Samuels v. Lido DAO: Motion to dismiss denied
Navigating Legal Complexity: The Case Against Lido DAO and Its Implications for the Crypto Industry
On November 18, 2024, Judge Vince Chhabria, U.S. District Court for the Northern District of California, issued an important decision in Andrew Samuels v. Lido DAO et al. concerning whether an individual can sue a DAO (decentralized autonomous organizations) for violation of federal securities laws. This blog post analyzes that decision and addresses any future implications.
What is a DAO?
A Decentralized Autonomous Organization (DAO) is an organizational structure enabled by blockchain technology. Unlike traditional corporations or partnerships, DAOs operate through smart contracts—self-executing code stored on a blockchain—to govern decision-making and manage assets. Key features of DAOs include decentralized governance, transparency, and community-driven operations.
In most DAOs, tokenholders vote on proposals to determine the organization’s direction. This can range from hiring developers to distributing funds. The underlying goal of a DAO is to reduce reliance on centralized leadership, making the organization ostensibly more democratic and less “centralized.” However, this decentralized nature also complicates questions of legal accountability and liability, as raised in Andrews.
Andrews v. Lido DAO
Andrew Samuels, a cryptocurrency investor, filed a lawsuit against Lido DAO and its key institutional backers, including Paradigm, Andreessen Horowitz, and Dragonfly Digital Management. Samuels purchased Lido’s tokens (LDO) tokens on the Gemini exchange between April and May 2023, suffering financial losses when the token’s value dropped.
The complaint alleges thatthe founders of Lido DAO, Vasiliy Shapovalov, Konstantin Lomashuk, and Jordan Fish, created the DAO in 2020 to operate an Ethereum staking service. The Complaint further alleges that:
The DAO operates through tokenholder votes for governance decisions.
Lido DAO keeps a percentage of staking rewards in its treasury for distribution to founders, early investors, and other tokenholders.
Lido DAO has over 70 employees managing its operations.
Investment firms like Paradigm Operations, Andreessen Horowitz, Dragonfly Digital Management, and Robot Ventures bought LDO tokens and are alleged to be members of the general partnership.
The investor defendants, except Robot Ventures, are alleged to have actively participated in managing Lido DAO, influencing governance decisions and contributing expertise.
The general partners were involved in various aspects of creating, issuing, and promoting LDO tokens, including working to list LDO on crypto exchanges, promoting its price through social media, and encouraging participation in Lido governance.
Accordingly, Samuels’ legal argument hinges on the assertion that LDO tokens qualify as securities under federal law and should have been registered with the SEC, as mandated by the Securities Act of 1933. The argument focuses on whether Lido DAO qualifies as a statutory seller under Section 12(a)(1) and the interpretation of Section 5(a)(1) regarding the sale of unregistered securities. In addition, and critically here, Samuels needed to sue the DAO itself, which he believed qualified as a general partnership under California law. The court granted Defendant Robot's motion to dismiss but allowed discovery to proceed against other defendants.
Key Legal Issues in the Case
The court’s analysis involves several pivotal questions, each of which underscores the complexity of applying traditional legal frameworks to emerging technologies, particularly in the context of determining whether Lido DAO operates as a general partnership under California law. Central to this determination is the premise that Lido DAO’s profit-driven activities and the significant governance influence exerted by key tokenholders, including institutional investors, constitute the "carrying on of a business for profit," which is a defining characteristic of a general partnership. This legal characterization potentially exposes partners to joint and several liability for the DAO’s actions.
This case showed courts’ willingness to apply traditional legal principles, like those governing partnerships, to innovative structures such as DAOs, underscoring the challenges faced by decentralized organizations. [Note: For more insight into how legal challenges have been approached in similar cases, such as CFTC v. Ooki DAO, which addresses liability within decentralized governance structures.]
Can Lido DAO Be Sued as a Legal Entity?
DAOs are designed to decentralize governance and obscure liability. However, critics argue that such entities often operate as a legal fiction, avoiding accountability under traditional corporate or partnership law. Here, the court held that Samuels plausibly alleged that Lido DAO qualifies as a general partnership under California law. This determination hinged on the DAO’s collective profit-making activities and the governance roles of its LDO tokenholders.
2. Are Institutional Backers Liable as General Partners?
The factual allegations concerning the general partners focus on the active roles played by prominent venture capital firms such as Andreessen Horowitz, Paradigm, and Dragonfly Digital Management. Samuels’s complaint alleges that these firms not only invested in Lido DAO but also significantly influenced its governance and operations. For instance:
Andreessen Horowitz (a16z): The complaint alleges that a16z publicly stated that it was actively participating in Lido DAO’s governance as part of its investment strategy. Specifically, the firm committed to contributing as both a staker and governance participant, with documented instances where it influenced proposals and voting outcomes within the DAO. These actions were presented as evidence of meaningful participation in the DAO’s decision-making processes, which aligns with the legal standard for establishing general partnership liability.
