Telegram Loses Latest Round With the SEC; Kik Begins the Next Round
Instant messaging giant Telegram and the U.S. Securities and Exchange Commission (SEC) have just finished another round in their court fight, with the judge declaring the SEC the winner. Meanwhile, Kik continued its battle against the SEC, denying the accusations the regulator raised against it.
Both cases could offer a glimpse into the future of how cryptoassets are regulated, at least in the U.S. A tightening of regulatory control over tokens could make for major changes in the industry.
U.S. District Judge P. Kevin Castel, of the Southern District of New York, said on Tuesday that the regulator has proven the likelihood of Telegram's digital tokens, Grams, being sold as unregistered securities.
To be more precise, Castel concluded in his 44-page opinion and order that “[t]he Court finds that the SEC has shown 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 [USD] 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.”
As a short recap of the case so far, Telegram had to push back the launch of its much-anticipated TON network and its digital token Gram, as the regulator issued an injunction against the company in October 2019. The app provider argues that its Gram token sale should be allowed to move forward, while the SEC is working hard to further block its USD 1.7 billion project. On its part, the Commission argues that Gram is a security and should be regulated like any other stock, bond, or similarly traded asset, and it charges Telegram with violating investor protection laws.
The judge says that, "considering the economic realities under the Howey test, the Court finds that, 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." This means that the token issuance would be violating the U.S. securities laws.
The judge further stated that the company knew that "reasonable purchasers" wouldn't want to pay USD 1.7 billion to get Grams tokens just as a means of storing or transferring value. "Instead," writes Castel, "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."
Telegram stated previously that it would not be in control over the new TON blockchain and would step back, which the judge doesn't seem to believe would happen. The Court finds that there's an implicit, even if formally disclaimed intention by 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 blockchain "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," Castel writes.
All this said, the Court finds that there's "a near-certain risk of a future harm, namely the completion of a public distribution of a security without a registration statement." Therefore, an injunction that prohibits the delivery of Grams to the Initial Purchasers and thereby preventing the "culmination of this ongoing violation, is appropriate and will be granted."
It's important to note that it is a preliminary injunction, not a final judgement.
Lawyers weigh in:
Kik v. SEC
Meanwhile, Kik Interactive filed a motion for summary judgement in the case the SEC brought against it. As reported, in September 2019, the operator of KIN coin decided to shut down its Kik messaging app over the regulatory pressure. In January that year, their battle with the SEC started, with the regulator claiming that Kik's USD 100-million ICO could be seen as unregistered securities.
Kik argues that the SEC "fails to meet two of Howey’s three requirements: common enterprise and expectation of profits based of the essential managerial efforts of others." This proves, the company says, that its sale of KIN during the token distribution event wasn't an investment contract and that the tokens don't have "the essential properties of a debt or equity security," which further means that there was no securities violation.
Furthermore, says Kik, KIN was "a medium of exchange to be used in a new digital economy, not as an investment opportunity," and that profit was not guaranteed to the buyers - not the price or the liquidity on the secondary market exchanges.
The SEC "seeks to stretch the definition of a “security” under the federal securities laws far beyond the plain language of" the Securities Act, asking the Court " to bless an unprecedented and dramatic expansion of the SEC’s regulatory authority," writes Kik, adding that, therefore, the Court "should decline the SEC’s invitation to ignore well established governing law."