Former CFTC Chairman Gary Gensler believes the recent Telegram ruling shows that a once popular structure for selling tokens won’t spare you from securities laws
A ruling Tuesday against Telegram may be the death knell for SAFT—the “simple agreement for future tokens”—a once popular idea for launching an initial coin offering. That’s according to what Gary Gensler, former Commodity Futures Trading Commission chairman, told Decrypt Wednesday.
In a wide-ranging interview, Gensler, who now lectures at MIT’s Sloan School of Management, said he believes the federal court ruling means the SAFT construct won’t spare companies from securities laws. And a token still has to pass the Howey Test, a hurdle in determining whether something qualifies as an investment contract.
“If the token, even two or three years later, is being bought in anticipation of profit, relying on some common enterprise, it’s still a security,” Gensler said.
SAFT, which debuted in late 2017, rested on the idea that tokens initially sold as securities could morph into something that was not a security after a network launched. But on Wednesday, that assumption was put to rest by a ruling in the SEC v. Telegram case when a federal district court judge issued a preliminary injunction prohibiting the social network from launching its gram token.
“It was a good day for investors and good day for investor protections,” he said. Gensler led the CFTC under the Obama administration from 2009 to 2014 when his term ended, well before the crypto bubble. He believes that 99% of all ICOs are investment contracts—even if they are issued under the guise of a SAFT contract.
In 2018, Telegram raised $1.7 billion for a future sale of a token. In Gensler’s view, both the sale of the SAFT contracts, which was a security and the gram tokens (which haven’t been issued yet) are part of the same investment scheme and thus securities.
In his 44-page order and ruling, Judge P. Kevin Castel agreed. The judge spelled out why he believes the SEC is likely to win the case if it goes to trial. Telegram immediately filed a notice of appeal to challenge the ruling.
What’s a SAFT?
The idea for SAFT was born in Silicon Valley. It was based on Y Combinator’s simple agreement for future equity, otherwise known as SAFE notes, which became a popular template for startup financing since it was introduced in 2013.
A more formal SAFT framework was developed in October 2017 by Marco Santori, formerly a top partner at law firm Cooley. (He left Cooley early the following year to become chief legal officer at wallet startup Blockchain.)
As described in Santori’s SAFT whitepaper, the general idea was simple. You sell tokens that don’t actually exist yet to accredited investors under SEC exemptions. Once the network goes live and the tokens are launched (because they can’t exist until the network does), the tokens become “utility tokens,” redeemable for specific functions on the network. According to the paper, utility tokens ought to pass the all-important Howey test. The test helps determine whether something is a security—because the buyer expects the purchase to appreciate in value over time, through the efforts of others.
Filecoin, the first project to use the SAFT agreement, raised more than $257 million that way—and has yet to launch its network. And there were others. Intangible Labs raised $133 million in a SAFT, but shut down amid SEC concerns, and returned the money to investors. Social network Kik raised part of its $100 million ICO money in a SAFT, but is in hot water with the SEC, and so on.
Where the logic breaks down
“The idea that somehow something could transition from being a security to something that’s not a security, was a novel suggestion in 2017 and 2018,” Gensler said.
Indeed, the SEC subsequently put out answers to questions in April 2019 that actually suggested that maybe something could transition to a utility offering, if it was sufficiently decentralized.
But one of the key tenets of the Howey Test is that an investment contract exists when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.
“If you look at that April guidance it is clear they were talking about something that no longer was relying on others for anticipation of profits,” Gensler said. “I think that basically Judge [Castel] was saying the SEC has the better argument in here, that people are still relying on Telegram, the company, for the value of the gram token.”
More than just SAFT
But Gensler believes the Telegram ruling had more to do with just the SAFT structure. It’s also about that guidance the SEC put out.
“It’s like, no, the gram token isn’t really just there as a utility to be used like a laundromat token. It’s not. It’s people are going to buy or sell the gram token in anticipation of profit in reliance on Telegram, the company, to support the value and future prospects of that token.”
That’s even more important than the structure, he continued. “It’s sort of like the structure can’t save you from that analysis. That analysis is critical. Is it that the gram tokens relying on the efforts of others and there’s an anticipation of profit? The answer is: Yes, it’s still a security.”
“In terms of SAFT, that means the structure does not relieve you of the basic analysis, which is, is the token being bought by others in anticipation of profit relying upon some common enterprise? And if the token, even two or three years later, is being bought in anticipation of profit, relying on some common enterprise, it’s still a security.”
Not a total loss for Telegram
If the SEC ultimately wins the case, Telegram can still issue its gram tokens. It just has to comply with securities laws, Gensler said, and that could be challenging. The same goes for Filecoin. If it ever issues its token, it likely still has to comply with securities laws, and that means various transparencies, investor protections, and disclosures, he said.
It also means that any exchange that traded such tokens would have to be registered, either as a broker-dealer or as a full market exchange. “So it has ramifications both for the tokens and it has ramifications for any exchange that might list the tokens,” Gensler said.
Will Filecoin or even Telegram (if courts rule in favor of the SEC) still issue their token? “That would be up to them. If they can’t, then they might have to disband the project and return the money. But maybe they could comply with securities laws,” he said.