Case 1:19-cv-09439-PKC Document 227 Filed 03/24/20 Page 1 of 44
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`UNITED STATES DISTRICT COURT
`SOUTHERN DISTRICT OF NEW YORK
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`SECURITIES AND EXCHANGE COMMISSION,
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`Plaintiff,
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`-against-
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`TELEGRAM GROUP INC. and TON ISSUER
`INC.,
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`Defendants.
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`CASTEL, U.S.D.J.
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` 19-cv-9439 (PKC)
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` OPINION
`AND ORDER
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`The Securities and Exchange Commission (“SEC”) seeks to enjoin Telegram
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`Group Inc. and TON Issuer Inc. (collectively “Telegram”) from engaging in a plan to distribute
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`“Grams,” a new cryptocurrency, in what it considers to be an unregistered offering of securities.
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`In early 2018, Telegram received $1.7 billion from 175 sophisticated entities and high net-worth
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`individuals in exchange for a promise to deliver 2.9 billion Grams. Telegram contends that the
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`agreements to sell the 2.9 billion Grams are lawful private placements of securities covered by an
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`exemption from the registration requirement. In Telegram’s view, only the agreements with the
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`individual purchasers are securities. Currently, the Grams will not be delivered to these purchasers
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`until the launch of Telegram’s new blockchain, the Telegram Open Network (“TON”) Blockchain.
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`Telegram views the anticipated resales of Grams by the 175 purchasers into a secondary public
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`market via the TON Blockchain as wholly-unrelated transactions and argues they would not be the
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`offering of securities.
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`The SEC sees things differently. The 175 initial purchasers are, in its view,
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`“underwriters” who, unless Telegram is enjoined from providing them Grams, will soon engage
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`Case 1:19-cv-09439-PKC Document 227 Filed 03/24/20 Page 2 of 44
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`in a distribution of Grams in the public market, whose participants would have been deprived of
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`the information that a registration statement would reveal.
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`Cryptocurrencies (sometimes called tokens or digital assets) are a lawful means of
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`storing or transferring value and may fluctuate in value as any commodity would. In the abstract,
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`an investment of money in a cryptocurrency utilized by members of a decentralized community
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`connected via blockchain technology, which itself is administered by this community of users
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`rather than by a common enterprise, is not likely to be deemed a security under the familiar test
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`laid out in S.E.C. v. W.J. Howey Co., 328 U.S. 293, 298–99 (1946). The SEC, for example, does
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`not contend that Bitcoins transferred on the Bitcoin blockchain are securities. The record
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`developed on the motion for a preliminary injunction presents a very different picture.
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`The Court finds that the SEC has shown a substantial likelihood of success in
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`proving that the contracts and understandings at issue, including the sale of 2.9 billion Grams to
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`175 purchasers in exchange for $1.7 billion, are part of a larger scheme to distribute those Grams
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`into a secondary public market, which would be supported by Telegram’s ongoing efforts.
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`Considering the economic realities under the Howey test, the Court finds that, in the context of
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`that scheme, the resale of Grams into the secondary public market would be an integral part of the
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`sale of securities without a required registration statement.
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`Telegram knew and understood that reasonable purchasers would not be willing to
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`pay $1.7 billion to acquire Grams merely as a means of storing or transferring value. Instead,
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`Telegram developed a scheme to maximize the amount initial purchasers would be willing to pay
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`Telegram by creating a structure to allow these purchasers to maximize the value they receive
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`upon resale in the public markets.
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`Case 1:19-cv-09439-PKC Document 227 Filed 03/24/20 Page 3 of 44
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`As part of its Howey analysis, the Court finds an implicit (though formally
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`disclaimed) intention on the part of Telegram to remain committed to the success of the TON
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`Blockchain post-launch. Indeed, Telegram, as a matter of fact rather than legal obligation, will be
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`the guiding force behind the TON Blockchain for the immediate post-launch period while the 175
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`purchasers unload their Grams into the secondary market. As such, the initial 175 purchasers
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`possess a reasonable expectation of profit based upon the efforts of Telegram because these
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`purchasers expect to reap whopping gains from the resale of Grams in the immediate post-launch
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`period. Under the Howey test, the series of contracts and understandings centered on Grams are a
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`security within the meaning of the Securities Act of 1933 (the “Securities Act”).
