By Rodney F. Tonkovic, J.D.
Accusing the SEC of "regulation by enforcement," Telegram Group Inc. has filed an answer in the Southern District of New York denying all charges related to an alleged unregistered digital token offering. The Commission filed an emergency action and obtained a temporary restraining order against the company on October 11, 2019, asserting that the digital tokens were securities being sold in violation of the registration provisions of the Securities Act. The answer asserts that the Commission has failed to provide clear guidance and is operating in an ad hoc manner that contradicts precedent and public statements by SEC officials (SEC v. Telegram Group Inc., November 12, 2019).
Grams. Telegram Group Inc. and its wholly owned subsidiary TON Issuer Inc. (collectively, "Telegram") own and operate a mobile messaging app called Telegram Messenger. In January 2018, Telegram began to raise capital to launch a blockchain called the "Telegram Open Network" or "TON" which would "host a new generation of cryptocurrencies and decentralized applications, at a massive scale." Telegram raised $1.7 billion from 171 initial purchasers via agreements for the purchase of digital-asset securities called "Grams," which would be created upon the launch of TON. Before the restraining order, Telegram had committed to deliver the Grams to purchasers in conjunction with TON's launch on October 31, 2019. Upon delivery, purchasers would then be able to resell the Grams on the open market.
SEC says it's a security. Accusing Telegram of avoiding the securities laws by labelling its product as a currency, the Commission alleged that Grams are securities and were being sold in violation of the registration provisions of Sections 5(a) and 5(c). In addition to the temporary order halting the resale of Grams, the Commission seeks permanent injunctions, disgorgement with prejudgment interest, and civil penalties.
Lack of guidance. In its answer to the complaint, Telegram denied each and every allegation in the complaint, even those "contained in all headings, titles, captions, footnotes or charts." The company did admit some uncontested details, such as the fact that it did not file any registration statement because "none was, is or will be required." Grams are a currency, not securities, Telegram emphatically stated.
Telegram asserts that its private placement to highly sophisticated, accredited investors was conducted pursuant to valid exemptions to registration under Regulations D and S. The crux of Telegram’s defense is that it was not provided sufficient notice that its actions would violate the Securities Act. According to Telegram, based on public comments by SEC officials, it believed in good faith that its private placement was in compliance. For example, Chairman Clayton has stated that it is possible to conduct an ICO without triggering the registration requirements. But, there has been no formal rulemaking, interpretation, or other action from which developers like Telegram can glean guidance.
As a result, the Commission's enforcement to date has been arbitrary, Telegram says. Here, the answer quotes a Congressman who accused the Commission of "regulation by enforcement" rather than by clear guidelines, an approach which was also been criticized by Commissioner Peirce. The company also points out that Bitcoin and Ethereum are presumed not to be securities while similar cryptocurrencies are deemed to be securities. Telegram also attempted to receive guidance and feedback directly from the Commission and voluntarily produced documents and engaged in discussions. Instead of working out any issues, the answer implies, the Commission instead initiated its enforcement action.
In addition to these defenses, Telegram maintains that the Commission lacks extraterritorial authority over any transactions between it and foreign purchasers. In addition, the company states that it is not subject to the jurisdiction of the court. Telegram asks that the claims be dismissed in their entirety and with prejudice.
The case is No. 19 Civ. 9439.