Rise in Financial Crime in the NFT Market Brings New Regulator Scrutiny | Proskauer – Blockchain and the law

With the enduring popularity of certain NFTs and the promise of their use in the metaverse and beyond, the hype around the new technology has been accompanied by growing concerns that NFTs are the centerpiece of traditional financial crimes. such as money laundering and electronic fraud. For example, on June 30, 2022, the Department of Justice indicted six people in four separate cryptocurrency fraud cases, which together involved over $130 million in investor funds. These indictments include allegations of a global Ponzi scheme selling unregistered crypto securities, a fraudulent initial coin offering involving false associations with large corporations, a fraudulent investment fund that allegedly traded on stock exchanges. cryptocurrency and the largest known non-fungible token (NFT). whitening plan to date.

In one such case, the defendant, Le Anh Tuan, a 26-year-old Vietnamese national, was charged in California with one count of conspiracy to commit wire fraud and one count of conspiracy to commit wire fraud. to commit international money laundering involving “Baller Ape” NFTs. . (United States vs. Tuan, no. 22-cr-273 (CD Cal. Indictment June 28, 2022)). Seeking to capitalize on the popular Bored Ape Yacht Club, Defendant launched the Baller Ape Club, with “Baller Ape” NFTs featuring characters in various outfits decorated with colorful accessories. According to the indictment, Tuan and unnamed co-conspirators first gained access to investors’ digital wallets and processed token transactions, then “dragged” investors shortly after sales began. Baller Ape Club’s public notices by ending the alleged project without notice and shutting down its website. . In total, approximately $2.6 million was allegedly stolen. To conceal the stolen funds, the defendant allegedly laundered the money through “chain-hopping”, a money laundering system in which funds are transferred across multiple cryptocurrency blockchains and decentralized services. cryptocurrency exchange are used to hide the trail of stolen funds.

United States vs. Tuan is just the most recent crime case to rock the NFT world. Earlier in June, Nathaniel Chastain, a former chief product officer at OpenSea, was indicted in New York in connection with the first-ever NFT digital asset “insider trading” scheme. (United States vs. Chastain, no. 22-cr-305 (SDNY sealed indictment May 31, 2022)). OpenSea is the largest online marketplace for buying and selling NFTs. Chastain allegedly launched a scheme by abusing his knowledge of confidential information to secretly buy dozens of NFTs before they were exposed on OpenSea. As part of the leadership team, Chastain was responsible for selecting NFTs to feature on the OpenSea homepage; OpenSea has kept these special NFT selections confidential until they go live, as a main page listing that often results in price increases. After the NFTs were presented, Chastain would allegedly sell them at a profit of two to five times its original purchase price. Running the alleged scheme from June 2021 to September 2021, some reports indicated that Chastain appeared to make a total profit of 18,875 ETH or $67,000 in September 2021 (which is not a large number given that news outlets reported at that time in August 2021 that OpenSea had a sales volume of $4 billion). To conceal the fraud, he allegedly made these transactions using anonymous digital cryptocurrency wallets and OpenSea accounts. The DOJ shaped the charges against Chastain as one count of wire fraud and one count of money laundering, seeking forfeiture of any criminal proceeds, among other remedies.[1]

These recent NFT-related offenses raise many legal questions regarding the status of NFTs. Chief among these concerns is legal uncertainty over whether existing securities laws apply to the new world of digital assets. (Note: The uncertainty surrounding NFTs and intellectual property protection is another issue, which is the subject of a related article.) Insider trading has traditionally been the basis for fees associated with securities transactions . NFTs, however, are often viewed as investment-grade digital collectibles and digital artworks, as opposed to securities, and to date there has been a noticeable lack of legal precedent regarding digital assets. in general that might offer some clarity. As such, it was unclear until Chastain’s indictment whether prosecutors would even address Chastain’s alleged business behavior in September 2021 under business regulations, and is in fact based on allegations of fraud. as opposed to violations of securities laws. Given the way the charges were framed in the Chastain case – the word “security” does not appear in the indictment – the indictment falls more into the general category of alleged financial crimes than a violation of securities law. Indeed, as U.S. Attorney for the Southern District of New York, Damian Williams, noted, “NFTs may be new, but this type of criminal scheme is not.” With new technology platforms and investment opportunities available, money laundering and deceptive business practices are two age-old problems that will invariably occur in the modern context.

In the absence of clear guidance on the regulatory status of NFTs, a bipartisan group in Congress has attempted to clarify the recently proposed proposal Responsible Financial Innovation Act (RFIA), sweeping bipartisan legislation that aims to create a comprehensive regulatory framework to govern digital assets. The RFIA is seeking to clarify the respective jurisdictions of the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) over digital assets. If passed, the bill would provide more regulatory clarity in determining whether a digital token is a commodity or a security, and among other things, by proposing that the majority of digital assets (subject to exceptions) be classified as goods subject to CFTC oversight. As a report on the bill to Congress noted: “The RFIA would reduce the SEC’s jurisdiction over digital assets as the agency currently conceives it.”

Despite the potential adoption of the RFIA, it is important to note that the SEC has previously stated that NFTs may still qualify as securities if they pass the ‘Howey Test”, which states that an “investment contract” exists when money is invested in a joint venture with a reasonable expectation of profit from the efforts of others. SEC vs. WJ Howey Co., 328 U.S. 293 (1946). The SEC generally turns to the ‘Howey Test’ as well as the nature of the transaction rather than the property being sold to determine if an investment contract exists. So even if some digital assets were treated as commodities under a new legal regime that includes an expanded role for the CFTC, the SEC would likely still seek to regulate digital assets that it believes are used to raise funds. funds in the manner of a traditional security or are aggregated and split into securities on digital assets. As such, we have to ask how digital assets and NFTs might be regulated and how the roles of the CFTC and SEC would be balanced under a comprehensive digital asset law. However, as Chairman Gensler recently commented on the RFIA bill, he is concerned that deregulating certain digital assets or removing them from SEC jurisdiction could create loopholes or “undermine” overall market regulation. .

As the OpenSea and “Baller Ape” NFT indictments revealed, the decentralized nature of the blockchain and transparent ledger can sometimes facilitate criminal activity and also expose it. Leveraging these innate qualities of blockchain technology while increasing responsible regulation from the SEC or CFTC can help promote a more robust, yet safer crypto space. At the same time, however, increased regulation may also counter the spirit of the crypto world, where many investors have turned precisely because of the lack of regulation in hopes of making a fortune.

[1] In the uncertain legal climate regarding the regulation of digital assets, several news sources have pointed out that this type of behavior may be much more common than expected. Some traders, unlike Chastain, may just be more careful and hide their tracks better. A trader and creator of NFTs, Fedor Linnik, confided that insider trading can occur in popular projects with 10,000 profile picture-style NFTs. Early buyers of a newly created NFT collection cannot discern valuable traits or rarities unique to their own NFT until reveal, leaving a window of time for creators who know which unrevealed NFTs will be the most rare and valuable and the time to buy them stealthily. market with the aim of reselling them later at a higher price. While some traders may capitalize on the lack of regulation, many others might avoid certain projects for this reason and have even documented potential crimes. This is exemplified by the traders themselves first exposing Chastian’s alleged criminal activity by using blockchain records to link his transactions to his publicly known Ethereum address. It is possible that if scrutiny continues from the crypto community or the government, more indictments will occur in the future.

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