- Yesterday, the U.S. Attorney for the Southern District of NY Damian Williams announced an indictment against Nathaniel Chastain who allegedly traded at least 45 NFTs while working at OpenSea based on confidential business information that OpenSea would feature the NFTs on its website (thereby attracting greater demand). Chastain allegedly profited by selling the NFTs at 2 to 5 times the original price he purchased them.
- The indictment was stunning. Why? Because many people in the NFT world held the misconception that insider trading was legal because NFTs hadn’t been classified as securities (yet). (The SEC is poised to issue clarification on that issue, though, but, for now, there’s no clear ruling or regulation deeming NFTs to be securities subject to SEC Rule 10b-5, which prohibits insider trading based on non-public information.)
- So how is insider NFT trading a felony outside of securities law? That’s a question a lot of people in the NFT world are wondering. Some may be fearing, too.
- Well, it turns out the U.S. government has already prosecuted cases under the broad wire fraud provision, 18 U.S.C. 1343, for a fraud involving so-called insider trading based on confidential business information.
- In 1987, the U.S. Supreme Court unanimously upheld this kind of application of the wire fraud provision in a case involving R. Foster Winans, who wrote a column “Heard on the Street” for the Wall St. Journal. Winans then shared some information with two brokers at Kidder Peabody that he received from his interviews with companies before the Journal published his “Heard” column. The brokers made prepublication trades for a profit of $690,000 shared among them.
- Here’s the most interesting part: The Wall St. Journal treated the column’s contents as confidential before it was published, but the information Winans actually used wasn’t confidential or inside information from the companies Winans interviewed. In other words, Winans’ column was confidential at the Journal before publication, no matter the contents.
- Nonetheless, the Court upheld Winans’ conviction for wire fraud, stating:
- “Here, the object of the scheme was to take the Journal‘s confidential business information —the publication schedule and contents of the ‘Heard’ column—and its intangible nature does not make it any less “property” protected by the mail and wire fraud statutes. McNally did not limit the scope of § 1341 to tangible as distinguished from intangible property rights.” Carpenter v. United States, 484 U.S. 19, 25, 108 S. Ct. 316, 320, 98 L. Ed. 2d 275 (1987).
- Confidential business information is an intangible property right (considered a trade secret).
- Even though Winans’ conviction was also upheld as a securities violation, the Court split evenly on that issue and therefore issued no opinion on it. This underscores how the wire fraud provision can be used for insider trading of confidential business information, regardless of securities law.
- We haven’t had time to think through all the scenarios. But it’s probably not the case that the wire fraud/insider trading violation is co-extensive with the SEC Rule 10b-5 insider trading violation. Winans involved a scenario in which a company employee took the company’s confidential business information and used it without authorization thereby “devis[ing] any scheme or artifice … for obtaining money or property by means of false or fraudulent pretenses.”
- It’s unclear whether that would also apply to co-founders or the CEO for an NFT project giving a tip about the NFTs to some friends. The co-founders or CEO arguably have the authority to disclose their confidential business information if it’s not regulated by securities law.
