This past Friday (October 11, 2019), the Securities and Exchange Commission filed an emergency action and temporary restraining order against Telegram, a messaging app similar to WhatsApp. The emergency action is an attempt by the SEC to stop Telegram’s unregistered offering of its digital asset, “Grams.” As the SEC outlines, Telegram failed to adhere to the requirements of an exempt offering using Regulation D, the investment agreements to purchase Grams and the Grams tokens themselves are securities, and the investors and Telegram would flood the U.S. markets with billions of Grams. Telegram will now work with the SEC and further assess whether it needs to further delay the launch of TON.
In the complaint, the SEC takes the position that both the Grams Purchase Agreement to purchase the tokens and the tokens themselves are securities. The SEC noted that “Telegram has taken the position that the Gram Purchase Agreements were investment contracts i.e., securities, and placed a restrictive legend on the Gram Purchase Agreements…Telegram, however, claimed that Grams, the heart of the Gram Purchase Agreements, without which the agreements have no value or purpose, were not securities but rather currency.” The SEC continues, “Grams are investment contracts. Based on Telegram’s own promotional materials and other acts, a reasonable purchaser of Grams would view their investments as sharing a common interest with other purchasers of Grams as well as sharing a common interest with Defendants in profiting from the success of Grams. The fortunes of each Gram purchaser were tied to one another and to the success of the overall venture, including the development of a TON ‘ecosystem’ integration with Messenger, and implementation of the new TON blockchain. Investors’ profits were also tied to Telegram’s profits based on Telegram’s significant holdings of Grams.”
The SEC’s complaint goes on to state that the Grams would have no utility or use upon the distribution of the Grams other than speculation. Much of the complaint focuses on the materials and discussions of Telegram insiders promoting the tokens as well as the undertaking that Telegram was promising to support the tokens and the continued development of the ecosystem after the launch. While the SEC’s complaint does not cycle through the factors of the Howey test, a key focus of the Howey analysis is what was offered or promised to potential purchasers to determine whether the promoter held out an investment opportunity. Such a determination requires “an objective inquiry into the character of the instrument or transaction offered based on what the purchasers were ‘led to expect,’” which includes the terms of the offer, the plan of distribution, economic inducements promised to the purchasers, and an analysis into the promotional materials used for the transaction.
Further, alluded to in the complaint by the SEC is that Grams’ investors are dependent on the managerial efforts of Telegram. One of Howey’s progeny cases, which is not mentioned in the complaint, but which shares similarities with Telegram’s role in the transaction, is the Second Circuit’s decision in Gary Plastic Packaging Corp. v. Merrill Lynch, Pierce, Fenner & Smith, Inc. In that case, the Second Circuit held that investors in certificates of deposit expected profits from Merrill Lynch’s managerial efforts because Merrill Lynch promised to create and operate a secondary market for the certificates. Investors thereby “bought an opportunity to participate in the CD Program and its secondary market. And, they are paying for the security of knowing that they may liquidate at a moment’s notice free from concern as to loss of income or capital.”
As the SEC points out in the current complaint, Telegram issued a two-page teaser to investors to expect a listing of Grams on the major cryptocurrency exchanges. A Telegram executive and Vice President of Business Development also projected to list Grams on his trading platform allowing Gram holders to trade Grams with no restrictions. Additionally, 52% of the supply of Grams would be “retained by the TON Reserve to protect the nascent cryptocurrency from speculative trading.” Similar to Merrill Lynch in the Gary Plastic case, but not argued by the SEC, Telegram appears to have promised to create a secondary market for Grams to immediately be sold with no restrictions and guaranteed some price stability for investors that wish to liquidate their positions.
There is still much to speculate whether Telegram will settle with the SEC or pursue a similar path to that of Kik. The facts and issues behind the Kik case heavily overlap on the surface with those of Telegram. Nonetheless, this lawsuit will be one to watch as the SEC’s regulation by enforcement continues.