Court Rules Digital Asset DAOs Can Be Sued by the CFTC

In September 2022, the Commodity Futures Trading Commission (CFTC) filed a complaint in federal district court in San Francisco against Ooki DAO, a decentralized autonomous organization (DAO), alleging violations of the Commodity Exchange Act (CEA) and CFTC Regulations. The CFTC alleged that bZeroX LLC transferred a blockchain-based software protocol to bZx DAO which renamed itself Ooki DAO. The CFTC alleged that Ooki DAO never registered with the CFTC and unlawfully engaged in off-exchange leveraged and margined retail commodity transactions in digital assets.

The CFTC's complaint was filed in tandem with an announced settlement between the CFTC and bZeroX's founding members for related regulatory violations. As we previously commented, the CFTC's action against the DAO itself relies on novel legal theories based upon characterization of the Ooki DAO as an "unincorporated association" comprised of those who hold the DAO's governance tokens and vote on DAO propositions. In an opinion issued by the court on December 20, 2022, finding the issues to be ones of "first impression," the court held that the CFTC did not have to serve individual token holders, that Ooki DAO received "both actual notice and the best notice practicable under the circumstances," and that "service was proper and complied with due process requirements." This decision also charts a course for the Securities and Exchange Commission (SEC) to follow in serving similar enforcement actions against DAOs.

Because the CFTC asserted its case against Ooki DAO as an entity, and not against its constituent token holders/voters, proceeding with the litigation required the CFTC to serve process on the DAO itself – which lacks a mailing address or other traditional avenue for service. In its motion filed shortly after the complaint, the CFTC sought alternative service on Ooki DAO, through "the online mechanisms the Ooki DAO has created to allow itself to be contacted by the public, namely €a 'Help Chat Box' and 'an online discussion forum' on its public website." Opinion at 4. The CFTC subsequently informed the court that it had, in fact, provided notice of the lawsuit through these mechanisms.

Thus far, no party or attorney for Ooki DAO has appeared in the case – but the CFTC's alternative form of service was challenged by four parties who filed amicus briefs in the case: LeXpunK, the DeFi Education Fund, Paradigm Operations LP, and Andreesen Horowitz (briefs available through links). The court considered these four amicus briefs and the CFTC's opposition to the amici, and held a hearing on December 7, 2022, at which counsel for the four amici appeared and argued against adequacy of service.

As the court's opinion explained, the amici's arguments fell into "two main categories: (1) Ooki DAO can neither be served nor stand as a defendant in this case because (A) it is a technology, not an entity, (B) it is not subject to enforcement under the CEA, and (C) it is not an unincorporated association; and (2) even if Ooki DAO is an unincorporated association and subject to enforcement under the CEA, it was not properly served here under federal or state service provisions." Opinion at 6. The court rejected both of these arguments, holding that Ooki DAO was capable of being sued and was properly served by the CFTC.

Ooki DAO Can Be Sued

The amici argued[1] that Ooki DAO is a "technology" rather than an entity or group of persons, such that suing the DAO makes as much sense as suing "the internet." The court rejected this position in summary fashion, observing that control over the software protocol resided in the DAO token holders, just as it had with the LLC that held control of the protocol prior to the owners' transferring of control to the DAO. Because the CFTC could have also sued the LLC – the DAO's predecessor in control of the protocol – so too could it sue the "organization" comprised of DAO token holders. Opinion at 7.

The court further held that under the Federal Rules of Civil Procedure and California law, the Ooki DAO has the capacity to be sued as an unincorporated association. Applying California law, the court concluded that Ooki DAO is a "group of two or more persons" joined by "mutual consent" for a "common lawful purpose" and that it "function[s] under a common name under circumstances where fairness requires the group to be recognized as a legal entity." Opinion at 9-13.

It is important to note that the court did not decide, for now, that the Ooki DAO is subject to liability under the CEA as an "unincorporated association" – which the amici had argued against. Rather, the court held that the question ripe for review was whether it was properly served, and the question of whether it will be subject to liability can be litigated at a later date – should the DAO make an appearance to substantively defend itself now that it has notice of the lawsuit. But the court's conclusion that the DAO is capable of being sued as an entity under California law suggests that the CFTC is likely to prevail on finding the DAO liable under the CEA.

Ooki DAO Was Properly Served

The court summarized the amici's arguments challenging the adequacy of service as falling into three main categories: "[1] amici argue that the CFTC was required to satisfy California service law under Civil Procedure Code section 416.40 but failed to do so; [2] they contend that even under California's alternative service provision, service was not reasonably calculated to provide actual notice to voting Token Holders; and [3] they assert that the CFTC should have and could have identified individual members of Ooki DAO to serve." Opinion at 13-14.

The court analyzed California law, finding that service of process under California law "aligns with constitutional due process requirements" and requires that "service must be reasonably calculated to give actual notice to the party being served." The court concluded that Ooki DAO had received such notice by electronic means, noting the CFTC's allegation that Ooki DAO "has structured its business ... in such a way that it can only be contacted via its online website, or perhaps through its social media accounts." Opinion at 17. The court concluded that the electronic means used were reasonably likely to notify "at least some" of the Ooki DAO token holders. The court also observed that subsequent posting on Ooki DAO public communications channels about the lawsuit indicated that the organization had received actual notice of the litigation.

Finally, the court disagreed with the amici that the CFTC should have served individual token holders and accepted the CFTC's argument that because the entity is the defendant and was properly served, the individual token holders did not need to be served at this time.

Conclusion

The court's ruling that Ooki DAO has been adequately served is an early victory for the CFTC in their novel theory of liability in this case and will likely embolden the Commission in bringing future enforcement actions against similarly situated decentralized autonomous organizations. In particular, the court's holding that a DAO can be subject to suit as an "unincorporated association" establishes a major foundational element of the CFTC's case: while the court's analysis on this point applied California law, such analysis is likely to be similar in other states, and the CFTC now has established California as a favorable jurisdiction.

The decision also suggests a pathway for the SEC to follow in its own enforcement actions in the cryptocurrency space. The SEC has focused its attention on DAOs since the earliest days of their use as a form of governance, including the landmark 2017 DAO Report, but the agency has generally targeted its enforcement actions on traditional legal entities (such as LLCs). The SEC is likely to take advantage of a theory that allows it to obtain jurisdiction over a DAO itself, along with its token holders.

The court acknowledged that its conclusion was preliminary, noting that "the CFTC sufficiently alleged, for the purposes of their service motion, that Ooki DAO is an unincorporated association under state law." Opinion at 10 (emphasis added). Should Ooki DAO appear in the case to defend itself, it will have the opportunity to contest the CFTC's allegations in a motion to dismiss or otherwise, and can assert the other points raised by amici (including a DAO's ultimate liability for unregistered off-exchange operations under the CEA). Now that Ooki DAO has been served, it remains to be seen whether the organization will appear in court or risk a default judgment.