On August 29, 2023, the U.S. Court of Appeals for the District of Columbia Circuit unanimously granted Grayscale’s petition to review the decision made by the Securities Exchange Commission (SEC) regarding the denial of Grayscale’s Bitcoin Exchange Traded Product (ETP). The court not only granted the review but also vacated the SEC’s initial denial order. The Court admonished the SEC for its “arbitrary and capricious” handling of Grayscale’s ETP application. The Court noted that the SEC’s treatment of this matter was inconsistent when compared to similar cases where bitcoin futures ETPs from Teucrium and Valkyrie had been approved.

This editorial has been authored by Wyatt Noble and Michael Handelsman, contributing writers for Kelman.Law.

A Concise Overview of Spot and Futures Markets

For those who are not well-versed in the intricacies of spot and futures markets, let’s delve into this topic. If you are already familiar with conventional financial markets and the recently sanctioned bitcoin futures, feel free to skip ahead.

In financial terms, the spot market pertains to the cash markets of commodities or financial instruments. In the spot market, one can promptly exchange cash for bitcoin and anticipate immediate delivery. On the other hand, derivatives markets involve financial instruments whose value is derived from the underlying spot market, even if they are not directly traded on it. Futures are one of these derivatives, representing contracts to buy or sell assets at predetermined prices on specific dates in the future. Investors frequently utilize futures to mitigate risks and participate in trading on commodity futures exchanges, such as the Chicago Mercantile Exchange (CME), which in turn falls under the regulatory purview of the Commodity Futures Trading Commission (CFTC).

Recent Developments in Bitcoin ETP Proposals

Over the past few years, the SEC has encountered multiple proposals for listing bitcoin ETPs, all of which were subsequently denied. The basis for these denials was the SEC’s belief that the proposed ETPs did not adhere to the requirement laid out in the Securities Exchange Act of 1934, which mandates that they must be designed to prevent fraudulent and manipulative activities. However, a curious discrepancy arises when one observes that the SEC approved the proposal by the New York Stock Exchange Arca (NYSE Arca) to list the Teucrium Bitcoin Futures Fund in April 2022. Moreover, the SEC gave the green light to Nasdaq’s proposal to list the Valkyrie XBTO Bitcoin Futures Fund a month later.

The Court’s Verdict and its Rationale

Grayscale’s primary argument revolved around the SEC’s arbitrary and capricious denial of its ETP, particularly when compared to the approval of bitcoin futures ETPs that shared substantial similarities. The Court sided with Grayscale, highlighting that the futures ETPs from Teucrium and Valkyrie exhibited almost identical exposure to the spot market price when compared to Grayscale’s proposed ETP. Additionally, the listing exchanges for all three entities’ ETPs had identical surveillance sharing agreements with CME, the platform where bitcoin futures are traded. Ultimately, the Court concluded that Grayscale had adequately demonstrated the substantial similarities between its proposed bitcoin ETP and the approved bitcoin futures ETPs in terms of relevant regulatory factors.

SEC’s Attempted Distinction and the Court’s View

The SEC sought to differentiate Grayscale’s ETP from the two futures ETPs through the application of the significant market test. This test mandates that bitcoin-based ETPs need to address concerns related to fraud and manipulation by establishing surveillance sharing agreements with markets that meet specific criteria. The Court, however, deemed that “Grayscale’s evidence directly addressed the [SEC’s] concerns,” particularly in regards to the SEC’s apprehensions about trading in Grayscale having a predominant influence on the CME futures market. The SEC’s assertion lacked a satisfactory explanation according to the Court. The Court further emphasized the necessity for consistent and predictable administrative adjudication, where similar cases must be treated in a similar fashion. Since the SEC had not satisfactorily justified its approval of two bitcoin futures ETPs while denying Grayscale’s, the Court granted Grayscale’s petition for review and annulled the SEC’s previous order.

