Telegram's Defeat Isn't 'Binding' in Kik Case, Judge Tells SEC

Kik's proverbial day in court may last a lot longer than Telegram's.

That’s the takeaway from a federal judge’s response to the U.S. Securities and Exchange Commission during a hearing in its case against messaging platform Kik over the company’s 2017 initial coin offering, which raised $100 million.

Judge Alvin K. Hellerstein, senior judge of the United States District Court for the Southern District of New York, rejected the SEC’s 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.

“I think that there is no binding precedent one way or another,” Hellerstein said.

Nearly 200 people dialed in to listen to Thursday’s 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 SEC’s argument) or that it didn’t (Kik’s 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 Kik’s, Judge Hellerstein interrupted. He noted that Judge P. Kevin Castel, who presided over the Telegram case, only found that there was a “likelihood of success” in the preliminary injunction ruling.

“Now with you, it’s different,” he told Schlegelmilch. “You’re asking for summary judgment. I understand that Judge Castel’s decision has a lot of reasoning that is comfortable to you. [It’s a] very well-reasoned decision characteristic of Judge Castel, but I think our issue is different.”

See also: Telegram Responds to SEC: Gram Tokens Are Not Securities

Common enterprise

The 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.

Schlegelmilch said the case against Kik rested on a single claim: that the entirety of Kik’s 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 – in this case, Kik’s promise to build an ecosystem for the use of its kin token.

“Here, the economic reality is that Kik engaged in an old-fashioned capital raise using a new-fangled device, the blockchain,” Schlegelmilch said.

Shlegelmilch went on to allege that Kik continually promised it would give the kin token value, referencing Kik’s 2017 white paper, which laid out its plans for kin. Kik allegedly told investors it would “build fundamental value for the new currency by integrating kin into its chat app,” Schlegelmilch said.

“This was a thing that had no value whatsoever. What it had was Kik’s promises to give it value. And that is a quintessential security, that is a quintessential investment contract and why this matters, Your Honor,” Schlegelmich said.

One element of Kik’s defense is similar to that of Telegram, which insisted its gram token offering for the TON project was a currency and not a security.

Despite his disagreement with the SEC over the supposed similarities with the Telegram case, Judge Hellerstein sounded unconvinced by Kik’s 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.

“I can’t see the difference between that and a stock,” Judge Hellerstein said, responding to Kik’s 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.

Kik’s defense

Kik, 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.

Judge Hellerstein pushed back on that statement. Any shareholder in a given company can “sell that share at a price and keep the profit for themselves,” he said. “That’s not what determines whether there’s a common enterprise.”

Gibbs said there were a slew of cases that showed "where the buyer has control over the resale and doesn't share profits for resale with anyone else, there is not a common enterprise,” and that the SEC had not cited cases that applied to the current situation.

“The 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,” Gibbs said. “They've 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.”

See also: A ‘Howey Test’ for Blockchain? Why the SEC’s ICO Guidance Isn’t Enough

Gibbs also reiterated Kik’s position that it could not have known at the time of sale that kin would become a security.

“One 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," 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.

Kik General Counsel Eileen Lyon told CoinDesk the legal team presented its arguments well, and the company is awaiting the judge’s decision.

"Judging by the numbers of people who dialed in for the hearing, this continues to be an important case for our industry,” Lyon said.