Updated: CFTC Charges Ooki with Failure to Register as FCM, Finds Members Personally Liable for DAO's Debts | Practical Law

Updated: CFTC Charges Ooki with Failure to Register as FCM, Finds Members Personally Liable for DAO's Debts | Practical Law

The CFTC issued an order filing and settling charges against the founders and owners of decentralized autonomous organization (DAO) Ooki, finding that Ooki was an unincorporated, for-profit association whose members may be held personally liable for the DAO's debts. The CFTC also filed a complaint charging Ooki with failure to register as an FCM and other violations.

Updated: CFTC Charges Ooki with Failure to Register as FCM, Finds Members Personally Liable for DAO's Debts

by Practical Law Finance
Published on 26 Sep 2022 • USA (National/Federal)
The CFTC issued an order filing and settling charges against the founders and owners of decentralized autonomous organization (DAO) Ooki, finding that Ooki was an unincorporated, for-profit association whose members may be held personally liable for the DAO's debts. The CFTC also filed a complaint charging Ooki with failure to register as an FCM and other violations.
On September 22, 2022, the CFTC issued an order filing and settling charges against the founders of decentralized autonomous organization (DAO) Ooki (Ooki) and its protocol creator, bZeroX LLC (bZeroX), finding that Ooki was an unincorporated, for-profit association whose members may be held personally liable for the DAO's debts. On the same day, the CFTC filed a complaint in a federal civil enforcement action in the US District Court for the Northern District of California charging Ooki with violation of the following, as detailed in the order:
  • Section 4(a) of the Commodity Exchange Act (CEA) (7 U.S.C. §6(a)), by engaging in unlawful off-exchange leveraged and margined retail commodity transactions, including executing such transactions with persons who are not eligible contract participants (ECPs) or eligible commercial entities, without being designated by the CFTC as a designated contract market (DCM).
  • Section 4(d) of the CEA (7 U.S.C. §6d), by soliciting and accepting orders for leveraged or margined retail commodity transactions with customers and accepting money or property to margin those transactions, which are activities that can only lawfully be performed by a registered futures commission merchant (FCM).
  • CFTC Regulation 42.2 (17 C.F.R. §42.2), which requires every FCM to comply with the Bank Secrecy Act (BSA), by failing to implement a customer information program and failing to implement know your customer (KYC) and anti-money laundering (AML) procedures, as well as advertising the absence of these controls.
The order and complaint allege that, from approximately June 1, 2019 to August 23, 2021, Ooki's owners and co-founders, Tom Bean and Kyle Kistner, designed, deployed, marketed, and made solicitations concerning a blockchain-based software product that accepted orders for margined and leveraged retail commodity transactions, functioning similarly to a trading platform. The DAO's blockchain protocol permitted users to contribute collateral to open leveraged positions the ultimate value of which was determined by the price difference between two digital assets from the time the position was established to the time it was closed. This protocol purported to offer users the ability to engage in these transactions in a decentralized environment.
The complaint alleges and the order states that under CEA Section 13(b) (7 USC §13c(b)), Bean and Kistner are personally liable for Ooki's violations because they were in control of and, as Ooki token holders, voted to govern Ooki during the time these violations occurred and did not act in good faith or knowingly induced Ooki's acts. This governance included the decision to transfer control of the blockchain protocol that was initially held by bZeroX to Ooki in an effort to make the protocol enforcement-proof due to Ooki's DAO status.
The complaint classifies Ooki as a for-profit unincorporated association because it charges fees for its products and services, generates revenue, has distributed revenue to its members in various forms, offers ownership rights in the Ooki DAO in the form of Ooki tokens, collects and liquidates collateral from users, and has never sought to be characterized as a not-for-profit organization in any federal or state registration or filing. In the order, the CFTC cited So. Cal. Darts Ass’n v. Zaffina, 762 F.3d 921, 927 (9th Cir. 2014) for its position that Ooki is an unincorporated association, defined as "a voluntary group of persons, without a charter, formed by mutual consent for the purpose of promoting a common objective."
The order requires Bean and Kistner to pay a $250,000 civil monetary penalty and to cease and desist from further violations of the CEA and CFTC regulations. In its complaint, the CFTC seeks restitution, disgorgement, civil monetary penalties, trading and registration bans, and injunctions against further violations of the CEA and CFTC regulations.
Despite agreeing with certain aspects of the order, including the registration and AML violations, CFTC Commissioner Summer K. Mersinger dissented from the order, stating that the order and complaint:
  • Failed to rely on any legal authority in the CEA or case law relevant to this type of action in its approach to determine liability for DAO token holders.
  • Arbitrarily defined Ooki as an unincorporated association in a manner that unfairly picks winners and losers and undermines the public interest by disincentivizing good governance in this new crypto environment.
  • Constituted blatant "regulation by enforcement" by setting policy based on new definitions and standards never before articulated by the CFTC or its staff, nor put out for public comment.
  • Ignored an alternative, well-established basis for imposing liability for Ooki's violations of the CEA and CFTC regulations (specifically, aiding-and-abetting liability) that is specifically authorized by Congress and that would address all of these issues.

