It’s never a good sign when a judge says the argument in favor of your motion, “is less than straightforward, to be polite.”
Unfortunately for messaging app turned blockchain developer Telegram, that’s exactly what Judge P. Kevin Castel of the federal District Court for the Southern District of New York said when its lawyers asked him to “clarify” whether the temporary injunction he issued on March 24 banning the sale of gram tokens to the general public applied to the U.S., or everywhere.
On April 1, he ruled that it applied everywhere.
A TON of bricks
That is a potentially fatal blow to the Telegram Open Network, or TON, blockchain.
Telegram pre-sold 2.9 billion gram tokens to 175 investors from around the globe for $1.7 billion in 2018. While agreeing that this was a securities sale under SEC rules, Telegram argues that the second phase was not. That called for the creation of all the gram tokens when TON went live, at which point the pre-buyers would be able to resell them to the public. Telegram claimed that grams would at that time become utility tokens usable on TON, and thus not a security subject to the Securities and Exchange Commission’s rules.
The SEC disagreed, and filed for the emergency injunction.
After the SEC stepped in, the original investors agreed to postpone the TON launch from its planned Oct. 31, 2019 until April 30, 2020. After that, they can vote on having their funds returned.
You know the answer
Judge Castel knocked several big holes in Telegram’s argument that it should be allowed to proceed with the gram sale outside the U.S.
For one thing, Judge Castel said that he simply approved the language the SEC initially suggested for the initial Oct. 16 emergency injunction—a prohibition on “delivering Grams to any person or entity or taking any other steps to effect any unregistered offer or sale of Grams.”
That language was perfectly clear, he said. If Telegram wanted to object to the wording, he added, that was the time.
Only one sale
Still, that was a procedural issue. A bigger issue, Judge Castel said, was with Telegram’s assertion that it’s plan for selling gram tokens had two distinct parts, only one of which was a sale of securities under the SEC’s jurisdiction.
Telegram’s argument “misses one of the central points,” of his March 24 ruling issuing a temporary injunction which will last throughout the lawsuit, Judge Castel said.
Specifically, he ruled that the pre-sale and resale were part of a single “scheme” that included “the expectation and intention that the Initial Purchasers would distribute Grams into a secondary public market.”
Which is to say both sales are part of a single securities offering. And because one part of that includes a sale to the general public, the resale would therefore be an unregistered and illegal securities offering.
Unable to exclude Americans
“To address this hole in its argument,” Judge Castel said, Telegram offered to ensure that none of the grams would be resold by American pre-buyers or to the American public.
That raises two problems, starting with serious questions about whether Telegram can legally modify its agreement with the initial 175 buyers in this manner, said Judge Castel.
“Second, and more fundamentally, the TON Blockchain was designed and is intended to grant anonymity to those who purchase or sell Grams,” he pointed out. “Therefore, any restriction as to whom a foreign Initial Purchaser could resell Grams would be of doubtful real-world enforceability.”
Updated 8:50 a.m. on April 2, 2020 to reflect moving a paragraph about the gram’s pre-sale and adding the first caption.