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`For reasons that will be more fully explained, the Court finds that the SEC has
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`shown a substantial likelihood of success in proving that Telegram’s present plan to distribute
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`Grams is an offering of securities under the Howey test to which no exemption applies. The motion
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`for a preliminary injunction will be granted.
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`At the preliminary injunction hearing, neither side offered live testimony, despite
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`an opportunity to do so. (Doc. 58). The parties presented the Court with a fulsome Joint
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`Stipulation of Facts (“Joint Stip.”), (Doc. 72), and each side offered deposition testimony, exhibits,
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`and declarations. The parties also filed cross-motions for summary judgment and the SEC filed a
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`motion to strike an affirmative defense, motions which the Court finds unnecessary to reach at this
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`juncture. Set forth below are the Court’s findings of fact and conclusions of law on the motion for
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`a preliminary injunction.1
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`1 Citations to evidence are illustrative only and are not intended to indicate that the cited evidence is the only evidence
`supporting the finding.
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`Case 1:19-cv-09439-PKC Document 227 Filed 03/24/20 Page 4 of 44
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`FINDINGS OF FACT AND CONCLUSIONS OF LAW
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`A. Telegram.
`In 2006, Pavel Durov founded VKontakte, a Russian version of Facebook. (Joint
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`Stip. ¶ 9). With the help of Nikolai Durov, his brother and a skilled programmer, Pavel
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`successfully built VKontakte into the largest Russian social media network. (Joint Stip. ¶¶ 11–
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`13). Pavel accumulated a sizeable personal fortune before exiting VKontakte and leaving Russia
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`over disputes with the Russian government. (Plaintiff’s Exhibit (“PX”) 18 at 2 (Doc. 122-18));
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`(Defs.’ Resp. to Pls.’ Counter-Statement at 51 (Doc. 120)).
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`In 2013, the Durov brothers founded Telegram and released Telegram Messenger,
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`which remains Telegram’s signature product. (Joint Stip. ¶¶ 16, 23); (Defs.’ 56.1 Statement ¶¶ 42,
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`45 (Doc. 75)). Telegram is a private company, (Pl.’s 56.1 Statement ¶ 154 (Doc. 80)), and Pavel
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`is its chief executive officer, (Joint Stip. ¶ 3). Messenger is a messaging app that offers end-to-
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`end encryption and also contains a diverse ecosystem of groups, channels, and in-app commerce.
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`(Joint Stip. ¶¶ 18–19, 22); (Doc. 80 at 1); (PX 18 at 7). Messenger is globally popular and
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`currently has a monthly user base of approximately 300 million. (Doc. 75 ¶ 43). Messenger is
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`also particularly popular among the cryptocurrency community and has been described as the
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`“cryptocurrency world’s preferred messaging app.” (Joint Stip. ¶ 23); (Joint Exhibit (“JX”) 8 at 12
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`(Doc. 72-8)). Telegram was founded with non-profit goals, (JX 8 at 5), and states that Messenger
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`will never charge user fees or introduce advertising on the app, (Joint Stip. ¶ 21). As such,
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`Messenger has never produced any revenues, (PX 18 at 1, 5), and, excluding the present offering
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`of Grams, the Durov brothers have never received any income from their wildly successful
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`creation. (Joint Stip. ¶¶ 14–15).
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`Case 1:19-cv-09439-PKC Document 227 Filed 03/24/20 Page 5 of 44
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`Messenger generates no revenues; nearly all of Messenger’s expenses prior to 2018,
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`including salaries and server costs, were paid for by Pavel out of his personal fortune. (Joint Stip.
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`¶ 17); (Doc. 80 ¶ 3). After receiving the $1.7 billion from the private offering of 2.9 billion Grams,
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`Telegram used this newly raised capital to cover “way over 90 percent” of Telegram’s expenses,
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`which includes the costs of Messenger. (PX 12 at 53:2–3 (Doc. 122-12)); (Doc. 80 ¶ 12); (Malloy
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`Decl., Ex. 4 at 1 (Doc. 167-4)). When describing its projected budgets for 2019 and 2020, which
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`totaled $180 and $220 million respectively, Telegram stated that it still lacked plans to generate
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`revenue from Messenger, so would continue to pay Messenger’s way using funds from the offering
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`of Grams and Pavel’s personal wealth for the foreseeable future. (Doc. 80 ¶ 26); (PX 18 at 5, 8).
