SEC gives Telegram TON of trouble

In the wake of a lawsuit by the U.S. Securities and Exchange Commission, messaging service Telegram told backers that it would likely postpone the public launch of its Gram token.

“Due to the increased level of regulatory uncertainty we take a break to analyze new information and adapt our policies,” the Telegram Open Network (TON) said in a message to current and future investors. “TON Board will be with you again once we have more clarity on the legal status of the TON.”

The lawsuit was filed in federal court on October 11. It is the latest hostile action by the SEC in its campaign to halt and reverse initial coin offerings and other public token sales. It has already sued another high-profile project, Kin token creator Kik, for violating securities laws.

Telegram Group Inc. and its wholly owned TON Issuer Inc. have until October 18 to respond.

TON planned to have the mainnet of its Ethereum-compatible, proof-of-stake blockchain go live on October 31. That’s now an unrealistic deadline given the nature of federal court cases.   

Sending a message

The SEC ‘s filing came on the same day it joined with the Commodity Futures Trading Commission (CFTC) and the Financial Crimes Enforcement Network (FinCEN), on a blunt warning to both cryptocurrency creators and investors.

“We are aware that market participants refer to digital assets using many different labels.” it said. “The label or terminology used to describe a digital asset… may not necessarily align with how that asset… is defined.”

SEC enforcement division directors repeated that language in the press release announcing the lawsuit and temporary restraining order.

“Our emergency action today is intended to prevent Telegram from flooding the U.S. markets with digital tokens that we allege were unlawfully sold,” said Stephanie Avakian, co-director of the SEC’s Division of Enforcement.

Co-director Steven Peikin added, “[w]e have repeatedly stated that issuers cannot avoid the federal securities laws just by labeling their product a cryptocurrency or a digital token.” 

The SEC has been fairly open about selecting high-profile targets in its battle against initial coin offerings (ICO). Even aside from the enormous dollar value of the Gram token sale, that makes Telegram a perfect target. 

For one thing, the blockchain itself is highly anticipated because of its huge planned scalability. Developers said in the TON whitepaper that uses would include in-app payments, hosting DApps, decentralized storage, and an anonymizer. A wallet and integration with Telegram Messaging are also to be included.

Beyond that, it’s worth noting that the lawsuit claims that Telegram Messenger is ubiquitous in the blockchain industry. 

“[R]ecent estimates suggest that Telegram now has 300 million monthly users and that more than 84% of projects involving blockchain technology have an active community of Messenger users,” according to the filing. 

That made it an even more inviting target for regulators.

Security is vital

The highly anticipated TON blockchain project was announced in January 2018.

Its goal was to monetize the otherwise-free Telegram messaging service. The privacy-focused app allows senders to send self-deleting messages, part of the reason why it’s so popular in the cryptocurrency market. 

TON developers sold 2.9 billion of its tokens to large investors. The October 31 launch would have allowed those 171 early investors to sell $1.7 billion worth of Gram tokens to the general public.

The SEC maintains that initial sale was a security offering, as the goal was to resell them at a profit to the general public.

In addition, $424.5 million of that $1.7 billion sale came from U.S. investors, according to the SEC. That gives the agency jurisdiction, it said in the lawsuit filed in the Southern District of Manhattan court. 

The lawsuit claims that Telegram Group acknowledged that its initial sale of Gram Purchase Agreements was a securities offering, with the actual tokens to be delivered on October 31. That initial sale was legal under Regulation D, a part of the law which allows the sale of securities to accredited—rich—investors with far less reporting requirements than a normal offering.

However, the SEC filing claims that Telegram Group wrongly maintained that the tokens themselves “were not securities but rather currency.”

Because of the inaccurate label, purchasers were not “advised that they may not sell Grams in the United States absent a registration statement,” the suit added.

The use case

The SEC made a big deal out of the fact that there are currently no uses for Grams. 

“In the Offering Documents, Telegram spoke of potential future uses for Grams, specifically, as a medium of exchange for goods and services (or “cryptocurrency”), to purchase not-yet-developed tools on the TON (e.g., network storage, blockchain-based domain names, identity-hiding services), and as a token for future unspecified uses that Telegram and other third parties may eventually develop,” the suit noted. “None of these uses of Grams existed at any time and Grams do not have legal tender status in any jurisdiction.”

Of course, the TON blockchain test network only went live in September. 

The SEC’s filing concluded with a recital of how the offering fit the four-part Howey Test defining a security:

“The Initial Purchasers’ purchases of Grams, and any subsequent purchases of Grams, were and will be [1] an investment of money, [2] in a common enterprise, [3] with an expectation of profits, [4] derived primarily from the current and future entrepreneurial and managerial efforts of Defendants and their agents to build the TON Blockchain and drive demand for Grams.” [Numbers added by Modern Consensus.] 

The SEC also said there is a basic problem with Telegram Group’s claim that Grams are a currency. It claimed that the secondary buyers who would purchase the tokens from the initial purchasers in the October 31 sale would share “a common interest with Defendants in profiting from the success of Grams.”

Because of that, the secondary sale would also fit the definition of a securities offering under the Howey test.