Not *That* Kind of Insider Trading

buying and selling this jpeg could lead to wire fraud charges

Disclaimer: I am not your lawyer, and this is not legal advice. I am a pseudonymous cartoon cat on the internet providing my opinion and my opinion alone.

On Wednesday, June 9th, 2022, Nathanial Chastain was charged by a grand jury in federal court with wire fraud and money laundering in connection with allegations that he traded NFTs on privileged information. Specifically, it is alleges that he knew (and, in fact, chose) which NFTs were going to be featured on OpenSea’s homepage and used this information to purchase those NFTs beforehand and later selling when the price increased for those NFTs based on the increased attention on the collection. Chastain used burner wallets to conceal the fact that he was doing so (although this subterfuge did not withstand fairly basic on-chain sleuthing which showed transfers between the wallets).

SDNY, in its press release, led with the headline“Former Employee Of NFT Marketplace Charged In First Ever Digital Asset Insider Trading Scheme,” leading NFT twitter to generally lose its collective hivemind.

I have some good news for all those concerned about incoming regulators: despite the headline, nowhere was Chastain charged with “insider trading” under securities laws. Indeed, the SEC is not a party to the indictment and the grand jury charges contain no analysis of the NFTs in question as securities. Instead, SDNY is using the term to refer to the general scheme in question even if the common understanding is, at this point, essentially synonymous with insider trading of securities.

Insider trading as generally understood is a kind of securities fraud whereby privileged insiders violate their fiduciary duty to shareholders by buying or selling securities based on material nonpublic information. In lay terms, you cannot trade on any information that you have access to because you work at a company (or your spouse or close relative does) but the public does not where that information would substantially impact an investor’s decision to buy or sell.

However, it is also broadly understood that there are all kinds of “insider trading” that are not illegal because the trader in question is either not a true “insider” or, more often, the asset in question is not a security. For example, it is generally not illegal for one to purchase real property (e.g., land) based on information gained about where a company intends to build additional stores or manufacturing facilities.

All this is to say: worry not NFT traders, the DOJ is not coming directly for your jpegs! Your NFTs are (probably) not, in fact, securities. However, they might be coming for you if you misappropriate commercial confidential information for your own gain and mislead your employer and the public about the fact that you are doing so…

Two other themes I have seen emerge on NFT Twitter in response to Chastain’s indictment:

(1) the notion that prosecutors or the U.S. government is going after a small timer like Chastain rather than true criminals committing large scale insider trading;

crypto whataboutism

(2) concerns that this is just the front edge of regulation on its way.

From a general policy standpoint, I understand and sympathize with the criticism of Chastain as the target of a federal grand jury. What does it say about the U.S. enforcement apparatus that it can only bring itself to go after relatively meaningless transgressions while massive fraudulent schemes (in both crypto and elsewhere) seem to often go unadressed?

It does indeed seem silly that the DOJ’s limited resources would be devoted to bringing criminal charges concerning the buying and selling of jpegs online. Matt Levine put it better than I could:

“But it is weird to put a person in prison for years because he … bought some internet cartoons … before … they were … put on a website? Like on the one hand it certainly seems like insider trading, sure, but on the other hand, does the US government have that much interest in protecting the level playing field of trading markets in internet cartoons? Were you really defrauded, when you sold this guy a copy of “Flipping and spinning” at the going price before he featured it on the homepage? When people worry about insider trading in stocks, it is because they think insider trading undermines confidence in the stock market. I feel like everything that has ever been thought, said or done about NFTs undermines confidence in the NFT market, so it’s kind of random to go after this.” (emphasis mine).

On the other hand, it’s unclear why enforcement efforts targeting fraud (which appears rampant in the space) are met with hostility. Chastain is indeed being “made an example of” but that’s because he engaged in something that looks like it might be fraud and the DOJ wants to bring winnable cases that put web3 on notice it’s not outside the reach of the law (not to mention this case was literally served on a platter by blockchain twitter and public reporting; high impact, low effort).

As to whether this is all part of some bigger plan by all the regulators finally coming into the space, I personally would not read much into a stand-alone case brought by the SDNY US Attorney’s office. While the SEC has made it clear that it has NFT’s in its sights, their regulatory and enforcement efforts are separate and apart from DOJ’s. It’s easy to conflate the two, but their jurisdictions are distinct and local U.S. Attorney’s offices are fairly decentralized entities with latitude to pursue cases at their discretion. The SEC is likely to take longer to build any cases and, in my opinion, is much more likely to target obvious rugpulls from projects that promised robust roadmaps rather than individual traders.

The regulators are indeed coming but this case won’t decide the fate of your pfp.

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