On June 1, 2022, the United States Department of Justice ("DOJ") laid the first-ever insider trading charges in relation to digital assets. The accused, Nathaniel Chastain, was arrested in Manhattan, New York, in connection with a scheme to commit insider trading of non-fungible tokens ("NFTs").

Chastain is a former product manager at Ozone Networks Inc. – also referred to as OpenSea ("OpenSea") – purported to be the world's largest online trading platform for NFTs and crypto-collectibles, backed by Mark Cuban, Kevin Durant, Alexis Ohanian and Tobias Lütke, among other notable investors. Specifically, Chastain was charged with one count of wire fraud and one count of money laundering.

In general, NFTs provide opportunities to establish and authenticate ownership over digital assets such as artwork, collectibles, videos and music. Despite explosive growth in transaction activity in recent years, NFTs and their trading practices have remained largely unregulated within the world of digital assets. Although this case was brought by the DOJ, as this article explains, we think that the charges against Chastain demonstrate the manner in which NFT activities are currently regulated and should be relevant to Canadians operating in the NFT space.

Allegations Against Chastain

According to the indictment laid by U.S. federal prosecutors, Chastain capitalized on material non-public information available to him as OpenSea's product manager in order to purchase and sell NFTs that he knew would soon be featured on OpenSea's web page. Typically, a main-page feature on OpenSea resulted in an increased valuation for both the featured NFT and other NFTs made by the same artist.

On 11 different occasions between June and September 2021, Chastain allegedly purchased more than 45 NFTs shortly before they were featured on OpenSea's home page. Days later, Chastain – allegedly concealing his identity by using anonymous digital currency wallets – sold the tokens for profits of two to five times greater than his initial purchase prices. These activities were flagged by active Twitter users who could observe transactions on the open blockchain, leading to Chastain's resignation from OpenSea.

The charges against Chastain present a novel approach to the enforcement of both insider trading and securities law, as they demonstrate that prosecutors are willing and able to regulate the crypto world. In the press release announcing the charges, United States Attorney Damian Williams stated: "NFTs might be new, but this type of criminal scheme is not. ... Today's charges demonstrate the commitment of this Office to stamping out insider trading – whether it occurs on the stock market or the blockchain." However, the fact that these charges were brought as wire fraud and not directly as securities fraud suggests that regulators may not be quite ready to recognize NFTs as securities. In the future, we anticipate that both the U.S. Securities and Exchange Commission and Canadian Securities Administrators will consider classifying certain forms of NFTs as securities with the associated legal and regulatory implications that flow from such a classification.

Implications for Canada

These charges may inform the approach of Canadian regulators in enforcing our laws within the digital asset landscape. While the Canadian Criminal Code and provincial securities laws specifically prohibit insider trading involving shares and other securities, the treatment of NFTs and other digital assets under these laws remain uncertain. Therefore, the charges against Chastain, and more specifically the comments of Williams, may lay the foundational groundwork for the prosecutorial treatment of insider trading of digital tokens north and south of the border. We view this is a necessary step towards the maturity of an industry that currently remains in its infancy. In order to achieve widespread adoption, digital assets must be trusted and accepted by the broader population, and in our view, this acceptance is significantly aided by participants understanding the regulatory landscape in which they are operating.

After Chastain's impugned conduct surfaced, OpenSea implemented two NFT insider trading policies:

1. prohibiting employees from buying and selling from collections or creators while they are featured on the site's home page, and

2. generally prohibiting employees from using confidential information to purchase or sell NFTs, regardless of whether they are available on OpenSea's platform.

In our view, OpenSea's implementation of these two trading policies is an important example of an industry participant taking a step to create and enforce policies that self-regulate insider NFT trading within their organization. We think that participants within the NFT space should be taking active compliance measures to limit potential legal and regulatory issues, even in the absence of clear legislation regulating their activities.

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