Competing motions for summary judgment requesting opposite outcomes were filed last week by the parties in the Securities and Exchange Commission’s enforcement action against Telegram Group Inc. and TON Issuer Inc. 

Previously, the SEC charged that defendants’ offering and sale of “Gram” cryptoassets during the first quarter of 2018 constituted a securities offering that was not appropriately registered, while defendants claimed their first quarter activities constituted the lawful offer and sale of an investment contract that was validly exempt from registration and that contemplated the ultimate delivery of cryptoassets – Grams – when (and if) the relevant blockchain was functional that would be virtual currencies and not securities. (Click here for background regarding the SEC’s enforcement action in the article “Messaging Service Company Denies SEC’s Claim That Sale and Issuance of Cryptocurrency Constitutes Unlawful Security Offering” in the November 17, 2019 edition of Bridging the Week.) 

Both the SEC and defendants sought immediate resolution of the Commission’s enforcement action consistent with their respective views without further judicial proceedings. 

In its brief supporting its motion, the SEC principally claimed that Grams were investment contracts when offered and sold, and would continue to be investment contracts when delivered to its purchasers – even though the SEC did not challenge that the purchasers were lawfully exempt persons in connection with an exempt offering. The SEC rested its argument on its claim that the initial coin offering “was the quintessential transaction where investors funded a company’s growth hoping to profit from its continued efforts and future successes.” The SEC claimed that defendants chose initial investors not because they intended to use their Grams to stake or validate new blocks on Telegram’s proposed blockchain, but because they were institutional investors and funds looking to profit from later resales. The defendants in their papers conceded that they offered and sold investment contracts pursuant to a lawful exemption from registration, but argued that when Grams were to be delivered they would be virtual currencies and not securities and therefore not under the jurisdiction of the SEC. This was because, among other things, at such time, defendants would have no role in maintaining the open-source blockchain that supported Grams. 

Defendants also argued that the SEC’s attention on early purchasers of investment contracts during 2018 was irrelevant. Instead, “[t]he relevant question here is how Defendants are marketing Grams to potential public buyers and what those buyers’ reasonable expectations will be when Grams are issued upon launch of the blockchain” which was anticipated in Fall 2019. According to defendants, Grams were marketed to such persons as a virtual currency.

The SEC’s enforcement action is being heard by a federal court in New York City.

In other legal and regulatory developments regarding cryptoassets:

  • Canadian Regulators Issue Guidance Describing When Entities Facilitating Digital Asset Transactions Implicate Securities Laws: The Canadian Securities Administrators issued guidance indicating that platforms permitting the trading of cryptoassets might implicate securities laws in Canada when the cryptoassets themselves are securities or derivatives or are derivatives based on cryptoassets. Although CSA conceded that some platforms based in Canada or offering services to Canadian persons are not subject to Canadian securities law, it said that platforms that solely provide their users contractual rights or claims to a cryptoasset as opposed to immediately delivering a cryptoasset to its users would be subject to securities legislation. Whether actual delivery has occurred is “fact specific and will depend on the economic realities of the relationship,” said CSA. Among other things, CSA will consider actual delivery to have taken place if after a transaction, the platform immediately transfers ownership, possession and control of a cryptoasset to a user and the user can deal with the cryptoasset freely without any involvement of the platform or an affiliate, and the platform or an affiliate has no security interest or other rights in the cryptoasset, and following immediate delivery, the user has no insolvency, fraud, performance or other risk of the platform.  
  • SEC Warns Consumers: Be Mindful of IEOs (Another Digital Asset Acronym): The SEC issued an advisory to investors warning them that initial offerings of digital assets by exchanges on behalf of companies – commonly known as initial exchange offerings or IEOs – may implicate US securities laws. Among other things, IEOs may be required to be registered and are not (and thus investors may not receive important, mandated disclosures), and the exchanges themselves may have to be registered as a national securities exchanges or as a broker-dealers and are not. Moreover, IEOs may be offered to US persons through overseas online platforms; these cryptoassets and platforms may also be subject to US securities laws, said the SEC.  
  • FCA Designated AML Supervisor of Many UK Digital Asset Activities: The UK Financial Conduct Authority noted that, as a result of new legislation, it is now the overseer of anti-money laundering and counterterrorist financing for certain cryptoasset activities. Businesses engaged in cryptoasset exchange provision, issuing new cryptoassets, or providing custodian wallets must comply with AML requirements as of January 10.  
  • SEC Sues Convicted Criminal for Alleged ICO Scam: The SEC charged Boaz Manor, another individual (Edith Pardo), and associated companies (CG Blockchain, Inc. and BCT Inc. SEZC) with raising US $30 million through an unlawful and fraudulent offering of digital securities – termed “BCT tokens” – from approximately August 2017 through September 2018. The funds were raised from US and non-US persons. The SEC alleged that, in connection with their role in this matter, defendants lied to investors about Mr. Manor’s identity, criminal background and role in the enterprise; Ms. Pardo’s role in the business; the persons involved in the business management team; the use of technology by certain hedge funds; and other matters. The SEC’s lawsuit was filed in a federal court in New Jersey. The SEC seeks an injunction against defendants as well as fines and disgorgement, among other remedies.

My View: As both SEC Chairman Jay Clayton and Director of the SEC’s Division of Corporation Finance, as well as the SEC’s Strategic Hub for Innovation and Financial Technology, have acknowledged, the nature of a cryptoasset can evolve over time. (Click here for background in the article “SEC Staff Outlines Characteristics of Cryptoassets That Could Cause Them to Be Regarded as Securities” in the April 7, 2019 edition of Bridging the Week.) A cryptoasset might be regarded as an investment contract, and thus a security, during one interval in its existence, but evolve over time to be considered a virtual currency at a later stage; ether is an example of such a cryptoasset.

Given the SEC’s Chairman’s and staff’s prior statements, the Commission’s position in its brief supporting its motion for summary judgment in the Telegram case seems disingenuous. Moreover, its assertion that initial investors did not purchase Grams with the ultimate intent to stake their digital coins on a blockchain in order to support an argument that Grams would always be securities seems far-fetched and an incredulous leap in a tortuous climb to support its views.