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`Telegram subsequently reported that, from January 2018 to January 2020, it spent $405 million,
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`about 24% of the proceeds from the offering of Grams, on the development of the TON Blockchain
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`and the operations of Messenger. (Joint Stip. ¶¶ 144–45).
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`B. The TON Blockchain and Grams.
`In 2017, Telegram began development of a proprietary blockchain and digital
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`asset.2 (Doc. 75 ¶ 49). The Durov brothers believed that Telegram could learn from the mistakes
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`of existing blockchains and, by correcting their flaws, enable Telegram’s new cryptocurrency to
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`be the first to achieve truly widespread adoption. (Doc. 75 ¶¶ 46–48). Telegram’s proposed
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`blockchain would be named the “Telegram Open Network” (“TON”) Blockchain and its native
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`token would be called the “Gram.”3 (Doc. 75 ¶¶ 49, 52).
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`2 A blockchain serves as the means of validating the authenticity of a transfer of a unit of cryptocurrency. It is a widely
`distributed but secure ledger or account of transactions. (Doc. 75 ¶¶ 1–3). Individual blockchain transactions are
`grouped together and then recorded in “blocks” that are linked to prior blocks creating a “chain.” (Doc. 75 ¶¶ 7–8).
`No centralized master copy of the blockchain exists; instead current versions of the blockchain are kept by individual
`users connected across a network. (Doc. 75 ¶¶ 9–10); (Waxman Decl. at 1 n.1 (Doc. 16)).
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`3 A unit of a cryptocurrency can be used to store and transfer value, provide access to real-world services, offer voting
`or governance rights within the blockchain, or power applications and smart contracts built into the blockchain.
`5
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`Case 1:19-cv-09439-PKC Document 227 Filed 03/24/20 Page 6 of 44
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`As part of the offering materials distributed in connection with the 2018 Sales
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`discussed below, Telegram released a White Paper, authored by Nikolai and dated January 18,
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`2018, that discussed the unique features of the proposed TON Blockchain. (Joint Stip. ¶ 90);
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`(JX 13 (Doc. 72-13)). The TON Blockchain would operate as a “Proof of Stake” system, which
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`would rely on validator nodes (computers running full versions of the TON Blockchain software)
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`to authenticate new blocks and to vote on rule changes. (Joint Stip. ¶¶ 122–23, 125); (JX 13 at 10);
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`(McKeon Report ¶ 86, 190 (Doc. 102-1)). Validators would earn Grams for their services and
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`would be required to stake at least 100,000 Grams as collateral. (Joint Stip. ¶¶ 125, 127); (JX 13
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`at 44). Due to the capital and technical resources required, acting as a validator would be beyond
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`the ability of the hypothetical mass market user of the TON Blockchain. (Herlihy Report ¶ 19);
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`(JX 13 at 45 (“[O]ne definitely cannot mine new TON coins on a home computer, let alone a
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`smartphone.”)).
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`According to the White Paper, at least initially, the supply of Grams would be
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`limited to five billion, which would be held by Telegram. (Joint Stip. ¶ 138); (JX 13 at 129). Each
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`Gram subsequently sold by Telegram would be priced according to a formula that was based on
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`the number of publicly outstanding Grams and priced each Gram slightly higher than the last one
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`sold. (Joint Stip. ¶¶ 144–46); (JX 13 at 129–31). The price produced by this formula is called the
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`“Reference Price.” (Joint Stip. ¶ 144); (JX 13 at 129–30). If the market price of Grams fell below
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`half of the Reference Price, Telegram (or the TON Foundation, discussed below), would have
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`discretion to repurchase Grams and, by reducing the number of Grams in circulation, potentially
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`prevent the market price from falling further. (Joint Stip. ¶ 122); (JX 13 at 131).
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`(Doc. 16 ¶¶ 4, 5); (Doody Report ¶ 11). For instance, the native digital asset of the Bitcoin blockchain is Bitcoin and
`of the Ethereum blockchain is Ether. (Doc. 75 ¶¶ 22–23); (Doody Report ¶ 10).
