Breaking Down the SEC’s Emergency Order Against Telegram (TON) [Full Analysis of the Entire Court Filing]
As noted in their previous post outlining the fundamentals of the press release by the SEC, the actual pdf for the order, which was submitted by the SEC to the Manhattan Supreme Court today can be found here:
In this follow-up to the original story detailing the order against Telegram, we’re going to conduct a thorough analysis of all information contained within the SEC’s order against Telegram.
Reason for the Emergency Action
According to the filing by the SEC, they have credible reason to believe that Telegram will be launching their token (i.e., distributing it to the initial buyers of their token sale), relatively soon — citing October 31st, 2019, as the date given by Telegram for when investors in the token sale would receive their tokens.
This seems to be corroborated by articles that were published this month by numerous outlets, such as CoinDesk:
Of course, the post referenced in the excerpt above, also makes it clear that TON was planning on launching in October.
A screenshot of the post is provided below:
Thus, there appears to be more than enough credence to the SEC’s claim that the token was going to be launched imminently.
The Issue the SEC Has With Telegram Moving Forward
In the ‘Summary’ portion of the filing, the SEC states:
“Unless enjoined, Defendants will go forward without filing a registration statement for the Grams as they are required to do under the Securities Act of 1933 (‘Securities Act’). In other words, Defendants plan to sell billions of securities that will quickly come to rest in the hands of U.S. investors without providing those investors important information about their business operations, financial condition, risk factors, and management.”
In relation to the last part of the SEC’s statement, even that seems to be corroborated by public statements about the TON token offering that have been made by various individuals and entities in the cryptosphere.
Below is an example from the most popular and well-respected authority on ICO/IEOs on Telegram:
As noted in that post, there truly are many unanswered questions that prospective investors and spectators have about the overall plan for the TON token.
Which is not to say that there hasn’t been a wealth of information posted in regards to the token (specifically on https://test.ton.org)
Further Claims by the SEC
Moving forward in the court filing, the SEC goes on to state that:
“As of October 11, 2019, Telegram has not filed a registration statement with the SEC for this planned offering of securities.”
“Once Telegram delivers the Grams to the Initial Purchasers, they will be able to resell billions of Grams on the open market to the investing public. Telegram and/or its affiliates will facilitate these sales on digital-asset trading platforms. Once these resales occur, Telegram will have completed its unregistered offering with billions of Grams trading on multiple platforms to a dispersed group of investors.”
The filing goes on to cite Section 5(a) and 5(c) of the Securities Act, which we found, extracted, and posted below for your review:
Request for Telegram to be Permanently Barred From Selling Securities
This part of the filing has the most far-reaching consequences for Telegram (shown below): ‘
As one can see the SEC is asking for Telegram to be permanently restrained and enjoined.
So, despite the temporary and immediate nature of the restraining order, the SEC is using this as a placeholder until they’re able to get a more permanent order against Telegram sustained.
This is made clear in section 12 (1), where the Commission states that they are seeking, “A temporary restraining order and a preliminary injunction against Defendants prohibiting them from participating in any offerings of unregistered securities…including but, not limited to, by distributing Grams to any persons.”
However, as noted in the statement above, these are just the temporary injunctions that the SEC is seeking.
Ultimately, the SEC is seeking a ‘final judgment’:
A) “Permanently enjoining the Defendants from engaging in the acts, practices, and courses of business alleged herein” [herein = the court filing]
B) “Order Defendants to disgorge their ill-gotten gains and to pay prejudgment interest thereon”
C) “Prohibiting Defendants, pursuant to Section 21(d)(5) of the Exchange Act [15 U.S.C. § 78(d)(5)], from participating in an offering of digital securities; and (d) imposing civil money penalties on Defendants pursuant to Section 20(d) of the Securities Act [15 U.S.C § 77t(d)].”
