A ruling last week in the class-action lawsuit against decentralized finance (DeFi) organization Lido DAO put DeFi stakeholders in line to be responsible for the misdeeds of the organizations they invest in, causing widespread consternation within the digital currency community. However, such reactions may be premature, as it remains to be seen whether any of the investors named in the lawsuit will end up being held liable once the case is heard.
On November 18, Judge Vince Chhabria of the United States District Court for the Northern District of California ruled that institutional investors in a decentralized autonomous organization (DAO), Lido DAO, could potentially be held liable for the actions of the he decentralized governing body behind the liquid. staking protocol on the Ethereum blockchain.
Broadly speaking, a DAO is a group managed by rules and smart contracts encoded in blockchain software, whose decisions are made collectively by members without, in theory, the need or presence of a central authority. Such a structure can make it difficult to hold individuals behind the organization accountable, which is why the Lido DAO lawsuit sought to bring certain key stakeholders into the crosshairs.
Judge Chhabria’s decision sparked a swift and concerned reaction from investors in DeFi – and crypto companies that benefit from the liability protection offered by DAOs – knowing that they could become liable for the projects’ actions decentralized in which they are involved.
Miles Jennings, general counsel and head of decentralization at Andreessen Horowitz (a16z) (NASDAQ: ZAHIDX), one of the venture capital (VC) firms named in the suit and now potentially responsible for Lido DAO’s actions, played this answer:
“Today, a California judge dealt a major blow to decentralized governance. Under the ruling, any participation in the DAO (even posting on a forum) could be sufficient to hold DAO members liable for the actions of other members under partnership laws.
However, such hyperbolic reactions may not be commensurate with the current decision.
The problem to solve
The class action in question began when Andrew Samuels, an investor who purchased 132 Lido (LDO) tokens in May 2023 and then resold them at a loss a few weeks later, sued Lido in December last year for violating the US securities regulations.
He alleged that the DAO had failed to register with the Securities and Exchange Commission (SEC) despite issuing securities tokens – a fact which, according to Chhabria’s ruling, has yet to be resolved. been contested.
The controversy arose because Samuels also sued several venture capital firms, particularly a16z, Dragonfly (NASDAQ: DFLI), Robot Ventures and Paradigm, alleging that as members of the Lido DAO partnership, they were responsible for his bad behavior.
The investment companies responded by attempting to have the complaint dismissed, asserting that their investment did not constitute a partnership under California law and that they therefore “could not be held liable…for the alleged conduct of a partnership “.
In his November 18 ruling on the motion to dismiss, Chhabria outlined the key issues under consideration:
“The first question is whether Lido DAO is likely to be prosecuted. The complaint alleges that it was founded by three investors whose whereabouts are unknown, and who apparently cannot be brought to justice in the United States.
On this issue, Chhabria ruled that Samuels had “sufficiently alleged” – note, not “sufficiently proven” – that Lido is a partnership under California law and therefore can be sued.
Specifically, he noted that under California law, “the association of two or more persons to operate as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership.
He also added that DAOs are “a type of organization that appears designed, at least in part, to avoid legal liability for its activities.”
However, the problem remains: if the location of the founders is distant and unknown, who can be held responsible? Hence the desire to include the largest investors in the DAO in the trial, which led to the second question considered by Chhabria:
“The second question is whether four large institutional investors in Lido – Paradigm Operations, Andreessen Horowitz, Dragonfly Digital Management and Robot Ventures – are members of the partnership. If so, they may be liable under California law for the partnership’s activities, including Lido’s failure to register its crypto tokens as securities.
On this second issue as well, Chhabria ruled that Samuels had “rightly alleged” that all investors except Robot Ventures – due to the evidence of its involvement being “much more sparse” – could be considered general partners and therefore responsible for the activities of the Lido. to drive.
Chhabria explained that “although the complaint does not contain all the details of the DAO’s operations and interactions with these investment companies, it appears that each of them, with the possible exception of Robot, played an active role in its management or intended to do so. .”
Strom in a teacup?
Despite the furore over the ruling, Chhabria made a point of emphasizing in his ruling that at this early stage of the case, Samuels only needed to adequately allege, not prove, that a partnership existed and that he had done it.
In other words, Samuels managed to convince the judge that there were arguments to be made. He is far from convincing himself or a jury that wrongdoing was committed and that venture capital firms are responsible for that wrongdoing.
So, Justice Chhabria’s decision simply means that the case will continue. This decision does not, as some have suggested, set a precedent, dangerous or otherwise, meaning that it is not a decision that will automatically apply to similar cases in the future, in which plaintiffs will have to always adequately assert a partnership in order to proceed with legal action. complaint/accusation.
So, to be clear, Chhabria did not find any of Lido DAO’s stakeholders and venture capitalists responsible. He simply decided that he would not dismiss the lawsuit and that it could therefore continue.
The venture capital firms mentioned could potentially be held liable, depending on the outcome of the trial, but only if it turns out, after all evidence has been presented and arguments heard, that their investment in Lido DAO constituted a partnership and whether Lido DAO is found to have illegally sold securities tokens – two substantial “ifs” remain to be decided.
Chhabria even acknowledged in his order that in the next phase of the case, when both sides present information to the court, it could become clear that the investment companies are not in partnership with Lido.
But before crypto-bros return to a state of blissful complacency, just because Monday’s decision isn’t significant at the moment doesn’t mean the case couldn’t be.
Hypothetical implications of the case
Participants in DAOs would probably like to believe that they cannot be held responsible for how their projects are used, whether because of the organizational structure that distributes operations and management across a network or because they do not literally cannot be located if something goes wrong. fake.
Some observers, however, argue that DAOs are not a unique new form of legal entity, that they are not that decentralized, and that they have founders or backers who can be held accountable. By allowing the lawsuit against Lido DAO and its investors to proceed, Chhabria appeared to sympathize with this position.
This case “presents several new and important questions about the ability of people in the crypto world to protect themselves from liability,” he said.
Therefore, while it is true that Chhabria’s decision does not prove significant in itself, it is also true that when the case ultimately comes to trial, a victory on all counts for Samuels would prove significant in context. of the DeFi space and digital assets.
Investors in DeFi projects and DAOs could potentially be responsible for the actions of these organizations and could increasingly be held accountable, primarily if the founders of these entities are anonymous and/or difficult to pin down.
This would have a substantial ripple effect on the market, making investing in DAOs and certain DeFi projects a much riskier proposition, especially for large institutional investors and venture capitalists.
Some may see this as a bad thing with “insidious over-intervention by government and the judiciary once again interfering in how and where people want to invest their money”, but it could also drive corporations venture capitalists to do more due diligence on potential DeFi and DAO partners. . This may also mean that any DeFi project wishing to attract large investors would have to get and keep its operations above board and in compliance.
Perhaps that’s what really upset crypto-bros about Monday’s decision, given the detrimental impact this form of indirect regulation could have on their questionable business practices, through potential partners demanding more and more proof of compliance because they don’t want to find themselves responsible for supporting questionable cryptocurrency projects to make money – a single sad tear rolls down our collective cheeks for these champions of long-standing free market libertarianism.
Regardless of which side of the fence one is on, DAOs, fans and critics will have plenty of time to formulate their various responses to the possible outcome of the class action. A case management conference is scheduled for Dec. 6 to set a timeline for the remainder of the case, which likely won’t be heard until later next year.
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