Commissioner Hester M. Peirce of the Securities and Exchange Commission (SEC) delivered a June 21 speech at Blockchain Week in Singapore where she expressed her dissent regarding the recent settlement between the SEC and Telegram.
It is unsurprising to hear Commissioner Peirce disagree with the recent court ruling barring the release of Telegram tokens to all investors, and subsequent settlement with the SEC. Commissioner Peirce has made it clear that she did not agree with the originating October 2019 emergency order filed by the SEC against Telegram.
Timeline of Telegram Raise and Court Case
|February 2018||Popular messaging app Telegram raises $850M using the SAFT (Simple Agreement for Future Tokens) structure|
|March 2018||Telegram raises an additional $850M using SAFT structure|
|October 2019||Distribution of Telegram Tokens to Investors scheduled for October 31, 2019|
|October 2019||SEC files an emergency action and temporary restraining order against Telegram to prevent the distribution of Telegram tokens to investors.|
|March 2020||The court orders that Telegram may not distribute tokens to any investor, American and foreign|
|June 2020||Telegram settles with the SEC and agrees to return $1.2Bn to investors, close operations, and pay $18.5M fine|
Synopsis of Telegram Raise
- $1.7Bn raised from investors ($424.5M from American investors)
- 171 investors (39 Americans)
- Accredited investors only
- A minimum investment of $1M per person or entity
- The invested money was to be used to develop the Telegram Open Network (TON) blockchain and grow and maintain Telegram Messenger.
What Issues Does Commissioner Peirce Raise?
The court sees “one single scheme”. Commissioner Peirce takes issue with the court treating the investment agreement between Telegram and the accredited investors, the delivery of the tokens to the investor, and the resale of the tokens, as one single scheme. She laments, “gone is the distinction between the investment contract (the agreement between Telegram and the accredited investors) and the token (the asset to be created and delivered under the agreement)”. Commissioner Peirce believes that the initial investments in the company are to raise capital to build the platform, and that those initial investments are separate from the resale of a functional token “… such tokens, once they have a consumptive use, should be able to be sold to purchasers outside of a securities transaction”. She believes the Howey test supports the idea that the resale of the tokens does not constitute as a security simply because the tokens were initially acquired as a part of a securities transaction.
What is a requirement for success, is deemed an illegal securities offering by the SEC. What the SEC sees as an illegal securities offering (widespread global distribution of the token), Commissioner Peirce sees as a necessary element for a successful blockchain. “I do not support the message that distributing tokens inherently involves a securities transaction…. I see [widespread distribution of tokens] as a necessary prerequisite for any successful blockchain network.”
The SEC is overreaching. Commissioner Peirce also takes issue with the fact that the SEC, asked and was granted, enforcement against a corporation that is not incorporated or based in the US, and only a quarter of the investors and total investment were US-based. She reminds us that the American way is not the only way in a global economy “This willingness of the SEC to ask for, and of the district court to grant, such sweeping injunctive relief against a non-US company, in a case where one-quarter of the funds came from US investors, reasonably might raise some concerns among our international colleagues… we would do well to recall that our way is not the only way. We should be cautious about asking for remedies that effectively impose our rules beyond our borders.”
At Your Own Risk – No Clear Path
Interestingly, Commissioner Peirce notes that Telegram employed sophisticated counsel, “made good faith efforts to comply with federal securities laws” and “engaged extensively with SEC staff”. It begs the question – what went wrong? Did the SEC give improper guidance? Did Telegram choose not to follow the SEC’s guidance? Did the SEC change its mind once Telegram was due to distribute tokens to investors? These questions do not have clear answers and continue to leave companies in risky and unknown waters when conducting token offerings in the United States and/or with American investors.
It is clear that Commissioner Peirce believes that the SEC is not doing enough to help guide companies in the right direction, she notes “rather than provide useful guidance on safety standards and functional braking technology… [leaving] the industry to guess at the path to compliance”. Companies should not have to assume the risk of guessing at the correct path to compliance.
Who Did the SEC Protect?
The case of SEC v Telegram Group Inc. and Ton Issuer Inc. was petitioned by three investors; seven investors are listed as interested parties. All the investors would have had to qualify as “accredited investors” under the federal definition to invest in the Telegram raise. The minimum threshold for investing in Telegram was USD$1,000,000.
At the end of her speech, Commissioner Peirce asks, “who did we protect by bringing this action?”. It is a good question – one would assume that an investor with the capital to invest $1M in the Telegram raise is a reasonably sophisticated person or entity that understands the inherent risks of investing in new technology and early stage start-ups. So, who did the SEC really protect in this case? It appears that the only people protected were a handful of sophisticated investors who were unhappy with the risk they knowingly took.
Since 2018 the crypto industry has witnessed a growing trend of companies refusing to accept American investors. It is likely that this trend of barring American investors will continue until there is clear guidance from the SEC. Due to the SEC’s enforcement actions and lack of guidance, most companies simply deem it too risky to allow American citizens, residents, or entities to invest in capital (token) raises.
In February of this year, Commissioner Peirce announced her proposal to bridge the gap between regulation and decentralization. She calls this proposal a safe harbor that gives companies a three-year grace period to develop a functional network. At the end of the three years, the tokens would not be deemed securities providing there is a functioning network where the token can actively be used for goods and services. Additional details about Commissioner Peirce’s safe harbor proposal can be found in the link above.
While Commissioner Peirce’s safe harbor proposal is well thought out and appears to be a great way to move forward, unfortunately, it is still simply a proposal. Given the ongoing refusal of the SEC to provide clear written guidance, rules, or regulation, we do not expect that Commissioner Peirce’s safe harbor will be adopted any time soon by the SEC. We expect to see other global markets take the lead in decentralized projects if clear guidance or regulations are not set out by the SEC.