This post concerns a lawsuit brought by the United States Commodity Futures Trading Commission (CFTC).  The complaint alleges that, from approximately June 1, 2019 to approximately August 23, 2021, bZeroX, LLC (bZeroX) designed, deployed, marketed, and made solicitations concerning a blockchain-based software protocol that accepted orders for and facilitated margined and leveraged retail commodity transactions (functioning similarly to a trading platform). This protocol (the bZx Protocol) permitted users to contribute margin (collateral) to open leveraged positions whose ultimate value was determined by the price difference between two digital assets from the time the position was established to the time it was closed. The bZx Protocol purported to offer users the ability to engage in these transactions in a decentralized environment—i.e., without third-party intermediaries taking custody of user assets.

According to the CFTC, these transactions were unlawful because they were required to take place on a designated contract market, but did not. Additionally, by soliciting and accepting orders for and entering into retail commodity transactions with customers, and accepting money or property (or extending credit in lieu thereof) to margin these transactions, bZeroX illegally operated as an unregistered futures commission merchant (FCM). bZeroX also failed to adopt a customer identification program as part of a Bank Secrecy Act compliance program, as required of FCMs.

 The complaint says that, on August 23, 2021, bZeroX transferred control of the bZx Protocol to the bZx DAO, which subsequently renamed itself, and is currently doing business as, the Ooki DAO. The Ooki DAO operates the Ooki Protocol (formerly the bZx Protocol) in the exact same manner as bZeroX and thus is continuing to violate the law in the same manner as bZeroX. By transferring control to a DAO, bZeroX’s founders touted to the bZeroX community members the operations would be enforcement-proof. The complaint says that one of bZeroX, LLC’s founders wrote:

It’s really exciting. We’re going to be really preparing for the new regulatory environment by ensuring bZx is future-proof. So many people across the industry right now are getting legal notices and lawmakers are trying to decide whether they want DeFi companies to register as virtual asset service providers or not – and really what we’re going to do is take all the steps possible to make sure that when regulators ask us to comply, that we have nothing we can really do because we’ve given it all to the community.

The CFTC served the summons, complaint, and additional related papers to the Ooki DAO via the mechanisms that the CFTC says the Ooki DAO held out as the appropriate mechanisms to contact it—i.e., a Help Chat Box on its website, with contemporaneous notice through an Online Forum linked through its website.  Judge William Orrick in the U.S. District Court for the Northern District of California entered an order authorizing such service, after the fact.

Four amici briefs have now been filed asking the Court to reconsider that decision. The request has been made by venture capital firms Paradigm and Andreessen Horowitz, crypto legal consortium LeXpunK, and the DeFi Education Fund.  Amici argue that the Commission’s proposed method of service may result in no potential defendant receiving notice of, or appearing in, the lawsuit. Indeed, no party appeared even for the limited purpose of contesting the Commission’s motion, meaning that without amicus participation, the Commission’s motion would stand unopposed.

While the Amici argue that the method of service violates constitutional due process protections and the federal rules of civil procedure, they are, practically speaking, also challenging the underlying premise of the suit.   They say that the CFTC’s inability to serve process on the DAO exposes the fundamental flaw of the Commission’s case.

The CFTC’s proposed method of service rests on a premise that Ooki DAO is analogous to an ordinary business entity. But DAOs are not ordinary business entities, and the CFTC has not adequately pled that its proposed method of service on Ooki DAO is likely to notify the parties potentially liable for the claims in this lawsuit.

The Andreessen Horowitz brief said that “allowing the CFTC to serve process on and proceed against defendant Ooki DAO under this theory could imperil an entire industry by chilling participation in decentralized governance or community activity.” Andreessen Horowitz also argued:

[The court should] require the CFTC to re-plead its allegations in a way that delineates the DAO’s lawful and unlawful purposes and request service on one or more identified members of the DAO who can respond to this action. If the CFTC cannot satisfy these requirements for serving an unincorporated association, then the proper course may be for the CFTC instead to bring its action against individuals (including John Doe defendants, if appropriate) and set forth the elements necessary to hold individuals accountable for misconduct under the various recognized forms of liability under the [Commodity Exchange Act].

In opposing the request for reconsideration, the CFTC argues that it had served the summons and complaint on the Ooki DAO via the only avenue the Ooki DAO itself made available for the public to contact it. Not only was this reasonably calculated to provide notice of the action, as the law requires, it did in fact provide notice to the Ooki DAO. For example, the CFTC notes that the Ooki DAO’s official Twitter account publicly confirmed that it had received the complaint, and noted that it was publicly discussing in its Online Forum how (if at all) to respond to the complaint

The CFTC also argues that amici assert that the CFTC has not sufficiently alleged that the Ooki DAO is an unincorporated association and consequently cannot rely on effecting service only on this alleged association. However, this argument is a challenge to the sufficiency of the allegations in the Complaint, and thus is appropriately raised in a motion to dismiss (or similar dispositive motion), not a motion for alternative service.

Finally, the CFTC states the Amici overstate the potential for the lawsuit to disincentivize participation in DAOs. Nothing prevented the Ooki DAO, upon taking control of the Ooki Protocol, from choosing to avail itself of some corporate form recognized by law to shield individual members from liability and limit potential creditors to monetary recovery from the Ooki DAO Treasury only. Indeed, industry commentators—including amicus Andreessen Horowitz—have proposed numerous entity structures with a goal of enabling nascent DAOs to address potential individual-member liability issues and achieve many other goals. Likewise, multiple states have set up LLC-like registration frameworks to facilitate DAO registration to attempt to obviate such individual liability issues. Here, Ooki DAO members did not choose to adopt such an approach, assuming—incorrectly—that eschewing a more traditional entity structure, with its concomitant individual-member liability protections, would “future-proof” it against regulation. Rather than disincentivizing DAO participation, the CFTC’s lawsuit seeks only to apply to DAOs the same rules that apply to any group of persons who organize for the purpose of a common business objective.

A hearing has been scheduled for November 30, 2022.

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