New action against the Ooki crypto-collective receives a reprimand from the Commissioner for Trade in Goods

Signage is seen outside the US Commodity Futures Trading Commission (CFTC) in Washington, DC, U.S., August 30, 2020. REUTERS/Andrew Kelly

(Reuters) – The U.S. Commodities Futures Trading Commission has developed a theory to prevent the decentralized, amorphous crypto collectives known as DAOs from exploiting their diffuse structure to avoid liability.

Not everyone on the commission is a fan, to put it mildly.

The CFTC stated Thursday, in a $250,000 settlement with the architects of a DAO that allegedly operated as an unregistered derivatives exchange, that DAOs are unincorporated, for-profit associations whose members, under longstanding contractual precedent, are personally liable for the DAO- debt.

Commissioner Summer Mersinger disagrees. In a stinging dissent, Mersinger accused the CFTC of wrongly relying on inapplicable precedent from private cases to exercise the government’s sanctioning power. Mersinger, a Republican who was appointed to the CFTC by President Joe Biden, said the agency should have engaged in formal rulemaking on DAO liability rather than engaging in “blatant ‘regulation by enforcement'” that could perversely discourage compliance with DAO regulations .

“The Commission’s approach to these actions will have public policy implications that extend far beyond this particular settlement and lawsuit,” Mersinger said. “Yet the commission has made this consequential decision without any public notice or input whatsoever. It is regulation by enforcement, plain and simple.”

The CFTC did not respond to my question about Mersinger’s criticism, which has been echoed by the Blockchain Association, a trade group for the crypto industry.

The DAO at the center of the controversy is Ooki, which controls a blockchain protocol that allows users to take long or short positions on cryptocurrency valuations. The CFTC alleged in its federal court complaint in San Francisco that Ooki DAO violated the Commodity Exchange Act by operating as an unregistered futures commission dealer and by failing to implement anti-money laundering and know-your-customer systems. The government claims that every Ooki token holder who has participated in DAO governance votes is responsible for the DAO’s conduct.

The CFTC’s simultaneously filed settlement agreement with the developers of the protocol, Tom Bean and Kyle Kistner, explains the commission’s theory in more detail. According to the government, Bean and Kistner first designed the protocol for bZeroX LLC, their limited liability company. In 2021, bZeroX transferred control of the protocol to a DAO, originally called bZx, then renamed Ooki.

The transfer, according to the CFTC, was specifically intended to insulate the protocol from regulation. Thursday’s filings cited comments from one of the founders during a conversation with bZeroX users: “It’s really exciting,” the unidentified founder reportedly said. “We’re really going to prepare for the new regulatory environment by making sure bZx is future-proof.” The idea, according to the CFTC filings, was that bZx could fend off regulators by asserting that control of the protocol belonged to the amorphous community of token holders.

The CFTC’s theory is that all Ooki DAO community members who exercised control can be held liable because the DAO meets the legal definition of an unincorporated association, and members of such associations are personally liable for their groups’ obligations.

In the Bean and Kistner settlement, the commission cited three cases to support this claim. In 1994’s Karl Rove & Company v. Thornburgh, the Fifth US Circuit Court of Appeals ruled that US Senate candidate Dick Thornburgh was liable, as a member of an unincorporated association, for his campaign’s obligations to Rove’s marketing firm. The New Hampshire Supreme Court ruled in a 1984 case that an individual member of a taxpayer association could be held liable for the fees of an attorney representing the group. And the Maine Supreme Court held in 1973 that members of a New Year’s Eve dance committee were liable to a plaintiff who slips and falls.

Under this precedent, the CFTC said, Bean and Kistner are personally liable for Ooki DAO’s debts.

I emailed Bean, Kistner and a bZx spokesperson but did not hear back. During the settlement, they did not admit or deny the CFTC’s allegations. Defense counsel in the CFTC case, Jason Gottlieb and Daniel Isaacs of Morrison Cohen, declined to comment.

CFTC Commissioner Mersinger said in his dissent that the CFTC should not have relied on three private cases to justify a government enforcement action. “I am skeptical of any federal or state agency exercising its power to sanction in this manner, based on a legal theory derived from state common law contracts and torts between private parties,” she wrote.

Furthermore, Mersinger argued, by defining DAO membership through token holders’ use of their voting rights, the CFTC will discourage DAO members from using that power so as not to trigger liability. It’s a policy mistake, Mersinger said, that will prevent good governance and compliance within DAOs.

Mersinger acknowledged that the Commodity Exchange Act does not give the CFTC specific authority over the Ooki DAO. But instead of advancing a new theory of liability in an enforcement case, she said, the commission could have relied on an aiding and abetting claim against Bean and Kistner while engaging in formal rulemaking — including public comment — to develop a fair policy for DAO liability.

Ooki’s lawyer has yet to appear, and DAO did not respond to my question via the chatbot. But I’m sure we’ll see Mersinger’s arguments resurface if Ooki files a motion to dismiss the CFTC lawsuit.

You can see why regulators are concerned about crypto developers trying to use DAOs to avoid liability. As I reported in July, in a story about a class-action lawsuit by Ooki DAO insiders who lost millions when the bZx protocol was hacked, thousands of DAOs are operating, and have billions of dollars in assets. (Plaintiffs in the class action claim that Ooki DAO is a general partnership and thus liable for the partners’ losses.)

The CFTC appears to have made a policy determination that litigation is the best way to define DAO exposure, just as the US Securities and Exchange Commission has relied on litigation to challenge crypto tokens as unregistered securities. I expect the Ooki case will show whether it was a good decision.

Read more:

how can insiders sue an amorphous crypto collective? they can’t, says the bzx defendant

Our standards: Thomson Reuters Trust Principles.

The opinions expressed are those of the author. They do not reflect the views of Reuters News, which is committed under the fiduciary principles to integrity, independence and freedom from bias.