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Last week, the U.S. Department of Justice did something new by applying established criminal theories of liability to tokens that can't be changed (NFTs). The U.S. attorney's office for the Southern District of New York released an indictment against Nathaniel Chastain on June 1. The indictment says that Chastain used NFTs sold on OpenSea, an NFT marketplace where Chastain used to work, as part of an insider trading scheme.

The DOJ is proud of the indictment because it is the "first-ever digital asset insider trading scheme." This is in line with President Joe Biden's executive order from March, which told different federal agencies to make sure that "digital assets are developed responsibly."

With the executive order and the indictment, operators of NFT and cryptocurrency marketplaces get a clear message that regulators are watching.

An NFT is a type of digital asset that is stored on a blockchain and proves who owns it and gives permission to use it for certain things. Even though the digital objects can be different, digital art and photos make up a big part of the market. On OpenSea's platform, users can make, sell, and buy NFTs. The Ethereum blockchain keeps track of creation and transfers, and ether, a cryptocurrency built on the Ethereum blockchain, is often used to buy things.

The indictment says that Chastain took advantage of how OpenSea's website promotes NFTs. OpenSea lists "featured NFTs" on its home page several times a week. When an NFT was featured on the homepage, its price usually went up because of the "increase in publicity and demand" that came with it. The Indictment says that Chastain knew which NFTs OpenSea would put on its homepage because, as an employee, he sometimes chose them.

The Indictment also says that Chastain agreed to keep these selections secret and not use what he knew about them to make money for himself.

The case of New York prosecutors

The Southern District of New York says Chastain used this private business information before it was made public. Prosecutors say that Chastain bought NFTs right before they were featured on the OpenSea homepage and then sold them for twice, three times, four times, or even five times what he paid for them.

Chastain is said to have kept the scheme a secret by buying and selling NFTs from different anonymous accounts and then moving money through even more anonymous accounts to hide his tracks.

Even though the indictment alleges facts and methods that are common in stock insider trading cases, it is different in important ways from most insider trading prosecutions. The indictment says that Chastain's scheme is a violation of the general wire fraud law, not of the rules and laws about insider trading from the U.S. Securities and Exchange Commission.

Still, the indictment uses the same theory about insider trading that is often used to prove violations of another law. For example, the wire fraud count is based on the fact that Chastain didn't do what he was supposed to do for OpenSea. In other words, the DOJ thinks that Chastain committed wire fraud when he broke his promise to OpenSea not to use confidential business information for personal gain. In order to be charged with wire fraud or insider trading, you don't have to have broken a duty.

Even though the indictment uses words that are often used in insider trading cases, like "confidential business information" and "obligation not to use such information," it doesn't call the NFTs at issue securities. So, it looks like the government was worried that it wouldn't win if it tried to bring this case as a typical case of insider trading.

If this theory about wire fraud turns out to be true, the DOJ could use it as a model to stop market manipulation for other assets, whether or not they are securities.

It's strange that there is no SEC case that goes along with what the Southern District of New York is doing. The SEC has been putting a lot of attention on how to regulate digital assets, especially NFTs.

Bloomberg said in March that the SEC was looking into NFTs and had sent out subpoenas about NFT offerings. In May, the SEC said that its crypto assets and cyber unit had doubled in size. In the middle of the announcement was a line that said the SEC will "focus on investigating securities law violations related to" NFTs and other crypto assets and stablecoins. Hester Peirce, an SEC commissioner, said again that the SEC was concentrating on fractional NFTs and NFT baskets.

Are NFTs like stocks?

The SEC has spent a lot of time and money looking into crypto markets, so it wouldn't be surprising if it decided that some or even most NFTs are securities. That would be in line with how aggressively it regulates cryptocurrency. It sounds like what former SEC Chairman Jay Clayton said in 2018 when he said, "I think every ICO (initial coin offering) I've seen is a security."

In fact, it looks like the SEC has said that some NFTs are securities already. The recent subpoenas it sent out about NFT offerings are based on this very assumption. What is still unknown is not whether the SEC will regulate NFT marketplaces, but how aggressively it will do so, and, of course, whether a court will agree with its definition of a security as it applies to NFTs.

The Chastain indictment shows that the SEC will work with the Southern District of New York to regulate NFT marketplaces.

Operators of NFT and cryptocurrency markets should require their employees, if they don't already, to keep important, private information secret and not use it to make money for themselves. Operators should also keep an eye on how their employees act to make sure they aren't doing insider trading or other manipulative things based on important, non-public information they have learned on the job.

To stop this kind of behavior, it's also important to have clear rules and procedures and to train people regularly. Even though there isn't an SEC case here, that doesn't mean that the SEC won't go after NFTs in the future for insider trading or other reasons.

Most likely, the SEC thought that the facts of this case and the digital assets in question didn't make a strong case for insider trading. It looks like both the SEC and the DOJ want to crack down hard on people who try to manipulate digital asset markets.

Even though it doesn't use this power very often, the Commodity Futures Trading Commission could theoretically use its insider trading law and rules to keep an eye on futures and derivatives of digital assets. This new and innovative move by the Southern District of New York shows that federal regulators are no longer just looking at digital asset securities. Federal regulators keep an eye on how the market is being manipulated.

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