Cryptocurrencies,  Regulation,  United States

SEC: Telegram lied about its ICO

The Securities and Exchange Commission is ‘deeply troubled’ by blockchain developer’s refusal to turn over bank records; Telegram condemns the SEC’s ‘scorched earth’ attack on SAFT utility token sales

The U.S. Securities and Exchange Commission asked a judge on Thursday to make messaging service turned blockchain developer Telegram open its books in an effort to stop what it believes is an illegal securities offering.

Telegram raised $1.7 billion in the first quarter of 2018 by pre-selling 2.9 million gram tokens. The SEC sued the firm in October. It believes bank records will prove that Telegram illegally sold gram tokens to resellers who earned a commission on sales and that it sold tokens after a March 2018 deadline.  

The SEC wants to clip Telegram’s wings (via Leo Jakobson)

In a move the financial watchdog described as “deeply troubling,” Telegram has so far refused to turn over even basic deposit and withdrawal statements showing how it has spent the money. 

The SEC filed a motion to compel, asking the judge to order Telegram to turn over its banks records before the agency deposes the company’s CEO and founder, Pavel Durov, in Dubai on Jan. 7-8. 

Meanwhile, in an opposition motion filed Friday, Telegram said that it has already handed over plenty of information to the agency and accused the SEC of using “scorched earth” tactics.

Attacking SAFT contracts

The core issue the SEC is fighting here is not really Telegram’s token sale, but the method it used—the SAFT contract, short for simple agreement for future tokens

Headshot of SEC Chairman Jay Clayton (via SEC).
SEC Chairman Jay Clayton (via SEC).

In a SAFT, a company promises tokens to accredited—that is, rich—investors after the network launches and the tokens become available. Ideally, investors can then turnaround and resell those tokens to the general public, hopefully for a premium. 

The Telegram suit is one of the SEC’s highest-profile cryptocurrency enforcement actions, as well as the one of the richest ICOs it has targeted. The SEC has gone lightly on some companies that admitted fault and agreed to a fine. Notably, in October, blockchain developer settled a suit over its $4 billion ICO for a comparatively tiny $24 million fine. Telegram could have opted to settle, but so far it hasn’t, choosing instead to fight the SEC suit aggressively.

Telegram sold those 2.9 billion gram tokens in an ICO between January to March 2018. While admitting that this was a securities sale, Telegram argued that its offering was exempt from registration as a security under Regulation D, because the tokens were sold exclusively to accredited investors. 

Utility or security?

The big question is whether SAFT investors can simply resell the tokens to the general public in what the SEC says is effectively another unregistered offering. 

Telegram argues once the network is live, grams will be utility tokens that function as a currency on TON,  and therefore, they are no longer securities bought as an investment. 

The SEC does not agree with that argument, and is using Telegram as a test case to establish legal precedent for its position. In August, the agency launched a suit against Kik Interactive, another high-profile ICO that relied on a SAFT. 

Telegram’s original plan was for TON to go live on Oct. 31, 2019. All that changed, however, when the SEC launched an emergency action on Oct. 11, 2019, temporarily halting the launch of the network. 

Telegram has now postponed TON’s launch to April 30, 2020. At that point investors can either extend the deadline again or get part of their money back.

SEC says Telegram lied

In its Jan. 2 filing, the SEC made clear that it is no longer looking just at the legality of Telegram’s SAFT token sales plan.

The SEC revealed that it believes Telegram’s bank withdrawals will prove the company violated the Regulation D standards in its sale to accredited investors. Specifically, the SEC believes Telegram sold gram tokens after the March 29 ICO cutoff and used underwriters to help sell them. This would nullify the Regulation D exemption, making the 2018 sale illegal.

The SEC “has evidence that certain entities tendered invoices to Telegram for commissions ranging between 10-15% to Telegram, based on the sale of certain purchase agreements,” SEC Senior Trial Attorney Jorge Tenreiro wrote.

“Telegram either raised more than the $1.7 billion for which it claimed exemption, or it did not raise $1.7 billion as of March 29, 2018,” he said in the motion. “Later funds may have been raised through underwriters.”

