By John Reed Stark*

You walk up to the gate at a zoo with a white horse on which you have painted black stripes. You insist that the horse is a zebra and therefore should be fed and displayed with the zebras. The zookeeper politely explains that your horse is not a zebra. You contend that the zookeeper is wrong, and moreover that the zookeeper’s definition of zebra is not clear -- so you walk right into the zoo and move your horse into the zebra compound.

The above fintech bedtime story is essentially being read right now to Judge P. Kevin Castel of the U.S. District Court of the Southern District of New York, in the cozy historic Daniel Patrick Moynihan United States Courthouse at 500 Pearl Street in lower Manhattan of New York City.

Specifically, the U.S. Securities and Exchange Commission (SEC) obtained a temporary restraining order (TRO) against Telegram Group Inc. and its wholly-owned subsidiary TON Issuer Inc. (Telegram). Now the SEC is in the midst of explaining to Judge Castel precisely why Telegram's digital token offering are securities, which require registration with the SEC.

Appointed by George W. Bush in 2003 and serving for almost 15 years before taking senior status on August 5, 2017, the savvy and experienced Judge Castel has maintained the typically furious pace of post-TRO expedited discovery and the case has progressed rapidly.

But the SEC Telegram matter is more than just the typical SEC emergency enforcement action. The SEC Telegram docket does not just provide a rapid-fire presentation of just about every issue facing cryptocurrency market participants today. The matter also offers a rare and vivid glimpse into the dramatic disparity between on the one hand, how the SEC enforcement division views digital token offerings (they should all be registered!) and on the other hand, how the so-called fintech bar views digital token offerings (they are not always securities!).

Indeed, chock full of critical and fascinating court filings, the robust and action-packed SEC/Telegram docket report warrants some special attention. Along these lines, this article presents:

Some key background relating to the SEC/Telegram TRO;

Noteworthy excerpts and useful links to copies of actual SEC and Telegram case filings (including briefs, declarations, emails, letters and other interesting exhibits), taken directly from the SDNY docket and neatly organized for quick and easy review; and

Commentary and highlights thrown in the mix, concluding with a prediction for the outcome of the recently filed dueling SEC/Telegram summary judgment motions.

For any cryptocurrency market participant, especially those working in the so-called fintech world, the Telegram/SEC court filings are a must-read, and this article presents them all, in order and in context, efficiently arranged for professional perusal.

The SEC and Digital Coin Offerings

Over the past several years, the SEC has steadily risen to become perhaps the most effective and outspoken crypto-police force in the world, filing a broad range of cryptocurrency-related enforcement actions and turning out a number of thoughtful, forward-thinking and comprehensive regulatory pronouncements. Concurrently, SEC Chairman Jay Clayton has launched his own anti-crypto crusade, bravely taking center stage and plainly asserting that cryptocurrency tokens looked and acted like securities and were susceptible to fraud and chicanery by insiders, management and better-informed traders and market participants.

Some examples of Chairman Clayton’s more biting cryptoisms over the past three years include:

“I have yet to see an ICO that doesn’t have a sufficient number of hallmarks of a security . . . there is also a distinct lack of information about many online platforms that list and trade virtual coins or tokens offered and sold in ICOs." (November 9, 2017, speaking at an SEC Conference);

“I believe every ICO I have ever seen is a security . . . ICOs should be regulated like securities offerings. End of Story” (February 6, 2018, testifying before the Senate Banking, Housing and Urban Affairs Committee);

“Let me turn to what is a security. A token, a digital asset where I give you my money and you go off and make a venture… And in return for me giving you my money, you’re going to give me a return in the secondary market by selling the token to somebody . . . That is a security. We regulate the offering of that security and we regulate the trading of that security. That’s our job and we’ve been doing it for a long time. We built a $19 trillion economy and a securities market that is the envy of the world -- all done by following these rules.” (June 6th, 2018, during a CNBC interview); and

“If investors think there’s the same rigor around cryptocurrency price discovery as there is on the Nasdaq or New York Stock Exchange ... they are sorely mistaken.” (September 19, 2019, speaking at the Delivering Alpha Conference).

Clearly, Chairman Clayton has adopted a dogmatic yet commonsensical approach to crypto-regulation – and has made a concerted effort to alert the securities bar and all fintech practitioners of the Commission’s crypto-enforcement priorities.

The SEC Telegram Enforcement Action

On Oct. 11, 2019, the SEC filed an emergency action and obtained temporary restraining order (TRO) against two offshore entities conducting an alleged unregistered, ongoing digital token offering in the U.S. and overseas that has raised more than $1.7 billion of investor funds.

According to the SEC’s complaint (found here), Telegram Group Inc. and its wholly-owned subsidiary TON Issuer Inc. began raising capital in January 2018 to finance the companies’ business, including the development of their own blockchain, the “Telegram Open Network” or “TON Blockchain,” as well as the mobile messaging application Telegram Messenger.

The SEC alleges that the defendants sold approximately 2.9 billion digital tokens called “Grams” at discounted prices to 171 initial purchasers worldwide, including more than 1 billion Grams to 39 U.S. purchasers. Telegram promised to deliver the Grams to the initial purchasers upon the launch of its blockchain by no later than October 31, 2019, at which time the purchasers and Telegram will be able to sell billions of Grams into U.S. markets. The SEC alleges that the defendants failed to register their offers and sales of Grams, which are securities, in violation of the registration provisions of the Securities Act of 1933.

At the time of the filing, senior SEC enforcement officials made clear their posture for violative cryptocurrency financing programs as well as their resolve for protecting investors from the perils of digital token offerings:

“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. “We allege that the defendants have failed to provide investors with information regarding Grams and Telegram’s business operations, financial condition, risk factors, and management that the securities laws require.”





