Interpretation | SEC, Telegram and Regulation 144

Source: Crypto Valley

Author: Scott Kupor

Translation: Zoe Zhou

Many people in the crypto community and other fields have been closely following the SEC's allegations of Telegram, which they believe is another regulatory test for the blockchain space. In a petition filed with the Federal Court in October 2019, the Securities and Exchange Commission stated that Telegram's sale of approximately 2.9 billion digital currencies ("Grams") violated the Securities Act of 1933.

But the US Securities and Exchange Commission has hidden an interesting nuance in its formal complaint, which is actually just an outdated reference, but has potential implications for the entire private equity market. Because the case may question nearly 50 years of how laws and practices have addressed the structuring of private equity transactions. Just last week, at the case's first public hearing, there were signs that this reference could have a wider impact on various types of "investors" and so-called "underwriters." In fact, this difference may be at the core of the case.

Extending from encryption to broader issues

The biggest question in this case is whether the things that were initially sold under the "securities" contract were "securities" after the sale. In this case, the "securities" contract was a digital currency purchase agreement (a commitment to deliver tokens in the future) that was sold to investors via Telegram before the network was released. That is, when the network is launched, the digital currency that is the basis of the initial investment contract can be traded on the network; or, more broadly, if the company ceases to exist, (in the case of complete decentralization) the network can still Does it still exist?

Considering the ongoing discussions on “securities” in the Howe test—not just labels, but also substances that make up securities. After the first hearing in the Southern District Court for the Southern District of New York last week, federal judges in the case said he would rule by April 30. However, he also emphasized that the court will not express an opinion on digital currency or a special case of digital currency, and whether digital currency is essentially a security is not the “focus of attention” in this case. He believes that the problem lies in the conditions for the sale and issue of digital currencies.

But the wider concern is whether Telegram has "financed", which has implications for other industries including digital currencies.

How did that happen?

First of all, some basic knowledge needs to be understood. In the United States, securities can only be sold if they are registered with the Securities and Exchange Commission or meet the conditions for exemption from registration. A typical example of a registered offering is an initial public offering (IPO)-the SEC reviews the information that a company discloses to potential buyers and imposes a series of continuous financial and operational information disclosure requirements on the issuer to protect the open market investor.

But the private equity market relies on a series of mature registration exemption procedures. In simple terms, a "certified" investor (meaning a wealthy person or an institution such as a university endowment fund and foundation) can issue a set of rules called 506 (b) or 506 (c) to the issuer under Regulation D Buy unregistered securities. In fact, securities law enables these so-called "worldly" buyers and sellers to complete transactions without the formal involvement of the SEC. But the premise is that all parties can protect themselves without the need for additional disclosure statements by the SEC.

The most obvious example is a due diligence conducted by a venture capital firm for Company X's Series A financing. The venture capital company signed a series of legal contracts with company X, which defined the company's rights and restrictions, and remit money to company X. As a result, the company was able to purchase Series A preferred shares of Company X. This is a typical process where a company sells unregistered securities to investors privately.

However, what would happen if the venture capital firm wanted to sell its shares in Company X at some point in the future? Under the rules established by the US Securities and Exchange Commission, the company could sell unregistered securities under Regulation 144. . According to the regulations, if certain conditions are met, restricted and controlled securities can be resold publicly. But the law states that if an investor holds securities for 6 to 12 months, the length of time depends on whether the company reports publicly and whether the investor is an affiliate of the company, then the investor is usually free to sell shares Another rich investor can also sell the company on the open market after listing.

Why is this important?

This is a common law born in the 1970s. This rule has always been an important factor in the rise of the venture capital industry, which has spawned many important companies, which in turn has created employment and economic growth …

But the SEC's allegations against Telegram seem to ignore the regulation.

Instead, the SEC stated in an initial lawsuit that private institutional investors who signed a Telegram purchase agreement (sold privately as securities under appropriate regulatory regulations) did so to distribute digital currency to unsuspecting investors. Rather than through an orderly sale to qualified investors who meet the requirements of the US Securities and Exchange Commission Reg.D to register for exemption before applying.

Although many investors have been holding digital currencies for more than a year (or according to another common practice, many people are able to "retrospect" the holding period on the date of the purchase agreement), we can also assume that digital currencies were initially purchased under wrong judgment . According to the US Securities and Exchange Commission, the only way investors can profit from their investments is by selling to unsuspecting investors.

In a legal sense, the SEC means that these investors are actually "underwriters", that is, intermediaries that buy Grams, whose purpose is to sell Grams or its underlying assets to an unsuspecting public. This not only contradicts the regulatory requirements established around Regulation 144 over the past 50 years, but also questions the nature of the purchase of private securities and the possibility of resale of these securities in private or public markets.

So why should we care about these? Because if the SEC's explanation is established, buyers of non-publicly issued securities can be considered underwriters. This has two major effects:

  • First, traditional underwriters (such as investment banks) may be held liable for any material misstatements or false statements made by the securities issuer. This is reasonable under the traditional underwriting model, because underwriters pay a certain fee when selling and selling securities—they are responsible for ensuring that information is fully and appropriately disclosed to buyers. However, according to the SEC's interpretation of the Telegram case under Regulation 144, any buyer of private securities will now be considered an underwriter. It may therefore be liable for the issuer's misconduct. This could mean that the buyer of the securities could theoretically sue another buyer for the bad behavior of the issuer / seller. This is obviously unreasonable.
  • Second, if the buyer is considered an underwriter, they may not be able to resell the legally common exemption for the security in the future. This is because in the Telegram case, although the case met the holding period stipulated in Regulation 144, the SEC's vision of a profitable sale was equated with an intent to sell to an unsuspecting public, so this was not allowed. Similarly, people will come to a strange conclusion: if people are unable to sell securities in the future when they comply with current laws and regulations, why should they buy securities?
Whether this claim can survive the Telegram case remains to be seen, but given the important precedents of private equity buyers and sellers, it is important to suspend and study it. If left unchecked, private companies may find themselves unable to raise funds from investors. Because investors may worry that when they plan to sell their investments later, they will assume greater responsibility as underwriters. This is important because a key basic principle of the private equity market is that early investors are willing to take risks and reduce the investment risks mentioned above for later investors.

If policymakers want to change the process of private enterprise financing and create businesses that can create value in other ways, they should respect normal rulemaking and legislative procedures, rather than seeking to change policy through enforcement action.