Cryptocurrecy Corner

On May 12th, Telegram announced that the Company would be abandoning their Telegram Open Network (“TON”) blockchain project after a long public battle with the Securities and Exchange Commission (“SEC”). The TON platform was first announced back in 2017 and the ensuing capital raise constituted one of the largest token sales to date, amassing a reported $1.7 billion dollars. Though many of the details around the platform’s development were kept under the radar, Telegram’s TON platform was intended to be a decentralized, scalable, and secure blockchain platform that would host and provide a variety of services, acting as a commerce hub, with its own native currency—the Gram, acting as a medium of exchange to facilitate on-platform transactions.

What follows is a brief timeline of the project and the ensuing clash with the SEC:

 

December 2017

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Reports around Telegram’s TON project surface in the media and a version of the primer for the project starts circulating.

 

January 2018

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Telegram begins conducting private token pre-sales of Grams through purchase agreements (SAFTs) to 171 accredited and institutional investors, including to 39 U.S. investors who invested a combined total of $424.5 million.

 

March 2018

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According to one (of the two) Form Ds filed in March of 2018, $1.7 billion dollars was raised in total by the offshore (BVI) issuers.

 

May 2018

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Reports surface that Telegram abandoned plans to conduct a follow-on ICO offering due to regulatory scrutiny.

 

October 11, 2019

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The SEC files an emergency restraining order in the Southern District of New York to halt the distribution of Grams, alleging Telegram violated the registration provisions of Sections 5(a) and 5(c) of the Securities Act of 1933, and seeks certain emergency relief, as well as permanent injunctions, disgorgement with prejudgment interest, and civil penalties.

 

October 16, 2019

 

Telegram files a response to the SEC’s emergency application, revealing that the project had been in discussions with the SEC over the past 18 months as to a path forward.

 

October 31, 2019

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Telegram investors allow an extension of the delivery deadline for the Gram tokens in the investment agreements from the end of October 2019 to the end of April 2020.

 

November 12, 2019

 

Telegram files an answer to the SEC and the court battle moves forward over the next several months.

 

January 6, 2020

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Telegram issues this short project overview which tries to enforce a narrative that the Grams constitute a medium of exchange on the platform as opposed to an investment product.

 

March 24, 2020

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The court grants the SEC’s request for a preliminary injunction, finding that the SEC had shown “a substantial likelihood of success in proving that the contracts and understandings at issue, including the sale of 2.9 billion Grams to 175 purchasers in exchange for $1.7 billion, are part of a larger scheme to distribute those Grams into a secondary public market, which would be supported by Telegram’s ongoing efforts.”

 

March 24, 2020

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Telegram files a notice of appeal signaling its intention to appeal the decision in the Second Circuit.

 

March 27, 2020

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Telegram asks the court to clarify the scope of the injunction, particularly whether it applied to transactions without a U.S. nexus with non-U.S. investors.  

 

March 30, 2020

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The SEC responds to Telegram’s letter, arguing to the court that the injunction “unambiguously, and properly, applies to Telegram’s delivery of Grams to ‘any person or entity’” and Telegram’s request amounts to a motion for reconsideration.

 

April 1, 2020

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The court sides with the SEC once more, agreeing that the scope of the injunction was unambiguously broad and admonishes Telegram for attempting to relitigate and introducing new arguments.

 

April 30, 2020

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Telegram misses extended deadline for token delivery, triggering the ability of investors to receive refunds and issues an offer to investors to either (i) issue a refund of 72% of their investment or (ii) convert the investment into a loan where investors would receive 110% of their original investment by April 30, 2021. Telegram also leaves open the possibility that investors could still receive Grams or other cryptocurrency. 

 

May 4, 2020

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Telegram informs U.S. investors that they can no longer participate in the project on a going forward basis and must receive the refund.

 

May 7, 2020

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Free TON community launches the project separately and apart from Telegram (Telegram released the source code in 2019) giving rise to the possibility that the project may continue to move forward but without Telegram’s involvement.

 

May 12, 2020

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Pavel Durov, Telegram’s CEO officially announces the death of the project.

Well, what does this all mean?

This is a pretty significant victory for the SEC on a couple of fronts, but the three main takeaways are as follows:

1. The SAFT is Dead. There have been loud intermittent calls that the simple agreement for future tokens (“SAFT”) model is dead on arrival from a regulatory compliance perspective but the Telegram proceedings can be seen pretty definitively as closing the door on the SAFT path to market for tokens. The SAFT model involves a private sale of investment contracts on the premise that, while the offering of SAFTs is a securities offering, the distribution of the tokens, once developed and serving a function, would not be. Ultimately, the SEC saw the SAFT model as an overarching scheme to conduct a public offering through a number of steps, thereby ineligible for a private placement exemption from registration. By granting the preliminary injunction in this case, the court indicated that it likely agreed. In terms of drawing lessons, the SAFT path to market can likely be seen as a fatal flaw for projects and one the SEC does not seem to have any appetite for forgiving or helping to build a path forward based on promises to unwind with respect to U.S. investors or otherwise carve out the U.S. on a going forward basis. I don’t see any token projects actively using this model on a going forward basis.

2. Reaffirmation of the U.S. Jurisdictional Reach. Another takeaway from these proceedings is the jurisdictional reach of the U.S. In his communication announcing the death of the project, Telegram’s CEO articulated a sense of astonishment (which is widely held by non-U.S. based crypto projects), remarking at the sheer scope of the U.S. SEC’s jurisdictional reach:

“[T]he US court declared that Grams couldn't be distributed not only in the United States, but globally. Why? Because, it said, a US citizen might find some way of accessing the TON platform after it launched. So, to prevent this, Grams shouldn’t be allowed to be distributed anywhere in the world – even if every other country on the planet seemed to be perfectly fine with TON. This court decision implies that other countries don’t have the sovereignty to decide what is good and what is bad for their own citizens.”

Though this is a bit reductivist as Telegram sought and received funding from U.S. investors, the outcome for the project is decidedly more dire than would otherwise be expected after the SEC’s light-touch settlement with EOS.  Telegram’s raise was the second largest token raise to date, only exceeded by the $4 billion raised by EOS in an ICO that purported to (but did not fully) block U.S. investors from participating. After the EOS settlement with the SEC, many believed token issuers with larger pockets would be able to negotiate more favorable settlements with the SEC - that proved not to be the case for Telegram.

3. Expect More Enforcement. We can probably expect more enforcement actions for tokens issued under similar fact patterns as the SEC continues to pursue projects that conducted token raises, whether by ICO or otherwise. 

More broadly, I predict nothing good for the token markets. As the SEC continues to mop the floor with token projects, I anticipate that any future settlement would mandate the delisting of tokens from exchanges (if listed) and, as a result, with no new market entrants, the universe of tokens traded on crypto exchanges will shrink. I expect that the SEC may pursue other market participants, depending on their bandwidth, including exchanges and early purchasers, particularly those that participated in pre-sales at steep discounts and resold tokens. The Telegram proceedings should certainly put early investors in token projects on alert, describing these initial purchasers as “statutory underwriters” with the sale to these investors as a “first step in an ongoing public distribution of securities”.


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