“We have repeatedly stated that issuers cannot avoid the federal securities laws just by labeling their product a cryptocurrency or a digital token,” Steven Peikin, Co-Director of the SEC’s Division of Enforcement. “Telegram seeks to obtain the benefits of a public offering without complying with the long-established disclosure responsibilities designed to protect the investing public.”

Judge Castel’s Order

On October 11, 2019, the same day as the SEC filing, Judge Castel granted the SEC’s motion for a TRO against Telegram and ordered expedited discovery, granting the SEC just about all of the relief that the SEC had requested.

In other words, Judge Castel believed that the SEC proved a prima facie case that a violation of the federal securities laws has occurred and (2) a likelihood that a violation will occur again in the future. The SEC’s compelling Memorandum of Law in support of their TRO application can be found here and Judge Castel’s order, a slightly marked-up version of the SEC’s proposed order, can be found here.

Telegram’s Answer

On October 12th, 2019, Telegram filed its answer, defenses and affirmative defenses (found here) and asked Judge Castel to dismiss claims that their sale of 2.9 billion digital tokens, known as Grams, was an unregistered securities offering that violated the Securities Act of 1933.

Though Telegram lambasted the SEC’s quest to block Telegram’s planned $1.7 billion digital token delivery as an improper “regulation by enforcement," Telegram eventually consented to stop delivering the tokens to purchasers until “the conclusion of the [preliminary injunction] hearing scheduled for February 18 and 19, 2020, except upon further order of the Court or agreement of the parties.” (Consent Order found here.)

However, Telegram also asserted that the SEC’s failure to establish clear guidelines for token issuers has led the agency to compensate with meritless and constitutionally vague SEC enforcement actions. Per Telegram’s answer (found here):

“Plaintiff has engaged in improper ‘regulation by enforcement’ in this nascent area of the law, failed to provide clear guidance and fair notice of its views as to what conduct constitutes a violation of the federal securities laws, and has now adopted an ad hoc legal position that is contrary to judicial precedent and the publicly expressed views of its own high-ranking officials.”

Telegram also argued that it had been the target of an enforcement approach that is not only inconsistent with the SEC’s publicly expressed desire to engage with developers in the cryptocurrency space but also inconsistent with the SEC’s track record of permitting the offering of cryptocurrencies similar to Grams:

“Even though the SEC has recognized that digital currencies present novel questions under the securities laws, it has not provided any formal, clear or workable guidance regarding how it would determine whether grams qualify as securities . . . A formal rule-making or at the very least an interpretation or policy statement from the SEC itself, with commentary from the public, is necessary for a paradigm shift such as this.”

Telegram’s Response

In addition to their October 11, 2019 answer, defenses and affirmative defenses (found here) Telegram also filed an October 16, 2019 Response in opposition to the SEC’s TRO (found here).

In their October 16th, 2019 Response, Telegram further asserted its consternation with the SEC TRO, attacking the SEC for trying to "steamroll" Telegram into consenting to a court order that would block a $1.7 billion token delivery. Telegram stated:

"In an apparent effort to gain a strategic litigation advantage, the SEC has refused to enter into a stipulation that would achieve the same practical result as an injunction and permit the court to resolve the underlying legal issues in this matter, and has continued to press for broad and burdensome 'emergency discovery' despite the absence of any emergency.”

Telegram also re-asserted that the SEC's theory that grams constitute securities was:

" . . . fundamentally flawed because the company has not and does not intend to offer grams to the public through an ICO. Instead, it sold them through private agreements with sophisticated purchasers who could use them once the TON Blockchain officially launches . . . Significantly, Telegram has already treated the private placement as a securities offering pursuant to valid exemptions to registration under the Securities Act of 1933 . . . The grams themselves, as distinct from the purchase contracts, will merely be a currency or commodity (like gold, silver or sugar) — not a 'security' — once the TON Blockchain launches."

The SEC and Telegram Legal Teams

The SEC’s investigation is being conducted by Daphna A. Waxman, Morgan B. Ward Doran, and John O. Enright of the SEC’s Cyber Unit. The case was being supervised by Carolyn Welshhans, then acting Chief of the SEC’s Cyber Unit (but is probably now supervised by newly appointed Cyber Unit Chief Kristina Littman and Lara Shalov Mehraban, Associate Regional Director of the New York Regional Office. The SEC’s litigation is led by Jorge G. Tenreiro and supported by Kevin McGrath, Ladan F. Stewart and Allison R. Levine.

Telegram Group and TON Issuer are represented by George A. Zimmerman, Christopher P. Malloy, Scott D. Musoff and Alex C. Drylewski of Skadden Arps Slate Meagher & Flom LLP.

An SEC Discovery Victory

Because the SEC enforcement action is a TRO, the matter commenced immediately on an extraordinarily fast track, with a crushing schedule of expedited discovery.

Depositions, document productions, dispositive motions, many of which can sometimes take years to complete in traditional litigation, are often completed in weeks or even days during a TRO. Indeed, the SEC/Telegram enforcement action is moving so quickly, it remains a difficult task to keep up with the constant flurry of court filings (SEC/Telegram litigation docket sheet found here).

Not surprisingly, there have arisen a few heated discovery skirmishes, the most prominent concerning whether the SEC was entitled to bank records relating to Telegram's digital token offering, specifically certain information involving debits showing how Telegram spent investor proceeds.

Telegram asserted that the bank records were: 1) not relevant; and 2) shielded by foreign privacy laws. The SEC asserted: 1) what could be more relevant to an SEC enforcement action than financial records pertaining to the fundraising at hand? and 2) foreign privacy statutes (sometimes referred to as “blocking” statutes) did not prohibit the SEC from seeking the basic information needed to protect investors. (The SEC’s Motion to Compel Letter can be found here. Telegram’s Opposition Letter can be found here.)

