The D.C. Circuit Court has ordered the Securities Exchange Commission (SEC) to take another look at its decision denying Grayscale’s application for a BTC exchange-traded product (ETP), saying that the SEC had not adequately explained its denial.
“The denial of Grayscale’s proposal was arbitrary and capricious because the Commission failed to explain its different treatment of similar products. We, therefore, grant Grayscale’s petition and vacate the order.”
In particular, the three-judge panel found that Grayscale successfully established that its proposed exchange-traded fund (ETF) was ‘materially similar, across relevant regulatory factors’ to the ETPs holding BTC futures already approved by the SEC. As a result, the rejection violated the Administrative Procedure Act (APA), which allows the court to set aside regulatory action that is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law.”
The ruling does not mean Grayscale’s BTC ETP (or anyone else’s) is approved. All that the judges can do in reviewing the SEC’s decisions is to determine whether the correct procedures were followed under the law and, if not, send the decision back to the SEC for review. That’s what happened here: the SEC must now go back to square one in its consideration of the Grayscale application.
The legal argument
The Grayscale ETF application was formally filed in June 2022 by the NYSE Arca exchange, which is intended to list the product. The listing of a new product by any exchange requires it to modify its rules, and any rule change must be approved by the SEC under the Securities Exchange Act. Thus, the SEC acts as the gatekeeper to new products, such as the many proposed BTC ETFs.
For such a rule change to be approved, the exchange filing the application must demonstrate that the rule change is consistent with the provisions of the Securities Exchange Act. One of these provisions is that the proposed rule must be “designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade,” and “to protect investors and the public interest.”
It is on that basis that the SEC declined the Grayscale application and many others. To the SEC, the BTC spot market is not sufficiently resistant to fraud and manipulation in order for the proposed new product to meet the requirements of the Act.
Grayscale had pointed to the SEC’s approval of ETPs holding BTC futures as opposed to holding BTC directly as evidence that the SEC’s rejection was arbitrary and unlawful. According to them, the same protections that justified those approvals apply equally to the spot market as they do to the futures market.
However, the SEC had argued that the futures ETPs were approved on the basis that those futures are traded on the highly-surveilled Chicago Mercantile Exchange, which could not be said of the spot market for BTC. Indeed, the CFTC, which regulates the futures market, has stated explicitly that its regulation of the futures market “does NOT provide for… value judgments about the underlying spot market.”
However, the court disagreed that this was an adequate explanation:
“NYSE Arca presented substantial evidence that Grayscale is similar, across the relevant regulatory factors, to BTC futures ETPs. The Commission failed to adequately explain why it approved the listing of two BTC futures ETPs but not Grayscale’s proposed BTC ETP. In the absence of a coherent explanation, this, unlike regulatory treatment of like products, is unlawful.”
Don’t celebrate yet
Now that a lower court has vacated the SEC’s denial of the Grayscale ETP, a ripple of optimism has traveled throughout the industry that a true BTC spot ETP might be around the corner; BTC shot up 5% on the news.
However, talk of a BTC spot ETP over the past 24 months has been awkwardly juxtaposed with a staggering amount of fraud and corruption within the digital asset industry, including through the use of BTC. This culminated over the past year in SEC enforcement actions against the biggest cryptocurrency exchanges in the industry—Binance and Coinbase (NASDAQ: COIN).
Additionally, there is an increasing realization that the most commonly traded digital assets are, in fact, illegal securities, including BTC. Against that background, it’s tough to see the SEC feel comfortable enough to approve a spot BTC ETP.
All now depends on the SEC’s next move. They could opt to appeal the ruling, or they could go back to the drawing board in considering Grayscale’s proposal. It’s clear that the SEC is of the opinion that a spot BTC ETP would constitute an unacceptable risk to investors – but the Commission will need to try a different tack if it is to avoid scrutiny under the APA.
Watch Blockchain Policy Matters with SEC Commissioner Hester Peirce
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