Subsequent Steps and Potential Implications

The ball is now in Grayscale’s and the SEC’s court, as they each have 45 days to decide whether to appeal. Given the Court’s ruling in favor of Grayscale, the likelihood of an appeal from their end seems minimal. However, the SEC’s stance remains uncertain as it has yet to respond to queries regarding the verdict. Should the SEC opt for an appeal, the case could either proceed to the U.S. Supreme Court or undergo an en banc panel review.

It is important to note that while this ruling signifies a significant setback for the SEC, it does not mandate immediate approval for the Grayscale ETP. Instead, it necessitates that the SEC reevaluates Grayscale’s application. Whether the SEC will now approve the application or find alternative grounds for rejection remains a matter for SEC legal experts to determine definitively.

Navigating Regulatory Uncertainty

In light of the ongoing ambiguity in regulations and the escalating frequency of enforcement actions by the SEC, seeking counsel from legal professionals well-versed in digital assets is of paramount importance. Engaging with attorneys at Kelman PLLC early on can streamline compliance with potentially applicable laws and regulations. This proactive approach can help businesses avoid legal complications and expenses that might otherwise impede their operations.

To initiate a conversation and set up a complimentary 30-minute consultation, you can complete our contact form here.

Feel free to share your insights and viewpoints on the recent court ruling in the Grayscale vs. SEC case in the comments section below.

Frequently Asked Questions (FAQs) about SEC Ruling on Bitcoin ETPs

What is the significance of the DC Circuit Court’s ruling regarding Grayscale and the SEC denial?

The DC Circuit Court’s ruling holds significant importance as it grants Grayscale’s petition for review, questioning the SEC’s denial of Grayscale’s Bitcoin Exchange Traded Product (ETP). The Court found the SEC’s treatment of Grayscale to be inconsistent with its approval of similar cases involving bitcoin futures ETPs.

What were the arguments put forth by Grayscale in this case?

Grayscale’s main argument was that the SEC’s denial of its ETP was “arbitrary and capricious,” especially when contrasted with the approval of materially similar bitcoin futures ETPs. The Court agreed with Grayscale, stating that the exposure of Teucrium and Valkyrie futures ETPs to the spot market price was nearly identical to Grayscale’s proposed ETP.

How did the Court view the SEC’s application of the significant market test?

The Court determined that Grayscale’s evidence effectively addressed the concerns raised by the SEC, including the fear that trading in Grayscale could unduly influence the CME futures market. The Court found the SEC’s explanation lacking and emphasized the importance of consistent and predictable administrative decisions, advocating for similar cases to be treated alike.

What are the potential consequences of this ruling for Grayscale and the SEC?

Following the ruling, both Grayscale and the SEC have a 45-day window to consider appealing. With the Court ruling in favor of Grayscale, the likelihood of an appeal from their side is minimal. If the SEC does not appeal, it will be required to reevaluate Grayscale’s ETP application. The final decision lies with the SEC, as it determines whether to approve the application or find alternative grounds for rejection.

How can businesses navigate regulatory uncertainty in the wake of this ruling?

Given the ongoing uncertainty in regulations and the growing frequency of SEC enforcement actions, seeking guidance from legal professionals familiar with digital assets is crucial. Engaging with experts at Kelman PLLC can streamline compliance with applicable laws and regulations, helping businesses avoid legal pitfalls and associated expenses.

Can you provide more information about spot and futures markets?

Certainly. Spot markets refer to cash markets for commodities or financial instruments where immediate exchange occurs. Derivatives markets involve instruments deriving value from the underlying spot market. Futures, a type of derivative, involve contracts to buy or sell assets at predetermined prices on future dates. Investors often use futures to manage risk, and commodity futures exchanges like the Chicago Mercantile Exchange (CME) play a significant role in this arena.

What happens if the SEC decides to appeal the Court’s ruling?

Should the SEC choose to appeal, the case could either proceed to the U.S. Supreme Court or undergo an en banc panel review. The final destination of the case would depend on the legal process and the subsequent decisions of the appellate courts.

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