Both Telegram on January 9, 2020 and the SEC on January 10, 2020, each also filed supplemental letters providing more comprehensive and definitive arguments. (The SEC’s “Renewed” Motion to Compel Letter can be found here, and Telegram’s supplemental “Scheduling” Letter Motion can be found here.)

The SEC’s extraordinarily powerful letter offers a detailed analysis in particular of foreign privacy protections in SEC proceedings and will likely serve as a primer for future SEC court cases where foreign privacy statutes become an issue. Not only is the letter's prose biting, artful and well-supported, but the detail and legal research on the foreign privacy issue is convincingly and comprehensively presented. Per the SEC’s letter:

“Telegram’s vague submission reveals Telegram’s broad, amorphous invocation of “data privacy” for what it is — a smokescreen aimed at improperly withholding relevant, responsive documents from the SEC . . . Invoking the words "foreign data privacy“ is not a talisman that exempts Telegram from its discovery obligations under the Federal Rules of Civil Procedure.”

As predicted, the SEC ultimately prevailed and Judge Castel ordered Telegram a rolling production of every record the SEC sought, albeit somewhat redacted (or for attorney’s eyes only). (Judge Castel’s brief and somewhat terse Order can be found here.)

SEC/Telegram Dueling Summary Judgment Motions

On January 15th, 2020, only a few days after resolving their intense discovery disputes, the SEC and Telegram each filed an extensive and voluminous series of dueling summary judgment motions.

Specifically, the SEC filed a motion to strike Telegram’s first affirmative defense and a motion for summary judgment on liability in its entirety. Concurrently, Telegram filed its own motion seeking summary judgment and a denial of the SEC’s application for a preliminary injunction.

These opposing dispositive motions, together with their accompanying declarations, exhibits and memoranda of support, provide a treasure trove of exposition relating to the SEC’s view of cryptocurrency offerings as well as Telegram’s at times outrageously flagrant violative fundraising efforts.

Below is a compendium of the SEC and Telegram summary judgment-related motions, declarations, etc., together commentary and interesting excerpts drawn from the various filings.

January 15, 2020 SEC Memorandum Of Law In Support Of Its Motion For Summary Judgment (Found Here)

In this memorandum, the SEC offers a vast array of documentary evidence plainly demonstrating first-hand that the Telegram Grams had all of the hallmarks of a traditional securities offering.

Along these lines, the SEC:

Meticulously offers a vast array of documents relating to the Telegram offering, including literature, materials, emails and other evidence of extensive and sophisticated promotional efforts relating to the Telegram offering;

Methodically applies each prong of the Howey Test to Telegram’s offering, supporting its arguments with emails, investor declarations, promotional materials, digital asset platform communications and other inculpatory documents; and

Carefully chronicles the Telegram offering process, demonstrating concerted and deliberate efforts of public distribution, while debunking with documentary proof any assertion that the Telegram offering somehow conformed with Regulation D.

The SEC also provides evidence of the financial situation at Telegram at the time of the offering of the Grams, namely, that Telegram launched its 2018 Gram sale because it was "short on cash" needed to buy Telegram Messenger’s servers and pay for related services.

At the time of the sale, Telegram touted its financing for the purpose of building a next-generation blockchain that would be faster and more versatile than its predecessors. But the SEC explains that Telegram CEO Pavel Durov had been looking for ways to raise money to pay for equipment and decided against conventional equity fundraising efforts in favor of a token sale.

Per Durov, Telegram opted for a digital token sale because a traditional equity sale "would affect the company’s integrity its values, and [its] ethos." Telegram also did not want to raise funds by charging users or selling ads, believing that doing so "would hamper its ability to expand its user base and keep up with competitors."

Key Summary Excerpts:

“In Howey, the Supreme Court defined “investment contracts,” and, thus, “securities,” as investments of money into a common enterprise with a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others . . . Here, the undisputed evidence shows that the investment contract Defendants marketed to institutional investors in exchange for $1.7 billion was the quintessential transaction where investors funded a company’s growth hoping to profit from its continued efforts and future successes. Telegram solicited these investments by fueling these expectations. It touted the past successes of its founders in this space and the expertise of its programmers and its promised future efforts to build an ambitiously revolutionary “TON network.” And it highlighted the large user base for its preexisting product, Telegram Messenger, and how integrating the network into Messenger could create “demand and value” for the Grams. Telegram also sold Grams at steep discounts from an expected opening “reference price,” according to a formula Telegram promised to use to support market prices; promised to and did facilitate trading Grams on digital asset platforms; and made clear it would retain control of a significant amount of Grams. All of this further fed investors’ reasonable expectations of profits from Telegram’s economically-aligned efforts.”





“In sum, in determining that the Grams were securities, this Court should look to the economic reality of what Telegram was doing: raising money to build a platform that would create value and profits for the investors. Much like a stock certificate, a Gram represents an asset. Here, when sold to the investors, that asset was an investment contract. And, upon the launch of the TON network, that asset will remain an investment contract. The sale of Grams was not registered and thus violated Section 5 of the Securities Act”





“Telegram did not market the Offering by itself. It paid 10-15% commissions to several entities to find investors . . . These promoters developed marketing materials, which Telegram -- and eventually members of the public as early as February 2018 -- received . . . The promoters’ marketing materials touted the ‘[b]ooming market of crypto assets[’] [growth] by 79x,’ promised to ‘provide instant liquidity’ upon delivery of Grams, and projected returns of “+494%’ on Grams.”





“Telegram did not file any documents with the SEC in connection with the Offering until after the SEC’s staff learned of the Offering and asked investors for contact information for Telegram’s counsel . . . Telegram only then filed Forms D, claiming an exemption for the Gram Purchase Agreements under Rule 506(c) of Regulation D . . . and/or Regulation S. Telegram neither registered its transactions in Grams nor claimed they were exempt from registration.”





