The crypto legal community witnessed a first this month when the Department of Justice announced the indictment of a former employee of OpenSea, the largest NFT marketplace. The employee was charged with what is believed to be the first-ever digital asset insider trading scheme.
This arrest comes fresh off the heels of the SEC’s expansion of its Crypto Assets and Cyber Unit in May and scandals involving alleged frontrunning of token listings at major exchanges.
As concerns about insider activity are fresh on everyone’s minds, let’s delve into this one.
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The OpenSea Insider Trading Charge
On June 1, 2022, federal prosecutors charged OpenSea’s former head of product, Nathaniel Chastain, with buying dozens of NFTs based upon advanced knowledge that they would soon be featured on OpenSea’s platform homepage.
The DOJ alleges that, as head of product, Chastain was aware of the historical pattern that the price buyers would pay for NFTs typically increased substantially upon being featured by OpenSea.
That was indeed the case, as Chastain allegedly sold the NFTs in question for 2x-5x the purchase price in a short time span.
The indictment asserts that Chastain owed a duty to his employer to keep business information confidential, which he violated by using the information for personal financial gain. To hide his tracks, Chastain set up anonymous wallets and accounts to make these transactions. But in the end, they were traced back to him and he was charged with wire fraud and money laundering.
The indictment follows OpenSea’s public acknowledgment in Fall 2021 of Chastain’s resignation amidst allegations of insider trading.
Legal Questions Surrounding NFTs
Before we analyze the OpenSea situation, let’s acknowledge that the indictment does not address many of the legal questions surrounding NFTs in any meaningful way.
Given that the case was brought up by the DOJ rather than the SEC, there was no need to wade in the debate of whether or not NFTs are securities in order to make an arrest. Accordingly, this case does not provide us with any greater clarity on whether or not NFTs are securities, nor whether the SEC would have to prove a token was a security to bring such an action.
The indictment similarly does not address fractionalization of NFTs, intellectual property rights or any of the other common legal questions in the NFT marketplace which the crypto legal community has discussed at length over the past few years.
The Department of Justice (cleverly) filed this case without having to take a position on any of these issues.
The Core Issue: A Duty to Employer
Rather, the OpenSea indictment is based upon the duty Chastain owed to his employer to maintain confidential information pursuant to his employment agreement. The indictment alleges that he illegally used confidential business information for personal gain via the secret purchase of dozens of NFTs shortly before they were featured on the platform.
It should be noted that the imposition of a higher duty is a central tenet to many SEC cases for insider trading. The name “insider trading” itself is focused on the presence of the insider, who owes fiduciary duties to the company and its shareholders, including trust and confidence, and their use of valuable, non-public knowledge for their own interests.
What does this mean for Crypto Law Insiders?
As we assess the significance of the OpenSea indictment, let’s remember that Mr. Chastain is innocent until proven guilty. Despite his apparent admission to the NFT trading scheme in connection with his resignation in Fall 2021, the DOJ will still need to demonstrate a crime has been committed.
Turning to our takeaways, a few observations:
- Overall, the indictment has limited ramifications for the NFT space generally, as the indictment is based upon the terms of an employment contract.
- There have been several recent reported incidents of “front running” trading by employees at crypto exchanges and marketplaces seeking to capitalize on material nonpublic information. It is clear the federal government is watching. Reportedly, the SEC has begun an investigation and contacted exchanges to inquire about their internal insider trading policies and protections.
- Let this matter serve as a reminder that the ledger is an open book.
- All crypto companies should be cognizant of the risks of employee trading, especially the crypto exchanges and marketplaces. At minimum, all crypto companies should adopt policies which advise their team against trading on material, non-public information about their company/projects. At Horizen, we have implemented a trading policy for all of our collaborators centered around these tenets.