The Legit Ledger Podcast Ep. 12
Fintech Enforcement In Light of the Ooki DAO Lawsuit with Bill Kane and Zack Golda
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In this episode of The Legit Ledger, Sheppard Mullin attorneys Bill Kane and Zack Golda join host Yasamin Parsafar to discuss the CFTC’s recent lawsuit against the Ooki DAO for allegedly offering leveraged and margined retail commodity transactions in digital assets in violation of the Commodity Exchange Act.
About Yasamin Parsafar
Yasamin Parsafar is a partner with the Intellectual Property Practice Group in Sheppard Mullin’s San Francisco office, where she serves as co-leader of the firm’s Blockchain & Fintech team. Her practice focuses on protecting her clients’ intellectual property rights through counseling, prosecution, enforcement, and litigation. Yasamin leverages her litigation experience to strengthen and protect her clients’ intellectual property, manage risks, and position businesses to succeed in the event of a dispute. She frequently advises and protects brands venturing into web3 on various issues related to non-fungible tokens, metaverses, games, online marketplaces, and other platforms.
About Bill Kane
As a partner in Sheppard Mullin’s Chicago litigation group, Bill Kane's national litigation practice focuses on complex commercial litigation and advice across industry sectors in corporate governance, director and officer issues, shareholder rights, media/entertainment and regulatory issues. He has more than 30 years of experience representing clients before trial and appellate courts, administrative agencies, private mediations and arbitrations. Bill previously served as an Assistant Attorney General in the Illinois Attorney General’s office where he represented the legislative, executive and judicial branches of state government.
He actively represents clients in contract disputes, business tort claims, antitrust and consumer protection issues. Bill also has experience in Special Purpose Acquisition Company or SPAC litigation. In addition to his experience in SPAC-related litigation, he also represents clients in contract disputes, business tort claims, antitrust and consumer protection issues. Bill’s practice includes representing private equity investors, along with directors and officers in partnership and shareholder litigation.
About Zack Golda
Zack Golda is an associate in Sheppard Mullin’s Business Trial Practice Group in the Orange County, California office, where he primarily focuses on general business litigation, including regulatory challenges, breach of contract, business torts, blockchain, sports and other high-stakes business litigation matters. As a member of the firm’s Blockchain Industry Group, Zack has litigated cases involving blockchain, privacy and regulatory issues. He has also drafted several articles about regulatory advances in the cryptocurrency space, covering topics such as decentralized autonomous organizations (DAOs) and SEC and CFTC regulation of the blockchain industry.
Zack also is a member of the California Regulatory Practice Group, where he advises clients on communicating with regulators, analyzing and responding to agency proposed rulemakings and, where necessary, litigating constitutional, statutory, and procedural challenges to newly passed regulations.
Hi, friends. Welcome to another episode of The Legit Ledger. I'm Yasamin Parsafar, the co-leader of Sheppard Mullin's Blockchain Team. I want to thank you all for joining and ask that if you enjoy this content to please subscribe and share with your friends. We really appreciate that and it gives us motivation to continue to produce this content.
You may recall a couple months ago on episode six, we discussed the class action lawsuit against the bZx DAO, which is now known as the Ooki DAO, related to a security breach. On today's episode, we're going to be discussing a recent lawsuit filed by the CFTC against members of the Ooki DAO. And joining us today we have Bill Kane and Zack Golda of Sheppard Mullin's Blockchain Team. Bill is a partner in the firm's Business Trials Practice Group. His practice is focused on complex litigation and regulatory matters, including emerging issues facing the fintech industry relating to the Commodity Futures Trading Commission and the Commodity Exchange Act. Zack, who's been on our podcast before, is an associate in the Business Trials Group focusing on complex business litigation.
Bill and Zack, thank you guys so much for joining us today.
Thanks for having us, Yas.
Yeah, you're welcome. It's fun to be here.
So Zack, I wanted to start by asking you to please give us a high-level explanation of what this lawsuit is about.
Sure. So this lawsuit was filed concurrently with a settlement that the CFTC released basically settling charges, the same charges that they bring in the lawsuit against the Ooki DAO or bZerox founders. And the CFTC alleges that the Ooki DAO, as it's run after the founders gave control to the DAO, basically has operated in violation of the Commodities Exchange Act for several reasons. And I think Bill's going to get into the specific claims later on. But the high-level core of it is that the DAO allegedly offered margin trading and lending services and didn't have the license required to do so and didn't implement Know Your Customer, KYC requirements, or for anti-money laundering laws.