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`Case 1:19-cv-09439-PKC Document 227 Filed 03/24/20 Page 7 of 44
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`C. The 2018 Sales to Initial Purchasers.
`In 2018, Telegram sold “interests in Grams” to 175 entities and high net worth
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`individuals (the “Initial Purchasers”) in exchange for dollars or euros. (Joint Stip. ¶ 40); (Doc. 75
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`¶ 100); (JX 11 § 2.3 (Doc. 72-11)). The agreements (the “Gram Purchase Agreements”) entitled
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`the Initial Purchasers to receive an allotment of Grams upon the launch of the TON Blockchain.
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`(Joint Stip. ¶ 140). Telegram sold to the Initial Purchasers in two rounds: the “Round One Sales”
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`in January to February 2018 and the “Round Two Sales” in February to March 2018 (collectively,
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`the “2018 Sales”). (Joint Stip. ¶¶ 41, 46, 54).
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`In the Round One Sales, Telegram sold approximately 2.25 billion Grams to 81
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`purchasers for $850 million, which included $385.5 million from 34 U.S. purchasers. (Joint Stip.
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`¶¶ 48–51); (JX 1 at 5 (Doc. 72-1)); (JX 9 at 17 (Doc. 72-9)). The Grams are to be delivered when,
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`as, and if the TON Blockchain launches. The price per Gram was approximately $0.38. (Joint
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`Stip. ¶ 87). The Gram Purchase Agreements for Round One Sales included a lockup provision,
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`which bars resale of Grams after their delivery to the Initial Purchaser. (Joint Stip. ¶ 88). Three
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`months after receiving the purchased and delivered Grams, the Round One Purchaser would be
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`permitted to resell up to one quarter of its allotment of Grams. The remaining three quarters of
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`the Grams would be free of restrictions in three equal tranches: 6, 12, and 18 months after the
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`launch of the TON Blockchain. (Joint Stip. ¶ 88). By February 2, 2018, the SEC had contacted
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`Telegram regarding the Round One Sales. (McGrath Decl., Ex. H (Doc. 83-8)); (McGrath Decl.,
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`Ex. K at 158:5–159:17 (Doc. 83-11)). On February 13, 2018, Telegram filed a Form D for the
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`Round One Sales, claiming an exemption under Rule 506(c). (Joint Stip. ¶¶ 48, 52); (JX 1 at 6).
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`In the Round Two Sales, Telegram sold approximately 700 million Grams to 94
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`purchasers for $850 million, which included $39 million from five U.S. purchasers. (Joint Stip.
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`Case 1:19-cv-09439-PKC Document 227 Filed 03/24/20 Page 8 of 44
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`¶¶ 55–56); (JX 2 at 5 (Doc. 72-2)). The price per Gram was approximately $1.33. (Joint Stip.
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`¶ 94). Grams purchased in the Round Two Sales did not carry a lockup provision. (Joint Stip.
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`¶ 93). On March 29, 2018, Telegram filed a Form D for the Round Two Sales, claiming an
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`exemption under Rule 506(c). (Joint Stip. ¶ 55); (JX 2 at 6). Because of the claimed exemptions,
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`Telegram did not register or file a registration statement for the Round One Sales or the Round
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`Two Sales. (Joint Stip. ¶¶ 58–59). In total, the 2018 Sales raised $1.7 billion in exchange for
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`approximately 2.9 billion Grams, which equates to 58% of all Grams. (Joint Stip. ¶ 43); (Doc. 75
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`¶¶ 102–03); (Doc. 80 ¶ 37).
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`In advance of the 2018 Sales, Telegram circulated to all Initial Purchasers as well
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`as other prospective purchasers a set of promotional materials, which included, among other
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`things, primers, the Gram Purchase Agreements, the January 18, 2018 White Paper, and an
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`explanation of certain risk factors. (Joint Stip. ¶¶ 60–64). These materials detailed the technical
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`specifications of the TON Blockchain and the Gram, the terms of the Gram Purchase Agreements,
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`Telegram’s plans for distributing Grams and promoting Grams as a mass market cryptocurrency,
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`as well as the financial opportunity presented by Grams. (Joint Stip. ¶¶ 60–104). In particular,
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`the promotional materials specified that 4% of Grams would be reserved for the Telegram
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`developers who were to build the TON Blockchain, including 1% for each Durov brother. (Joint
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`Stip. ¶¶ 158–59); (JX 9 at 16). The developers’ Grams would be subject to a four-year lockup
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`period post-launch. (Joint Stip. ¶ 160); (JX 9 at 18).
