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Telegram Appeals Federal Court Injunction to Stop Gram Distribution

Telegram has filed an appeal to yesterday’s ruling by a United Stated federal court in favour of the US Securities and Exchange Commission (SEC) which has prohibited the issuance of Gram tokens for the time being.

Court Sides with SEC early

The SEC has won an important decision in their court case against Telegram over the legal status of the latter’s $1.7 billion Gram token offering in 2018. The SEC has maintained throughout that the tokens sold were unregistered securities and yesterday the US federal court granted the regulator an injuction to halt the distribution of Grams as the legal battle continues.

The injunction states, “For reasons that will be more fully explained, the Court finds that the SEC has shown a substantial likelihood of success in proving that Telegram’s present plan to distribute Grams is an offering of securities under the Howey test to which no exemption applies. The motion for a preliminary injunction will be granted.”

The SEC believes through its examination via the Howey test that the contracts governing the Telegram’s token issuance qualify Gram tokens as securities. Per the filing, ““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 (the “Securities Act”).”

Telegram immediately filed a notice of appeal with the Court of Appeals for the Second Circuit.

Former SEC Counsel Has Little Hope for Appeal

The evidence being presented to the court by the SEC’s Howey Test appears to have compelled them to act in favour of the regulator early in the legal proceedings – this cannot be a good sign for Telegram and their TON network.

On Feb. 18, Telegram’s lawyer, Alexander Drylewski had criticized the application of the SEC’s Howey Test, citing that a test designed to categorize securities does not apply to digital assets that are offered with a promise of managerial oversight, that will increase their value over time. The lawyer argued that when TON blockchain launches, Grams will not be securities but commodities.

Philip Moustakis, attorney at Seward & Kissel LLP and former SEC counsel told Blockchain.News that Telegram’s defense was not looking good and believes the SEC has applied the Howey test correctly.

Moustakis said,“Telegram argues the “interests in Grams” are one transaction and the “delivery of Grams,” another. However, the court, rightly in my view, held the Howey test requires it to examine the entire series of understandings, transactions, and undertakings at the time they were made, meaning the totality of the facts and circumstances underlying the economic reality of the investment, including at the moment in time when investors separated with their money.” He concluded, “In other words, an issuer cannot avoid application of the federal securities laws by separating in time the capital raise and the delivery of the digital representation of the investor’s interest in that capital raise. And, at delivery, in my view, the Grams would still represent the series of promises and understandings that led up to their distribution”

The case between the SEC and Telegram is ongoing and we will continue to bring you updates.

Regulating Cryptocurrencies like XRP with Securities Laws Not Always the Best Approach – Former SEC Executive

Joe Hall, a former Senior Policy executive at the SEC under the Bush administration, has commented on the Securities and Exchange Commission (SEC)’s decision to sue Ripple for XRP. He, for one, thinks that cryptocurrencies are here to stay.

The lawsuit against Ripple has shook the entire crypto industry, as the outcome of the case will likely influence the way cryptocurrencies are treated in the US. Hall, who is also a partner at Davis Polk, now commented on the agency’s move and its persistence in classifying cryptocurrencies with the Howey Test. He called the SEC’s decision to sue Ripple Labs for ongoing XRP sales “remarkable on several levels.”

XRP fails to be exempted like Ethereum

He suggested that there may have been a disagreement among commissioners on whether to administer a lawsuit for XRP, as it was announced at an unlikely time – just as Jay Clayton was exiting the agency as chairman. With the lawsuit slapped on Ripple Labs, many crypto exchanges and funds have backed away from XRP, causing its market cap to drop significantly. An estimated $14.5 billion in market cap was wiped out following the SEC’s announced plan to pursue Ripple for unregistered securities through XRP.

Hall questioned why XRP did not receive a similar treatment as its fellow cryptocurrency Ethereum. He said that the former director of the SEC’s Division of Corporation Finance Bill Hinman had said that “Ether might have been born a security, but later morphed into a non-security,” and that it would have been a “fair bet” for XRP to receive a similar treatment.