Translating the Above
As you probably got the gist from what’s written above, Telegram may be in some hot shit, but just to summarize:
- This order that you’re seeing today by the SEC is the ‘temporary restraining order and preliminary injunction against Defendants’ (Defendants = Telegram, obviously)
- The purpose of the restraining order is to pretty much stop Telegram in its tracks while the SEC continues their investigation
- Ultimately, the SEC is looking for a permanent injunction against Telegram, which means that:
- They want to bar Telegram from any future token sales
- Force Telegram to “disgorge their ill-gotten gains” ; that means forfeit ALL $1.7 BILLION (that’s what they reference earlier in the filing as ‘ill-gotten’, specifically)
- impose civil money penalties on top of the forfeiture of said gains
The Court Filing Names Pavel Durov, Nikolai Durov, and the TON Foundation
The filing specifically names Pavel Durov, Nikolai Durov, and the TON Foundation.
Both Pavel Durov and Dr. Nikolai Durov (both Russian citizens), are the co-founders, CEOs, and figureheads at the top of the messenger app, Telegram.
As noted by the SEC in the court filing, Telegram is, by far, the most popular messaging application for the cryptocurrency/blockchain community.
Below are some screenshots from the court filing in reference to the information provided above:
Skipping Through a Few Parts
From this point, there are a few parts in the intermediate that do not necessarily need to be included in this write-up.
For the most part, we’re just going to skip past:
- Background information about Telegram (who created it, when, why & what communities it serves)
- What a ‘digital asset’ is
- How ‘ICOs’ work
- The framework of the Securities laws that the SEC alleges Telegram breached with the TON token
Let’s move forward to #45 on the court filing, where the SEC provides more information about the offering as well as some of the deficiencies that led them to summarily declare the entire token sale, illegal.
Qualms that the SEC Had with TON (and Other Relevant Information)
Details of the Token Sale
- Round One purchasers paid $0.37 / Gram
- Round Two purchasers paid $1.33 / Gram
- ‘Reference Price of Grams at launch was supposed to be $3.62
- The token sale began in early 2018 (January, specifically)
- Telegram sold approximately 2.3 billion Grams in the first phase
- From the 2.3 billion Grams sold in ‘Round One’, Telegram raised $850 million
- Telegram sold another 639 million Grams in the second phase
- From the 639 million Grams sold in ‘Round Two’, Telegram raised another $850 million
- In total, 2.9 billion Grams were sold
- According to the SEC, more than 1 billion of the 2.9 billion Grams sold (total) were to U.S. investors, totaling $424.5 million / $1.7 billion total that Telegram raised
Qualms That the SEC Had With Telegram Regarding Their Disclosures
In paragraph #46–48, the SEC alleges that:
- Telegram did not prepare or file any registration statement for the Grams that it offered or sold, “intends to offer or sell in the Offering”
- Telegram’s Gram Purchase Agreements, ‘did not contain information about Telegram’s financial history or ability to generate profits’
- “Purchasers who may buy or receive Grams will not receive any document containing information about Defendants’ [Telegram] operations, financial condition, or other factors relevant in considering whether to invest in Grams.”
- “Nor will they receive information about how the Durovs are being compensated as a result of the Offering.”
- “Because Telegram did not register the Offering, investors in Grams will be deprived of material information relating to their investment. “
- “Defendants essentially seek to obtain the benefits of a registered public offering without assuming the disclosure responsibilities and legal structures designed to protect the investing public.”
- “Telegram has taken the position that the Gram Purchase Agreements were investment contracts, i.e., securities, and placed a restrictive legend on the Gram Purchase Agreements.”
- “The legend warned United States residents that ‘the offer and sale of this security has not been registered under the U.S. Securities Act of 1933’ and ‘may not be offered, sold or otherwise transferred…except pursuant to an effective registration statements.’”
- “Telegram, however, claimed that Grams, the heart of the Gram Purchase Agreements, without which the agreements have no value or purpose, were not securities but rather currency.”
- “Telegram thus placed no restrictive legends on any Grams, nor were purchasers advised that they may not sell Grams in the United States absent a registration statement.”
- “Purchasers of Grams are not restricted from selling them to others, other than as provided for by certain contractual lockups placed on some Grams sold to Initial Purchasers.”
The SEC goes on to claims that Grams, by themselves, constitute ‘investment contracts’.
