On October 11, 2019, the Securities and Exchange Commission (the “SEC”) filed an emergency action and obtained a temporary restraining order against Telegram Group Inc. and its subsidiary TON Issuer Inc. (together, “Telegram”) for conducting an alleged unregistered securities offering in the U.S. and overseas that raised more than $1.7 billion.1 The SEC also seeks permanent injunctions, disgorgement with prejudgment interest, and civil penalties against the two offshore entities.
The SEC’s complaint alleges that between January and March 2018, Telegram raised approximately $1.7 billion from sales of 2.9 billion digital tokens called “Grams” to 171 investors, $424.5 million of which was raised from 39 U.S. investors. Telegram raised the capital to finance the companies’ business, including the development of their own blockchain, blockchain platform, and their encrypted mobile messaging application which already serves approximately 300 million monthly users worldwide. Telegram promised to deliver the Grams upon the launch of its blockchain, no later than October 31, 2019, at which time the tokens could be sold into U.S. markets.
According to the complaint, Telegram took the position that Gram Purchase Agreements are securities and included a warning that the offer of the security had not been registered under the Securities Act. Telegram also claimed, however, that the Grams underlying the Purchase Agreements constitute a currency, not a security, and thus did not warn investors that the tokens could not be sold in the United States. The SEC rejected this argument, alleging that “Grams are not a currency because, among other things, there are not any products or services that can be purchased with Grams. Rather, there is an expectation on the part of investors that they will profit if Telegram builds out the functionalities it has promised,” including the development of the blockchain and integration with their messenger application. The SEC alleged that defendants failed to register their offers and sales of Grams, which are securities, in violation of the registration provisions of the Securities Act of 1933.
Takeaways
The Telegram case provides several useful lessons for those considering a token offering. Most importantly, the SEC did not credit Telegram’s argument that the Grams token is not a security. Again, according to the SEC’s complaint, Telegram had taken the position that while the token purchase agreement for the Gram was a security, the token itself is not. Telegram’s novel position reflects recent statements by SEC Chairman Jay Clayton that while ICOs, on the whole, are securities offerings, it does not necessarily follow that all cryptocurrencies are securities-“I want to go back to separating ICOs and cryptocurrencies. ICOs that are securities offerings, we should regulate them like we regulate securities offerings.”2 Chairman Clayton cautions, however, that “[w]hile there are cryptocurrencies that, at least as currently designed, promoted and used, do not appear to be securities, simply calling something a ‘currency’ or a currency based product does not mean that it is not a security.” Chairman Clayton’s remarks have also been echoed in public remarks by the Director of the Division of Corporation Finance Bill Hinman, as well as by other members of SEC senior management.3
Similarly, in the SEC’s press release about the Telegram case, Steven Peikin, co-director of the SEC’s Enforcement Division noted that “[w]e have repeatedly stated that issuers cannot avoid the federal securities laws just by labeling their product a cryptocurrency or a digital token. Telegram seeks to obtain the benefits of a public offering without complying with the long-established disclosure responsibilities designed to protect the investing public.”4 A fundamental difference between many ICOs and IPOs, particularly those the SEC has brought enforcement actions against, is that, in the ICO, one purchases shares in a company’s primary asset, hoping to profit off of its further development and success thanks to the efforts of company management, rather than shares in the company itself. As long as that remains the model, in the SEC’s view, investors should be afforded the same kinds of disclosures they would receive in a traditional public securities offering.
Another notable aspect of this case is the timing of the SEC’s action. In contrast to some other ICOs the SEC has pursued, the token in this case had not yet been delivered to investors. The SEC filed its emergency action just 10 days before the ICO was set to launch “to prevent Telegram from flooding the U.S. markets with digital tokens that we allege were unlawfully sold.”5 This enabled the SEC enforcement staff to step in before the tokens were disseminated in the U.S. and resold in the secondary market, at which point it would have been far more difficult to unwind or bring the offering into compliance.
Finally, the SEC’s action against Telegram is representative of larger trends in the SEC’s treatment of digital assets: that the SEC’s jurisdiction is far-reaching, and that no ICO is too big for the SEC to pursue. The SEC will pursue overseas issuers of digital assets or cryptocurrencies who offer and sell those assets into the U.S. or otherwise access the U.S. capital markets, and together with the recent Block.one settlement,6 this filing demonstrates the SEC has the ability to investigate and prosecute the largest ICOs or digital asset issuers.
Although significant guidance exists with respect to the treatment of token offerings, the analysis remains highly complex and involves a case-by-case review. Additionally, the interpretations of laws and regulations surrounding digital assets are subject to change. If you have any questions regarding issues that may arise in connection with an offering of digital assets or any other blockchain-related questions, please speak with your S&K contact attorney or any member of our Blockchain and Cryptocurrency Group.
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1 SEC v. Telegram Group Inc. and TON Issuer Inc., 19 Civ. 9439 (PKC) (S.D.N.Y. Oct. 11, 2019), available at https://www.sec.gov/litigation/complaints/2019/comp-pr2019-212.pdf.
2 Chairman Jay Clayton, Testimony on Virtual Currencies: The Roles of the SEC and CFTC, February 6, 2018, https://www.sec.gov/news/testimony/testimony-virtual-currencies-oversight-role-us-securities-and-exchange-commission.
3 See William Hinman, Dir., Div. of Corp. Fin., Remarks at the Yahoo Finance All Markets Summit: Crypto: Digital Asset Transactions: When Howey Met Gary (Plastic) (June 14, 2018), available at https://www.sec.gov/news/speech/speech-hinman-061418; Heath Tarbert, Chairman, U.S. Commodity Futures Trading Comm’n, et. al, Leaders of CFTC, FinCEN, and SEC Issue Joint Statement on Activities Involving Digital Assets (Oct. 11, 2019), available at https://www.sec.gov/news/public-statement/cftc-fincen-secjointstatementdigitalassets.
4 Press Release, Sec. and Exch. Comm’n, SEC Halts Alleged $1.7 Billion Unregistered Digital Token Offering (Oct. 11, 2019), available at https://www.sec.gov/news/press-release/2019-212.
5 Id.
6 In re Block.one, Securities Act of 1933 Release No. 10714 (Sept. 30, 2019), available at https://www.sec.gov/litigation/admin/2019/33-10714.pdf.