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`The 1% of Grams given to each Durov brother is not the full extent of their ability
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`to profit from the 2018 Sales. Indeed, the offering materials specifically noted that Telegram
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`retained full discretion to allocate the funds raised between the TON Blockchain, Messenger, and
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`Telegram generally. (JX 15 at 7–8). While a portion of the $1.7 billion has been used to develop
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`Case 1:19-cv-09439-PKC Document 227 Filed 03/24/20 Page 9 of 44
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`the TON Blockchain, counsel for Telegram made plain at oral argument that Telegram still
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`reserves the right to dividend any unspent portion of the proceeds of the 2018 Sales to Telegram’s
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`shareholders, i.e. the Durov brothers. As noted, Messenger charges no user fees and sells no
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`advertising and, thus, the proceeds of the 2018 Sales stand to be a major source of the Durov
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`brothers’ profit for their years-long development of Telegram and Messenger.
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`The offering materials further detailed plans to integrate the TON Blockchain with
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`Messenger in order to “leverag[e] Telegram’s massive user base and developed ecosystem.” (JX 9
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`at 11). Specifically, Telegram stated that 10% of Grams would be reserved for use in post-launch
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`incentive programs, which would encourage the widespread adoption of Grams. (Joint Stip.
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`¶ 163); (JX 9 at 16). Half of this pool, 5% of all Grams, will be “distributed on a first-come, first-
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`served basis to users of Telegram Messenger” who request Grams via a process within Messenger.
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`(Defs.’ Resp. Pl.’s 56.1 Statement ¶ 387 (Doc. 95)). Telegram also aimed to ensure that “[t]he
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`Gram will serve as the principal currency for the in-app economy on [Messenger]” and that
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`“Telegram’s existing ecosystem will offer simple ways of buying the TON coins (Grams) and a
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`range of services to spend them on, driving demand for the cryptocurrency.” (JX 9 at 11, 13). The
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`offering materials described Messenger-integrated applications to further mainstream adoption of
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`the TON Blockchain. In particular, Telegram pitched that “[i]ntegrated into Telegram
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`applications, the TON [W]allet is expected to become the world’s most adopted cryptocurrency
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`wallet.”4 (JX 9 at 11). Finally, the offering materials again emphasized that Telegram would use
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`any proceeds raised to fund both the development of the TON Blockchain as well as the ongoing
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`operations and expansion of Messenger. (JX 9 at 19).
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`4 Digital wallets, pieces of software akin to a bank account for digital assets, store “private keys,” which grant control
`over individual tokens, and permit users to easily send and receive tokens via the blockchain. (Doc. 75 ¶¶ 24–29).
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`Case 1:19-cv-09439-PKC Document 227 Filed 03/24/20 Page 10 of 44
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`Next, the promotional materials specified that Grams unallocated in the
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`aforementioned plans and unsold in the 2018 Sales, an amount ultimately totaling 28% of Grams,
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`would be allocated to a reserve pool, the TON Reserve. (Joint Stip. ¶ 162). Telegram stated its
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`intention to create a non-profit foundation, the TON Foundation, to which it would transfer control
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`of the TON Reserve as well as of governance functions for the TON Blockchain. (Joint Stip.
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`¶¶ 147, 151); (JX 15 at 8 (Doc. 72-15)); (JX 9 at 20). However, Telegram noted that there was no
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`timetable for creating the TON Foundation and stated that it might not be created at all. (Joint
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`Stip. ¶ 148); (JX 15 at 8). If the TON Foundation is not formed, then the TON Reserve would
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`purportedly be “locked for perpetuity.” (Doc. 75 ¶ 231). If created, the TON Foundation would
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`be controlled by a board on which the Durov brothers would sit,5 (Joint Stip. ¶ 153), and would
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`have discretion to buy and sell Grams as needed to support the market price of Grams. (Joint Stip.
