TheCorporateCounsel.net

May 19, 2023

More on “Insider Trading” & NFTs

As Liz mentioned last week in her blog about the 2 year sentence for a former product manager at Coinbase who illegally traded in tokens, in early May, the jury returned a guilty verdict in what has been referred to as the first “insider trading” conviction involving NFTs. But, rather than charge insider trading, the U.S. Attorney’s Office actually relied on wire fraud and money laundering charges, which avoided the question of whether the NFTs constituted securities. This Norton Rose Fulbright alert summarizes the facts of the case:

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’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.

As Liz has blogged, in the Coinbase case, the SEC filed a parallel complaint, which did allege that the trading violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and will turn on whether the crypto assets are securities. Per this article from Proskauer, there the defendants argue that secondary market trades involving crypto tokens are not securities transactions, even if the tokens were investment contracts at issuance, since there are “no binding promises running from the developers to the tokenholders.”

Meredith Ervine