The SEC moved to stop Telegram and its wholly owned subsidiary TON Issuer, Inc. from continuing its ongoing offering of the digital-asset “Grams”. According to the SEC, the offering of Grams was an illegal offering of securities. Telegram sought to issue a substantial number of Grams no later than October 30, 2019.

In summary, the SEC holds that Telegram’s distribution of Grams was a public offering of securities and devised a plan to distribute Grams as securities prior to a functional blockchain (‘TON”).   This view is further advanced through the citing of evidence suggesting the initial purchasers acquired the right to buy Grams for the purpose of quickly selling them for a profit through a distribution to the general investing public, i.e. retail investors.  The SEC maintains such distribution was essential to ensure Grams are sufficiently decentralized and for the initial purchasers to realize a profit.  Viewing the entire process of issuance and distribution, the SEC views Telegram’s distribution of Grams as a public offering of securities because the contend that Telegram always intended for the block of securities to ultimately come to rest in the hands of the investing public. The SEC maintains there is no exemption available for this public sale of Grams.

The initial purchasers under the Gram Purchase Agreements, according to the evidence from investors outlined by the SEC, intended to distribute Grams at a profit and do not appear to have entered into the private placement Purchase Agreements for their own long-term investment. The opportunity presents the initial purchasers with a quick profit through the distribution of Gram to the general public without registration and without providing sufficient public information regarding the investment; this information asymmetry deprives investors of material information relating to their investment. Rule 500 provides a substantive prohibition to such a plan or scheme to avoid registration, regardless of whether an exemption is technically complied with by the issuer. The SEC seems to be suggesting without stating it that Telegram planned to avoid registration by taking this path with the limited number of large initial purchasers acting as distributors of Gram securities to the general public. The key here seems to be the premature distribution of Grams under the private placement Reg D Purchase Agreements before the Grams were able to be utilized on TON, before TON was fully functional, and before Grams could be used for their intended purpose. As a result Grams continue to be securities and the corresponding quick sale and distribution of Grams to the general public is a public offering of securities without an exemption. The SEC seems to take the view that Telegram is distributing Grams to the initial purchasers as only a first step because Grams had to be more widely distributed to the public to be sufficiently decentralized. The SEC maintains that TON was designed from the beginning to require the Initial Purchasers to immediately distribute their holdings to the public. The SEC references the high public interest in purchasing Grams by retail investors as a substantial factor. In fact, future interests in Grams are already being traded in an IOC in Asian markets on, albeit without apparent involvement of Telegram or its affiliates.  Key to this analysis is  the premature distribution of Gram to the public to sufficiently decentralize prior to a functioning TON and without adequate public information.

Telegram’s lawyers responded that Gram is not a security but rather a currency or commodity. Telegram seems to maintain that Grams, unlike the purchase contracts, will not be securities once the TON Blockchain launches. A factual issue arises as to whether the TON Blockchain is functional, and, if functional, if it is sufficiently functional.  Telegram cites SEC Director Hinman’s speech in which he stated that a digital currency all by itself is not a security just as orange groves by themselves are not securities. This, of course, is well understood and accepted precedent from Howey. However, in Howey the orange groves existed. The key here seems to be timing and the SEC maintains TON is not yet functional. Telegram, in its brief, and admittedly not an attempt at a complete defense, does not address this timing question. Telegram’s lawyers simply maintain that Grams are not securities, maintaining that crypto is the new orange.  The all important facts and circumstances driving the analysis change if Telegram substantially plants the orange grove before distributing the oranges, i.e. builds a substantial functioning and useful TON blockchain before issuing Grams. It comes down to timing and Telegram’s self-imposed deadline with investors boxed Telegram into a corner without a functional TON.  

With the announced delay of the launch until April, Telegram has time now to expedite and complete the substantial planting of a decentralized orange grove prior to issuing Grams. The industry would certainly welcome clarity from the SEC or the courts in establishing SAFT’s as investment contract, blockchains as orange groves, and cryptocurrencies as oranges to be harvested and sold as commodities. If Telegram takes that path, the SEC action or litigation might well afford the industry some important guidance from the regulator or the court with respect to these issues of timing and decentralization. 

As of now, the Court postponed the hearing until Feb. 18–19, 2020.  Judge Castel ruled Telegram may not distribute Grams prior to the hearing and until the court can make a decision.  As mentioned, Telegram already planned to delay the launch until April 2020.  This may be a good opportunity for Telegram to finish the Orange Groves.

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