Federal authorities did not charge an ex-OpenSea employee with securities fraud after they accused him of insider trading. Instead, they reached for their Louisville Slugger.
In June, Nathaniel Chastain was charged with wire fraud for allegedly purchasing and selling nonfungible tokens (NFTs) on the OpenSea app using confidential information. Together with the related mail fraud legislation, the statute is expansive, adaptive, and potent. They are the “Stradivarius, our Colt 45, our Louisville Slugger, our Cuisinart, and our true love” for federal prosecutors, once quipped federal judge and former prosecutor Jed Rakoff.
Wire fraud is not typically employed in “insider trading” cases, which frequently involve securities fraud allegations. However, wire fraud can provide Justice Department prosecutors with a significant edge in digital asset cases: the opportunity to sidestep the thorny question of whether the asset is a security.
In court filings, Chastain contended that a “insider trading” wire fraud accusation needs “the actuality of trade in securities or commodities.” Last Monday in Manhattan, Judge Jesse Furman rejected the reasoning and refused to dismiss the charge.
Furman’s decision upholds the Justice Department’s strategy. In comparison to the Securities and Exchange Commission’s regulators, it also highlights the DOJ’s latitude in policing markets for digital assets like NFTs and crypto tokens. The SEC alone has the authority to enforce securities laws.
The DOJ, which has given digital assets more attention under the Biden administration, has the power to take action against behavior that might be beyond the SEC’s purview. According to attorneys, the Chastain case will probably serve as a guide for prosecutors in cases like this.
“The decision opens up the possibility for future digital asset ‘insider trading’ actions without actually having to address that heavily debated question of whether a digital asset is a security,” Eversheds Sutherland (US) LLP attorney Andrea Gordon said. “They don’t even have to go into that.”
Property Fraud
Prosecutors have used the wide wire fraud law in a number of high-profile cases. Both Trevor Milton, the creator of the electric trick manufacturer Nikola, and Elizabeth Holmes, the founder of the failed blood firm Theranos, were found guilty of wire fraud.
Federal prosecutors also used the legislation to bring charges against New Jersey authorities in the Varsity Blues college admissions scandal as well as the “Bridgegate” affair, which caused traffic jams on the George Washington Bridge.
Chastain’s case is “an ideal illustration of the breadth of the principles of mail and wire fraud,” Robert Anello, a partner at Morvillo Abramowitz Grand Iason & Anello PC, said.
Chastain was in charge of choosing the NFTs that would be displayed on the OpenSea homepage, a position that tended to increase the NFT’s value. Authorities claim that he purchased numerous NFTs covertly just before they were showcased, then profitably sold them.
The DOJ referred to it as the “first ever digital asset insider trading scheme” when it announced the accusations in June. Additionally, he was accused of money laundering. No equivalent legal action has been filed by the SEC against Chastain.
Chastain asserts that the NFTs he purchased and sold are neither a security nor a commodity. He stated that this is a requirement for charges of insider trading. Ultimately, the protection of financial markets is the basis of insider trading case law, he stated.
In his order, Judge Furman of the Southern District of New York stated that the argument was “entirely without validity.” The judge stated that Chastain was not charged with insider trading in the traditional sense, which entails securities fraud. Chastain was instead charged under Section 1343 with wire fraud.
“Section 1343 makes no reference to securities or commodities,” the judge said. “To accept Chastain’s argument would be to read an additional element into the wire fraud statute, which the Court may not do.”
Chastain’s lawyer, David Miller of Greenberg Traurig LLP, declined to comment.
The DOJ may have confused the waters by referring to the case as “insider trading,” but the indictment’s legal theories are sound, according to attorneys.
“It’s straight-forward property fraud,” George Washington law school professor Randall Eliason said. “Calling it insider trading is just kind of a way to make a splash. But it’s really not, strictly speaking, insider trading.”
In another case involving digital assets, Ishan Wahi, a former product manager at the cryptocurrency exchange Coinbase, was charged with wire fraud. Wahi is accused of disclosing confidential information in order to assist his brother and a friend in purchasing crypto tokens before they were listed on the market.
Nikhil, the brother of Wahi, pled guilty to a charge of wire fraud last month.
H. Gregory Baker, chair of the Securities Litigation group at Patterson Belknap Webb & Tyler LLP and a former SEC attorney, stated that Furman’s decision makes it clear that the DOJ can still pursue insider trading-like wrongdoings involving digital assets using wire fraud statutes when it is unclear whether the assets are governed by federal securities laws.
Wild West
The agency filed its own insider trading investigation against the Wahi brothers and Sameer Ramani, their acquaintance. The SEC’s complaint charges securities fraud, thus the agency must demonstrate that the relevant assets are in fact securities.
The so-called Howey Test, taken from a 1946 Supreme Court decision, is utilized by regulators and courts to evaluate if something is a security. Gary Gensler, chairman of the Securities and Exchange Commission, has stated that he believes the majority of digital coins to be securities, despite a great deal of ambiguity.
“It’s kind of the wild, wild west,” Gordon said.
Others contend that cryptocurrency behaves more like a commodity, like oil or grain. The cryptocurrency exchange site Coinbase has stated that it does not list securities. The problem is also being raised in numerous investor-filed cases. The DOJ can, for the time being, avoid this argument.
“If I’m the DOJ, I say let the CFTC, SEC, and the rest of the world fight out whether it’s a security, a commodity, or neither,” Anello said. “I don’t need to know that because I can prosecute people for any fraud.”
The SEC is now litigating a complaint that accuses Ripple Labs of deceiving investors on its XRP cryptocurrency token. The case hinges on whether XRP is a securities subject to SEC jurisdiction.
“If SEC gets bad decisions about whether cryptocurrencies are securities or not, they could really be hamstrung, whereas DOJ is going to have a much better tool to police fraud in this area,” said Ballard Spahr LLP attorney David Axelrod, a former federal prosecutor and SEC attorney.
About Property
Prosecutors face problems when attempting to prove wire fraud since it requires the defendant to “deprive another of money or property.” Furman stated that Chastain’s contention that information concerning OpenSea’s homepage listings do not constitute property has “some force.” These questions—what is or is not property—can be problematic in and of themselves.
In the Bridgegate case, the Supreme Court of the United States determined that the Port Authority’s desire to control the George Washington Bridge did not constitute a sufficient property interest.
Next month, the US Court of Appeals for the First Circuit will hear claims relating to the Varsity Blues investigation that a college admission offer is not property.
“If you had a case alleging someone took NFTs from their employer, that’s property,” Eliason said. “But if you’re arguing these internal business decisions about what we put on the website next week [are] property, that’s a lot dicier.”
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