcement will continue to rely on flexible and open authorities, whether under the guise of criminal wire fraud or civil interdicts. unfair and deceptive acts and practices by agencies like the Federal Trade Commission. The DOJ, in particular, has shown an unwavering commitment to developing enforcement capabilities in this space, and those seeking to avoid law enforcement scrutiny should implement compliance functions that will help avoid an outcome. similar. To mitigate potential risks, companies should proactively develop training programs that educate employees on their responsibilities as market participants when a company issues new NFTs or makes initial coin offerings. Companies should also review their representations to consumers on these issues to confirm that their actual practices match their market claims.

The authors would like to thank Kameryn Garel-McCullough for his efforts in writing this legal update.


1 Press Release, United States Department of Justice, Former NFT Marketplace Employee Charged in First-Ever Digital Asset Insider Scheme (June 1, 2022), https://www.justice.gov/usao-sdny/pr/former-employee-nft-marketplace-charged-first-ever-digital-asset-insider-trading-scheme.

2 Ryan Browne, NFT Trade Grows 21,000% to Over $17 Billion in 2021, Report Finds, CNBC (Mar 10, 2022, 01:00), https://www.cnbc.com/2022/03/10/trading-in-nfts-spiked-21000percent-to-top-17-billion-in-2021-report.html.

3 OpenSea, https://opensea.io/about (last visit June 1, 2022).

4 Identifier.

5 Press Release, US Department of Just., above footnote 1.

6 Identifier.

seven Identifier.

8 Tony Newmyer, Former OpenSea executive charged in first-ever NFT insider trading caseWashington Post (June 1, 2022, 6:29 p.m.), https://www.washingtonpost.com/business/2022/06/01/nft-insider-trading-opensea/.

9 Will Gottsegen, OpenSea Exec accused of insider trading resigns, CoinDesk (September 16, 2021, 3:13 p.m.), https://www.coindesk.com/business/2021/09/16/opensea-exec-accused-of-insider-trading-leaves-company/.

ten Press Release, US Department of Just., above footnote 1.

11 Identifier.

12 Gottsegen, above footnote 9.

13 Press Release, US Department of Just., above footnote 1.

14 17 CFR § 240.10b-5.

15 Press Release, US Department of Just., above footnote 1.