On August 29, 2023, a three-judge panel of the D.C. Circuit Court of Appeals unanimously sided with Grayscale in its long-running battle with the Securities and Exchange Commission (“SEC”) regarding its application to launch the first bitcoin exchange-traded fund. Observing that the SEC’s denial of Grayscale’s proposal was “arbitrary and capricious” because it was inconsistent with the SEC’s treatment of similar products, the Court vacated the SEC’s June 2022 rejection of a proposed rule change that would allow NYSE Arca to list Grayscale Bitcoin Trust (“GBTC”) shares on its exchange. The Court’s Order and implications for the future of spot bitcoin exchange-traded product (“ETP”) listings are summarized below.
In fall 2021, NYSE Arca proposed listing shares of GBTC on the exchange as a spot bitcoin ETP. After delaying a decision for nearly eight months, the SEC denied GBTC’s application in June 2022, finding that NYSE Arca’s proposed rule change was not “designed to prevent fraudulent and manipulative acts and practices” and failed to satisfy the SEC’s significant market test, which requires the listing exchange to have a surveillance sharing agreement (“SSA”) in place with a “regulated market of significant size.” However, in spring 2022, the SEC had approved the listing of two bitcoin futures ETPs, the Teucrium Bitcoin Futures Fund and the Valkyrie XBTO Bitcoin Futures Fund, that would invest primarily in bitcoin futures contracts listed on the Chicago Mercantile Exchange (“CME”). For both futures-based ETPs, the SEC’s basis of approval was rooted in the fact that the listing exchange had an SSA in place with the CME, which the SEC determined to be a regulated market of significant size with respect to CME Bitcoin Futures.
After the SEC’s denial, Grayscale sued the SEC under the Administrative Procedures Act, arguing that the denial of GBTC’s listing was “arbitrary and capricious” in light of the SEC’s approval of two similar bitcoin futures-based ETPs.
The Court’s Order
The Court agreed with Grayscale’s argument, finding that GBTC was materially similar to SEC-approved bitcoin futures ETPs across the relevant regulatory factors. Specifically, the Court found that “the underlying assets—bitcoin and bitcoin futures—are closely correlated.” The Court also found that “surveillance sharing agreements with the CME are identical and should have the same likelihood of detecting fraudulent or manipulative conduct in the market for bitcoin and bitcoin futures.”
The Court analyzed the SEC’s test for whether NYSE Arca had an SSA in place with a “regulated market of significant size,” enabling it to assess whether market manipulation will be detected in the market subject to the SSA. The test has two prongs:
First, there must be “a reasonable likelihood that a person attempting to manipulate the ETP would … have to trade on [the related] market to successfully manipulate the ETP”; and
Second, it must be “unlikely that trading in the ETP would be the predominant influence on prices in [the surveilled] market.”
The Court found that the SEC failed to reasonably explain why it approved the listing of two bitcoin futures ETPs, but not GBTC’s similar proposal. The Court also found that the SEC failed to provide a sufficient reason for finding that the CME’s bitcoin futures markets was sufficiently large to be able to avoid manipulation so as to justify the approval of bitcoin futures-based ETPs, but not sufficiently large relative to the deeper and more liquid spot bitcoin markets so as to justify approval of GBTC’s listing. The Court concluded that “[t]he [SEC] failed to adequately explain why it approved the listing of two bitcoin futures ETPs but not Grayscale’s proposed bitcoin ETP. In the absence of a coherent explanation, this unlike regulatory treatment of like products is unlawful.”
The Court’s action does not necessarily mean that GBTC (or anyone else) will be able to list shares of a spot bitcoin ETP any time soon. Indeed, shortly after the Grayscale decision, the SEC announced that it will postpone decisions on a number of other outstanding spot bitcoin ETPs until at least October 19, 2023.
As a preliminary matter, the SEC could potentially appeal the ruling (up until October 30, 2023), and the appeals process can take time. Even if it does not, the Court’s ruling left open the procedures the SEC must follow going forward. Specifically, the Court noted that it “will not substitute [its] policy judgments for that of the agency,” thus suggesting that GBTC’s filing application may ultimately be sent back to the SEC for review—thus giving the SEC another opportunity to reject it, albeit on a different basis. In this scenario, the new denial could itself then be subject to another appeal by GBTC to the DC Circuit.
Even if the SEC does not appeal the ruling, NYSE Arca may need to make a new filing on behalf of GBTC to list its shares on the exchange. The timing of any SEC decision to permit GBTC to list on an exchange is also uncertain. With a completely new filing, it is possible that the SEC can take another eight months to reach a decision on GBTC. Finally, the SEC could rescind previously approved bitcoin futures ETPs. While this drastic measure is unlikely, it would turn the Court’s GBTC ruling on its head, as the core of the argument hinges on the SEC’s disparate treatment of bitcoin futures ETP and spot bitcoin ETP listing applications.
For its part, Grayscale submitted a comment on September 5th to its original 2021 SEC filing suggesting that “the best use of resources now is for the Commission to issue an order approving NYSE Arca’s Rule 19b-4 filing and authorize the staff to work with Grayscale and NYSE Arca to finalize the prompt listing of the Trust’s shares.” They note that “[i]f any other reason could be offered in attempting to differentiate spot bitcoin ETPs from bitcoin futures ETPs—whether based on the Exchange Act’s requirement that rules be “designed to prevent fraudulent and manipulative acts and practices” or otherwise—we are confident that it would have surfaced by now in one of the fifteen Commission orders, including Grayscale’s disapproval order, that rejected spot bitcoin Rule 19b-4 filings even after bitcoin futures ETPs began trading.” In addition, Grayscale pointed out that “[t]he Trust’s Rule 19b-4 filing has now been pending for nearly three times the length permitted for Commission action under Section 19(b) of the Exchange Act.”
With respect to other pending petitions for a spot bitcoin ETP listing, there is widespread speculation that the SEC will grant approval, if at all, to a number of sponsors at the same time rather than picking a “winner” from among the many applicants. However, even if spot bitcoin ETP listings are approved, it is unclear whether the SEC’s Division of Corporation Finance is prepared to approve the registration statements for GBTC or any other spot bitcoin ETP, which would be a required step before a spot bitcoin ETP could be listed on an exchange.
While the prospects for spot bitcoin ETP approvals continue to be an outstanding question, Grayscale’s victory could signal a coming change in the crypto regulatory environment.
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