Syed Rahman and Ulrich Schmidt assess the case and the issues arising from it.
The first conviction for insider trading involving NFTs has been overturned.
The 2nd U.S. Circuit Court of Appeals in Manhattan agreed with Nathaniel Chastain, a 35-year-old former product manager at OpenSea, that erroneous jury instructions could have led to his conviction.
Chastain was appealing his May 2023 wire fraud and money laundering conviction and the resulting three-month prison sentence. As yet, prosecutors have not indicated whether they intend to retry him.
Prosecutors had alleged that Chastain stole confidential information from OpenSea about which NFTs would be featured on its home page and then secretly bought those NFTs. He made a profit by selling them on when the price went up after they had been on OpenSea.
Court papers showed that he made $57,000 from buying and selling 15 NFTs. He used an anonymous account into which he had transferred cryptocurrency and transferred proceeds from the sales to his personal account.
But Circuit Court Judge Steven Menashi said the trial judge erred by telling jurors a wire fraud conviction did not require proof that Chastain stole information that had commercial value to OpenSea. He added that the trial judge was also wrong to instruct jurors that they could find that Chastain schemed to defraud if he had departed from "traditional notions of fundamental honesty and fair play in the general and business life of society." If that were the test, Judge Menashi said, "almost any deceptive act could be criminal."
Lessons
There are important lessons that can be learnt from this decision. Most importantly, this decision affects the US government’s ability to police insider trading of digital assets that are not securities. Whilst many cryptoassets are considered securities, the SEC has stated that many others, including Bitcoin - and now, NFTs - are not.
Chastain’s conviction was overturned as the court held that the wire fraud laws under which he was convicted only protect confidential information which has commercial value or economic significance to the holder, in this case OpenSea. The court held that the confidential information was likely to be only tangential to OpenSea’s business and, therefore, lacked commercial value.
In future matters, prosecutors will have to prove that confidential business information had commercial value. This is a greater requirement than was the case previously, when a company’s exclusive right to information was enough to satisfy wire fraud laws; with no need to prove commercial value. As such, there is now a new threshold set by the court, further illustrating the liberalising of the rules governing digital assets that is ongoing under the Trump administration.
Risk
It is difficult to state clearly whether there is an enhanced risk of insider trading within the world of cryptoassets and NFTs. While some will argue that there is no significantly higher level of insider trading in this sector than in traditional markets, there are many concealment methods within the crypto world which develop at a faster pace than the authorities can follow. As such, insider trading may not be punished as often as in the traditional markets, and a lack of a deterrent effect could serve to increase such activity in the future.
Crypto traders must, therefore, carefully analyse all aspects of the assets they are considering purchasing. With the ever-evolving crypto landscape and the multiple ways investors can be defrauded, it is vital that traders thoroughly assess all relevant matters before investing.
