Telegram’s Defeat Isn’t ‘Binding’ in Kik Case, Judge Tells SEC
Kikâs proverbial day in court may last a lot longer than Telegramâs.
Thatâs the takeaway from a federal judgeâs response to the U.S. Securities and Exchange Commission during a hearing in its case against messaging platform Kik over the companyâs 2017 initial coin offering, which raised $100 million.Â
Judge Alvin K. Hellerstein, senior judge of the United States District Court for the Southern District of New York, rejected the SECâs argument that the token sale was similar to that of Telegram, another messaging company which raised money for a blockchain project, and should face a similar outcome. The SEC won a preliminary injunction against Telegram this year, ordering the company to halt the issuance of its gram tokens, and the firm later discontinued the TON project.Â
Related: Telegram Agrees to Pay $18.5M Penalty in SEC Settlement Over Failed TON Offering
âI think that there is no binding precedent one way or another,â Hellerstein said.
Nearly 200 people dialed in to listen to Thursdayâs hearing, which took place just over a year after the SEC filed suit. Both the SEC and Kik have filed for summary judgment, meaning they hope to end the lawsuit before it reaches a jury trial, either by a ruling that Kik violated securities laws (the SECâs argument) or that it didnât (Kikâs argument). It is now up to the judge to either grant a judgment or let the trial proceed, unless the parties settle.
When SEC counsel Stephan Schlegelmilch invoked the Telegram case as a very similar token offering to Kikâs, Judge Hellerstein interrupted. He noted that Judge P. Kevin Castel, who presided over the Telegram case, only found that there was a âlikelihood of successâ in the preliminary injunction ruling.Â
âNow with you, itâs different,â he told Schlegelmilch. âYouâre asking for summary judgment. I understand that Judge Castelâs decision has a lot of reasoning that is comfortable to you. [Itâs a] very well-reasoned decision characteristic of Judge Castel, but I think our issue is different.â
Related: Alleged Shopin ICO Fraudster Pays $450K Fine in Ether
See also: Telegram Responds to SEC: Gram Tokens Are Not Securities
Common enterpriseThe hearing quickly turned into a two-hour-long debate on the application of the Howey Test, a U.S. Supreme Court case used as a precedent to determine if a financial instrument is a security.Â
Schlegelmilch said the case against Kik rested on a single claim: that the entirety of Kikâs offering of 1 trillion kin was an unregistered securities sale that violated Section 5 of the Securities Act. The token sale, the SEC said, was an investment contract where the investor expected to profit off the efforts of others â in this case, Kikâs promise to build an ecosystem for the use of its kin token.Â
âHere, the economic reality is that Kik engaged in an old-fashioned capital raise using a new-fangled device, the blockchain,â Schlegelmilch said.Â
Shlegelmilch went on to allege that Kik continually promised it would give the kin token value, referencing Kikâs 2017 white paper, which laid out its plans for kin. Kik allegedly told investors it would âbuild fundamental value for the new currency by integrating kin into its chat app,â Schlegelmilch said.Â
âThis was a thing that had no value whatsoever. What it had was Kikâs promises to give it value. And that is a quintessential security, that is a quintessential investment contract and why this matters, Your Honor,â Schlegelmich said.Â
One element of Kikâs defense is similar to that of Telegram, which insisted its gram token offering for the TON project was a currency and not a security.Â
Despite his disagreement with the SEC over the supposed similarities with the Telegram case, Judge Hellerstein sounded unconvinced by Kikâs argument the initial coin offering (ICO) did not violate securities laws because its token, known as kin, is used as a currency by its app users.Â
âI canât see the difference between that and a stock,â Judge Hellerstein said, responding to Kikâs defense that under the Howey Test the kin offering did not qualify as a common enterprise where the purchaser was led to expect profits from the efforts of the promoter or a third party. Â
Kikâs defenseKik, represented by Patrick Gibbs of Cooley LLP, argued there were no contractual obligations between Kik and kin purchasers, and that if one owner sold his kin for profit, that profit is not shared with other owners.Â
Judge Hellerstein pushed back on that statement. Any shareholder in a given company can âsell that share at a price and keep the profit for themselves,â he said. âThatâs not what determines whether thereâs a common enterprise.â
Gibbs said there were a slew of cases that showed âwhere the buyer has control over the resale and doesnât share profits for resale with anyone else, there is not a common enterprise,â and that the SEC had not cited cases that applied to the current situation.
âThe SEC has not cited a single case, not one where the alleged profit was going to come from capital appreciation only, resale of an asset at a higher price,â Gibbs said. âTheyâve cited to you a bunch of cases ⦠where the profits take the form of a share of a stream of profits or dividends that are paid out over time for an ongoing business.â
See also: A âHowey Testâ for Blockchain? Why the SECâs ICO Guidance Isnât Enough
Gibbs also reiterated Kikâs position that it could not have known at the time of sale that kin would become a security.Â
âOne of the cases that we think lays out a very useful framework for thinking about when the sale of an asset becomes an investment contract, and therefore security, is one that cited all of our papers,â he said, referring to Rodriguez vs. Banco Central Corporation, heard almost three decades ago, where swamp land was sold to unsuspecting investors on the alleged promise that the area was ripe for future development. The land sales were not deemed securities.Â
Kik General Counsel Eileen Lyon told CoinDesk the legal team presented its arguments well, and the company is awaiting the judgeâs decision.Â
âJudging by the numbers of people who dialed in for the hearing, this continues to be an important case for our industry,â Lyon said..
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