The SEC also notes that the Round One purchasers were subject to a smart contract enforced ‘lock-up period’ that limited the amount of Gram tokens that could be sold to ‘tranches’, which subsequent Round Two purchasers were not subject to.
This was followed up by the denial of the idea that Grams were a currency with the SEC’s statement that, “Grams are not a currency because they have no realistic currency uses at this time.”
SEC Alleges That Funds Raised by Telegram Exceed What They Will Need to Develop the TON Blockchain
In paragraph #55, the SEC states that Telegram stated in their offering documents that the funds raised in their TON token offering would not only be used for the development of the TON Blockchain, but for the Telegram Messenger as well.
Specifically, it is states that Telegram estimated they would spend approximately $520 million of the $1.7 billion raised from the token sale on the Messenger alone “between 2019 and 2021”.
SEC Claims That Some of the Funds Have Been Used Already
According to the SEC in paragraph #56 of the filing:
“As of January 31st, 2019, Defendants had used approximately $218 million of the $1.7 billion raised to support the development of Messenger and the TON Blockchain.”
The filing is careful to note that investors have zero ‘say’ over how the funds raised by Telegram would be spent and that Telegram also possesses ultimate and sole control over decision making as it pertains to the spending of said funds.
SEC Further Claims That Telegram Has Led Investors to Believe That They Will Profit Based on Telegram’s Efforts
In Section ‘C’ of the court filing by the SEC, they elaborate on Telegram’s marketing to prospective investors and how certain statements by the company were designed to entice investors based on the perceived profitability of the token offering.
Below is an excerpt from the court filing, outlining some of the statements that the SEC outlined:
SEC Alleges That Telegram ‘Intentionally Leaked’ Information About the Token Sale
Under the same section (‘C’), as the one covered above, in paragraph #59, the SEC alleges that:
“The Whitepaper, Primers, and Teasers subequently were intentionally leaked as a part of the Offering and currently be found on the Internet.”
The SEC also mentions that they have evidence that Pavel Durov, specifically, had sent information about the token sale to individuals in the United States in both California and New York, specifically (among others).
They also state that Pavel, “marketed the sale of Grams himself, using business and other contacts to solicit investments and spread the word about the impending Offering.”
SEC Knew About Telegram’s Conversations With Exchanges As Well
In paragraph #79, the SEC states that, “Telegram itself is currently in conversations with at least four digital-asset trading platforms, some of which are U.S.-based, to discuss listing Grams on their platforms.”
This seems to be corroborated by Coinbase’s recent announcement that it would be providing custody for Telegram’s token in anticipation of the token’s release this month (October 2019):
Today we’re announcing support for the secure storage of GRM, SOL & OXT from each network’s respective launch. We have a track record of providing seamless custody solutions at launch as both the first & largest custodian for both Blockstack & Algorand.https://t.co/LwNzh5NVl4
— Coinbase Custody (@CoinbaseCustody) October 9, 2019
Before the tweet above (which came just two days before the SEC’s emergency order), Coinbase had indicated interest in adding Telegram’s token to their exchange (curiously, well before the announced launch of said token), back on September 19th, 2019:
SEC Claims That Telegram Had a Pump and Dump Planned
In paragraph #87 of the filing, the SEC states:
“Under Telegram’s Formula, Defendants would price the first Gram at $0.10, and every subsequent Gram at an amount one-billionth higher than the prior sales price. As such, Telegram designed the price of Grams to increase ‘exponential[ly].’ Indeed, Telegram sold Grams to Initial Purchasers at a deep discount to an expected market price of $3.62 at launch.”
The figure shown in paragraph #89 drills the point home on this as well:
SEC Outlines How Telegram Would Have Held Unilateral Control of the Telegram Token’s Development
In paragraph #92, the SEC notes that the, “Telegram development team is also needed to complete the TON Blockchain to allow Grams to achieve the value Telegram touted in the Offering Documents.”
It is alleged that the ‘Whitepaper’ also made it clear that the Defendants would “remain in control of the development of the TON Blockchain”, also noting that the TON Blockchain team would have enough votes to ensure that decisions (particularly development ones) would have to go in the direction of Telegram’s choosing.
