{"id":14795,"date":"2019-10-13T21:46:19","date_gmt":"2019-10-13T21:46:19","guid":{"rendered":"https:\/\/davidgerard.co.uk\/blockchain\/?p=14795"},"modified":"2019-10-14T10:53:33","modified_gmt":"2019-10-14T10:53:33","slug":"sec-blocks-the-telegram-ico-what-this-means-and-what-happens-now","status":"publish","type":"post","link":"https:\/\/davidgerard.co.uk\/blockchain\/2019\/10\/13\/sec-blocks-the-telegram-ico-what-this-means-and-what-happens-now\/","title":{"rendered":"SEC blocks the Telegram ICO \u2014 what this means, and what happens now"},"content":{"rendered":"

The Telegram Open Network \u2014 and billions of Gram tokens, as its native currency \u2014 was meant to go live by 31 October 2019. But the US Securities and Exchange Commission obtained an emergency action<\/a> on Friday, halting it.<\/p>\n

The SEC is bringing a case against Telegram to shut down TON and Grams entirely, and make Telegram give back the money and pay a fine \u2014 because Telegram’s whole scheme was to skin precisely the retail buyers who securities registration is meant to protect from being ripped off.<\/p>\n

… the TON Blockchain was designed from inception<\/i> to require the Initial Purchasers to immediately distribute their holdings to the public.<\/p>\n

… This distribution is to be accomplished without furnishing ultimate purchasers the information about Telegram and Grams required in a registration statement.<\/p><\/blockquote>\n

The SEC action came as a complete surprise to me \u2014 I expected all Telegram’s problems to be compliance with money-laundering laws.<\/a><\/p>\n

But then, this order against Telegram appears to be the context for Friday’s joint announcement on crypto and money laundering<\/a> by the SEC, the CFTC and FinCEN.<\/a><\/p>\n

I was also surprised the SEC took so long \u2014 the facts haven’t changed since early 2018. But the Commission’s been investigating thoroughly, and talking to Telegram and to a pile of the investors who bought in.<\/p>\n

And then Telegram refused to accept a subpoena!<\/a> This is an excellent way to get the SEC’s full attention, an emergency order and a suit.<\/p>\n

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What this means right now<\/h3>\n

The Telegram Open Network is probably dead.<\/b> The emergency order stops Telegram from “delivering Grams to any persons, or taking any other steps to effect any unregistered offer or sale of Grams.” This is worldwide \u2014 not just for the US.<\/p>\n

SAFTs are dead.<\/b> In a “Simple Agreement for Future Tokens,” you don’t get the tokens until the network launches. It was proposed as a way to do an ICO<\/a> such that the token futures were the restricted securities \u2014 but the resulting tokens would be freely tradeable as commodities.<\/p>\n

But the SEC only cares whether an offering fits the Howey test<\/a> \u2014 the test for whether an offering is a security in the US. If you issue a token at a discount to investors, then flood the retail market with it so the investors can profit, the token is a security \u2014 even if you haven’t delivered it yet.<\/p>\n

A lot of people thought SAFTs couldn’t work \u2014 that you couldn’t magically transmute a security into a non-security by putting in an extra step and saying “utility token.” The SEC seems to concur.<\/p>\n

(This also kills KodakCoin’s SAFT-based ICO token<\/a> stone dead. Not that it had any life left in it, but anyway.)<\/p>\n

Of course, Telegram could<\/i> win on this in court! So I guess the question is: “do you feel lucky?”<\/p>\n

TON can delay or cancel the launch.<\/b> The sales agreement<\/a> lists “action by any Governmental Authority” under section 9, “Force Majeure,” as an excuse for any “failure or delay.”<\/p>\n

The SEC complaint<\/h3>\n

The complaint<\/a> (PDF) is thirty-one pages. It has the sort of listing of facts and legal rationale that I was surprised not to see in the recent settlement with EOS.<\/a><\/p>\n