“ . . . No reasonable factfinder could conclude that sophisticated investors spent $1.7 billion in 2018 to purchase large, varying quantities of Grams for any reason other than the expectation of profit based on Telegram’s efforts.”

Favorite Footnote:

“During its investigation, SEC staff inquired of Telegram’s counsel whether Telegram was aware of the Liquid/Gram Asia sale [where Gram Asia in 2018 and 2019, apparently through the Liquid platform sold at least one million grams for $4 each in a “grey” market that developed after the Gram offering], to which counsel responded that Telegram “has not had any involvement with Liquid or its announcement; does not know which Gram purchasers (if any) could be involved; does not have any information about and has not had any communications with ‘Gram Asia’; and has not had any communications with Liquid or its representatives regarding the purported offering.” . . . Similarly, at his deposition, Durov [Telegram CEO] stated “definitely no” when asked if anyone from Telegram had met with representatives of Liquid with respect to their sale of Grams, and could not recall ever meeting anyone from Liquid . . . In just the last three days, after months of producing redacted documents despite Plaintiff’s insistent requests, Telegram has finally produced hundreds of key documents in un-redacted form. Among these productions are documents that show that both Telegram and its lawyers communicated and/or met with representatives of Liquid in 2018, . . . calling into question Telegram’s prior insistence that it had no information to share about Liquid.”





January 15, 2020 SEC Memorandum Of Law In Support Of Its Motion To Strike Telegram’s First Affirmative Defense (Found Here)

In this Memorandum, the SEC tackles head-on some of the private bar’s more oft-shouted criticisms, including that the SEC’s offering regulations are vague and out-dated and that the SEC wrongfully regulates via SEC enforcement.

The SEC also presents a compelling timeline of key events that not only belies Telegram's assertion of good faith in their dealings with the SEC, but also presents a useful sequence of events relating to the Gram offering.

For example, the SEC notes that Telegram never contacted SEC staff before the first sales round of their token offering. Indeed, in the SEC's January 7, 2020, deposition of Telegram CEO Pavel Durov, Durov confirmed that Telegram did not attempt to contact the SEC before the private placement of Grams began because "we thought it was too early due to the fact that we didn't know specifically what we would be doing." According to Durov, the TON engineers were still conducting “research and exploratory work” at that time. Durov also confirmed that Telegram had not contacted the SEC by the time he signed the first purchase agreement for Grams. Here is the precise sequence of events around the time:

January 8, 2018 : SEC learns through media reports that Telegram was planning a sale of digital tokens.

: SEC learns through media reports that Telegram was planning a sale of digital tokens. January 19, 2018 : The “Date of First Sale” of Grams.

: The “Date of First Sale” of Grams. January 19, 2018 : SEC staff began contacting potential Grams purchasers to obtain information about the sale and Telegram’s counsel contact information. Unable to identify Telegram’s counsel, the SEC staff asked that their names be conveyed by the investors to Telegram’s counsel.

: SEC staff began contacting potential Grams purchasers to obtain information about the sale and Telegram’s counsel contact information. Unable to identify Telegram’s counsel, the SEC staff asked that their names be conveyed by the investors to Telegram’s counsel. February 2, 2018 : Telegram's counsel emailed and called an SEC staff member to discuss the SEC’s “interest in . . . Telegram.”

: Telegram's counsel emailed and called an SEC staff member to discuss the SEC’s “interest in . . . Telegram.” February 2, 2018 : SEC enforcement division staff begin nonpublic investigation of the Gram offering.

: SEC enforcement division staff begin nonpublic investigation of the Gram offering. February 13, 2018 : Telegram Group Inc. and TON Issuer Inc. filed an SEC Form D noticing “purchase agreements for cryptocurrency quote for amounts totaling $850, million. The date of the first sale was January 29, 2018. Per the SEC, the Form D "must be filed within 15 days after the first sale of securities in the offering. For this purpose, the date of first sale is the date on which the first investor is irrevocably contractually committed to invest." (Telegram's Regulation D filing can be found here).

: Telegram Group Inc. and TON Issuer Inc. filed an SEC Form D noticing “purchase agreements for cryptocurrency quote for amounts totaling $850, million. The date of the first sale was January 29, 2018. Per the SEC, the Form D "must be filed within 15 days after the first sale of securities in the offering. For this purpose, the date of first sale is the date on which the first investor is irrevocably contractually committed to invest." (Telegram's Regulation D filing can be found here). March 29, 2018 : Telegram Group Inc. and TON Issuer Inc. filed an SEC Form D noticing an additional $850, million raised through purchase agreements. the Form D indicated that the date of the first sale was March 14, 2018.

: Telegram Group Inc. and TON Issuer Inc. filed an SEC Form D noticing an additional $850, million raised through purchase agreements. the Form D indicated that the date of the first sale was March 14, 2018. September 26, 2019 : SEC enforcement staff asks Telegram's lawyers if they would accept service of a subpoena on behalf of Telegram and TON.

: SEC enforcement staff asks Telegram's lawyers if they would accept service of a subpoena on behalf of Telegram and TON. September 30, 2019 : Telegram's lawyers inform SEC enforcement staff that they are not authorized to accept service for Telegram but nonetheless continue to advocate vigorously on Telegram's behalf (Telegram's "refusal to accept service" letter here).

: Telegram's lawyers inform SEC enforcement staff that they are not authorized to accept service for Telegram but nonetheless continue to advocate vigorously on Telegram's behalf (Telegram's "refusal to accept service" letter here). October 11, 2019 : Less than three weeks before the planned rollout of $1.7 billion worth of Grams, Telegram informs the SEC staff that, while Telegram anticipated that the launch would take place prior to October 31, 2019, and would keep the SEC apprised of the precise timing, it did not know “the exact date of the launch.”

