On June 8, 2023, Judge Orrick of the Northern District California entered an Order and Default Judgment in a case the U.S. Commodity Futures Trading Commission (“CFTC”) brought against the Ooki DAO. The case has garnered a lot of attention because of issues it raised concerning whether a DAO (a decentralized autonomous organization) could be held liable for violating the law. Indeed, the CFTC issued a Statement that said:
[I]n a precedent-setting decision, the court held that the Ooki DAO is a ‘person’ under the Commodity Exchange Act and thus can be held liable for violations of the law. The court then held that the Ooki DAO did, in fact, violate the law as charged. . . . This decision should serve as a wake-up call to anyone who believes they can circumvent the law by adopting a DAO structure, intending to insulate themselves from law enforcement and ultimately putting the public at risk.
It is understandable for the CFTC to tout this part of the decision, since many in the industry have operated under the belief that the decentralized nature of a DAO made it immune from regulatory oversight.
The CFTC filed this action against Ooki DAO, alleging it is, and has been, violating the Commodity Exchange Act (“CEA”). The complaint alleged 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.
Ooki DAO failed to appear or respond. The CFTC therefore moved for entry of default. The CFTC then filed its Motion for Default Judgment. Although Ooki Dao did not respond, four amici moved to file an amicus brief responding to the CFTC’s motion, which the court permitted.
The court went through the factors that must be considered before entering a default judgment. The first factor is the possibility of prejudice. The court held it favored default because, without it, both the CFTC and the affected public “will likely be without other recourse for recovery.”
As to merits of the claim — the most important part for precedential purposes — the CFTC alleged that Ooki DAO violated the CEA. The CEA assigns liability to “[a]ny person” who takes particular actions and defines “person” to include “individuals, associations, partnerships, corporations, and trusts.” But the CEA does not further define “association.” The court noted that it had previously found that the CFTC sufficiently pleaded facts showing that Ooki DAO is an unincorporated association. Although that holding was in the context of a service of process issue, the court said those definitions were not limited to service provision. Thus, for those same reasons, the CFTC’s complaint contained sufficient well-pleaded factual allegations that, assuming they are true (which a court must do on default), establish Ooki DAO as an unincorporated association under state and federal law. Therefore, given the well-pleaded facts, Ooki DAO was subject to suit under the CEA as an unincorporated association.
The court went on to hold that, for each of the alleged violations of the CEA — (1) engaging in unlawful off-exchange leveraged and margined retail commodity transactions; (2) engaging in activities that can only lawfully be performed by a registered futures commission merchant, ; and (3) failing to implement a CIP, KYC, and anti-money laundering procedures — the complaint alleged sufficient facts to establish liability.
A third factor to consider on a default judgment is the possibility of a dispute concerning material facts. The court stressed that Ooki DAO “intentionally chose not to appear.” The only fact that amici contested concerned whether Ooki DAO had the ability to operate or control the Ooki Protocol. The court had previously determined that it did, reasoning that Ooki DAO Token Holders controlled the Keys, which in turn were used to govern and control the Protocol. And there was the fact of a prior settlement, where Ooki DAO’s founders admitted to the unlawful operation of the trading platform.
As to the “excusable neglect” factor, Ooki DAO’s failure to participate in the litigation was, the court said, due to a “strategic decision” to not appear, not because it was unaware of the litigation. Thus, there was no excusable neglect.
As to a final factor to be considered on a motion for default judgment, while policy grounds favor a resolution on the merits of this dispute, that policy is outweighed by the resolution of the matter. Ooki DAO intentionally chose to not appear, respond, or at all participate in the lawsuit. Given Ooki DAO’s strategic nonparticipation, the CFTC would have no recourse in this matter without a default judgment. The court also noted the fact that the CFTC pleaded that Ooki DAO’s unlawful behavior continued via operation of the trading platform. Thus, without the default judgment, the CFTC would be unable to stop the unlawful acts and protect the public, as it is so charged to do. Accordingly, this factor also favored default.
With respect to the remedies, the CFTC had shown not only past violations, but also the transfer of control of the unlawful conduct from an LLC to a DAO, apparently for the express purpose of avoiding regulation, as well as ongoing violations of the CEA. This was sufficient to establish likelihood of future violations absent permanent injunctive relief and, therefore, the request was granted.
The court also granted the CFTC’s request for the removal of Ooki DAO’s website. A default judgment cannot generally provide relief different from what is demanded in the complaint. However, here, the complaint explained that the website facilitated Ooki DAO’s violations of the CEA, and the complaint clearly requested a permanent injunction precluding Ooki DAO from continuing to violate the CEA. Because the complaint made clear that the website was critical for operating the Protocol and making it available to the public, it was clear to the court that shutting down the website was critical to shutting down the Protocol and precluding access by the public. Indeed, shutting down the website could be the only way of ensuring that the permanent injunction has any effect.
Finally, the court entered a fine for $643,542, which was the statutory remedy of $214,514 per violation of the Act.
The CFTC was correct in its Statement, saying this is a very important precedent in establishing that a DAO could be held liable as a person (because the court considered it an unincorporated association). Indeed, in those states in which unincorporated associations are not given limited liability, a court might choose to treat such an association as a general partnership, which would mean that, potentially, its members are personally liable for its obligations. This could have significant ramifications. But it should also be kept in mind that the court’s order was a default order, meaning that the merits were never challenged. There should be little doubt that point will be made when this decision is cited in the future.
Despite the order to shut down the website, as of the publication of this post on June 13, 2023, it had not yet been taken down. Accordingly, we might soon be looking at an entire new thicket of issues concerning how court orders against a DAO are enforced.
