United States v. Chastain, 22-crim-00305 (S.D.N.Y. 2022)

Summary

On June 1, 2022, the DOJ arrested and charged Nathaniel Chastain, a former OpenSea executive who resigned in the midst of a huge controversy last year. Back in September 2021, some folks scanning the public blockchain discovered a strange pattern: Chastain's wallets appeared to be buying NFTs shortly before they were listed on OpenSea's homepage when the price was low and selling them shortly after they were listed as the prices went up due to increased exposure. That was particularly problematic because Chastain himself was responsible for choosing what got listed on the homepage.

Nine months later, the DOJ charged Chastain with one count each of wire fraud and money laundering for this alleged activity. These are the same charges in the Frosties case. It thus appears the DOJ is expanding the application of "wire fraud" in the very straightforward sense there (false promises in exchange for money) to what many people online are calling "insider trading," and is exactly how the DOJ itself is characterizing the conduct.

That term is usually applied in the context of buying or selling public company securities on the basis of material, non-public information that (usually) allows the person exploiting the information to profit handsomely from a stock dropping or soaring. Doing so is very plainly illegal under Section 10(b) of the Exchange Act (15 U.S.C. § 78j(b)) and Rule 10b-5 (17 C.F.R. § 240.10b-5). One of the keys to those kinds of cases is that the person has an obligation to keep the information confidential that they have violated, as Matt Levine and Jason Gottlieb explain quite well (and also discuss this case too).

Equally plainly, those are not the charges the government has brought against Chastain here. It's just good old fashioned wire fraud and money laundering. But the government calls it insider trading in the first line of the indictment. The government is thus pushing to apply traditional wire fraud principles to a new situation: using inside information to sell NFTs at the right time for profit. Normally fraud requires some active representation or statement that other people rely on to their detriment.

Just having inside information and exploiting it to strategic advantage in an open market of other people buying and selling the same asset doesn't exactly fit the normal fraud framework, because there's no representation or false pretense – it's just an offer to buy or sell an asset at a certain price, and there is generally no requirement that all buyers/sellers have access to all of the same information. (Note, however, that trading on confidential information like this is the cornerstone of securities insider trading cases, the theory being that you have defrauded a person by agreeing to keep the information confidential but instead exploited it in the public market.)

But Chastain did not just "have" inside information that he then used to strategic advantage. The indictment alleges he actually was responsible for selecting which NFTs would be featured on OpenSea's homepage:

This allegation is likely the lynchpin of the government's fraud case because it's how they can meet the "false and fraudulent pretenses, representations, and promises" element of wire fraud. What the government is arguing here is that if you (1) have specific control over a public marketplace; (2) secretly buy things you know are about to be listed on that marketplace in a very prominent way; and (3) are actually the person responsible for choosing what gets prominently listed, then it is a fraudulent pretense you have created that permits you to exploit that knowledge by buying low right before the listing and then dumping the NFTs right after the listing for profits of 2X-5X what you paid.

The government also highlights two other facts to suggest Chastain's conduct was fraudulent. First, that this conduct was specifically in violation of a confidentiality agreement Chastain had with OpenSea that prevented him from using confidential information "except for the benefit of OpenSea." Breaching a contract isn't normally enough to get you to fraud (unless you never intended to perform, as Ira Rothken points out on Twitter), but when your breach enables you to exploit unwitting buyers based on a situation you have created, it seems a lot closer. And this allegation puts the charge in the more traditional framework of an insider trading case. Second, the government alleges Chastain tried to conceal what he was doing by using anonymous accounts to funnel the proceeds of his sales, suggesting he knew what he was doing was wrong.

It's far too early to say if the government's theory of wire fraud here will be successful, but it has a lot of intuitive appeal. If the government can get the case to a jury, and successfully explain what happened here, this case could be very tough to successfully defend. It appears the case will be hotly contested, however, as Chastain has retained Greenberg Traurig, a prominent law firm, to defend him. Reportedly Chastain's attorneys said at the first hearing in which they appeared that they would be moving to dismiss the charges entirely, a move that rarely succeeds in the criminal context, while also noting that the case involves novel legal issues.

Note, however, this case doesn't mean the government thinks NFTs are securities, at least for purposes of this novel "insider trading" complaint. Nor are the facts of this case necessarily easy to translate to a lot of other contexts, since Chastain held such a key position that enabled the alleged fraud, in addition to violating a confidentiality agreement.

This case should give pause to influencers and project creators who buy assets for low values and then intentionally create a lot of hype around those assets and then take advantage of that hype to dump their own recently acquired holdings on other buyers. If this theory of "insider trading" holds water, such conduct could be criminal and carry stiff monetary penalties in addition to an up to 20 year prison term for each offense.

Posture

The government's complaint has been filed and the defendants have negotiated the terms of pre-trial release. Unlike in the Frosties case which restricted the defendants' ability to use cryptocurrency or buy/sell NFTs, the only crypto-related restriction on Chastain is that he not contact OpenSea employees.

The parties will now engage in pre-trial motion practice (including a possible motion to dismiss the charges entirely), discovery, and likely plea deal negotiations. If a plea deal is not reached, or the case is not dismissed for other reasons, the case will proceed to trial.

Pursuant to a text-only minute entry on June 15, the court ordered the following dates/deadlines:

Motion to Dismiss due by 8/19/2022. Opposition due by 9/2/2022. Replies due by 9/12/2022. Any other motions due by 9/30/2022. Opposition due by 10/14/2022. Replies due by 10/21/2022. The next pretrial conference is scheduled for 10/27/2022 at 3:30 PM.

Docket

Full court docket is available through PACER, which is most easily accessed through Court Listener.

Authors

This article was drafted by @Lawtoshi.