CFTC Takes Unprecedented Action Against Ooki DAO

Unprecedented Case Facts. The CFTC filed a complaint against the Ooki DAO protocol as an “unincorporated association.” The founders, Tom Bean and Kyle Kistner, were fined $250,000 for failing to register with the Commission. Notably, there were no allegations of any fraud.

Case Facts: From bZeroX to Ooki DAO

On August 23, 2021, the bZeroX, LLC transferred control of the bZx protocol to the bZx DAO, which was later named the Ooki Dao. The protocol allowed for a non-custodial, kyc-less, peer-to-peer smart contract system that allowed for leverage and margin trading. The protocol was governed by voting tokens. When the founders transferred the ownership to the community, they poked the bear a bit, making comments that now the DAO was “enforcement proof.”

Service on the DAO: A Novel Approach

The CFTC served the lawsuit through a post in an online discussion forum. A lazy and highly unconventional approach compared to an in person delivery by a process server. The CFTC’s motion for alternative service asks the Northern District of California Judge to bypass all the service laws because “by choosing to organize itself as a DAO, the Ooki DAO has structured its business in a way that has erected significant obstacles to traditional service of process.” Apparently no DAO members responded to the CFTC’s request for an address in the Ooki telegram chat, despite 112 views.

Non-Custodial Protocol. The bZeroX did collect some $50,000 in fees from users, prior to the conversion to the DAO, and the DAO continued to collect at least $500,000 in origination fees, trading fees, and a percentage of interest paid to lenders. Prior to the conversion to the DAO, the LLC kept the “administrator keys” which meant they had access and control over the funds held in the smart contracts. They could, at any time, pause or suspend withdrawals of assets and redemptions of tokens. At the time of the DAO conversion, the admin keys went to the DAO.

Questionable Legal Basis and Implications for DAOs

The CFTC concluded in its complaint that: (1) the Ooki tokens were commodities, (2) they needed to be traded only on a registered commodities exchange, and (3) that the Ooki DAO was an unregistered Futures Commission Merchant (“FCM”). Each of these definitions is a stretch because Ooki coins don’t settle 28 days in the future, a general prerequisite for being a commodity and being required to trade on a registered exchange. The non-custodial nature makes the FCM registration requirement a stretch as well.

Unincorporated Associations: A Problematic Precedent

Defining the Ooki DAO as an unincorporated association with members including everyone who ever voted their tokens creates a new precedent that makes no sense. Votes can be on any topic, not just CEA rules, so penalizing someone for voting on a non-related topic is overly broad. This type of approach is unfair and discourages voting participation in DAO governance.

Self-Governance vs. CFTC Enforcement

The risks the CFTC purports to eliminate can actually be handled through the very governance mechanisms it just penalized.

Ooki DAO’s Response and the Chilling Effect

The Ooki DAO is considering how to fight back, and teams like the LexPunk legal army are gathering in droves to try and support them so all DAOs don’t get classified as unincorporated associations, where all holders can be penalized for their voting contribution. They are considering doing a big NFT sale to raise funds for a legal team, but undoubtedly, that will require members to vote.

Chilling Effect. It will be interesting to see if this CFTC action deters members from participating in DAO voting. At least one developer has reacted.

Dissent and Concerns Raised by Commissioner Mersinger

Commissioner Mersinger highlighted a major problem with the unincorporated association definition because it relies on a state-law doctrine that members of for-profit unincorporated associations are jointly and severally liable for the debts of that association. There was no legal precedent for charging a DAO as an unincorporated association, so the CFTC relied on state case law related to a contractual dispute and a slip and fall case – both very different because they were civil cases between private parties, not involving any commodities or futures, and settled based on state and not federal laws.

See Karl Rove & Co. v. Thornburgh, 39 F.3d 1273 (5th Cir. 1994) (breach of contract); Shortlidge v. Gutoski, 484 A.2d 1083, 1086 (N.H. 1984) (breach of contract); and Libby v. Perry, 311 A.2d 527 (Me. 1973) (slip-and-fall case in which the plaintiff was awarded $7,500 for a broken leg). Although Thornburgh is a federal case, it was based on diversity jurisdiction and therefore decided under State law.

The big difference is that the CFTC is not merely collecting an unpaid contractual debt owed by Ooki DAO, it’s actually imposing a civil monetary penalty that only the government can impose. And that penalty came with a cease-and-desist order, a prohibition on future participation, and sets a precedent for all other DAOs.

Mersinger said,

I am skeptical of any Federal or State governmental agency wielding its power to sanction in this manner, i.e., based on a legal theory from State common law contract and tort cases between private parties. Nor have I seen any indication that Congress intended the CFTC to do so—rather than relying on the principal-agent, aiding-and-abetting, and control person liability provisions that it specifically set out for the CFTC in the CEA.

Regulation by Enforcement and Due Process Concerns

The CFTC made this decision without any public notice or input whatsoever. The CEA doesn’t have any provisions that would regulate the Ooki DAO, so if the CFTC wanted to regulate such entities, it should have undertaken the proper steps to expand the CEA through a public notice-and-comment rulemaking to answer questions such as: 1) How do you become a member of a DAO? and 2) Who will be personally liable for the DAOs decisions if it violates the CEA and CFTC rules?

Public comment. Providing a public comment opportunity, followed by a formal rule and explanation would have alerted participants of the potential outcomes and consequences for their participation in DAOs. The way it stands, the CFTC has never published anything to inform the public that, based on state contract and tort cases between private parties, the CFTC believes that a voting member of a DAOis subject to personal liability and sanctions violating the CEA and CFTC rules.

Due Process. Mike Wawszczak, the General Counsel of Alliance DAO commented that, “The requirement for clarity in regulation is essential to the protections provided in the Due Process Clause of the Fifth Amendment.” See United States v. Williams 533 U.S. 285, 304 (2008). (“A conviction or punishment fails to comply with due process if the statute or regulation “fails to provide a person of ordinary intelligence fair notice of what is prohibited, or is so standardless that it authorizes or encourages serious discriminatory enforcement.”)

Commissioner Johnson’s Comments and the Shifting Regulatory Landscape

CFTC Commissioner Kristin Johnson spoke at the Market Risk Advisory Committee Meeting on Sept 28, she praised the CFTCs work because, apparently, the digital asset industry has “targeted vulnerable or marginalized retail investors.”

Who’s the better regulator for crypto? Absent Giancarlo, and former advisor, Andreas Anatonopolous, the CFTC is not looking like the same agency that spoke so fondly of the emerging digital asset class back in 2017. Now the CFTC appears committed to expanding its reach through outlandish means, and focusing on the white house’s climate agenda.

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