: Less than three weeks before the planned rollout of $1.7 billion worth of Grams, Telegram informs the SEC staff that, while Telegram anticipated that the launch would take place prior to October 31, 2019, and would keep the SEC apprised of the precise timing, it did not know “the exact date of the launch.” October 11, 2019 : SEC files emergency civil litigation TRO against Telegram and TON (SEC Complaint found here).

As an aside, after at least a year of working with the SEC on Telegram's behalf, Telegram's counsel's refusal to accept service of a subpoena from the SEC was probably not the best approach to handling an already heated and volatile situation. While this may have merely been an administrative misstep or a communications issue between Telegram and their counsel, and while there may indeed be an innocent explanation for the odd refusal, it nonetheless likely threw a wrench into the SEC/Telegram relationship.

SEC enforcement staff in particular are not deterred by a refusal to accept service, but will instead likely redouble investigatory efforts, accelerate investigatory deadlines, immediately begin exploring litigation – and in general dig-in big-time (which is exactly what appears to have happened in this case).

Key Summary Excerpts:

“This void-for-vagueness affirmative defense is legally insufficient and should therefore be stricken. To the SEC’s knowledge, no federal court has ever accepted a defendant’s argument that the term “investment contract” is unconstitutionally vague; indeed, the Second Circuit has twice rejected that argument. Telegram contends that this Court should nevertheless be the first in the nearly 87-year history of the Securities Act to declare the term unconstitutionally vague. In doing so, Telegram fails to acknowledge that the Supreme Court’s decision in SEC v. W.J. Howey & Co., 328 U.S. 293 (1946) (“Howey”), has for decades provided a workable definition of “investment contract,” providing persons of ordinary intelligence with notice of the scope of the statute’s application and foreclosing arbitrary enforcement, as courts addressing the issue—including another district court in this Circuit in the digital asset context—have uniformly found. Telegram’s suggestion, in its lengthy preamble to its affirmative defenses, that the SEC must issue regulations or issue more guidance before it can exercise the discretion Congress gave it to enforce the securities statutes also has no merit, as it finds no support in the Due Process Clause, the Supreme Court’s void-for-vagueness jurisprudence, or any other principle of law.”

“On approximately January 8, 2018, SEC staff learned that Telegram was planning a sale of digital tokens . . . On approximately January 29, 2018—the same day as the “Date of First Sale” . . . SEC staff began contacting potential Grams purchasers to obtain information about the sale and Telegram’s counsel contact information . . . The SEC staff was unable to identify Telegram’s counsel, but asked that their names be conveyed to Telegram’s counsel . . . On February 2, 201 8— only after the SEC had already reached out to potential Grams purchasers and tried to identify Telegram’s counsel — counsel emailed and called an SEC staff member to discuss the SEC’s “interest in . . . Telegram.” . . . Though Telegram states that it “attempted to receive SEC guidance and feedback on the TON Blockchain” . . . it did not do so before it made its first sales to investors. . . . The SEC then conducted a non-public investigation into whether Telegram had violated the federal securities laws. Although Telegram provided information about its dealings with U.S.-based investors . . . it eventually refused to accept service of an investigative subpoena.”

Favorite Footnote:

“Telegram’s complaint that the SEC should have told Telegram it was violating the law before bringing this action is also meritless. “No action or failure to act by the [SEC] . . . shall be construed to mean that the [SEC] has in any way passed upon the merits of, or given approval to, any security or transaction.” 15 U.S.C. § 78z. Thus, “the SEC’s failure to prosecute at an earlier stage does not estop the agency from proceeding once it finally accumulated sufficient evidence to do so.” Graham v. SEC, 222 F.3d 994, 1007–08 (D.C. Cir. 2000).”

January 15, 2020 SEC Rule 56.1 Statement In Support Of Its Motion For Summary Judgment (Statement of Undisputed Material Facts) (Found Here)

This SEC Rule 56.1 Statement presents a lengthy, detailed and painstaking documentation of the multiple means and methods that Telegram employed to promote its digital token offering – all of which the SEC argues trigger the legal requirement of SEC registration.

Amid the many compelling items of evidence submitted are sworn declarations from eight initial purchasers of the TON investment which outline, among other things, each investor's perspective of the TON investment. (Links to the eight investor sworn declarations found here – Investor #1; Investor #2; Investor #3; Investor #4; Investor #5; Investor #6; Investor #7; and Investor #8.)

The declarations evidence that the investors themselves considered Grams to be securities and bought them NOT to use on the blockchain as validators (on TON's purported proof-of-stake network) but rather to BUY and SELL as an investment. In total, the declarations paint a vivid picture of what looks from every angle to have the hallmarks of a conventional and traditional securities offering. For instance, certain of the eight investors attest that:

They did not purchase Grams for consumptive use;

They purchased Grams in order to profit from their investments by selling Grams at an opportune time on secondary markets once the lockup period was over;

They purchased Grams with the hope that there would ultimately be a secondary market for trading Grams, including because of direct communications with Telegram about listing Grams on exchanges;

Their investment in Grams could be profitable because of Telegram’s efforts;

They believed the price of Grams would ultimately trade higher than they purchased Grams because they believed that Telegram’s Messenger application would continue to grow and drive demand for Grams;

They believed the price of Grams would ultimately trade higher than they purchased Grams for based on their confidence in the Telegram founders’ reputations and past success with Telegram Messenger, which gave them confidence that Telegram could build and launch the TON Network;

They believed Grams would ultimately trade higher than the price at which they purchased Grams because Telegram told investors it planned to do additional offerings of Grams at higher prices because there was a lot of demand for Grams;

At the time they bought Grams, they believed that the Telegram team would continue to support and grow the TON network after launch;

They did not plan to become validators of the TON network, or have not taken any substantial steps to do so;

Telegram did not ask them at the time they entered into the purchase agreements whether they planned to act as validators on the TON Blockchain;

At the time they executed the purchase agreements, they understood they were entering into an agreement with Telegram to buy Grams, which they owned at the time they transferred their funds, but which were to be delivered at a later date;

Telegram did not ask them at the time they entered into the purchase agreements what they planned to do with Grams after they purchased them; and

They heard rumors about interests in Grams trading on secondary markets before Grams had launched, and some discussed those rumors with Telegram.

