An appeals court panel ruled that the SEC’s rejection of a proposed bitcoin spot ETP was arbitrary and capricious, opening the door to the potential launch of numerous ETPs in the near future.
On August 29, 2023, a three-judge panel of the Court of Appeals for the District of Columbia Circuit ruled in favor of Grayscale Investments, LLC on a petition for review of an order of the Securities and Exchange Commission (SEC ).
Grayscale proposed to the SEC in October 2021 that Grayscale would convert its Bitcoin Trust into an exchange-traded product (ETP) based on the Bitcoin spot market (rather than Bitcoin futures). Since ETPs are traded on exchanges and investors in the ETP would not need to purchase the digital asset directly, an ETP could potentially accelerate retail and institutional adoption.
The SEC rejected Grayscale’s proposal in June 2022 because it claimed the ETP did not meet consumer protection requirements, including measures “designed to prevent fraudulent and manipulative acts and practices.” Grayscale then sued the SEC under the Securities and Exchange Act of 1934, asking the Court of Appeals to review the SEC’s denial. In its decision, the Court of Appeal panel overturned the SEC’s refusal.
The Court’s reasoning
At the outset, the Court stated that the Administrative Procedure Act requires the Court to set aside agency actions that are “arbitrary, capricious, constitute an abuse of discretion, or fail to comply with law.” The Court reviews the agency’s decision to determine whether it is “reasonable and reasonably explained.”
Grayscale argued that the approved Bitcoin futures ETPs and its proposed Bitcoin spot ETP are “materially similar” and therefore deserve similar treatment.
The Court agreed with Grayscale that the SEC failed to adequately explain why it disagreed that the Bitcoin futures and spot markets were highly correlated or why it ultimately approved the listing of two Bitcoin futures ETPs, but not the spot Bitcoin ETP offered by Grayscale. According to the ruling, “Grayscale presented undisputed evidence that there is a 99.9% correlation between the Bitcoin spot market and CME futures prices. » Grayscale also demonstrated identical surveillance sharing arrangements to detect fraud or manipulation in the market, as well as significant similarity “between relevant regulatory factors.”
The Court held that the approval of one and the refusal of the other were arbitrary and capricious because “[i]n the absence of a coherent explanation [from the SEC]this treatment contrary to the regulation of similar products is illegal.
Next procedural steps
The SEC indicated that it was reviewing the Court’s decision. He has a period of 45 days after entry of the judgment to request a new hearing by the college or by a in bench session in the same court (i.e., a repeat with the participation of all judges of the Circuit Court of Appeals rather than the three-judge panel). According to the Rules and the Manual of Practice and Internal Procedure of the Court, a request for rehearing in bench must explain why the case is of exceptional importance or cite precedent believed to be contrary to the committee’s judgment.
The SEC may also request a writ of certiorari for review by the United States Supreme Court (within 90 days of entry of judgment or denial of a timely request for rehearing, whichever is later ).
If the SEC chooses not to request a rehearing or appeal, the Court will issue a formal warrant seven days after the deadline for requesting a rehearing has expired. The mandate would specify actions the SEC should take as a result of the decision, such as asking the SEC to approve Grayscale’s proposed bitcoin ETP, or to reconsider the proposal.
The SEC could file a motion to suspend the mandate, but must demonstrate that the motion would raise a substantial issue and that good cause exists for a stay. The Court may grant unopposed motions requesting stays for up to 90 days.
If the SEC is ordered to reconsider the proposal, it could still reject it with better justification for the original reasons for its refusal, or on other grounds. For example, the SEC could provide clearer evidence to support its assertion that the bitcoin futures and spot markets are uncorrelated, or that the underlying spot market is clearly subject to manipulation due to its lack of regulatory oversight.
Conclusion
Although the decision was a simple determination of reasonableness and fairness under the Administrative Procedure Act (rather than a comment on the underlying company or asset class), it encouraged the asset sector digital, on the heels of a perceived victory in the SEC v. Ripple case (for more, see this Latham blog post). Several proposals for spot Bitcoin ETPs remain open with the SEC. The Court’s decision therefore constitutes a positive development for all market participants advocating for a spot Bitcoin ETP.
