On March 24, 2020, federal Judge P. Kevin Castel issued a long-anticipated opinion in the SEC’s ongoing efforts to block Telegram’s $1.7 billion initial coin offering. Judge Castel found that Telegram’s planned distribution of Gram tokens constitutes a securities offering under federal law for which no exemption from registration is available. He therefore granted the SEC a preliminary injunction blocking Telegram from distributing its Gram tokens to investors.

Telegram made a series of highly technical arguments to the court in order to disaggregate key steps in the Gram offering, which occurred in a series of stages to investors worldwide over a period of time. The court, however, disregarded these form-over-substance arguments in carefully parsing through each of the elements of the Howey test. Importantly, Judge Castel found that Howey refers to an investment contract, i.e., a security, as “a contract, transaction or scheme,” using the term “scheme” in a “descriptive, not pejorative, sense.” He reasoned that this case presents a “scheme” to be evaluated under Howey that consists of the full set of contracts, expectations and understandings centered on the sales and distribution of the Gram. According to the judge, Howey requires an examination of the entirety of the parties’ understandings and expectations.

In sum, Judge Castel found that the SEC has shown a substantial likelihood of success in proving that the Gram purchase agreements, Telegram’s implied undertakings and its understandings with the initial purchasers, including the intended and expected resale of Grams into a public market, amount to the distribution of securities, thereby requiring compliance with the registration requirements under the federal securities laws. Telegram failed to establish a viable private placement exemption. Further, the judge concluded that the SEC has shown that the sale and imminent delivery of Grams represent a single ongoing violation. The court also found that the delivery of Grams to the initial purchasers, who would resell them into the public market, represents a near-certain risk of a future harm.

Telegram has appealed the ruling. To many in the crypto community who had hoped for a ruling against the SEC, Judge Castel’s decision is surely disappointing. But no matter how the appellate court ultimately rules, the SEC is not likely to move off its expansive conception of the securities laws in the context of digital assets, nor is it likely to cease its efforts to prevent unregistered offerings of such digital assets.

While certain private placement exemptions remain viable alternatives for some offerings of digital securities, they all limit the ability of issuers to place tokens in the hands of large numbers of purchasers. To date the SEC has only approved two Regulation A offerings of digital securities, and it has approved no traditional public offerings. These remain challenging times for issuers of digital securities.