According to the SEC, Telegram's employees had a similar view of Grams, i.e that they were essentially securities and used traditional capital market terms to explain the logic of the offering. For instance, Telegram employee Shyam Parekh, a former Morgan Stanley banker, told an investor in a March 6, 2019 email that the investor had the right to 72,835,916.68 Grams and that “the Fund has clear title to such securities,” “will be entitled to receive . . . Grams when they are issued,” and that “the securities are not pledged.” (Email chain from Parekh found here).

Parekh even goes so far as to begin working with a range of online digital currency trading platforms, including global token trading platform Coinbase, in anticipation of a listing of Grams. For example, on April 4, 2019, Parekh told one investor, “As regards listing, we’ve had inquiries from a number of large exchanges, and are in discussions with a few of them to see how they might be able to support Grams.” (Email working with Coinbase found here) (Email to investor found here).

In fact, throughout their Rule 56.1 Memorandum, the SEC presents an array of Parekh's communications, which altogether create the overwhelming impression of an initial public offering, as opposed to some sort of digital token validation opportunity or private placement.

January 15, 2020 Telegram Memorandum Of Law (1) In Support Of Their Motion For Summary Judgment And (2) In Opposition To Plaintiff’s Application For A Preliminary Injunction (Found Here);

This Telegram letter motion, while perhaps as voluminous as the SEC’s, remains far less compelling, and is laden with weakly supported bold proclamations.

For example, Telegram asserts that “Grams will not entitle purchasers to any income, any dividends, or any interests in Telegram ... nor do they resemble stock or any other form of equity.” But these indicia, while perhaps novel, are not particularly relevant and have little to do with an analysis under Howey, as is set forth in the numerous SEC enforcement actions involving initial coin offerings. Telegram’s lack of support for their position is not surprising, because Telegram has the difficult task of arguing two sides of the same coin.

On the one hand, Telegram contends that the Telegram offering was for the future issuance of Grams, a commodity or currency (yes, Telegram actually argues that Grams trigger both classifications) subject to jurisdiction of the U.S. Commodity Futures and Trading Commission. And, once the Grams are delivered, they will not be securities under the Howey test.

On the other hand, Telegram contends that the classification of Grams is beside the point, because the Telegram offering was a private placement of securities, and therefore exempt from registration under the Securities Act pursuant to SEC Regulation D.

Separating the notion of Grams (whatever their classification) from the notion of the actual securities tendered in the Telegram offering posed a significant challenge for Telegram in its motion – because the two seem inexorably linked.

Along these lines, Telegram’s filings fail to rebut the SEC claim that the initial purchasers and later investors of the Telegram offering expected to profit from Telegram's work developing the TON blockchain and integrating it with the Telegram messenger app.

In their most favorable light, Telegram’s contentions evidence that Telegram somehow lost control of its own offering. Telegram’s filings reveal a financial ecosystem of unregulated, unsophisticated and irrepressible investors and promoters working under radically differing international regulatory paradigms – many of whom had severely conflicting understandings of what Telegram was actually pitching in its offering.

Telegram also has the burden to establish their compliance with Regulation D, which is awkwardly handled in their motion. This is also not surprising -- Telegram’s pleadings make clear that Telegram was operating in the unwieldy, unregulated, untethered and Wild West world of uncontrollable crypto-hype and unsavory digital asset trading platforms, together with an emerging international grey market of unscrupulous salespeople, profiteers and crypto-opportunists, all yearning for the chance to get rich quick by buying and selling Grams.

Successfully conducting any Regulation D private placement requires an intricate and comprehensive legal process, and precise control of all offering-related communications, documentation, sales presentations and every other aspect of the transaction. Yet, given the sheer size and multiple global participants in the Telegram offering, together with the worldwide hype surrounding Grams, such control and restraint seemed virtually impossible. Indeed, any slip-up in the offering process could be fatal for Telegram -- because any failure to meet Regulation D's strict and stringent requirements can result in Telegram "blowing" their exemption, and mandating rescission of the offering in its entirety.

Telegram’s filings also fail to counter the SEC’s multiple contentions (found here beginning with the SEC’s October 11, 2019 filing against Telegram), that Telegram paid commissions to purchasers who were buying Grams to resell to other investors, which rendered them statutory underwriters (such that Telegram’s offering would not qualify for a securities registration exemption). For instance, the SEC offers two potentially damaging examples of Telegram’s suspected underwriting efforts (found here and here) which indicate that Telegram may have kept selling tokens after its initial sale, undermining the firm's argument that the sale was exempt from registration. All in all, Telegram does not offer much evidence to contradict this troubling SEC assertion.

Key Summary Excerpts:

“The record demonstrates that the SEC cannot establish two prongs of Howey: (1) following launch of the TON Blockchain, future Gram purchasers will not have an expectation of profits based on the entrepreneurial or managerial efforts of Telegram; and (2) there will be no common enterprise in Grams,"

"Whether Telegram's private placement constituted a securities offering is not an open question because Telegram has already treated it as such, and conducted it pursuant to exemptions to registration under the Securities Act.”

“This non-fraud action presents the narrow legal question of whether Defendants’ yet-to-be-issued digital currency, called Grams, constitutes a “security” subject to the U.S. federal securities laws. Defendants submit that the SEC has impermissibly stretched its jurisdiction far beyond what the law allows and that Grams, when launched, will not be a security but rather a currency or commodity subject to anti-fraud and anti-manipulation oversight by the U.S. Commodity Futures and Trading Commission (“CFTC”).”