Paradigm: Paradigm is also alleged to have played a pivotal role in shaping Lido’s operations. The firm’s influence is detailed in blog posts and communications, where it was described as providing guidance on governance and decentralization strategies. Furthermore, Paradigm’s deep technical involvement, including contributions to protocol development and research, is cited as evidence of its active engagement in managing Lido DAO’s business activities.
Dragonfly Digital Management: Dragonfly’s participation includes not only a significant financial investment but also active governance involvement. For example, Dragonfly used its LDO tokens to vote on proposals, including one that resulted in additional token allocations to itself. The firm’s actions, such as explicitly stating intentions to take a more active role in governance, reinforce the argument that it was a co-owner actively participating in the DAO’s operations.
The court acknowledged that these allegations plausibly demonstrated that these institutional backers functioned as members of a general partnership under California law. By contrast, Robot Ventures was found not to have demonstrated similar involvement, as the complaint lacked sufficient allegations of its participation in Lido DAO’s governance beyond its initial investment and public praise for the DAO. With respect to the other VCs. the court agreed that these firms played active roles in governance and development—from influencing key decisions to voting on token distributions—making them potentially liable for the DAO’s actions.
3. Does Lido DAO Qualify as a “Statutory Seller”?
Liability under Section 12(a)(1) applies to those who “offer or sell” unregistered securities. Lido DAO did not directly sell tokens to Samuels; he purchased them on the secondary market. Yet, the court determined that Lido DAO solicited token purchases through its marketing campaigns, promotional materials, and efforts to list LDO on major exchanges. These activities, the court held, sufficed to establish solicitation liability under securities law.
4. Are Secondary Market Transactions Covered by the Securities Act?
The defendants argued that the Securities Act only applies to public offerings, not secondary market transactions. The court disagreed, noting that Section 12(a)(1) liability extends beyond initial public offerings, encompassing any sale of unregistered securities unless explicitly exempted by law.
Implications for the Crypto Industry
This case sets important precedents for DAOs, token issuers, and institutional investors, as they are now suddenly liable, under traditional legal principles, for actions taken by DAOs, including the issuance of tokens under federal securities laws:
1. Heightened Legal Risks for DAOs
The ruling makes clear that DAOs cannot avoid legal scrutiny by virtue of their decentralized structures. Courts are willing to treat DAOs as general partnerships, exposing tokenholders—particularly institutional investors with significant influence—to joint and several liability for the entity’s actions. This precedent raises significant concerns for the viability of DAOs, especially those operating without clear regulatory compliance. Founders and contributors must carefully assess the risks of engaging in DAO governance, as participation could result in personal or corporate liability.
2. Expanded Scope of Solicitation Liability
By recognizing solicitation liability for marketing efforts and exchange listings, the court broadens the scope of activities that can lead to securities law violations. Token issuers can no longer rely on indirect sales through exchanges to shield themselves from legal exposure. Any promotional effort that encourages the purchase of tokens could trigger liability under Section 12(a)(1).
3. Secondary Market Scrutiny
The court’s interpretation that secondary market transactions are subject to securities laws adds a new layer of complexity for token issuers and exchanges. Crypto projects that rely on exchange listings to enhance liquidity and token value must now consider how their actions may expose them to liability, even for transactions occurring long after an initial token sale.
4. Institutional Accountability
Venture capital firms and other institutional investors may face heightened risks when backing crypto projects. Their involvement in governance, even if limited to voting on proposals or offering strategic advice, can be construed as active participation in a general partnership. This finding may deter institutional investment in DAOs unless clear legal protections are established.
What’s Next for Lido DAO and the Crypto Industry?
While the court’s decision was only a motion to dismiss, where the court must accept allegations as true, it sets the stage for significant legal battles ahead in the world of decentralized finance. The case now heads into discovery where the parties will determine if the allegations in the complaint are accurate.
For the broader industry, this case serves as notice that calling themselves a “DAO” does not necessarily insulate token issuers from liability. DAOs must reconsider their governance structures, token issuance strategies, and compliance protocols. Institutional investors, too, must carefully evaluate the legal risks associated with DAO participation, weighing the potential for liability against the promise of decentralized innovation.
As the crypto ecosystem continues to mature, cases like Samuels v. Lido DAO make clear that traditional legal frameworks, however inapplicable, are going to be continued to used by courts to determine whether certain entities or issues are in violation of federal securities laws.
Dynamis has significant experience in all aspects of decentralized finance and crypto in general. It is important when considering counsel to pick lawyers who have knowledge of the field and emerging technology. Please do not hesitate to reach out for a free initial consultation at crypto@dynamisllp.com and view our crypto legal guide.
