A US financial regulator is scratching its head over how to properly sue a crypto group accused of regulatory violations, highlighting the enforcement difficulty in the emerging technology realm.
Judge William Orrick in the US District Court for the Northern District of California will hold a hearing next month to reconsider his decision to allow the Commodity Futures Trading Commission to serve Ooki DAO, a “decentralized autonomous organization,” and its members with notice of the lawsuit by posting a copy of the complaint in an online help box and chat forum.
Ooki DAO—which, like other DAOs, allows its cryptocurrency members to make collective decisions—has no central, identifiable management. It also has no headquarters or mailing address, posing serious hurdles to serving the lawsuit, the CFTC says.
Posting the complaint in a chatbox falls short of the Constitution’s requirement that a person be notified of a case against them, crypto advocates say.
Concerns about the CFTC’s attempt to serve Ooki highlights broader questions about the commission’s first-ever case against a DAO. That includes its view about the type of legal entity a DAO is, and the extent its members—who may be located worldwide in remote places—face personal liability for the DAO’s actions.
There are almost 5,000 DAOs, according to analytics site DeepDAO, and many expect DAOs to become even more popular.
“Service of process is an important issue,” said Eric Sibbitt, co-chair of the Global Fintech & Payments practice at Paul Hastings LLP. “It’s important because of what the consequences of that may be.”
The CFTC’s lawsuit, filed in September, alleges Ooki operated as an unregistered derivatives exchange. The agency seeks to hold Ooki liable as an “unincorporated association,” a designation that can apply to charities and other groups whose members have a common purpose.
Relying on various cases decided under state law, the CFTC has indicated that each of the members in the DAO who voted on a governance proposal can be liable for federal regulatory violations.
This is a new theory that attorneys say has sweeping implications for DAOs. There are concerns the commission is now combining this broad view of liability with a form of service that doesn’t give DAO members fair notice of the legal claims against them.
LeXpunK, a self-described community of lawyers and software developers, said in a recent amicus brief the CFTC’s approach to service appears designed to obtain a default judgment. LeXpunK and others worry it could set dangerous precedents for other cases involving DAOs.
The CFTC is targeting individuals who never had a chance to defend themselves, LeXpunK said, adding that “this is inconsistent with due process.”
A CFTC spokesperson declined to comment.
DAOs are amorphous collectives, described by one investor as an internet community with a shared bank account. They have dealt in a number of blockchain-based initiatives that have generated attention, including buying notable art and a Wu-Tang Clan album. One raised over $40 million to try to buy a copy of the US Constitution.
A DAO in theory operates automatically by rules encoded in computer programs, governed by holders of special tokens who can vote to change those rules.
Speaking at DC Fintech Week 2022 this month, CFTC chair Rostin Behnam said being part of a DAO isn’t a “free pass” from regulation. Ooki was “clear fraud” and had been intentionally structured to evade CFTC regulation, Behnam said.
The commission’s lawsuit accused the Ooki of violating the Commodity Exchange Act’s registration requirements and anti-money laundering rules, among others. Two co-founders of Ooki’s predecessor, bZeroX LLC, have already settled with the CFTC. They and bZeroX agreed to pay a $250,000 fine.
“This is, I think, an extreme where it’s so egregious and so obvious that we would be essentially, objectively failing to do our job if we didn’t bring this case,” Behnam said.
But the CFTC’s theory of liability for Ooki members—which could be applied to many DAOs—could have a chilling effect on this kind of organizational structure, attorneys said.
A member’s vote—even on something relatively trivial, like a logo design—may expose that individual to liability for how the exchange is run, they said.
“What if you voted against the implementation of the protocol that the CFTC is now taking issue with?” Polsinelli PC attorney Jonathan Schmalfeld said. “Why are you, as someone who was trying to do the right thing and voted against it, also now being held liable?”
The suit against Ooki is stumbling out of the gate.
The CFTC said in court papers it served Ooki via a help chat box and an internet chat forum because those are “the sole mechanisms the Ooki DAO has chosen for the public to contact it directly.” Ooki members have gotten wind of the action, the CFTC said, noting the forum post was viewed over 100 times.
It’s unclear is whether anyone who saw the complaint had the authority to act on behalf of the DAO, some legal experts say. Others argue the CFTC is cutting corners by trying to sue—and serve—the DAO itself when the agency actually believes that its individual members are liable for violations.
Service through a help box and internet chat forum doesn’t give those individuals reasonable notice of the suit, several lawyers and crypto groups argue.
“I think you need to do more than just post it in a chatbox and count the number of views,” said Elizabeth Lan Davis, co-chair of Davis Wright Tremaine LLP’s national financial services practice and a former CFTC attorney.
What the CFTC did is akin to posting a complaint on a bulletin board in the middle of a town square, said Daniel McAvoy, co-chair of Polsinelli’s FinTech and Blockchain practice.
“It feels like people are trying to take a shortcut and not do the homework that’s necessary to figure out who the people are,” he said.
LeXpunK and other pro-crypto groups argue the CFTC should be required to take additional steps to identify Ooki members and provide the individuals with notice of the suit.
The CFTC’s approach to service could also create problems with international agreements outlining how people in other countries can be served with a lawsuit, attorneys say.
In a case against crypto exchange Binance, an Arizona federal judge recently said executives couldn’t be served through Twitter because it wasn’t clear what country they lived in and whether service through Twitter would violate international law.
The CFTC’s case highlights challenges in policing new technologies. While regulators need to be able to pursue bad actors, “you don’t want it to be that the CFTC or some other group of plaintiffs can just run roughshod” and file lawsuits that investors don’t know about, Brooklyn Law School professor Robin Effron said.
Wyoming and Tennesse have passed legislation recognizing DAOs as legal entities, and allow them to register as a kind of LLC. Other states are working on DAO-specific legislation. There have been calls for more clarity at the federal level about DAOs and the status of its members.
“It’s time for states and federal governments to take this seriously and start writing rules and guidance that account for this,” Effron said.