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Chamber of Digital Commerce sides with Telegram in SEC lawsuit

Posted: 23 January 2020 4:38 pm
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The Chamber of Digital Commerce is weighing in to untick some of the Howey Test boxes.

The Chamber of Digital Commerce, an industry association that describes itself as "the world's leading trade association representing the digital asset and blockchain industry", and whose members include a pretty high-power selection of businesses, has injected an amicus curiae brief into the SEC vs Telegram lawsuit.

An amicus curiae (literally "friend of the court") is essentially when someone who's not involved in a case jumps in to provide additional information.

The crux of the Telegram vs SEC case is, unsurprisingly, that the SEC is alleging Telegram carried out an unregistered securities sale, based on allegations that the Gram tokens passed (failed?) the Howey Test.

Consequently, the SEC alleges that Telegram "failed to provide investors with information regarding Grams and Telegram's business operations, financial condition, risk factors, and management that securities laws require" and that Telegram violated the law by conducting a public offering of securities without a registration or an exemption from registration.

Et tu Howey?

The four points of the Howey Test are that:

  • The thing is offered in exchange for money.
  • The purchasers have an expectation of profits.
  • The funds raised are invested in a common enterprise.
  • Buyers are dependent on the efforts of a promoter or a third party to realise profits from their purchase.

The SEC argues that Telegram fulfilled these points, as:

  • Gram tokens were obviously being sold for money. Telegram is thought to have raised about US$1.7 billion from this token sale.
  • Telegram marketed the token sale in a way that strongly implied the token would grow in value. It even sold Grams at discounts relative to an expected opening "reference price".
  • The funds raised from the token sale were spent on Telegram as a messaging app, as well as growth of its blockchain. There was little differentiation between them, the SEC said.
  • Buyers were dependent on the growth of the Telegram messaging app and blockchain for their Grams to appreciate in value.

If something ticks all these boxes, it's arguably a security. And if it's a security its sale has to be appropriately registered with the SEC and purchasers should be provided a lot of detailed financial information. Telegram did neither.

"The undisputed evidence shows that the investment contract defendants marketed to institutional investors in exchange for $1.7 billion was the quintessential transaction where investors funded a company's growth hoping to profit from its continued efforts and future successes," the SEC said. "Telegram solicited these investments by fueling these expectations. It touted the past successes of its founders in this space and the expertise of its programmers and its promised future efforts to build an ambitiously revolutionary 'TON network'."

In its amicus curiae, the Chamber of Digital Commerce methodically set about trying to untick or at least blur, some of those boxes.

"Investment" ab aliquo alio nomine

A lot of things tick every box of the Howey Test when you get strict about it. A McDonald's free Big Mac promotion is arguably an illegal securities sale. And when the tokens are intended to be a functional type of gas for a future network, as the Telegram tokens allegedly are, an early-stage token sale arguably starts looking more like a really great deal on a software licence.

"Centralised technology companies regularly offer consumers a license or subscription to use their goods or services, the value of which is contingent on the continued success of that particular entity and the network it created and supports. Yet, these are still commercial transactions, not securities transactions. The same is true for digital assets," the Chamber of Digital Commerce argued in its amicus curiae.

If someone is buying a token at what they perceive to be a low price, with the intention of using the token later, their "profit" is arguably realised in money savings rather than money earned. It's a ridiculous distinction, the Chamber suggested.

Besides, even if some token buyers were motivated by profits, it doesn't make sense to tar the entire token with the same brush.

"It does not follow that, simply because Purchaser A entered into a securities transaction motivated by profit, Purchaser B is similarly motivated in a commercial transaction," the Chamber said.

The insistence that Gram buyers were focused on profits derived from a third party is also dubious, the Chamber suggested. After all, the cryptocurrency itself is just a lump of electrons. The value attached to stocks and more traditional securities comes from them being intrinsically imbued with a relationship between the holder and another entity, but cryptocurrencies typically don't carry any such relationship.

"The sale of a digital asset may simply be a commercial transaction that does not necessitate any on-going relationship with a promoter who is responsible for the success or failure of an enterprise," the Chamber of Digital Commerce said.

Many of the points being made here are similar to those considered around the time when people were talking about Ethereum being a security. It ended when the SEC decided that even though the Ethereum ICO may have been an illegal security sale, the token has since achieved sufficient decentralisation and functionality that it was no longer a security.

"Uncertainty as to how federal securities laws apply to digital assets is stifling economic development in the United States," the Chamber said. "We... respectfully request that the Court affirm that a digital asset is not a security solely by virtue of being in digital form or recorded in a blockchain database."

Or maybe Telegram can just settle up and pay a farcically small penalty already. EOS parent company Block.One settled a $4.1 billion unregistered token sale with a $24 million penalty (~0.5% of the total). An equivalent penalty for Telegram's $1.7 billion token sale would be roughly $10 million.



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