In the year August 23, 2022 – Regulation and enforcement are hot topics in the cryptocurrency space as debate centers around the complex issue of classifying digital assets as securities, commodities or a separate asset class. In the midst of this debate, the Department of Justice (DOJ) sent a message – the classification is irrelevant to its purpose. In recent lawsuits, the DOJ has used 18 USC § 1343, a statute dating back to the 1800s, to bring innovation cases in the cryptocurrency space that are not based on how digital property is classified.
My previous post in February 2022 highlighted how the DOJ intends to use the wire fraud statute to prosecute racketeering (ie, take the money and run the schemes), insider trading, and market manipulation of digital assets. (See McGinley, “Expect Lawsuit Soon in NFT Space,” Reuters Legal News (Feb. 4, 2022)).
Since then, the DOJ has used wire fraud to prosecute the first two matrimonial NFTs and two digital asset insider trading cases. The DOJ has not recently used wire fraud in a major market manipulation case, but market manipulation and spoofing by crypto whales (creating orders with the intention of canceling them) may be a future area of focus based on public reports. They are individuals or entities that own a certain amount of cryptocurrency.
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This article examines the DOJ’s use of the Wire Fraud Act in the first half of 2022 and what to expect going forward.
Wire fraud law in a nutshell
The Wire Fraud Act is based on the similar Mail Fraud Act of 1872, which was passed to combat mail fraud. The Wire Fraud Act has expanded the law beyond letters to all forms of telecommunications, including telephone and now email, text messaging and social media. Generally, the wire fraud statute prohibits the fraudulent use of wire communications to obtain money or property, often by misrepresentation or false promises.
The law is agreeable; It does not depend on the subject. Prosecutors have applied to insider trading schemes, fraud and other market manipulation. It is a powerful tool for prosecutors. Because of this, Judge Jed Rakoff famously said, “They are our Stradivarius, our Colt 45, our Louisville Slugger, our restaurant — and our true love” in prosecuting the mail and wire fraud statutes. (Jed S. Rakoff, “The Federal Mail Fraud Act (Part 1),” 8 Duq. L. Rev. 771, 771 (1980)). The DOJ’s recent cases in the crypto space only prove Judge Rakoff’s point.
1. Carpet pull handles
In the year In the first half of 2022, the DOJ charged two innovative NFT carpet cases using the wire fraud statute, both of which are still pending. First, in March 2022, the United States Attorney’s Office for the Southern District of New York (SDNY) prosecuted the first fraud case involving NFTs in US v. Nguyen. SDNY has alleged that the creators of the Frosties NFT collection misled buyers to $1.1 million that they would receive benefits in addition to the cartoon-like figures.
Second, in June 2022, the DOJ Fraud Division in US v. Tuan accused the creator of the “Baller Ape” NFT project of the second NFT carpet drag, accusing him of a $2.6 million carpet drag. The accusations in that case are even worse: the creators did not provide anything to the buyers, not even images.
In any event, the classification of NFTs is immaterial to a wire fraud case, and the DOJ has not alleged that the NFTs at issue are securities or commodities. The DOJ alleges the basic concept of wire fraud – buyers of these NFTs don’t receive what they were promised.
2. Internal trade issues
The DOJ has taken a similar approach in the insider trading space, filing cases that are not based on the complexity of the asset. In June 2022, SDNY filed its first digital asset smuggling case against former OpenSea employee Nathaniel Chastain.
According to the US v. Chastain lawsuit, Chastain knew in advance which NFTs would be offered on OpenSea’s homepage, causing the NFT price to increase in general. Chastain bought the NFTs before they listed and sold them after they listed for a profit, reportedly around $67,000.
A month later, in US v. Wahi, SDNY filed another digital asset insider trading lawsuit — this time against a former Coinbase employee and two others for their involvement in the same scheme. The lawsuit alleges that a Coinbase employee named Ishan Wahi knew which tokens the exchange was listing and tipped this information to his brother and a friend, for a profit of $1.6 million on the information.