Novel Procedural Issues Regarding Service on Ooki

The CFTC's action against Ooki has presented a novel procedural issue. Because Ooki has no headquarters, leadership, or registered agent, the CFTC has asked the court to allow it to serve Ooki token holders by posting notice and case documents at the Ooki.com website. On October 31, 2022, venture capital firm Andreesen Horowitz filed an amicus brief presenting three major arguments on the Ooki service issue:
  • Under California law, plaintiffs cannot rely on alternative service to notify unincorporated associations about cases unless their lawsuits acknowledge that the associations serve a lawful purpose. Andreesen Horowitz claims that the CFTC cannot rely on alternative service because its complaint against Ooki alleged only illegal conduct, and for the CFTC to proceed it must replead the case to identify Ooki's legitimate purpose, then distinguish the DAO's allegedly illegal conduct.
  • The CFTC should have framed its suit to assert claims only against DAO members who did something wrong, rather than contending that every DAO token holder can be liable for the collective's allegedly illegal actions.
  • The CFTC's assertion of diffuse liability for DAO members will stymie the innovative use of blockchains and smart contracts. The CFTC's attempt to spread blame to all DAO members, regardless of their actual conduct, will stifle the potential to transform online commerce and technological engagement promoted by community-based governance.
The CFTC declined to comment on Andreesen Horowitz's brief, but it did request additional time from the court for to respond to these arguments.
Update: The CFTC issued an order on December 12, 2022 requiring the CFTC to serve two identified Ooki token holders, Tom Bean and Kyle Kistner (Ooki's owners and co-founders), as proxies for the DAO. However, on December 20, 2022, the United States District Court for the Northern District of California issued an order (December 20, 2022 order) responding to several amicus briefs filed in support of Ooki, finding Ooki deemed to be served as of the date of the December 20, 2022 order because:
  • Ooki is an entity, not a technology, as asserted by amici law firms, and the CFTC can and did strategically choose to sue the entity rather than the individuals behind Ooki and consequently did not need to serve the individuals.
  • The issue of whether Ooki is subject to liability under the CEA is not relevant to the issue of service but rather goes to the merit of the CFTC's case, and consequently does not need to be assessed for the issue of service.
  • The CFTC sufficiently alleged that Ooki has the capacity to be sued as an unincorporated association because California law provides a mechanism for unincorporated associations to be sued.
  • By posting on Ooki's chat box and online forum discussion, the CFTC reasonably calculated that these actions would apprise Ooki of this litigation because Ooki controls its website via its token holders, making it highly likely that Ooki saw the post on its website, particularly because it generated so much attention in the national media. Also, according to the court's order, Ooki appears to have received actual notice because the CFTC's service via the chat box and forum led to a flurry of discussion on the forum and Ooki’s other public communication channels, including its Twitter account.
  • The December 12, 2022 order requiring the CFTC to serve known token holders, even after the DAO received actual notice, was a "belt-and-suspenders procedure" to ensure that the due process requirements under the US Constitution were also met. The December 20, 2022 order noted the US Constitution requires that notice is “reasonably calculated, under all the circumstances, to apprise interested parties of the pendency of the action and afford them an opportunity to present their objections."
  • The CFTC utilized all of the information reasonably at its disposal to serve Ooki and Ooki had actual notice of the CFTC's litigation.