Comparing apples and oranges?

Hall suggests that the SEC’s decision to regulate digital assets with the Howey Test may not be the best approach. The Howey Test essentially measures whether an asset falls under the umbrella term of security. It says that if an asset provides an investor with profit that is based on the efforts of a third party, it is ruled a security.

The Howey Test was previously applied to a citrus grove in Florida, where the oranges sold by the Florida native were deemed securities, as it complied to the test. However, Hall suggested that the Howey Test should not be used for cryptocurrencies like XRP. He said:

“It’s not obvious that the SEC’s approach to regulating crypto should be grounded in metaphors about oranges and principles articulated in a case decided three-quarters of a century ago which – take it from one who knows – is nearly impossible to apply with consistency and predictability across the digital asset class.”

The Davis Polk partner added that it may be impractical to apply securities laws to the whole cryptocurrency market despite the appeal of digital assets as a viable investment. This is due to the dynamic nature of digital assets and the fact that many are transacted on a blockchain with peer-to-peer transactions. He said:

“The regulatory obligations governing transactions in securities make it impractical to use them in many ordinary commercial or peer-to-peer transactions. Digital assets need to flow freely from user to user over a blockchain to enable the exchange of value and information.”

While Hall suggested that some aspects of securities laws could be applicable to digital currencies if they were sold as an investment contract cryptocurrency, he suggested that other aspects were not, as it would defeat the use of a cryptocurrency.

He said it remains a mystery why the SEC decided to pursue XRP as it did, as a loss in XRP’s litigation would “epically damage the SEC’s regulatory project when it comes to digital assets.”

Is the Howey Test outdated?

The SEC’s persistence in applying the Howey Test to cryptocurrencies has been criticized not only by Joe Hall, but by founder of TechCrunch Michael Arrington.

Arrington had suggested that the Howey Test was outdated, as it was “hundred-year-old test” that should therefore not be applicable anymore in a modern world.

Paradigm Challenges SEC's Authority in Lawsuit Against Binance

On September 29, 2023, Paradigm filed an amicus brief in the ongoing lawsuit between the U.S. Securities and Exchange Commission (SEC) and Binance, a leading cryptocurrency exchange. Paradigm is not an investor in Binance and has no direct financial interest in the lawsuit’s outcome. However, the firm believes that the SEC’s actions represent a form of government overreach that could have significant implications for the broader financial and crypto markets.

The SEC initiated legal action against Binance in June 2023, accusing the exchange of multiple violations of securities laws. These include operating without the necessary licenses and registrations as an exchange, broker-dealer, or clearing agency. The SEC’s investigation into Binance began in May 2023. In its amicus brief, Paradigm argues that the SEC is attempting to change existing laws without adhering to the established rulemaking process, thereby acting outside its regulatory scope.

Paradigm’s brief raises several critical points that challenge the SEC’s interpretation of securities law. The firm argues that the SEC’s expansive interpretation of “investment contract” could bring a wide range of asset sales under the purview of securities laws. Paradigm also highlights flaws in the SEC’s application of the Howey test, a legal standard used to determine what constitutes a security.

Circle, a stablecoin services company specializing in blockchain technology, has also been brought into the legal battle between Binance and the SEC as well. Circle argues that stablecoins, a type of cryptocurrency designed to maintain a stable value, should not be treated as securities, adding another dimension to the ongoing case.

Paradigm emphasizes that regulatory gaps do exist in the crypto sector and that it is Congress’s responsibility to fill these gaps. This perspective aligns with SEC Chair Gary Gensler’s Congressional testimony, where he acknowledged the SEC’s limitations in regulating crypto secondary markets.

Paradigm’s amicus brief serves as a significant counterpoint to the SEC’s actions against Binance and other crypto exchanges. By challenging the SEC’s authority and interpretation of securities law, Paradigm adds a layer of complexity to an already intricate legal landscape. The firm’s stance could potentially influence how securities laws are applied to the crypto industry in the future.