The legal battle between the U.S. SEC and Telegram could be a strong warning against the SAFT process.
Telegram is a popular, global, cloud-based instant messaging,
videotelephone and voice-over service company. Particularly popular with
crypto-enthusiasts, at the end of 2017, Telegram came up with a plan to raise funds
to support the development of a new crypto asset, dubbed Gram, and a
network originally planned as the Telegraph Open Network. Proceeds would
also fund further expansion of the messaging service that had
previously been funded by the founders.
Telegram set out to
fundraise in two distinct stages. The first involved the sale of
contractual rights to acquire Grams if and when they were successfully
launched. The second stage would be to release the Grams themselves.
This process is widely known as the SAFT — an acronym for Simple Agreement for Future Tokens — although the contracts issued by Telegram did not actually use that particular label.
Telegram
was well aware that the contractual rights would be treated as
securities by U.S. regulators, notably the Securities and Exchange
Commission. Because it is illegal to sell securities in the United
States unless those sales are registered with the SEC or exempt from
such registration, those sales were limited to verified accredited
investors in order to comply with one of the available exemptions from
registration. In essence, this meant that only wealthy individuals or
entities were allowed to invest in those contracts. The sale of those
contractual rights occurred in early 2018, raising about $1.7 billion from investors worldwide. A total of 39 of the 171 initial purchasers were in the United States.
With
the proceeds in hand, Telegram promptly set about finalizing the
development of the Grams. In October 2019, just before Telegram was
ready to begin the second phase and launch its Grams, the SEC initiated a complaint in federal court seeking to halt the planned release. A temporary restraining order was issued, and Telegram and the SEC squared off.
Telegram
argued it had complied with the requirements of the U.S. law by
registering the contractual rights and waiting to issue Grams until they
were functional. At that point, the company argued, the Grams would not
be securities. The SEC contended that the entire plan amounted to a
single “scheme” to distribute Grams, which were not registered or exempt
from registration. Under this view, because there was a single scheme,
the original purchasers of the contractual rights would be
“underwriters” acting for Telegram, and thus the entire distribution
would be tainted because the ultimate purchasers would not all qualify
as accredited investors.
On March 24, 2020, in a widely reported decision, Judge Peter Castel ruled
in favor of the SEC. Shortly thereafter, after being told by the judge
that the injunction applied to all sales regardless of where in the
world the original purchasers might be located, Telegram abandoned its
plans and settled with the SEC, agreeing to pay a fine of $18.5 million
to the SEC and to return $1.2 billion — the remaining proceeds from the sale of contractual rights — to the original purchasers.
This
is not the first time the SEC has gone after a crypto-entrepreneur or
objected to the SAFT process. It is not the first time the Commission
has intervened in the absence of any claimed fraud. It is not the first
time the SEC has sought to reach crypto-entrepreneurs operating
primarily overseas.
It is, however, the first time that the SEC
has prevailed on the position that a SAFT (or sale of contractual rights
to acquire a crypto asset when launched) has to be integrated with the
eventual sales or resales of the asset because the original purchasers
are actually underwriters.
The key takeaways from the judge’s decision
The
decision in SEC v. Telegram was reached on a motion for preliminary
judgement, not after a full trial. Nevertheless, because there is no
appeal, the ruling is binding on Telegram and is currently the most
recent indication of how broadly the SEC intends to pursue SAFT
distributions and how courts might react.
When it comes to crypto
sales using the SAFT process, it does not matter what entrepreneurs call
contractual rights. Telegram did not call the contractual rights SAFTs,
but the SEC’s known hostility to the process easily translated to the
arguments the Commission made in the case.
The result in the case
was highly fact-specific, but the SEC clearly has taken the general
position that both phases of a SAFT distribution can constitute a single
offering, especially when the purchasers of the contractual rights have
the immediate power to resell crypto assets that are issued to them.
Merely
deciding to limit initial sales to non-citizens outside the boundaries
of the U.S. is not enough to assure that the SEC will not intervene.
Efforts by Telegram to limit the scope of the preliminary injunction
were unsuccessful, which means that the company was not allowed to
proceed with selling Grams anywhere in the world.
Finally, there
is another case to watch closely. SEC v. Kik is currently being
considered in the same federal district (the Southern District of New
York) but by a different judge. It, too, involves an international
offering of tokens pursuant of the SAFT process, and the judge in that
case has already said that the facts before it are distinguishable from
those in Telegram. Until and unless this case is decided in favor of
Kik, however, the current state of the law stands as a significant
warning to any crypto-entrepreneur contemplating the SAFT process.
This
is part one of a three-part series on the legal case between the U.S.
SEC and Telegram’s claims to be securities — read part two on why this
decision should not be followed in other cases here, and part three on
the decision to apply U.S. requirements extraterritorially here.
The
views, thoughts and opinions expressed here are the author’s alone and
do not necessarily reflect or represent the views and opinions of
Cointelegraph.
The
opinions expressed are the author’s alone and do not necessarily reflect
the views of the University or its affiliates. This article is for
general information purposes and is not intended to be and should not be
taken as legal advice.
source link:https://cointelegraph.com/news/sec-vs-telegram-part-1-key-takeaways-for-now