Thanks, Zack. And as we've discussed before, one of the characteristics of a DAO is that there's no centralized leadership. So can you explain how has the CFTC defined the class of DAO members in this case?
Sure. So the CFTC is asserting in the complaint that the Ooki DAO is an unincorporated association. And unincorporated association theory, each member of the association is treated as a partner for purposes under the law, and they have joint and several liability for the debts of the unincorporated association, including civil and criminal penalties that the CFTC is seeking in this action.
They're defining the scope of membership by token holders who have voted on a governance proposal from August 23, 2021 to the present. And that's distinct from what we saw with the class action lawsuit, which kind of went for investors, right? But here they're going for members who have actually held tokens and voted on the governance platform that the DAO operates.
Okay, that's interesting. Bill, what do you think of the CFTC's allegations here? If a non-DAO entity provided the services that are alleged in this complaint, would that violate the CEA?
Well, first of all, it's really great to be here, and it's good to be here in the new Chicago offices. I know a lot of people are still at on the couch eating Fritos in America. But it's time to get back to the office. And we are. So thanks for having me. I think there's an old song called Smoke on the Water. When there's smoke on the water, there's fire in the sky. You've got CFTC here...
Wait, hold on. Hold on. You still listen to Deep Purple, Bill?
Some of us do, Zack.
Okay. Okay. I'll let you go on.
But to be serious, what the CFTC is doing here is very interesting from a number of perspectives, some of which Zack and I have discussed in white papers and expressed opinions on along with a lawyer William de Sierra-Pambley in our office. And that is that the CFTC here with this lawsuit is really making an effort to progressively and proactively regulate this burgeoning fintech market. So we're seeing a lot more enforcement actions from the CFTC.
And in this case in particular, I'll call it the “Okie Dokie” case because I'm from Indiana and I don't know how the heck to pronounce this defendant's name. But what the defendant did not do and which the CFTC is consistently across the board being very aggressive on is engaged in trading, if you will, and leverage transactions involved in the retail market. So if you were to have nothing to do and want to sleep at night, go read the complaint, you'll see that what they're really getting at here is, these are retail commodity transactions as they view it. And the CFTC becomes hypervigilant in instances where the investing public or the retail investing public could be impacted.
And so that's what they've done here. And I think why that's important to what we're seeing in the industry is good regulations and transparency in the markets allows them to be efficient and it's going to allow the markets, in particular the United States to maintain its lead in the global markets.
Now, if you're the defendants here, if I had to take a flyer, you're not going to buy me a martini tonight for saying this, and I'm not saying that the CFTC is absolutely right in this case, but if you look at what they're claiming, they're basically saying that they were engaged in a number of activities that required clearance licensing, if you will, from the CFTC.
And one of the things that the CFTC has really made an effort to do is to have its doors open or their phones readily available for market participants to call them, to get pre-clearance, to try and understand whether they need to be licensed or registered for the conduct that they're engaging in.
Thanks, Bill. We'll be sure to link your white papers in the show notes. So thanks for mentioning that. Should the fact that this is a DAO change the analysis at all?
That's a very good question. It's frankly a difficult question. I don't think so. I think that what the CFTC is looking at the market activity, what is the impact on the market from the conduct regardless of the product or the way in which the product is constructed? So my answer would be no.
I mean, one of the problems is the market is moving at light speed and the regulators are kind of like Wookiee.
Wait, do you mean Chewbacca?
You know, when he's trying to start the Millennium Falcon and he floods the carburetor and the bad guys are going really fast and he can't get off the ground.
Yeah. Yeah. Okay.
So if we look at the way in which regulators are trying to keep up with the market, we've got to get politicians in one room and they all have to agree, which is a challenge. We've got to get the most important regulators, SEC and the CFTC, to sit down and agree on how they're going to carve up the pie, who's going to have regulatory authority. And these are all very, very difficult things to do in the real world. You've got agencies who are gunning for power. You have politicians who want to control the agencies. And so it's just a very slow process.
In the meantime, market participants like Okie Dokie, they may have decided we can't wait, we're just going to go, we're just going to move forward. The regulations are unclear and we don't want to be last in the market. The consequence of that kind of conduct, the CFTC is telling the market is you may end up on the other end of a lawsuit.
Right. That's very helpful. In addition to the CFTC's legal theory about violations of the Commodities Exchange Act that you guys are discussing, I understand that this case also raises issues that are related to litigation procedure generally. Can you guys speak a little bit about what issues the CFTC has from just a pure general litigation perspective?