“ . . . Telegram raised capital by privately entering into purchase agreements (“Purchase Agreements”) with only a select number of high-net-worth, highly sophisticated purchasers that provided for the future issuance of a currency (Grams), but only following the completion and successful launch of the open source, decentralized TON Blockchain (“Private Placement”).2 These Purchase Agreements were expressly treated as securities and offered pursuant to exemptions to registration under the Securities Act of 1933 (“Securities Act”). If the TON Blockchain does not launch, then Telegram is contractually required to return unspent funds to the Private Placement purchasers and no Grams will be created or issued. Once the system is launched, Telegram will not have any ongoing managerial or entrepreneurial control over it (and in fact has publicly disclaimed any such control).”

“For 18 months leading up to the filing of this action, Telegram attempted to engage with the SEC and solicit guidance regarding its plans for Grams, including producing thousands of pages of communications, conducting countless in-person meetings, phone calls and emails, and even making changes to the contemplated features of the project based on the limited feedback it obtained. Despite this, the SEC failed to provide meaningful guidance and rushed into this Court at the eleventh hour to enjoin the launch of the TON Blockchain with the urgency it would normally reserve for shutting down a boiler room pump-and-dump scheme. This was contrary to the SEC’s stated desire to engage with developers of digital asset technologies and follows its prolonged failure to provide any workable guidance in this area, which has led to sharp criticism by U.S. lawmakers and one of the SEC’s own commissioners.”

“As Rep. Warren Davidson (R-OH) publicly expressed, “[t]he SEC is doing a complete patchwork of regulation. No one knows where they’re going,” and its approach of regulation through enforcement has “all the charm and inefficiencies of third-world power structures.” SEC Commissioner Hester Peirce recently added: “I am concerned about how the SEC has regulated this space, because I believe our lack of a workable regulatory framework has hindered innovation and growth . . . [and] offer[s] no clear path for a functioning token network to emerge.”’ The SEC’s pursuit of “regulation through enforcement” here stands in contrast to past situations where it provided concrete guidance to resolve uncertainty regarding whether a new asset class fell within the definition of a security”

“Although unclear, the SEC appears to suggest that the Private Placement was in fact a “public distribution” of Grams and that the private purchasers are in fact statutory underwriters because they may sell their Grams in the future. This is belied by the record and common sense. Grams do not exist yet, and may never exist unless the TON platform is successfully launched; thus, there has not been — and can never be — a “public distribution” of a security. Rather, Grams were specifically designed (and intended and understood from the beginning) to be a digital currency, not a security, thus defeating the SEC’s “past violation” theory. Moreover, the undisputed record reflects that Defendants entered into the Purchase Agreements with only highly sophisticated, high-net-worth accredited investors, through which the purchasers were required to represent and warrant that they were purchasing the right to receive Grams for themselves and without any intent to publicly distribute a statutory security.”





January 15, 2020 Telegram Rule 56.1 Statement In Support Of Their Motion For Summary Judgment (Found Here)

Not surprisingly, Telegram and the SEC present dramatically differing viewpoints regarding Telegram's cooperation with the SEC, which becomes particularly acute after reading Telegram's Rule 56.1 Statement. What also becomes clear is that Telegram is employing a flawed "cooperation credit" strategy, which ends up damaging its credibility.

For instance, the SEC’s filings contain various examples evidencing Telegram’s lack of trustworthiness and candor, including Telegram’s conducting their offering in the midst of working with the SEC as to its structure, and Telegram’s refusal to allow their longstanding U.S. law firm accept service of an SEC subpoena. (Perhaps Telegram’s fallback litigation defense plan was to evade service of process like some sort of deadbeat spouse . . . (Counsel’s Letter refusing acceptance of service found here.))

Yet Telegram’s Rule 56.1 Statement paints a rosy picture of harmonious negotiation and collaboration between Telegram and the SEC and a combination of surprise, disappointment and shock that the SEC filed its TRO:

“On February 2, 2018, the SEC sent a letter to "Telegram LLC," which stated that "The staff of the Securities and Exchange Commission is conducting an investigation in the matter identified above and requests that your client, Telegram LLC (`Telegram'), voluntarily produce to the staff' a number of categories of documents. Both sides agreed to the scope of Telegram's voluntary production of documents, and over the next 18 months, Telegram engaged in good faith and voluntary discussions with the SEC in order to explain the details of its project and to obtain guidance regarding the potential application of the federal securities laws. Defenses ¶ 36. 284. Between February 2018 and the commencement of this litigation, Telegram voluntarily: (i) provided productions of thousands of pages of messages and communications with U.S. purchasers; (ii) submitted a detailed legal memorandum on June 26, 2018, regarding its securities analysis of Grams, along with four supplemental memoranda dated November 28, 2018, February 27, 2019, March 18, 2019, and July 25, 2019; (iii) participated in three in-person presentations to the SEC, during which it answered hundreds of questions regarding the Blockchain, the TON Foundation, Grams and related matters; and (iv) engaged in regular email and telephone discussions with the SEC and promptly answered questions and provided additional information regarding a wide range of topics relating to the above.”

Telegram goes on in their Rule 56.1 Statement to chronicle 40 instances of Telegram’s emails, conference calls and document productions between February 6, 2018 (Telegram’s first production of documents to the SEC) and October 11, 2019 (the date of the SEC’s TRO filing) – all in an effort to convince the court of their cooperative efforts (Telegram’s Rule 56.1 Statement found here).

