US DOJ Brings Its First-Ever Insider Trading Prosecution Involving Digital Assets
The Department of Justice (DOJ) continues to position itself as the principal law enforcement agency focused on the investigation and enforcement of digital asset-related offenses with its first-ever insider trading prosecution involving digital assets. On June 1, 2022, the U.S. Attorney’s Office for the Southern District of New York (SDNY) unsealed an indictment charging a former employee of a Non-Fungible Token (NFT) marketplace called OpenSea with insider trading in relation to the employee’s alleged use of confidential information about what NFTs were going to be featured on OpenSea’s homepage for his own personal financial gain.1
Background
An NFT is a tradeable digital asset in the form of an original digital image, audio or other artifact that has its ownership recorded on the blockchain. Following the surge in popularity of cryptocurrency, the NFT market has similarly experienced explosive growth since 2021, with sales rising by 21,000% in just one year to more than $17 billion.2 OpenSea was at the heart of this massive expansion. The first and largest marketplace for NFTs, OpenSea touts itself as a platform that has sold more than 80 million NFTs, including art, photography, music, sports memorabilia and domain name NFTs.3 OpenSea represents that it has made $20 billion in sales since its founding in 2017.4
The OpenSea employee whom the SDNY charged, Nate Chastain, was the head of products and responsible for selecting NFTs to be featured on OpenSea’s homepage.5 OpenSea treated this information as confidential until the moment the NFT appeared on its homepage.6 Once an NFT appeared on OpenSea’s homepage, the price buyers were willing to pay for the NFT typically increased by a wide margin, as did the price for other NFTs made by the same creator.7
In September 2021, allegations appeared on Twitter tying Chastain to the front running of NFTs (i.e., purchasing based on advance non-public information).8 After learning of this conduct, OpenSea ordered an internal investigation and enhanced its internal controls to prevent similar conduct by other employees.9 Thereafter, Chastain resigned.
The Indictment
The SDNY indictment alleges that, over an approximately three-month period in 2021, during the extraordinary explosion in NFT sales noted above, Chastain allegedly used confidential information about the NFTs that would be featured on OpenSea’s homepage to purchase dozens of NFTs.10 Once the NFTs were featured on OpenSea’s homepage, and their value skyrocketed, Chastain would sell the NFTs at profits that were two to five times the original purchase price.11 Chastain surreptitiously carried out these sales by establishing 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 an “insider trading” case because NFTs generally are not classified as securities, prosecutors did not rely on Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, the statute and regulation typically favored in insider trading cases.14 Instead, prosecutors relied on the wire fraud statute in relation to Chastain’s purchase and resale of the NFTs in violation of duties Chastain owed to OpenSea as an employee and the money laundering statute for the use of anonymous wallets to secrete the ill-gotten profits of the resale.15
Takeaway
Companies and investors dealing in digital assets such as NFTs should be mindful of the SDNY’s prosecution. This prosecution shows that the lack of clarity in regulations governing the digital assets space will not be a safe harbor, and the government’s trend of “regulation by enforcement” appears as if it will continue unabated. Absent more specific legislation or regulatory guidance, law enforcement will continue to rely on flexible and open-ended authorities—whether under the guise of criminal wire fraud or civil prohibitions on unfair and deceptive acts and practices enforced by agencies like the Federal Trade Commission. DOJ in particular has shown its unwavering commitment to developing enforcement capabilities in this space, and those looking to avoid law enforcement scrutiny should implement compliance functions that will help avoid a similar outcome. To mitigate potential risk, companies should proactively develop training programs that educate employees about their responsibilities as actors in the marketplace when a company issues new NFTs or makes initial coin offerings. Companies also should review their consumer-facing representations on these issues to confirm that their actual practices match their claims to the market.
The authors would like to thank Kameryn Garel-McCullough for his effort in writing this Legal Update.
1 Press Release, U.S. Dep’t of Justice, Former Employee of NFT Marketplace Charged in First Ever Digital Asset Insider Trader 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, Trading in NFTs Spiked 21.000% to More Than $17 billion in 2021, Report Says, CNBC (Mar. 10, 2022, 1:00am), 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 visited June 1, 2022).
5 Press Release, U.S. Dep’t of Just., supra note 1.
8 Tony Newmyer, Former OpenSea Executive Charged in First-Ever NFT Insider Trading Case, Wash. Post (June 1, 2022, 6:29 PM), https://www.washingtonpost.com/business/2022/06/01/nft-insider-trading-opensea/.
9 Will Gottsegen, OpenSea Exec Accused of Insider Trading Resigns, CoinDesk (Sept. 16, 2021, 3:13 PM), https://www.coindesk.com/business/2021/09/16/opensea-exec-accused-of-insider-trading-leaves-company/.
10 Press Release, U.S. Dep’t of Just., supra note 1.