Yeah, certainly. So the first real major hurdle has kind of already presented itself, and that's service of process. So in the traditional sense, you normally when you're serving someone, you actually go physically hand them a piece of paper. That's traditional service of process. And over time, we've developed other methods, but it's still pretty tied to that where you are territorially, you're in the forum state, you're there, and the court can, while preserving due process, serve you as a defendant in this lawsuit. And you can be bound by that service.
But here we have a DAO. And the DAO doesn't really exist in meatspace. It doesn't exist in the real world per se. It's a collection of people from all over who are interacting on these blockchain networks. And so the CFTC in this case filed a motion for alternative service trying to serve members of the Ooki DAO by posting the summons and complaint on the Ooki Governance Forum in something on the forum called the Help Chat Box. And the court initially approved this method of service on October 3rd. And so this is really fascinating because it shows how rapid changes in technology affect even the basic rules involving the procedures by which lawsuits and due process is accomplished.
No, I think that's right. In this particular case, and there has been controversy about its filing and so forth, Commissioner Johnson came out recently at a Market Advisory Committee meeting and she went on record saying that emerging technologies often don't fit neatly into the commission's areas of responsibility and it can lead to lack of clarity in the regulatory framework that doesn't get unnoticed. And she was talking specifically about this case.
So here we're ignoring the CFTC rules, just basic procedural rules that we as litigators see every day in service is really up in the air. In the old days, you had to follow the rule and serve with a particular process server of a certain age and so forth to serve someone. And if they were difficult to serve, for example, once I had someone dress up as a pizza delivery guy. He knocked on the door and said, "Here's your pizza." Our defendant liked pizza and grabbed the box, and we opened it and he was served.
So little bit different today with the defendant as we have in this case. Where we have decentralized organization principals who may be in different states or different countries, makes it very difficult. So I think what the CFTC did here is actually quite impressive from a legal standpoint to be creative and innovative. And they're testing the waters on the method of service or processes as Zack was describing.
Yeah, testing the smoky waters, if you will. But this issue is really kind of already created a pushback from not just the defendants but the crypto industry in general.
So two crypto advocacy groups actually filed requests to be amici curiae in the court. And that's just a fancy lawyer word for friends of the court. They're non-parties who are allowed to file briefs and argue. And in response to these two groups filing these briefs, the court on October 12th issued an order actually allowing them to file motions for reconsideration of the service of process approval. That's going to be decided on November 30th. So it'll be interesting to see all of these arguments come to a head, especially once the issue is fully briefed. Because as Bill was saying, this is a core aspect of litigation. It doesn't matter if you're the CFTC, the SEC, or just Joe Blow attorney doing something on his own, you got to follow these rules.
So this is going to be really important to watch. And it's really interesting because if you can serve someone by going to a website you know that they've visited at least one before, and posting the complaint there, it arguably dilutes the due process rights that are the foundation really for courts’ authority to issue judgments. And on the other hand, it may be the only way to actually serve the members of this DAO.
So the inherently anonymous nature of blockchain addresses could make this actually the only possible way that service can be done. And in that case, if you're doing it the only way it can be done, it's hard to argue that it isn't fair. So it's a delicate balance. But now we'll hear the rest of the story. Right?
Yeah. I'm sorry to interrupt. We've talked about all the rules and regulations we need for the financial industry, but this really gets into the rules of basic procedure. And you can see now how the change in the financial industry is bleeding over into basic, the need to change the procedural rules. It's pretty fascinating stuff.
Right. I've actually taken a look at the amicus briefs, and one group, the DeFi Education Fund filed their proposed motion for reconsideration with their brief. So we got a lot of source material to work with there. Interesting aside, the DeFi Education Fund was initially formed when another DAO, the Uniswap DAO voted to create this kind of 501(c) non-profit organization to pursue DeFi's interest in Washington as a lobbying group. And now here we are seeing them trying to make an impact on law. So it's just kind of interesting to see the development of DAOs as an experiment to now actually potentially impacting such basic rules of litigation.
But the DeFi Education Fund argues that first of all, that the DAO is not a proper defendant because it's not a person. I think they're going to have an uphill battle with that one personally because as Bill said it's clear, if you take the CFTC allegations as true, this DAO was engaging in conduct targeting retail traders. It's going to be hard to say that they should have no liability whatsoever, no chance of liability for that action.