Why This Part is Important
This is essentially the SEC subtly claiming that Telegram is a largely centralized blockchain, given the fact that its development would be (and was planned to be) entirely contingent on the Telegram Blockchain dev team.
Obviously, with such unilateral control, it is hard to argue that a blockchain structure is anywhere near decentralized or distributed — and it certainly is not trustless.
SEC Claims the Tokens Had ‘No Significant Use’ Other Than ‘Uses Calculated to Increase Investor Profit’
In paragraphs #96 and #97, the SEC makes it clear that there was no apparent use for Telegram’s token beyond ensuring that investors in said token would achieve a profit.
Thus, in that way, the SEC essentially defines Telegram’s token as a ponzi of sorts.
The SEC does acknowledge that Telegram listed a number of future plans and potential implementations for the token, but also that none of these solutions were in place at the time that Telegram was soliciting investment.
Specifically, in paragraph #98, the SEC states:
“The TON ‘ecosystem’ did not exist and does not exist today. There are not now and have never been any products or services that can be purchased with Grams. The TON functionalities as pitched by Telegram were (and remain) entirely dependent on the funds provided by investors. Meanwhile, the principal means by which investors would reasonably expect to profit is through their resale of Grams.”
SEC Continues to Pick Away at the Concept That Telegram’s Blockchain Idea Was Decentralized at All
From paragraph #104 and onward, the SEC makes some cogent points about why the blockchain was far from decentralized, even going as far as to state that, “Telegram engaged in a coordinated, centralized effort to create the Durovs’ vision of a new, scalable blockchain.”
The filing goes on to state that:
- Defendants [Telegram] knew in order to deploy their blockchain, they would have to create some sort of sense of decentralization
- The filing goes on to state that, “The TON Blockchain can only become truly decentralized if Grams holders other than the original Grams purchasers actually stake Grams and, thereby, act as ‘validators’ of transactions on the TON Blockchain.”
- The filing goes further to explicitly state that, “If the original Grams purchasers alone all immediately staked their holdings, the TON Blockchain would be centralized rather than decentralized and, therefore, subject to misuse and majority attacks.”
- The SEC uses the facts above to conclude that, “This fundamental need for additional Grams holders demonstrates that the TON Blockchain was designed fron inception to require the Initial Purchasers to immediately distribute their holdings to the public.”
TON Foundation Would Be Centralized as Well
As noted in paragraph #109, the ‘TON Foundation’ was (or is) to be created by the Durovs, directly. Thus, in addition to holding unilateral control over the blockchain (via majority ‘votes’), they would also hold complete control over the actions of the Foundation as well.
Conclusion (Penalties Sought)
“An Order temporarily and preliminary, and a Final Judgment permanently, restraining and enjoining Defendants, and each of their respective agents, servants, employees, attorneys and other persons in active concert or participation with each of them who receive actual notice of the injunction by personal service or otherwise, from any ongoing and future violations of Sections 5(a) and 5(c) of the Securities Act [15 U.S.C. § 77e(a), 77e(c)], including, but not limited to, by delivering Grams to any persons, or taking any other steps to effect any unregistered offer or sale of Grams.”
“An Order temporarily and preliminarily enjoining and restraining Defendants, and any person or entity acting at their direction or on their behalf, from destroying, altering, concealing or otherwise interfering with the acess of the Commission to relevant documents.”
“An Order providing that the Commission may take expedited discovery; and may effect service of the Complaint and the Order to Show Cause moving papers by alternative means, namely by email service on Defendants’ U.S.-based legal counsel.”
“A Final Judgment directing each of the Defendants to disgorge all ill-gotten gains, including prejudgment interest thereon”
“A Final Judgment prohibiting Defendants from participating in any offering of digital asset securities pursuant to Section 21 (d)(5) of the Exchange Act [15 U.S.C. § 78u(d)(5)]”
“A Final Judgment directing the Defendants to pay civil money penalties pursuant to Section 20(d) of the Securities Act [15 U.S.C. § 77t(d)]”
“Such other and further relief as the Court deems appropriate and necessary for the benefit of investors.”
This was a massive piece put together by ZeroNoncense and we felt it needed to be shared in full to the entire crypto audience and world!