iJudge P. Kevin Castel of the Southern District of New York struck his gavel and hung up on Telegram’s contentious $1.7 billion initial coin offering (“ICO”). Judge Castel ruled Telegram's planned distribution of Grams, a digital asset to be used on the TON Blockchain, likely constitutes a securities offering under the Securities Act of 1933 (the “Securities Act”) and should not be afforded an exemption from registration. Castel granted the U.S. Securities and Exchange Commission (“SEC”) a preliminary injunction preventing Telegram’s distribution of its Gram tokens for the foreseeable future. Judge Castel ruled against Telegram, finding that “the economic reality is that the Gram Purchase Agreements and the anticipated distribution of Grams by the Initial Purchasers to the public via the TON Blockchain are part of a single scheme.”
Telegram argued that the ICO took place through two separate transactions; (1) the initial sale of a security exempt from registration with the SEC under the Securities Act pursuant to the safe harbor of Regulation D; and (2) a planned distribution of the digital asset to be called Grams to the initial purchasers in the ICO. Telegram argued only the first of these transactions should be subject to securities laws because the later distribution of Grams did not constitute securities.
The Gram Purchase Agreement is a structure similar to the Simple Agreement for Future Tokens (SAFT) which was commonly used by issuer of digital assets and for which we have voiced concern that the SEC would not look at favorably {1}, {Richard Levin calls the SAFT a “Frankenstein financial product” and noting that SAFTs are garbage” {2}) noting that “[h]opefully, the Kik enforcement action will bring an end to the use of this ill-conceived financial product that is highly likely to expose the issuer of the SAFT (and the digital token issued upon conversion of a SAFT) to a potential SEC investigation and possible SEC enforcement action {3}.
Following this ruling Telegram requested that Judge Castel allow the Gram’s to be issued outside of the United States. This request was soundly rejected as it was not in the initial request by Telegram and since the court did not believe that Telegram could “implement safeguards” to prevent U.S persons from obtaining the Gram digital assets. Judge Castel also noted that since “the TON Blockchain was designed and is intended to grant anonymity to those who purchase or sell Grams […] any restriction as to whom a foreign Initial Purchaser could resell Grams would be of doubtful real-world enforceability.”
Judge Castel’s ruling and the injunction blocking Telegram from distributing Grams, even outside of the United States, purchased during ICO while not expected will make it very difficult for other firms trying to raise capital through similar distribution schemes.
Telegram has appealed to the Second Circuit and the Blockchain Association Files Amicus Brief but we would be surprised if Judge Castel’s ruling were overturned.
The case is U.S. Securities and Exchange Commission v. Telegram Group Inc. et al., case number 1:19-cv-09439, in the U.S. District Court for the Southern District of New York.
[1} Startups Love This Cryptocurrency Strategy. Regulators Say Not So Fast, Wall Street Journal (April 24, 2018)
{2) Time To Kik SAFTS To The Curb, Block Tribune (June 25, 2019