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`¶¶ 164–65). Though Telegram now disclaims the TON Foundation’s power to buy Grams on the
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`open market, the offering materials highlighted this power. (Joint Stip. ¶¶ 167–68); (JX 13 at 131).
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`Finally, the offering materials stated that participants in the 2018 Sales would
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`receive a substantial discount on the price of Grams as compared to later sales. (JX 3 at 2
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`(Doc. 72-3) (describing a “private discount” of between 65.2% and 72% as compared to the price
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`at an eventual public sale)). Based on the number of Grams sold, the Reference Price of Grams at
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`the launch of the TON Blockchain would be approximately $3.62. (Joint Stip. ¶ 143).
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`5 The parties agree that, in its present formulation, the TON Foundation would be overseen by a board consisting of
`the Durov brothers and three other “independent” members, who would have “no connection to Telegram or its
`affiliates with experience in blockchain technology and/or TON.” (Joint Stip. ¶ 154). However, Telegram has not
`consistently claimed that non-Durov board positions would be held by “independent” directors. (Drylewski Decl.,
`Ex. 4 at 24 (Doc. 73-4) (“[T]he TON Foundation will have the following associated members or persons: (i) Pavel
`Durov; (ii) Nikolai Durov; and (iii) any other member or person selected by Pavel Durov and Nikolai Durov prior to
`the initial issuance of Grams or the incumbent members of the TON Foundation post-initial issuance.”)).
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`Case 1:19-cv-09439-PKC Document 227 Filed 03/24/20 Page 11 of 44
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`D. Post-2018 Sales Actions.
`Following receipt of funds from the 2018 Sales, Telegram began to develop the
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`TON Blockchain and Grams. As discussed, Telegram also used funds from the 2018 Sales to
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`maintain and expand Messenger. (Joint Stip. ¶¶ 144–45). In October 2019, Telegram was
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`prepared to launch the TON Blockchain and distribute Grams to the Initial Purchasers by the end
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`of the month. (Doc. 75 ¶ 219); (McGrath Decl., Ex. J (Doc. 83-10)). If Telegram did not deliver
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`Grams to the Initial Purchasers by October 31, 2019, the Gram Purchase Agreements would have
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`obligated Telegram to refund any remaining funds from the 2018 Sales. (Joint Stip. ¶ 116). After
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`this litigation commenced, the deadline was extended to April 30, 2020. (Joint Stip. ¶ 117). Since
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`then Telegram has also continued efforts to further develop the TON Blockchain. (Joint Stip.
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`¶ 210). On January 6, 2020, Telegram posted a public statement to its website regarding the TON
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`Blockchain, which stated that “Telegram will have no control over TON” and that “Grams won’t
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`help you get rich.” (Drylewski Decl., Ex. 3 at 1, 2 (Doc. 73-3)).
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`E. Preliminary Injunction Standard in an SEC Action.
`Section 20(b) of the Securities Act provides that:
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`Whenever it shall appear to the Commission that any person is engaged or
`about to engage in any acts or practices which constitute or will constitute
`a violation of the provisions of this subchapter, or of any rule or regulation
`prescribed under authority thereof, the Commission may, in its discretion,
`bring an action in any district court of the United States . . . to enjoin such
`acts or practices, and upon a proper showing, a permanent or temporary
`injunction or restraining order shall be granted without bond.
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`15 U.S.C. § 77t(b) (2018).
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`The required “proper showing” depends on the nature of the relief sought. S.E.C.
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`v. Gonzalez de Castilla, 145 F. Supp. 2d 402, 414–15 (S.D.N.Y. 2001). “A preliminary injunction
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`enjoining violations of the securities laws is appropriate if the SEC makes a substantial showing
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`of likelihood of success as to . . . a current violation . . . .” S.E.C. v. Cavanagh, 155 F.3d 129, 132
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`Case 1:19-cv-09439-PKC Document 227 Filed 03/24/20 Page 12 of 44
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`(2d Cir. 1998) (quoting S.E.C. v. Unifund SAL, 910 F.2d 1028, 1041 (2d Cir. 1990)). If the SEC
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`seeks to enjoin an ongoing violation of the securities laws, as is the case here, it must make a
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`proper showing of a risk of future harm, but does not need to show a risk of repetition. United
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`States v. Or. St. Med. Soc’y, 343 U.S. 326, 333 (1952) (“The sole function of an action for
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`injunction is to forestall future violations. . . . All it takes to make the cause of action for relief by
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`injunction is a real threat of future violation or a contemporary violation of a nature likely to
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`continue or recur.”); S.E.C. v. Commonwealth Chem. Sec., Inc., 574 F.2d 90, 99 (2d Cir. 1978)
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`(“Except for the case where the SEC steps in to prevent an ongoing violation, this language seems
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`to require a finding of ‘likelihood’ or ‘propensity’ to engage in future violations.”); see also S.E.C.
