The revolution appears to have ended. Crypto burst on the scene with a “get-off-the-grid” message that appealed to many. The message moved forward with many adopting the new crypto coins. As the revolution moved forward SEC Chairman Clayton invoked Stanley Sporkin’s “gatekeeper theory” to caution professions of their obligations. As more cases were brought the revolution began to morph with at least some claiming the “revolution needs rules,” a startling message for an “off-the-grid” movement.
Now the revolution may be ending. Telegram Group, Inc., perhaps one of the most innovative crypto offerings has agreed to settle with the Commission following months of litigation. The firm consented to the entry of a permanent injunction based on Securities Act Sections 5(a) and 5(c). The company also agreed that for the next three years it will notify the Commission staff before participating in the issuance of any digital assets. In addition, Telegram will pay disgorgement on a joint and several basis with its co-defendant, in the amount of $1,224,000 with credits for amounts that have been returned. The order also imposes a penalty in the amount of $18,500,000. SEC v. Telegram Group Inc., Civil Action No. 19 Civ. 9439 (S.D.N.Y. Filed Oct 11, 2019).
Defendant Telegram Group Inc. is a privately-owned British Islands firm based in Dubai, UAE. Its primary product was Messenger, a private, encrypted messaging application with about 300 million monthly users. Telegram is owned by Dr. Nikolai Durov and his brother, Pavel. Both are Russian citizens. Pavel resides in Nevis where he is also a citizen. Dr. Durov is the Chief Technology Officer of Telegram. The TON Foundation, controlled by the brothers, is a Cayman Islands non-profit, dedicated to promoting and supporting the TON Blockchain.
The Durov brothers launched a version of Telegram Messenger in late 2013. Users of the service were told that it is “free and will always be free”– it will not sell advertisements. More importantly, users were assured that their privacy is taken seriously and that the company would “never give third parties access to your data.” Users can have secret chats since there is “disappearing content” and the use of encrypted data transmitted over multiple servers. The first generation, however, did not have the capability to replace high volume transaction mechanisms like credit cards and fiat currency.
By late 2017 the brothers were prepared to launch the next generation of Telegram. It was touted as capable of operating on decentralized applications at a massive scale. The new iteration, called “Telegram Open Network” or “TON,” was designed to host the next-generation of multi-blockchain systems. Telegram described the system as “always [an] expanding and contracting decentralized supercomputer and value transfer system.” Initial investments were solicited to launch.
Over a three-month, period beginning in January 2018, Telegram entered into Gram Purchase Agreements with Initial Purchasers. The agreements called for TON Issuer Inc., a subsidiary of Telegram, to issue a new cryptocurrency called “Grams.” A new blockchain platform would be launched known as “TON Network.” Investors purchased Grams for delivery following the completion of the TON Blockchain. After completion of that project, investors would be reimbursed less expenses.
The initial offerings were conducted in two phases. Together about 2.9 billion Grams were sold in exchange for $1.7 billion. Over $400 million was raised in the U.S.
Telegram cautioned that the Gram Purchase Agreement is an investment contract. The agreement cautioned U.S. based investors that the offer and sale of the security – referencing the Agreement – was not registered under the Securities Act of 1933 and cannot be transferred absent an effective registration statement. Grams, however, are not securities, according to Telegram. Grams are a currency.
Investors were told that the Grams would appreciate in value over time. This would come not from the ability to exchange them for goods and services which was not existent, but from the build-out of the ecosystem or the TON Network. The series of documents used in connection with the offerings noted that the capital raised from the initial solicitations would be pooled and used over time in connection with the development of the network. Subsequent issuances of Grams would be priced at a premium to those acquired in the initial offerings. Investors had a collective, shared interest in the success of the buildout in view of the potential for the pooled assets to appreciate. The offering materials committed to deliver the Grams and launch the TON Blockchain by no later than October 31, 2019.
In March 2019 Telegram released a beta version of the TON Blockchain. The network was designed to test the functionality of TON and Grams. This test was important to the ultimate delivery of the Grams in the Fall 2019. A critical requirement of the proposed TON Network and Blockchain is numerosity. Widespread distribution and use of Grams across the globe was key to fulfilling the promise of the initial offerings . This was because if only the original Grams purchasers state their holdings, the TON Blockchain would, by definition become centralized. At the time the complaint was filed last fall, Defendants were preparing for the next offering, needed in part, to fund the continued development of the network. The complaint alleges violations of Securities Act Sections 5(a) and 5(c).
The Telegram approach to crypto and its uses may well have been one of the most creative. It was telling that no fraud claim was asserted by the Commission. At the same time, it appears that the revolution may well be at an end.