There does exist some, albeit unusual, evidence of a working relationship between the SEC and Telegram, but it appears de minimis. For instance, at one point, Telegram’s counsel accidentally sent a production of documents to the SEC that contained documents protected by the attorney-client privilege or work product doctrine. The SEC quickly noticed the confidential nature of the production, and in the spirit of fair play and perhaps a little “there but for the grace of God go I,” returned the documents to Telegram's counsel forthwith. (Mistaken production email chain found here.)

However, Telegram fails to mention that the SEC enforcement division contacted Telegram as early as February 8, 2018 -- only after the SEC had already reached out to potential Grams purchasers and tried to identify Telegram’s counsel. At that point, Telegram’s counsel emailed and called an SEC staff member to discuss the SEC enforcement division’s “interest in . . . Telegram.” Though Telegram argues that it attempted to receive SEC guidance and feedback on the TON Blockchain, Telegram CEO Pavel Durov actually admits in his deposition to not doing so before Telegram made its first sales to investors.

Furthermore, Telegram’s experience is not very different from any other company engaged in discussions with, or under investigation by, the SEC. Both the SEC’s corporate finance and enforcement processes process can be long, drawn out and replete with submissions, emails, calls, meetings, etc. – and cooperative efforts during that time are typically not a defense to unlawful conduct.

Moreover, per the SEC, and as most SEC defense lawyers will attest, merely engaging with the SEC in discussions about an offering or other regulatory event (especially with the SEC enforcement division) does not somehow preclude or “estop” the SEC enforcement division from filing a civil action at any time.

Predictions

The SEC’s strategy versus Telegram is clearly one of Shock and Awe - and it worked.

The SEC’s impressive and voluminous set of filings, affidavits, emails and broad swath of inculpatory (and oft times astonishing) evidence coupled with a myriad of thoughtful, precise and powerful arguments, presents a well-ordered and compelling case that Telegram's token sale was merely a substitute for a traditional, run-of-the-mill equity financing.

Meanwhile, the Telegram summary judgment motion is far less convincing, and while presenting perhaps a legitimate contention that there exist enough disputed facts to reject summary judgment, is a far cry from even being barely probative.

To me, Telegram’s filings come off as a whiny dissertation of irrelevant, anecdotal and unpersuasive grievances, including:

Deriding the vagaries of the SEC definition of a security (which is historically flexible so as to be “capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.”) Indeed, by emphasizing elasticity in the regulation of securities, Congress and the Supreme Court intentionally anticipated/contemplated that issuers would devise new investment vehicles to raise funds from the public;

Mocking the unfairness of the SEC’s mixed bag of crypto-related regulatory pronouncements (which quite to the contrary, have been exhaustive, comprehensive, transparent, consistent and steadfast.) Indeed, the SEC has gone the extra mile in publicizing its position concerning digital token offerings; and

Falling back on that old SEC defense lawyer "go-to" of the unfairness of “regulation through enforcement” (which is actually the means by which much of securities regulation is developed and crystallized.) Indeed, Howey and its progeny provide clear, explicit standards that courts have applied to SEC enforcement actions for decades, from investments in eel farms and ostrich breeding to wholly bogus prime bank securities and digital coin offerings.

The least compelling sections of Telegram’s brief are the multiple times Telegram carps about the SEC’s cryptocurrency position. Here is one example:

“SEC officials and its Strategic Hub for Innovation and Financial Technology made public statements regarding whether a given digital asset should be considered a “security.” These statements were often vague, sometimes indecipherable, and offered no meaningful insight into the SEC’s position regarding the questions addressed.”

This “vagueness” argument, oft repeated and celebrated by crypto-believers on the lecture circuit, is a red herring. With respect to digital tokens and digital assets, never in its 87-year history has the SEC taken such drastic measures to make their views known.

For example, the SEC has used multiple distribution channels to share its message and concerns regarding cryptocurrencies, digital trading platforms, initial coin offerings, etc. The SEC has publicized their position through countless enforcement actions, multiple speeches, a series of Investor Alerts, a rare Section 21(a) Report of Investigation, Congressional testimony and several official SEC Statements and proclamations. To claim a lack of clarity and meaning amid such a concerted SEC effort for transparency, notice and candor seems sorely misguided to say the least.

SEC Chairman Jay Clayton has also engaged in a massive multi-year crypto-tour, always speaking bluntly and thoughtfully about the need for digital token offerings to be registered and the many misconceptions in the digital asset marketplace. Speaking at a legal gathering two years ago in January of 2018, almost exactly the same time that the SEC enforcement staff began their investigation of Telegram, Chairman Clayton even went so far as to admonish the lawyers counseling clients engaged in digital coin and token offerings.

My take is that the SEC will prevail on their most recent motions or, perhaps because of disputed facts, will prevail at trial. No matter how Telegram cleverly pivots in their papers, Telegram cannot escape the reality of what it was doing, i.e. raising money to build a platform that would create value and profits for their investors. Nothing in Telegram's sizable filings adequately counters the SEC position that much like a stock certificate, a Gram represents an asset that looks, sounds and acts like an investment contract – not a currency or a commodity.

In other words (and to return to my fintech zoo-related bedtime story of the introduction), if it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck.

*John Reed Stark is president of John Reed Stark Consulting LLC, a data breach response and digital compliance firm. Formerly, Mr. Stark served for almost 20 years in the Enforcement Division of the U.S. Securities and Exchange Commission, the last 11 of which as Chief of its Office of Internet Enforcement. He currently teaches a cyber-law course as a Senior Lecturing Fellow at Duke Law School. Mr. Stark also worked for 15 years as an Adjunct Professor of Law at the Georgetown University Law Center, where he taught several courses on the juxtaposition of law, technology and crime, and for five years as managing director of global data breach response firm, Stroz Friedberg, including three years heading its Washington, D.C. office. Mr. Stark is the author of "The Cybersecurity Due Diligence Handbook."