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Insider Trading in NFTs? That’s Not a Crime, Defense Lawyers Claim

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Insider trading in a company’s stock is illegal, but what about insider trading in digital art?

Federal prosecutors, in a novel case over trading in nonfungible tokens, or NFTs, will test whether fraud theories used to police capital markets also apply to the more unorthodox market that boomed during the Covid pandemic.

Nathaniel Chastain,

a former employee of the NFT market OpenSea, in June became the first person charged in a scheme that prosecutors described as insider trading in NFTs, a kind of digital proof of purchase for goods like art.

But the New York Council of Defense Lawyers, an industry group of advocates, argues that prosecutors want to contort the law to turn workplace misconduct that they claim isn’t actual insider trading into a felony. They urged a judge to take the unusual step of throwing out the case before a jury sees it.

The rise of play-to-earn videogames – in which gamers trade NFTs – offers a glimpse into how the metaverse could attract users with monetary rewards, and what pushbacks may come with it. Photo illustration: Josephine Chu

Because Mr. Chastain is charged under the relatively encompassing wire fraud statute, rather than the securities fraud statute commonly used in insider trading cases, prosecutors arguably won’t have to wrangle over the thorny question of whether a digital asset like an NFT is a security under the law.

Mr. Chastain’s crime, under the theory prosecutors outlined, was stealing OpenSea’s confidential information. He was also charged with money-laundering.

A green light for prosecutors could “massively expand wire fraud to capture all sorts of workplace indiscretions” that might not even get an employee in trouble, let alone prosecuted, the NYCDL said in a filing last week.

A lawyer for Mr. Chastain,

David Miller,

declined to comment. When Mr. Chastain was charged, OpenSea, which is legally known as Ozone Networks Inc., said that it had begun an investigation and ultimately asked him to leave.

Mr. Chastain had been involved in picking the NFTs that would be featured on OpenSea’s website, exposure that can rapidly increase a work’s value. Prosecutors say that between June and September of last year he used that confidential knowledge to buy around 45 of the picks in advance and turn a quick profit once their public display bumped up demand.

Mr. Chastain more than quadrupled his money on “Spectrum of a Ramenfication Theory,” an NFT drawing of aliens eating ramen, the indictment states.

Though the market for NFTs has been turbulent, it has made some people rich. NFTs featuring apes, a beloved symbol to early crypto adopters, have sold for more than $1 million.

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NYCDL said that if prosecutors win, the case against Mr. Chastain could allow a range of prosecutions if an employee used work information elsewhere, such as a whistleblower being charged for taking company material to show a journalist, or an executive who knows his corporation will be relocating to small city and buys a home before prices rise.

The case comes amid a campaign by the U.S. Justice Department to more aggressively pursue wrongdoing, an effort first outlined by U.S. Deputy Attorney General

Lisa Monaco

in a speech last year.

“She basically said, ‘Be bold, take risks’,” said

Seth DuCharme,

a former Brooklyn federal prosecutor who now works as a partner at law firm Bracewell LLP.

Digital assets are an “intriguing area for those who want it to be at the front of the hunting party,” Mr. DuCharme said. But ultimately prosecutors will have to convince a jury that Mr. Chastain was involved in something like “lying, cheating and stealing” and that he knew he was doing something wrong, Mr. DuCharme said.

“It’s typically not in the interest of justice to notify people of what is criminal behavior by prosecuting them,” he said.

Ian McGinley,

a former New York federal prosecutor who is now a partner at the firm Akin Gump Strauss Hauer & Feld LLP, said prosecutors have a lot of leeway in bringing cases under the fraud statute.

“It’s a good thing for prosecutors to have flexibility to confront new technologies because at the end of the day, fraud is fraud,” he said.

The case against Mr. Chastain could turn on whether OpenSea considered the listings on its front page commercially valuable, Mr. McGinley said.

“The question will be where to limit enforcement because not every misuse of information is a crime,” he said.

Write to Richard Vanderford at [email protected]

Copyright ©2022 Dow Jones & Company, Inc. All Rights Reserved. 87990cbe856818d5eddac44c7b1cdeb8

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