On October 11, 2019 the U.S. Securities and Exchange Commission (SEC) filed an emergency action in the United States District Court for the Southern District of New York, and obtained a temporary restraining order against Telegram Group Inc. and its wholly-owned subsidiary, TON Issuer Inc. According to the SEC’s complaint,[1] the two offshore entities were conducting an unregistered offering of securities in the form of digital tokens in the U.S. and overseas that has raised more than $1.7 billion to finance the companies’ business, including the development of their own blockchain—the “Telegram Open Network” or “TON Blockchain”—and the popular mobile messaging application Telegram Messenger. In addition to the temporary relief already obtained, the SEC seeks, among other relief, an order preliminarily and permanently enjoining defendants from engaging in the conduct alleged, directing defendants to disgorge their ill-gotten gains, with interest, and imposing civil money penalties.

Beginning in January 2018, Telegram used the Simple Agreement for Future Tokens (SAFT) structure to sell approximately 2.9 billion of their digital tokens—called “Grams”—at discounted prices to 171 initial purchasers worldwide, including more than 1 billion Grams to 39 U.S. purchasers. The SEC contends that Grams are securities, and that Telegram failed to register the securities, in violation of the Securities Act of 1933.[2] Moreover, at the time of the sales, Telegram promised to deliver the Grams to the initial purchasers no later than October 31, 2019, following which time both the purchasers and Telegram would have been able to sell billions of Grams in U.S. and foreign markets. Should that happen, the SEC asserted, “it will be virtually impossible to unwind the Offering, given that many purchasers’ identities will be shrouded in secrecy, and given the variety of unregulated markets where Grams may be sold.” As a result, the SEC pursued the action to “prevent Telegram from flooding the U.S. markets with digital tokens” that the SEC alleges were unlawfully sold.

On October 16, 2019, defendants filed their response[3] to the SEC’s emergency application for a preliminary injunction. Telegram contends that there is no need for a preliminary injunction. Telegram asserts that it has “voluntarily engaged with, and solicited feedback from, the SEC regarding the development and planned launch of its decentralized blockchain platform … and Grams” over the past eighteen months, including the production of thousands of pages of documents, submission of multiple detailed memoranda, participation in in-person presentations, engaging in regular email and telephone discussions, and making modifications to the TON Blockchain to address the SEC’s concerns. Telegram argues that the SEC never requested any delay in the launch, and never advised Telegram that it intended to seek an injunction. Thus, Telegram contends, any emergency is one of the SEC’s own making. In any event, Telegram argues, it has “agreed to stipulate that it will not make any offer, sales or deliveries of its expected cryptocurrency … in order to maintain the status quo until [the] Court can resolve the legal issues at the heart of the matter.” To that end, Telegram argues that the SEC’s theory that Grams are a security is “fundamentally flawed” because Telegram engaged in a private placement pursuant to valid exemptions to registration under the Securities Act of 1933, and the Grams themselves are a currency or commodity—not a security. According to Telegram, the SEC has refused such a stipulation, opting instead to insist that Telegram consent to the entry of a preliminary injunction and proceed with expedited discovery.

Outside of the legal action, Telegram has responded by telling its investors that Telegram will delay launch of the TON blockchain, moving the deadline to April 30, 2020. Since the original investment agreement had Telegram delivering Grams prior to October 31, 2019, investors apparently will have the option to either agree to the amended terms or receive from Telegram a refund on a portion of their investment.

The case against Telegram is the latest example of the SEC’s aggressive enforcement actions against digital token offerings since issuing the DAO Report. In June 2019, the SEC filed a similar complaint[4] against Kik Interactive Inc. for selling $100 million worth of their “Kin” tokens to the public. After filing a biting 117-page answer[5] in August 2019, Kik announced on September 24, 2019 that it would shut down its core messaging app and reduce staff to 19. These actions would help Kik reduce operating costs and position them to have enough capital to both develop their Kin ecosystem and litigate their case against the SEC. Additionally, on September 30, 2019, the SEC settled another token offering case with Block.One which had the company pay $24 million in total penalties but avoided having to register their ERC-20 token to be registered as a security.[6]