January 17, 2020

SEC to Obtain Telegram Data

2020 got off to a busy start with the U.S. Securities and Exchange Commission (“SEC”) securing an important victory in the ongoing court battle with Telegram Group Inc. (“Telegram”), a popular messaging app which allegedly violated U.S. securities laws by offering a digital asset that was a security without a registration or an exemption from registration with the SEC. As of a January 13 filing, Gram has agreed to supply all bank records to the SEC.

The Battle Commences

The dispute over bank records is the most recent fight between the SEC and Telegram that started in October 2019 when the SEC filed an enforcement action against the company to prevent an alleged unlawful offer and sale of digital assets that are securities. Telegram and its wholly-owned subsidiary TON Issuer raised capital in early 2018 by selling digital tokens called “Grams,” purportedly to finance the development of a blockchain network – the Telegram Open Network (“TON”) – and to fund the continued operation of the company’s Telegram Messenger mobile messaging application. TON was supposed to launch by October 31, 2019.

The SEC alleges Telegram continued to sell its tokens after its private placement had been completed and has stated that those sales undercut the argument that the offer and sale of the tokens were exempt under the Securities Act of 1933. The Grams sold were not designed to provide any equity interest or profit sharing in Telegram. The value of the Grams was to be based on being a network currency on a yet to be released blockchain

Telegram allegedly raised about $1.7 billion by selling 2.9 billion Grams to 171 purchasers worldwide. The SEC claims “[a] large portion of this capital came from U.S. investors: Telegram sold more than 1 billion Grams to 39 U.S. Purchasers, raising $424.5 million from the U.S. market.”

The SEC alleges the sale of Grams violated US securities laws because “the defendants . . . failed to provide investors with information regarding Grams and Telegram’s business operations, financial condition, risk factors and management that securities laws require.” The SEC claims Telegram violated Section 5(a) and 5(c) of the Securities Act by conducting a public offering of securities without a registration or an exemption from registration.

The Next Fight in the Battle

The SEC’s latest motion in the case claims Telegram failed to comply with the SEC’s production request by only providing information on credits related to its bank records, without providing access to debits. The motion requested access to Telegram’s bank records to investigate both debits and credits related to the sale of Grams. Initially, in what turned out to be a temporary setback for the SEC, a New York federal judge blocked the SEC from immediately accessing Telegram’s bank record. The court instead requested that Telegram propose a schedule setting out a review plan covering the bank records requested by the SEC to ensure that any disclosures would comply with data privacy laws. On January 10, the SEC filed additional documents with the court including invoices related to commission requests connected to the sale of Grams.

The court ordered Telegram to provide all requested records by February 26. Telegram wasted no time in acquiescing to the decision and on the same day sent a letter stating that all information will be submitted to the court by January 15. Only time will tell if the documents provided are compliant in the eyes of the SEC and this case is likely to have many more twists and turns in the months ahead.

Telegram has agreed not to offer or sell any more Grams until the conclusion of a hearing scheduled for February 18 and 19 to determine if Grams are securities that are subject to the SEC’s jurisdiction. Telegram has not launched the TON where the Grams are to be used and has indicated the TON network may not be integrated into the popular Telegram Messenger after launch.  Without the connection to the messenger, its millions of users may question the Gram’s value proposition.

The Eye of Sauron is Upon You – SEC to focus on Cryptocurrency and FinTech in 2020

The SEC’s Division of Trading and Markets Office of Compliance Inspections and Examinations (“OCIE”) released its annual examination priorities for 2020. OCIE indicated financial technology (“FinTech”) will be an area of focus this year.

OCIE plans to consider six factors when reviewing digital assets: “(1) investment sustainability, (2) portfolio management and trading practices, (3) safety of client funds and assets, (4) pricing and valuation, (5) effectiveness of compliance programs and controls and (6) supervision of employee outside business activities.”

OCIE examinations do not always lead to SEC investigations and enforcement actions. However, FinTech firms should recognize the examination priorities letter is a clear signal the SEC will continue to monitor blockchain and digital assets in 2020.

I Come From a Land Down Under

The Reserve Bank of Australia (“RBA”) ended 2019 by focusing on Facebook’s Libra payment token. In an official submission before an Australian Senate inquiry into FinTech, the RBA discussed its concerns with FinTech and digital assets. While noting that innovations in payment systems could boost the Australian economy and allow for a movement toward a more substantial digital economy, the RBA raised questions about the stability of a global cryptocurrency. The RBA stated that it did not envision cryptocurrencies like Bitcoin having success in Australia due to their volatile nature. However, on a positive note, the RBA stated that it is “all-in” on the use of stablecoins in Australia.

The RBA indicated that it has been working with Facebook on the regulation of Libra, noting that “Libra has the potential to become widely used given the involvement of various companies such as Facebook that may be able to leverage their large existing user bases and technological capabilities.”

Hope Springs Eternal – Eternal Sunshine of Spotless Minds

Another year and hope springs eternal. In this highly contentious election year, another draft bill is circulating in the U.S. Congress. The principal aim of the Currency Act of 2020 is to divide digital assets in to three categories: crypto-commodities, crypto-securities and cryptocurrencies and for each to have an assigned regulator. Cryptocurrencies would be defined as a “representations of United States currency or synthetic derivatives resting on a blockchain or decentralized cryptographic ledger.” Under such a definition Bitcoin would not be considered a cryptocurrency. The Currency Act follows other proposed and currently languishing proposed legislation, including the Token Taxonomy Act of 2019, which was introduced in April 2019 but did not move beyond referral to the House Financial Services Committee. Unlike the 2020 Act, the Token Taxonomy Act is most known for its attempt to exclude certain digital assists from the purview of the securities laws.