SEC obtains preliminary injunctive relief against Telegram’s $1.7 billion token sale

6 April 2020 Reed Smith Client Alerts

主页观点 SEC obtains preliminary injunctive relief against Telegram’s $1.7 billion token sale

On March 24, 2020, the United States District Court of the Southern District of New York granted the Securities and Exchange Commission (SEC) preliminary injunctive relief against Telegram Group Inc. and TON Issuer Inc. (the Defendants).¹ In early 2018, pursuant to an exemption for private placements, the Defendants raised almost $1.7 billion from both U.S. and foreign sophisticated investors through purchase agreements in order to build the TON blockchain network and its native cryptocurrency (Grams).² In exchange, these investors would receive $2.9 billion worth of Grams upon launch of the TON blockchain. In October 2019, the SEC filed an emergency action and obtained a temporary restraining order against the Defendants, alleging that the Defendants’ plan to distribute Grams to the investors constituted an illegal securities offering. On February 19, the SEC and the Defendants appeared before Judge Castel in the Southern District of New York at a hearing on the Court’s order to show cause.

作者: Herbert F. Kozlov

The Court determined that the SEC had shown a substantial likelihood of success in proving that the Defendants’ 2018 offering was "part of a larger scheme to distribute those Grams into a secondary public market, which would be supported by Telegram's ongoing efforts."³ According to the Court, such an offering would constitute the offering of securities under the Howey test. The Howey test provides the framework for determining whether an instrument is an "investment contract," which may need to be registered as a securities offering unless an exemption applies. It consists of the following four prongs: (i) investment of money, (ii) common enterprise, (iii) expectation of profit, and (iv) efforts of another.⁴

The Defendants argued that their offering consisted of two distinct sets of transactions: the 2018 purchase agreements with sophisticated investors, and the delivery of the Grams when the TON blockchain launches.⁵ While the Defendants conceded that the purchase agreements are securities, the Defendants claimed that the Grams would be commodities upon issuance. According to the Defendants, these two sets of transactions must be reviewed separately from a securities law perspective. The analysis of whether or not the issuance of Grams constitutes a securities offering must be made at the launch of the TON blockchain.

The Court, however, found that the determination of whether an instrument is a security must be made in the context of “the series of understandings, transactions, and undertakings at the time they were made"⁶ (i.e., at the time the Defendants entered into purchase agreements with investors in 2018). The Court also specifically noted that the economic reality of the 2018 purchase agreements and subsequent distribution of Grams is that they are a part of a "single scheme."⁷ As a result, the Court determined that the SEC had proven with substantial likelihood of success that the Defendants’ activities constituted an investment contract under the Howey test that needed to be registered as a securities offering before being sold to the public in a secondary market.⁸ Interestingly, the Court’s order is in line with the "investment contract" framework for digital assets that the SEC released in April 2019,⁹ which highlighted that an investment contract is more than just the form and terms of the instrument itself, but that all relevant related transactions must be taken into account as well.¹⁰

The Defendants immediately filed a notice of appeal to the United States Court of Appeals for the Second Circuit. Regardless of any appeal, it is noteworthy that the Court made no final determination with respect to the classification of Grams themselves as securities, and therefore, it is unlikely that the Second Circuit will provide a final determination in this regard. For now, the Court's order provides another warning for entities seeking to raise funds for the development of blockchain ecosystems with native cryptocurrencies.

SEC v. Telegram Grp. Inc., No. 19-cv-9439 (PKC) (S.D.N.Y. Mar. 24, 2020).
Telegram developed the TON blockchain as a proof-of-stake system with the hope that it would lead to widespread adoption of Grams as a medium of exchange. Id. at 5.
Id. at 2.
SEC v. W.J. Howey Co., 328 U.S. 293, 298-99 (1946).
SEC v. Telegram Grp. Inc., at 17. The Defendants sought to establish that the purchase agreements are securities exempt from the registration requirement under the safe harbors provided in section 4(a)(2) of the Securities Act and Rule 506(c) of Regulation D. Id.
Id. at 18-19.
Id. at 18.
Id. at 43. Notably, the Court also determined that the investors in the 2018 purchase agreements were statutory underwriters in violation of Rule 506(c). Id. at 41-43.
SEC, Framework for “Investment Contract” Analysis of Digital Assets (published April 3, 2020),
Id. The framework expressly states: “The focus of the Howey analysis is not only on the form and terms of the instrument itself (in this case, the digital asset) but also on the circumstances surrounding the digital asset and the manner in which it is offered, sold, or resold (which includes secondary market sales). Therefore, issuers and other persons and entities engaged in the marketing, offer, sale, resale, or distribution of any digital asset will need to analyze the relevant transactions to determine if the federal securities laws apply.” Id.

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