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`v. Gentile, 939 F.3d 549, 556 (3d Cir. 2019) (“This principle is a corollary to the most basic rule
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`of preventive injunctive relief—that the plaintiff must show a cognizable risk of future harm.”
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`(citing Or. St. Med. Soc’y, 343 U.S. at 333)). The SEC does not need “to show risk of irreparable
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`injury or the unavailability of remedies at law” as required of private litigants. Unifund SAL, 910
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`F.2d at 1036. Therefore, for a preliminary injunction, the SEC must make a substantial showing
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`of the likelihood of success in proving a current violation of the securities law as well as a
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`substantial showing of a risk of future harm in the absence of such an injunction.
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`F. Section 5 Liability and the Howey Test.
`Section 5 of the Securities Act prohibits the offer, sale, or delivery after sale of any
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`security without an effective or filed registration statement. 15 U.S.C. § 77e(a), (c). As such, a
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`prima facie case of a section 5 violation requires the SEC to show: (1) that no registration
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`statement was in effect or filed; (2) defendant offered or sold a security; and (3) the offer or sale
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`took place in interstate commerce. S.E.C. v. Cavanagh, 1 F. Supp. 2d 337, 361 (S.D.N.Y.), aff’d,
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`155 F.3d 129 (2d Cir. 1998). In this case, the foundational question is whether Telegram’s
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`contract, transaction, or scheme amounts to an offer or sale of a security.
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`“Congress’ purpose in enacting the securities laws was to regulate investments, in
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`whatever form they are made and by whatever name they are called.” S.E.C. v. Edwards, 540 U.S.
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`389, 393 (2004) (quoting Reves v. Ernst & Young, 494 U.S. 56, 61 (1990)). As such,
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`section 2(a)(1) of the Securities Act defines a “security” to include an “investment contract” as
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`well as investment vehicles such as stocks and bonds.6 15 U.S.C. § 77b(a)(1). Known as the
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`Howey test, the Supreme Court defined an “investment contract” as “a contract, transaction or
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`scheme whereby a person invests his money in a common enterprise and is led to expect profits
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`solely from the efforts of the promoter or a third party.” S.E.C. v. W.J. Howey Co., 328 U.S. 293,
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`298–99 (1946).
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`“The enterprise and the described materials, by the very nature of the operation of
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`the securities laws, must be examined as of the time that the transaction took place, together with
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`the knowledge and the objective intentions and expectations of the parties at that time.” S.E.C. v.
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`Aqua–Sonic Prods. Corp., 524 F. Supp. 866, 876 (S.D.N.Y. 1981) (citing United Hous. Found.,
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`Inc. v. Forman, 421 U.S. 837, 852–53 (1975)), aff’d, 687 F.2d 577 (2d Cir. 1982); see also Finkel
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`v. Stratton Corp., 962 F.2d 169, 173 (2d Cir. 1992) (“[A] a sale occurs for [Securities Act] purposes
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`when ‘the parties obligate[ ] themselves to perform what they had agreed to perform even if the
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`formal performance of their agreement is to be after a lapse of time.’” (quoting Radiation
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`Dynamics, Inc. v. Goldmuntz, 464 F.2d 876, 891 (2d Cir. 1972))).
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`This definition of investment contract “embodies a flexible rather than a static
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`principle, one that is capable of adaptation to meet the countless and variable schemes devised by
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`6 Section 3(a) of the Securities Exchange Act of 1934 contains a slightly different definition of “security.” 15 U.S.C.
