35-year-old Russian billionaire and entrepreneur, Pavel Durov, is no stranger to duking it out with governments.
As the founder of Vkontakte, Russia’s largest social network, Durov was pressured by the Kremlin to shut down opposition groups on the platform in 2012. But the well-known libertarian blankly refused.
Later Durov claimed that his resistance was purely a business decision, but anyone familiar with the eccentric figure knows how his ideology drives everything that he does.
For a few years, Durov continued sparring with the Russian authorities until 2014, when he was falsely accused of committing a hit and run on a police officer.
At that point, Durov knew that this was not a game he could win. And finally, he fled the country.
Inspired by his experience of being spied on by the Russian authorities, Durov went on to build one of the world’s most prominent encrypted messaging apps, Telegram. The app has now grown to over 200 million users and is a household name for everyone in the crypto community.
Durov and Telegram became even more aligned with crypto when their blockchain project, the Telegram Open Network (TON), was announced in 2018.
Telegram raised $1.7 billion for the TON project in 2018, the second-largest token sale to date, and everything looked bright for everyone on board.
Cash was flush and the company was scheduled to release the network in October 2019… until a different government agency came knocking. This time it was the United State’s SEC.
Just one week before the launch of the TON, the SEC issued a cease and desist order and even emergency restraining orders against Durov and his team to prevent them from launching.
Now, Telegram and the SEC are embroiled in a critical legal battle to determine whether or not the project’s GRAM token can be considered a security token.
Ultimately Durov traded authoritarian Russia for the land of opportunity and rule of law, only to find out that the US government was just as willing to shut him down.
While I don’t see the US trying to frame Durov with a hit and run on a Police officer, they won’t be pulling any punches as they try to take TON down.
And unfortunately, as much as I am a fan of Durov’s cause, from a legal perspective, his recent decisions are undermining the company’s legal case and putting the business in danger. Read on in today’s article to find out why…
A Tale of Two Token Offerings
To give you a basic understanding of Telegram’s token offerings from a securities perspective, let me break down how the offerings were set up.
Telegram’s first offering was for the TON token, which raised funds for building the network and gave investors access to purchase discounted pre-sale GRAM tokens.
The second offering, which has not taken place yet, is for the GRAM token. This is a separate token that is to be used within the network itself.
Telegram acknowledges that the TON offering was a security token offering. And to avoid needing to register with the SEC, it specifically limited the offering to only accredited investors and filed for an exemption to the registration requirements under Reg D 506(c).
In other words, they did exactly what they were supposed to do according to the SEC’s own guidelines.
The SEC’s issue, however, isn’t with the TON token. It’s GRAM.
From Telegram’s point of view, GRAM is a utility token, not a security token. It argues that the two offerings are akin to a capital raise for a theatre, where investors would then have the ability to buy pre-sale tickets. The capital raise would undoubtedly be a security offering, but the tickets themselves shouldn’t be considered securities.
Needless to say, the SEC doesn’t share this perspective.
The SEC argues that GRAM can’t be considered a utility token because there is nothing that it can buy within the network. Moreover, rather than being two separate offerings, the SEC is taking the stance that these are actually just two parts of the same token offering.
While this may seem like a subtle difference, this fine distinction has great implications for how Telegram’s offerings are viewed by the courts.
So, is GRAM a security token or not?
Is GRAM a Security Token?
Telegram’s response provides a very complex argument that relies heavily on technicalities of the law. It’s such a nuanced securities issue that so far I can’t say definitively one way or another how the courts will decide this case.
That said, the real issues here aren’t the technical details of Telegram’s argument, but the overall interpretation of its activities.
In many ways, Telegram’s argument is along the lines of having found a loophole in the definition of a security. And now it is using this loophole to claim that its token shouldn’t be classified as a security.
Unfortunately, that kind of logic does not resonate with the SEC. The regulatory agency has shown many times in the past that it looks past technical distinctions to see the totality of a situation.
In essence, if a token sale looks and smells like an unregistered securities offering… then it is one. They don’t need a DNA sample to prove it.
As much as I want to cheer for most crypto projects, from a legal perspective, I have to admit that Telegram’s offering certainly looks like a securities offering to me.
And with Telegram’s latest letter to the courts, I’ve lost even more confidence in Telegram’s defense. The letter highlighted a ruling from a recent case that had nothing at all to do with securities law or Telegram’s case, which gives me the impression that they are starting to feel desperate.
So if it’s likely that Telegram’s token offerings were security offerings, why did they risk it? Here’s what I think…
Why didn’t Telegram hold a public offering?
In raising $1.7 billion, the most logical step for Telegram would have been to do a public offering. After all, there are many companies that have held public offerings for far less.
Of course, in some cases, companies are unable to go public because it is prohibitively expensive. But clearly that was not the situation in Telegram’s case.
So why didn’t Telegram hold a public offering?
For two reasons, they didn’t want to jump through hoops with the SEC and force owners of GRAM to be limited on what they did with their tokens.
But also, knowing Durov’s history, I wouldn’t be surprised if the primary reason is ideological.
This is also likely why Telegram did not attempt to settle with the SEC after receiving the first complaint.
While I can understand this on a personal level, on a legal and business level, it is very ill-advised and telling about the company’s leadership.
The fact is, Durov’s priorities seem to be primarily ideological rather than business-focused. Because if Durov’s focus was on the business and shareholders, the company would have followed a very different course of action.
Any savvy entrepreneur should know to look at the most recent cases with the SEC to understand his chances. And looking at the latest battles between crypto projects and the SEC, the lessons are very clear.
Block.One, which held the largest token sale to date, settled as quickly as it could with the SEC. The project paid a very small fine in proportion to the amount it raised and was able to continue operations with barely a hiccup.
Meanwhile, Kik, another popular messaging platform, stood up to the SEC and was wiped out.
After seeing what happened to Kik, Durov should have known that he’s not fighting on a fair playing ground. And just like when he was faced with the Russian justice system, that’s when he should have known to walk away.
What does this mean for Crypto Law Insiders?
What we can see by the SEC’s latest line of crypto-related cases is that the agency is willing to take on anyone.
From Telegram’s experience with regulators, the SEC has shown very clearly that it is not interested in working amicably with companies. Instead, it is taking a hammer approach, even with companies that have $1.7 billion to fight them.
This raises a difficult issue for many actors in the crypto space.
Do you stick to your ideals, the ones that brought you to crypto in the first place? Or do you bow down to regulators to keep your projects alive?
For founders, there is no easy answer to this question. It’s all about what you want to stand for.
For investors, however, the answer is crystal clear…
Make sure that the projects you invest in are aligned with your personal goals.
If you’re looking to support a cause, go ahead and invest in a project with an ideological leader.
But if you’re looking purely for returns, you want to make sure that the company’s leaders want the same, and won’t engage in drawn out and costly legal battles purely on a whim.