The SEC investigated thoroughly, and spoke to both Telegram and multiple investors in Grams. The complaint’s riveting just as journalism \u2014 though the SEC has rather greater powers of fact-finding than most journalists.<\/p>\n

The Telegram Open Network<\/h3>\n

Telegram had been planning something like Grams for quite some time. Pavel and Nikolai Durov liked the idea of a cryptocurrency \u2014 but existing cryptos were too slow and inefficient to use as a currency in Messenger.<\/p>\n

Telegram announced the Telegram Open Network (TON) in late 2017 \u2014 “designed to host a new generation of cryptocurrencies and decentralized applications, at a massive scale.”<\/p>\n

Telegram, and particularly Pavel Durov himself, solicited investments to build this network \u2014 in the heat of the ICO frenzy,<\/a> at the peak of the 2017 Bitcoin bubble.<\/p>\n

Telegram sold Grams from January through to March 2018, accepting euros and US dollars. They sold 2.3 billion Grams at $0.37 each in phase 1, and 639 million Grams at $1.33 each in phase 2, taking $850 million in each phase.<\/p>\n

Not all the money would be spent building TON \u2014 Telegram had said that they would spend $520 million of the takings on Telegram Messenger’s operational expenses between 2019 and 2021. As of 31 January 2019, Telegram had spent $218 million on TON development and Telegram expenses.<\/p>\n

Grams as securities<\/h3>\n

The Howey test<\/a> is simple, straightforward and broad \u2014 “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.”<\/p>\n

The SEC’s argument that the Grams themselves are securities is that “the Initial Purchasers and subsequent investors expect to profit from Telegram\u2019s work.”<\/p>\n

Telegram repeatedly emphasised their own role, and the expertise of Pavel and Nikolai Durov, in making money for the initial purchasers.<\/p>\n

If Telegram builds the promised functionality, the investors who bought billions of Grams cheap will profit:<\/p>\n

… they will be able to resell billions of Grams on the open market to the investing public. Telegram and\/or its affiliates will facilitate these sales on digital-asset trading platforms. Once these resales occur, Telegram will have completed its unregistered offering with billions of Grams trading on multiple platforms to a dispersed group of investors.<\/p><\/blockquote>\n

Telegram sold the tokens to accredited investors<\/a>\u00a0\u2014 i.e.,<\/i> rich enough to know better \u2014 and duly filed exemptions from registration as a security, as restricted offerings under Regulation D section 506(c).<\/a> This is fine.<\/p>\n

But it’s one thing to run a restricted offering to a hundred or so accredited investors \u2014 it’s quite another to disperse what you sold to any number of non-accredited retail buyers, so that the investors can profit:<\/p>\n

Defendants essentially seek to obtain the benefits of a registered public offering without assuming the disclosure responsibilities and legal strictures designed to protect the investing public.<\/p><\/blockquote>\n

Listing Grams on exchanges \u2014 to skin the retail suckers<\/h3>\n

You may remember that puzzling September blog post from Coinbase,<\/a> listing all the *cough* <\/i>minor altcoins<\/i><\/a> that they’re looking to list. Who cares about all these near-dead altcoins, anyway?<\/p>\n

It turns out it was a push by the crypto venture capitalists who bought large piles of the coins cheap \u2014 because they’d really like<\/i> to offload their coins onto retail suckers.<\/p>\n

That is \u2014 Telegram, working with the initial purchasers of Grams, set out to skin the retail buyers that securities registration is intended to protect. This sort of scam is precisely why securities registration exists.<\/p>\n

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Coinbase is exploring listing all of these assets. The vast majority of them are VC chains that will very likely crash in value immediately after being listed. Some VCs already wrote off these investments. Coinbase is basically considering facilitating a retail dump \ud83d\udc4f\ud83c\udffb\ud83d\udc4f\ud83c\udffb\ud83d\udc4f\ud83c\udffb pic.twitter.com\/fVMqPMBUhP<\/a><\/p>\n

— Larry Cermak (@lawmaster) September 19, 2019<\/a><\/p><\/blockquote>\n