Identifying Gram: What Is Going on in Legal Battle Between Telegram and U.S. Financial Watchdog?

News and Analysis

Russian-born entrepreneur and programmer Pavel Durov, who is most famous for the creation of the encrypted chat app Telegram, has been under scrutiny of the United States financial regulators since 2019. That year, the U.S. Securities and Exchange Commission (SEC) turned its attention to Telegram and its wholly-owned subsidiary, TON Issuer.

The regulator accused Telegram of conducting an unregistered initial token offering of Gram (GRM) tokens. Gram is a cryptocurrency based on the blockchain platform Telegram Open Network (TON) and is aimed at serving as the native digital currency for the in-app economy on Telegram for over 400 million users.

American Investors as a Stumbling Point

Through the token sale, Telegram raised $1.7 billion, having sold around 2.9 billion Grams to 171 purchasers. A large part of the capital came from 39 American purchasers, who bought more than 1 billion Grams.

Since Telegram ostensibly intends to capitalize its business and allocate some of the funds for the development of TON, the SEC claims Grams to be securities, not a currency. The SEC claimed in a complaint filed with the U.S. District Court for the Southern District of New York:

“Grams are securities because the Initial Purchasers and subsequent investors expect to profit from Telegram’s work: the development of a TON ‘ecosystem,’ integration with Messenger, and implementation of the new TON Blockchain. Grams are not a currency because, among other things, there are not any products or services that can be purchased with Grams.”

As such, the SEC filed an emergency action and obtained a temporary restraining order against the companies until the dispute is resolved. Telegram disagreed and subsequently filed a notice of appeal.

However, the court appears to be supportive of the financial regulator’s stance as it has ruled that Telegram can’t transfer the cryptocurrency to the investors, which basically means it can’t launch the TON platform, at this point.

The tricky part is that the purchase agreement considers Telegram to owe investors a termination amount in the case Gram is not issued until the deadline date, which was April 30, 2019. Durov promised investors to repay 72%, or $1.2 billion, of their original investment.

In its arguments, the court relied on the four-part Howey test created by the U.S. Supreme Court to determine whether an investment contract implies that the transaction is a type of security.

According to the Howey test, an instrument can be considered a security if it is an investment of money, if it is an investment in a common enterprise, if an entity conducts a transaction with an expectation of profits, and if any profit is derived solely from the efforts of the promoters or third parties.

The court made it clear it believes that the SEC will be able to prove that Gram tokens fall under the definitions set forth by Howey.

The Echo of the “Tcherepnin V. Knight” Precedent

Looking deeper into the case, Russian news publication pointed out a case dubbed “Tcherepnin v. Knight” initiated in 1967. Back then, the U.S. District Court for the Northern District of Illinois had to decide whether a withdrawable capital share in an Illinois savings and loan association is a “security” within the meaning of the Securities Exchange Act of 1934.

In that case, a group of individuals, who held withdrawable capital shares in City Savings Association of Chicago, filed a class action with the court, alleging that the sales of the shares to them by City Savings did not comply with U.S. securities law, and asking that the sales be rescinded.

The petitioners claimed that the solicitations contained false and misleading statements, which violated U.S. securities law. Specifically, it was said that “the Association had been denied federal insurance of its accounts because of its unsafe financial policies, and that the Association had been forced to restrict withdrawals by holders of previously purchased shares.”

Eventually, the Court of Appeals agreed with respondents that the withdrawable capital shares issued by City Savings did not fit the definition of securities, and ruled that the District Court was without jurisdiction in the case.

What is important here is that according to the “Tcherepnin v. Knight” case:

“In analyzing whether something is a security, ‘form should be disregarded for substance,’ ‘and the emphasis should be on economic realities underlying a transaction, and not on the name appended thereto’.”

For Telegram, this apparently means that the court should discard the description of Gram tokens—including statements such as that it is a cryptocurrency—and evaluate Durov’s offering to investors in substance.

What’s Next? suggested that Durov may agree with the SEC’s claims that Gram is a security. As such, the companies will have to pay a fine to the SEC, fill in all necessary forms, and finally launch Gram. However, in this case, Telegram will have to disclose all information about its operations, get tested and certified by the regulator, and provide it with corporate reports on a regular basis.

Alternatively, Telegram can back off from its American investors. Thus, the SEC would have no reason to raise claims against Gram tokens. But in this case, Telegram will not be able to keep U.S. citizens from buying Grams, which means that the SEC will be able to accuse the company of selling unregistered securities again if any American purchases it.

TON Without Durov’s Involvement

As the Telegram team has been struggling to win the court case against the SEC and roll out TON as scheduled, the community—including TON developers and major PoS validators—stepped in and launched Free TON powered by a native token dubbed TON Crystal.

The protocol was developed by Durov’s brother, Nikolai Durov, together with the Telegram team. In a declaration accompanying the Free TON launch, the developers said:

“The TON protocol represents an opportunity to create a massively scalable network benefiting hundreds of millions of people. Centered around smart contracts with easy to use tools for developers and users, it can promote free trade, equal opportunities, censorship resistance, and cooperation during an unprecedented threat from a pandemic and an economic crisis.”

Despite the long-awaited launch and fuss around it, some industry players remain skeptical about TON without Durov’s direct involvement. As a co-founder of payment service provider Qiwi, Sergei Solonin, previously told ForkLog:

“I think it’s possible, but it won’t be as popular as if they [Telegram] launched it themselves. The strength of the brand and the personality, in this case, is one of the important factors.”

In the reality where a group of independent developers took initiative and successfully launched the Free TON network with its own token, it remains to be seen whether Durov will continue fighting with the American regulator for his original idea or make concessions.

Written by Ana Alexandre

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