After months of litigation concerning the distribution of Telegram’s Gram digital currency, the company announced that it is ending its Telegram Open Network blockchain project (TON) and the Gram token at the heart of the controversy.
The move comes on the heels of a legal blow in March, where the U.S. District Court for the Southern District of New York granted a preliminary injunction against Telegram, preventing it from providing Gram tokens to investors.
While not binding in terms of precedent, the injunction was granted on the basis that the U.S. Securities and Exchange Commission (SEC) had shown a substantial likelihood of success in their action—a clear signal that were the case to have been fully litigated, the Court would have likely found that in taking capital from private investors in exchange for the promise of future Gram tokens, it was dealing in unregistered securities in contravention of the U.S.’ securities laws.
Telegram’s argument was that the tokens can’t be considered securities (more on that below) and that while the initial agreements with investors did constitute securities, they qualified for an SEC filing exemption on the basis that they were being offered to private investors, rather than public ones.
SAFTS and the Howey Test
Beyond the other outstanding cases addressing similar topics, the view taken by the Court will have real-life implications on the viability of coin offerings in the U.S., and the viability of the Simple Agreement for Future Tokens (SAFT) structure often used by cryptocurrency companies to raise capital for token development without being caught by securities legislation.
Under the SAFT model, investors agree to provide capital to a budding token company in exchange for the right to the tokens, which are only delivered once the tokens and the network underpinning them is developed.
The reason this structure is preferred is because of the definition of securities. Dealing in securities brings with it a host of obligations to the U.S. SEC. The U.S. Howey test is used by Courts to determine whether a contract or arrangement is a security; most relevant to the SAFT question is whether there is an expectation of profits on the part of the investor and whether the expectation is based solely on the efforts of others. If the answer to those questions is yes, then the arrangement likely constitutes a security.
In theory, the SAFT model allows tokens to escape the boundaries of the Howey test. The initial agreement with investors is a security—but because the agreement is with private investors, as a security it is exempt from the SEC’s filing obligations. It is the tokens themselves that escape classification as securities, because at the time they are exchanged, are already fully developed and so any future ‘profits’ merely come from the normal workings of a supply and demand market, which isn’t enough to satisfy the Howey test.
But the view adopted by the Court in the Telegram case puts the viability of SAFT in jeopardy. The Court viewed the entire process—from the initial investment agreement through to the eventual distribution of the tokens once developed—as a part of the same scheme, which it collectively considered to fall within the definition of securities.
The judgment introduces uncertainty into what was a trusted avenue for developers to raise funds and distribute their tokens without inviting onerous SEC filing obligations. Future entrepreneurs will be wary of proceeding on a SAFT basis, fearing that they will unintentionally be in non-compliance with the SEC’s reporting obligations—which carries with it the potential for fines and even prison time.
Ultimately, the legal issue at the heart of the Telegram case still remains, and the companies in similar positions that were eagerly awaiting its outcome will have to wait before getting an authoritative answer. Software developer Kik finds itself in a similar position as Telegram, and their case with the SEC is still before the Court. Whether or not the Court will follow the same reasoning as in the Telegram case remains to be seen, but the SEC filed a motion for summary judgment this month, apparently emboldened by the outcome in the Telegram case.
Depending on the Court’s decision as to the motion for summary judgment, we may be about to see the Telegram reasoning become precedent.