On May 3, 2023, Nathaniel Chastain, the former product manager of the NFT marketplace OpenSea, was convicted by a federal jury in the Southern District of New York for what is being called the first insider trading conviction in the digital asset space.
The premise of the case is that insider trading occurs when the trader misappropriates material non-public information in breach of a duty of confidentiality and uses the mails or wires to profit from a purchase or sale. The novelty is that in this case the purchase was of an NFT— which may not necessarily be a security or a commodity. As a result, prosecutors avoided litigating whether the NFTs at issue would constitute securities or commodities. "Nathanial Chastain exploited his advanced knowledge of which NFTs would be featured on OpenSea's website to make profitable trades for himself," U.S. Attorney Damian Williams said in a statement. "Although this case involved novel trades in crypto assets, there was nothing particularly innovative about his conduct – it was fraud." The DOJ's theory focused on Chastain's conduct and general principals of fairness. He misappropriated OpenSea's confidential business information that he obtained only by virtue of his position with the company in violation of a duty he owed to OpenSea, traded based on that confidential knowledge giving himself an unfair advantage over others and profited from his actions.
As part of his responsibilities as product manager at OpenSea, Chastain was in charge of selecting what digital art would be featured on OpenSea's homepage. He was also required to keep this information confidential pursuant to an employee confidentiality agreement. Chastain's wire fraud conviction was based on his misuse of that confidential information to purchase the NFTs ahead of OpenSea featuring them on its homepage, knowing the NFTs would increase in value from this favorable placement. He then sold them for up to 5 times the price he paid, pocketing roughly $57,000 in profit. The money laundering charge stemmed from Chastain's attempt to conceal his scheme by using multiple anonymous wallets and OpenSea accounts to make the purchases and sales and transfer the illegal proceeds back to his own wallet. This conviction shows just how robust the application of federal anti-fraud statues can be for addressing allegedly fraudulent conduct in the digital asset marketplace. It reinforces how the DOJ will apply insider trading liability to any situation where material, non-public information gives the seller an advantage irrespective of whether the object being sold is a security, commodity or something else. It should be a warning for traders and operators of NFT and cryptocurrency marketplaces that irrespective of how an NFT is characterized, trading and dealing in NFTs will be subject to well understood principles of fairness and fraud. The industry is learning that U.S. regulators will not wait for new regulations if they can use existing rules to hold bad actors accountable. The open question is whether, as the SEC and other regulators increase their focus on NFTs and other digital assets, the SEC will seek to extend the argument that NFTs are securities subject to the anti-fraud provisions of the securities laws as well.
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