`§ 78c(a)(10). However, “[a]lthough the precise wording of the two definitional sections differs, the Supreme Court
`has consistently held that the definitions are virtually identical and the coverage of the two Acts may be considered
`the same.” Gary Plastic Packaging Corp. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 756 F.2d 230, 238 (2d Cir.
`1985) (citing United Hous. Found., Inc. v. Forman, 421 U.S. 837, 847 n.12 (1975)).
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`those who seek the use of the money of others on the promise of profits.” Howey, 328 U.S. at 299.
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`In the analysis of purported investment contracts, “form should be disregarded for substance and
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`the emphasis should be on economic reality.” Tcherepnin v. Knight, 389 U.S. 332, 336 (1967);
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`see also Forman, 421 U.S. at 849 (stating that “Congress intended the application of [the securities
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`laws] to turn on the economic realities underlying a transaction, and not on the name appended
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`thereto”); Glen-Arden Commodities, Inc. v. Costantino, 493 F.2d 1027, 1034 (2d Cir. 1974)
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`(asking “whether, in light of the economic reality and the totality of circumstances,” an instrument
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`was an investment contract). Disclaimers, if contrary to the apparent economic reality of a
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`transaction, may be considered by the Court but are not dispositive. S.E.C. v. SG Ltd., 265 F.3d
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`42, 54 (1st Cir. 2001).
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`The Howey test provides the mode of analysis for an unconventional scheme or
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`contract alleged to fall within the securities laws. Howey itself determined that a “scheme”
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`involving the sale of small tracts of land, evidenced by contracts of sale and warranty deeds,
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`together with service contracts for the growing of oranges on the land amounted to an “investment
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`contract” that was a “security.” Howey, 328 U.S. at 299–300. Courts have found other schemes
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`and contracts governing a range of intangible and tangible assets to be securities. Glen-Arden
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`Commodities, 493 F.2d 1027 (whiskey casks); Miller v. Cent. Chinchilla Grp., Inc., 494 F.2d 414
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`(8th Cir. 1974) (chinchillas); Balestra v. ATBCOIN LLC, 380 F. Supp. 3d 340 (S.D.N.Y. 2019)
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`(digital tokens).
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`G. Exemptions from the Registration Requirement.
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`If the relevant instruments are securities and a prima facie case of a section 5
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`violation is then established, “the burden shifts to the defendant to show that the securities were
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`exempt from the registration requirement.” Cavanagh, 155 F.3d at 133 (citing S.E.C. v. Ralston
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`Purina Co., 346 U.S. 119, 126 (1953)). “Registration exemptions are construed strictly to promote
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`full disclosure of information for the protection of the investing public.” S.E.C. v. Cavanagh, 445
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`F.3d 105, 115 (2d Cir. 2006). In this case, there are two relevant safe harbors from the registration
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`requirement, section 4(a) of the Securities Act and Rule 506(c) of Regulation D.
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`Section 4(a)(1) exempts from the registration requirement of section 5 “transactions
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`by any person other than an issuer, underwriter, or dealer,” while section 4(a)(2) exempts
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`“transactions by an issuer not involving a public offering.” 15 U.S.C. § 77d(a)(1)–(2).
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`Section 2(a)(11) of the Securities Act defines an “underwriter” as “any person who has purchased
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`from an issuer with a view to . . . the distribution of any security.” Id. § 77b(a)(11). A
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`“‘distribution,’ as used in Section 2[(a)(11),] has been held to mean the equivalent of a ‘public
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`offering.’” Neuwirth Inv. Fund Ltd. v. Swanton, 422 F. Supp. 1187, 1194–95 (S.D.N.Y. 1975);
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`see also Gilligan, Will & Co. v. S.E.C., 267 F.2d 461, 466 (2d Cir. 1959) (stating that a
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`“‘distribution’ requires a ‘public offering’”); Berckeley Inv. Grp., Ltd. v. Colkitt, 455 F.3d 195,
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`215 (3d Cir. 2006) (“[T]hose courts interpreting [section 4(a)(1)] have uniformly concluded that
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`the term ‘distribution’ is synonymous with ‘public offering’ as set forth under Section 4[a](2).”).
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`In defining “public offering,” the Supreme Court held that “it is essential to
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`examine the circumstances under which the distinction [between