Telegram stalling tactics

The SEC doesn’t like that Telegram is refusing to release its accounting records. 

“Defendants are now refusing to disclose the bank records concerning how they have spent the $1.7 billion they raised from investors in the past two years and to answer questions about the disposition of investor funds,” Tenreiro told the court. “At bottom, Telegram does not want to tell the SEC what it has done with the $1.7 billion raised from investors.”

SEC: What is Telegram hiding?

Earlier in its investigation, the SEC said, Telegram reported having spent $218 million “for general corporate purposes,” as of Jan. 31, 2019. But it has refused to provide any other information on how much it spent developing TON or what it has done with the rest of its investors’ money.

When the SEC initially demanded the bank records in October, Telegram promptly stalled, the SEC said in its motion to Federal District Judge P. Kevin Castel of the Southern District of New York on Thursday. 

Telegram’s tactics included turning over just a list of deposits, then claiming it misunderstood that the SEC wanted withdrawals as well. Telegram also suggested “that it may not have access to its own bank records because it has changed banks,” said Tenreiro.

This was “even though we had had an extended discussion with them on December 27 regarding our need for bank records including credits and debits… was reiterated in writing the day before,” Tenreiro said. 

He added that the SEC needs to see the debits to determine “how Telegram spent the investors’ money.”

“Scorched earth” approach

Telegram, needless to say, sees things differently. In a response filed with the court Friday night, the company didn’t quite accuse the SEC of lying. But, it did complain that the agency was misrepresenting its response to the bank record requests. 

The company has already turned over “hundreds of thousands of pages,” said Alexander Drylewski, Telegram’s attorney from the white-shoe firm Skadden, Arps, Slate, Meagher & Flom. The SEC, he added, rejected an offer to have a Telegram representative testify about how it spent the $1.7 billion it had raised.

The SEC’s suggestion that Telegram has “not been forthcoming about the nature or amount of their expenditures from the private placement is without basis, and frankly, not well taken,” Drylewski added. 

Telegram: The SEC is not just wrong, it’s also mean.

He also took offense to the suggestion of fraud in the SEC’s claim that Telegram was withholding information on how it spent 2018 investors’ money.

“Despite the narrow nature of this case, which does not involve any allegations of fraud, or that the defendants misrepresented how they would use the funds raised, the SEC has taken a ‘scorched earth’ approach to discovery,” Drylewski replied. 

Telegram’s pre-sale materials “disclosed that ‘a significant portion of funds… are expected to be retained by [Telegram] for its own purposes rather than committed solely to the development and launch of the TON Network,” he pointed out.

In addition, turning over its bank records is far more onerous a task than the SEC has made out, Drylewski added. To meet European and other foreign data privacy laws, Telegram would have to scrutinize and redact information from each transaction—an enormously expensive and time consuming task.

Fishing for violations

Another major point that Drylewski made was that the lawsuit the SEC actually filed has nothing to do with the 2018 ICO.

“The critical legal issue in this case is whether the grams themselves—as distinct from the privately sold purchase agreements [or SAFTs]—will be ‘securities’ once they are created upon launch of the TON blockchain,” Drylewski said. 

Even ignoring that, the SEC did “not provide one shred of evidence” to back this up its claims about Regulation D violations in the 2018 ICO, said Drylewski. As for the SEC’s claim that Telegram violated the rules by using underwriters, the commissions it cited were merely finder’s fees for introductions to potential non-U.S. investors, he added. 

“At its base,” Drylewski said, the SEC’s “request boils down to mere speculation that defendants bank records will reveal some yet-undiscovered, unspecified, and unparticularized ‘wrongdoing.’”

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Leo Jakobson, Modern Consensus editor-in-chief, is a New York-based journalist who has traveled the world writing about incentive travel. He has also covered consumer and employee engagement, small business, the East Coast side of the Internet boom and bust, and New York City crime, nightlife, and politics. Disclosure: Jakobson has put some 401k money into Grayscale Bitcoin Trust.