In both cases, the DOJ charged wire fraud, not securities fraud, which is common in insider trading cases. Although this theory may be contested in court and defendants may plead not guilty, the Supreme Court’s 1987 decision in Carpenter v. United States (484 US 19) has a long history of using wire fraud to prosecute insider trading. (1987) that case involved a Wall Street Journal columnist who wrote about new stocks in his column. This information was considered confidential business information of the newspaper. The associates at a brokerage firm used the information to trade stocks.The DOJ relied on Carpenter because the alleged embezzlement was similar to that of Chastain and Wahi.
Relying on wire fraud gives the DOJ additional advantages. First, the DOJ can avoid difficult and complicated litigation over whether the underlying assets are securities. Second, it allows the DOJ to act unilaterally. In a typical securities fraud case, for example, the DOJ and SEC work in parallel and bring cases at the same time. Despite the benefits of this combination, it takes time. When the DOJ only charges wire fraud, coordination is reduced because the SEC cannot charge wire fraud. Rather, the SEC can only bring enforcement actions when the underlying asset is a security.
1. Misrepresentation/misrepresentation issues
In both NFT cases, the DOJ focused on representations made to the purchasers of the NFTs concerned. While these were not large-scale frauds, they underscored the DOJ’s focus on the accuracy of disclosures that defendants make to buyers of digital assets — regardless of the underlying asset.
In the future, we can expect the DOJ to focus on larger disclosure cases, perhaps at the corporate level. Crypto companies frequently interact with the public through various forms of social media. Companies often respond to market events in real time. While communicating with the public quickly and frequently has business benefits, it can also lead to mistakes. The DOJ has previously used wire fraud to prosecute misinformation on social media in other contexts (see US v. Milton, SDNY 2021).
2. Major internal business issues
The first digital asset insider trading case involved a defendant who allegedly made less than $100,000 in profits. The second, a month later, charged three defendants with approximately $1.5 million in profits. This trend is likely to increase in complexity and dollar value, especially when reports of significant insider trading problems exist in this space. (See Foldi and Ostroff, “Crypto May Have Insider Trading Problem,” Wall Street Journal (May 21, 2022).
Insider issues in a particular industry often start out relatively small and involve those close to the source of information. Over time, they evolve to focus on downstream TPs—that is, individuals in business organizations who are a few steps removed from the data, but who can make large trades. I expect the DOJ to continue to focus on investigating insider trading by large market participants and crypto-focused businesses.
3. Cases of market manipulation
Ultimately, we can expect the DOJ to use the wire fraud statute to prosecute market manipulation in the digital asset space. The media has been reporting on suspected deceptive trading practices in the cryptocurrency markets, including bath trading and fraud. (See, for example, “In Crypto, Market Manipulation Remains a Problem,” PYMTS.com (August 1, 2022)).
In regards to spoofing, the practice of using crypto-wallets to buy and sell ‘walls’ has drawn attention. These “walls” are essentially price points created by placing large buy or sell orders to artificially raise the price of a token in order to create an opportunity to sell or buy.
In the year In 2018, the DOJ investigated price manipulation in crypto markets. (Robinson and Schoenberg, “US Begins to Shift Criminal Probe to Bitcoin Valuation,” Bloomberg (May 24, 2018)). In the year Given the growing popularity of crypto in our economy since 2018, it makes sense for the DOJ to step up its focus on these practices.
Although the DOJ’s track record of using wire fraud to prosecute fraudulent cases has been mixed (beyond the scope of this article), the DOJ recently won a case involving precious metal futures in the 7th US Circuit Court of Appeals using the wire fraud theory. . (See, e.g., United States v. Chan, (7th Cir. July 6, 2022)). This success encourages the DOJ to apply wire fraud to crypto market fraud.
As crypto became mainstream, prosecutors responded with one of the DOJ’s oldest tools — wire fraud. In the year In the first half of 2022, DOJ was actively pursuing cases under the Wire Fraud Act, and we can expect this trend to continue and expand to other financial fraud cases commonly prosecuted by DOJ, including corporate disclosure and market manipulation cases.
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The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and impartiality under the principles of integrity. Westlaw Today is owned by Thomson Reuters and operates independently of Reuters News.