First NFT “insider trading” trial ends in criminal conviction based on novel theory

On May 3, 2023 a jury convicted Nathaniel Chastain of wire fraud and money laundering in a prosecution brought by the US Attorney's Office for the Southern District of New York involving non-fungible tokens (NFTs).

Although heralded by the media and prosecutors as the first "insider trading" conviction based on trading in NFTs, the prosecution relied on a novel theory that charged wire fraud rather than securities fraud, largely avoiding issues concerning whether the NFTs in question could be considered securities.

As we have previously described in SDNY and SEC bring first cryptocurrency insider trading case, the government remains focused on cracking down on illicit behavior in the digital asset industry. This conviction demonstrates that juries can be willing to endorse novel legal theories that prosecutors push in pursuit of this goal.

According to the indictment, at the time of the alleged offenses, Nathaniel Chastain was an employee of OpenSea, the largest online market for NFTs. OpenSea typically featured certain NFTs on its homepage, and changed the featured NFT multiple times each week. Chastain was responsible for selecting the NFT to be featured on OpenSea's homepage, and OpenSea kept this information confidential until the selected NFT appeared on its homepage. The publicity from being featured on OpenSea's homepage often resulted in substantial increases in the price that buyers were willing to pay for that NFT, as well as the prices of other NFTs made by that same creator. Chastain was alleged to have used his knowledge of upcoming featured NFTs to purchase those NFTs, or other NFTs made by the same creator, in advance of the NFT being featured on OpenSea's homepage. Chastain then sold those NFTs shortly after they were featured, by which time they had often doubled or even tripled in value, resulting in substantial profit to Chastain.

Chastain argued during his defense that he lacked criminal intent, in part, because his company had failed to explicitly prohibit the behavior. Chastain's conduct was exposed on social media, not by the company itself, occasioning his prompt resignation. The jury deliberated for a few days but ultimately did not accept Chastain's defense, instead apparently agreeing with prosecutors that a boilerplate employee confidentiality agreement executed by company employees prohibited the misconduct. The company's senior management were called as prosecution witnesses. Albeit doing so equivocally, they testified that the confidentiality agreement prohibited Chastain's conduct, which became an essential element of the government's case. 

Apart from featuring a digital asset, the circumstances leading to Chastain's conviction bear some resemblance to conventional insider trading and front running schemes in that Chastain used inside knowledge of future transactions that would substantially affect the price of the asset (here, NFTs). Insider trading convictions are far from groundbreaking, but Chastain was not convicted of any securities-specific offense. Instead, the prosecutors charged Chastain under general wire fraud and money laundering statutes. In fact, prior to trial, Chastain attempted to exclude the use of the term "insider trading" at trial. His motion was denied with the court reasoning that "[i]ts classic meaning notwithstanding, the term 'insider trading' is not an inapt description of the facts of this case" because "Chastain is accused of improperly using confidential, non-public (or 'inside') information about an asset to buy and then sell (or 'trade') that asset on a public market."

Despite this resemblance, Chastain's conviction was not based on trading in any security or commodity, but on the somewhat creative theory of prosecution that Chastain had misappropriated OpenSea's property, in the form of its confidential business information regarding which NFTs would be featured on OpenSea's homepage. The government argued that, based on Carpenter v. United States, 484 U.S. 19 (1987), a case involving securities rather than digital assets, because OpenSea employees were obliged to keep this information confidential and use it only for the benefit of OpenSea, Chastain's conduct defrauded OpenSea of its property, i.e., its confidential business information. Prior to and during trial, Chastain argued that his conduct did not deprive OpenSea of its property, i.e., its confidential business information, because that information lacked commercial value and was not property, and because OpenSea did not treat this information as confidential. Nonetheless, the jury found Chastain guilty of all charges.

The New York Council of Defense Lawyers was critical of the government's case, and prior to trial filed an amicus brief arguing that the government's overbroad definition of "property" would permit it to bring fraud charges against any employee who uses their employer's information for non-work purposes. The amici cautioned that embracing this theory would encourage prosecutors to avoid bringing more complex securities fraud charges in favor of this new "misappropriation" theory of wire fraud and money laundering.

Takeaways

This conviction reflects the government's continuing determination to crack down on exploitative behavior in the digital assets space, even if it requires increasingly creative approaches to enforcement.

Moreover, the novel legal theory by which the conviction was obtained shows the government's willingness to reach conduct that resembles conventional frauds while avoiding thorny, unresolved legal questions regarding whether digital assets are properly considered securities or commodities under federal law.

This successful conviction is likely to only further increase the government's willingness to consider exploring its already expansive tool chest of conventional charges, rather than venture into more unsettled territory, in pursuit of its prosecutorial goals.

What is yet to be seen, but perhaps the logical next step, is for the government to pursue similar conventional charges against companies who, despite being placed in a position of trust by their clients, fail to institute sufficient preventative compliance measures and programming.