SEC v. Telegram Grp. Inc. - 448 F. Supp. 3d 352 (S.D.N.Y. 2020)

Rule:

Section 2(a)(1) of the Securities Act defines a "security" to include an "investment contract" as well as investment vehicles such as stocks and bonds. Known as the Howey test, the Supreme Court defined an "investment contract" as "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." The enterprise and the described materials, by the very nature of the operation of the securities laws, must be examined as of the time that the transaction took place, together with the knowledge and the objective intentions and expectations of the parties at that time.

Facts:

The Securities and Exchange Commission ("SEC") sought to enjoin Telegram Group Inc. and TON Issuer Inc. (collectively "Telegram") from engaging in a plan to distribute "Grams," a new cryptocurrency, in what it considers to be an unregistered offering of securities. In early 2018, Telegram received $1.7 billion from 175 sophisticated entities and high net-worth individuals in exchange for a promise to deliver 2.9 billion Grams. Telegram contended that the agreements to sell the 2.9 billion Grams are lawful private placements of securities covered by an exemption from the registration requirement. In Telegram's view, only the agreements with the individual purchasers were securities. Currently, the Grams will not be delivered to these purchasers until the launch of Telegram's new blockchain, the Telegram Open Network ("TON") Blockchain. Telegram viewed the anticipated resales of Grams by the 175 purchasers into a secondary public market via the TON Blockchain as wholly-unrelated transactions and argues they would not be the offering of securities. For the SEC, however, the 175 initial purchasers were  "underwriters" who, unless Telegram is enjoined from providing them Grams, will soon engage in a distribution of Grams in the public market, whose participants would have been deprived of the information that a registration statement would reveal.

Issue:

Was SEC able to show a substantial likelihood of success in proving that Telegram’s present plan to distribute Grams was an offering of securities under the Howey test?

Answer:

Yes.

Conclusion:

SEC was able to show a substantial likelihood of success in proving that the contracts and understandings at issue, including the sale of 2.9 billion Grams to 175 purchasers in exchange for $1.7 billion, are part of a larger scheme to distribute those Grams into a secondary public market, which would be supported by Telegram's ongoing efforts. Considering the economic realities under the Howey test, in the context of that scheme, the resale of Grams into the secondary public market would be an integral part of the sale of securities without a required registration statement. Telegram knew and understood that reasonable purchasers would not be willing to pay $1.7 billion to acquire Grams merely as a means of storing or transferring value. Instead, Telegram developed a scheme to maximize the amount initial purchasers would be willing to pay Telegram by creating a structure to allow these purchasers to maximize the value they receive upon resale in the public markets. As part of its Howey analysis, the Court found an implicit (though formally disclaimed) intention on the part of Telegram to remain committed to the success of the TON Blockchain post-launch. Indeed, Telegram, as a matter of fact rather than legal obligation, will be the guiding force behind the TON Blockchain for the immediate post-launch period while the 175 purchasers unload their Grams into the secondary market. As such, the initial 175 purchasers possess a reasonable expectation of profit based upon the efforts of Telegram because these purchasers expect to reap whopping gains from the resale of Grams in the immediate post-launch period. Under the Howey test, the series of contracts and understandings centered on Grams are a security within the meaning of the Securities Act of 1933.