The other arguments are that the commission hasn't offered any guidance for how the token holders contribute to violations and has given no path to registration for DAOs. So it's kind of this double-edged sword. You're coming after us for failing to register, but you haven't told us that there's any way for us to register. How's that fair?
And in the venue where the CFTC sued, they sued in the Northern District of California. So California law, state law applies as far as business associations go. And no need to explain why. That's complicated lawyer stuff. But under Cal law, an unincorporated association requires mutual consent for a common purpose. And the DeFi Education Fund is trying to argue that there is not a common purpose here. Again, I kind of think that's an uphill battle given what the CFTC has alleged about the targeting of retail traders with these commodity futures. But we'll have to see how that comes out because once it's fully briefed, these arguments may be more fully fleshed out and there may be more meat to them.
Right. Yeah. I am really curious to see how this turns out, especially that service issue because I haven't seen that before, and I think that's definitely going to impact a lot of other parties in the Web3 space.
So I wanted to speak a little bit about the broader issue of enforcement and particularly regulation by enforcement. So we know this is a hot topic because there has been criticism of the SEC for taking the approach to regulation by enforcement, and we saw a number of settlements in 2021 through 2022. And Bill, do you see any meaningful difference between what the SEC has been doing with their regulation by enforcement and what the CFTC is doing in this case?
Yeah. I would have to say, and then I'll hand this off to Zack, the CFTC's been more aggressive in court, in filing in court versus what I call demand letters and settlements. Would you agree with me on that, Zack?
Yeah, I absolutely agree. I think that's actually the critical difference here between the SEC's enforcement actions and the CFTC'S lawsuit against Ooki DAO.
So the SEC's regulation by enforcement method is typically they issue these letters to founder entities who've started these DAOs but maybe now don't control them anymore, and they obtain a settlement. That settlement isn't binding law on anyone. I mean, it's informative for the SEC itself for how they want their policy to go, but it really isn't binding. It's just a settlement. And so it's not law. But it still has the effect of telling the industry, "Hey, if you come in here and you start these kinds of businesses, we're coming after you."
So even though it's not law, it has the effect of keeping people from doing things that the SEC doesn't necessarily like. And the regulators are kind of, to play on Bill's metaphor earlier, they're kind of keeping the Millennium Falcon on the ground as the markets take off outside of the US in our global economy. Then that is a risk for several reasons. We don't want the US to fall behind and we really don't want the US to not have access to new, potentially better financial tools just because our regulators tell us we can't. That seems very un-American if you ask me.
So they're gunking up the carburetor again in the Millennium Falcon?
Oh yeah, they're gunking it up. The hyperdrive, that's a space carburetor, is not going anywhere.
The CFTC here, it's interesting because they did actually do that first step similar to the SEC. They got the settlement against the individual founders, but then they took it a step further. So by taking this case to court, I'd argue that the CFTC is actually doing its enforcement job correctly when it comes to novel issues. Rather than just take the settlement and the benefits that they receive from the settlement and then kind of telling the industry what they don't like without having a neutral arbiter, the judge look over it, they are now taking the chance that the court will rule in favor of Okie Dokie, Ooki DAO. You got me saying it now, Bill.
There you go again.
Either way, this is going to be at least persuasive authority from the district court. And if Ooki DAO does win, there's a high likelihood that this gets taken up to the Ninth Circuit and becomes law one way or another. And that is significant. Sure, it could take a few years, but that's kind of how the enforcement mechanism should work for novel issues is that we got to take it to the courts. We got to see what this is actually like in an adversarial context.
And just to add to that, I know we've often said the regulators are gray, we don't know what they're saying and which way they're going. I'll just quote something, a recent quote from the head of enforcement at the CFTC, as it related to this case. And Gretchen Lowe said, "Margined, leveraged, or financed digital asset trading offered to retail US customers," which is what we have here in this case, "must occur on properly registered and regulated exchanges in accordance with all applicable laws and regulations. These requirements apply equally to entities with more traditional business structures as well as DAOs."
So they're taking a very aggressive standpoint, again, when it comes to retail-type products. And you may have a decentralized platform, they don't care. If it's impacting the customer, the retail markets, they're going to take enforcement action. That's how I read that.
Thanks so much, Bill. I think that's a great place to end because we are at time now. So Zack and Bill, thank you so much for joining us today. I want to thank all of our listeners for joining us. If you have any Web3 legal needs or if you have any topic suggestions or would like to be a guest on our show, please do not hesitate to reach out. We really appreciate all of you and we look forward to hearing from you soon.
Great. Thank you.
Thank you. Good chat.
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