Preliminary Matters

Digital asset manager Grayscale has filed its opening brief against the United States Securities Exchange Commission (SEC) to challenge its decision denying Grayscale’s application to convert the Grayscale Bitcoin Trust (GBTC) to a spot Bitcoin exchange-traded find (ETF). The world’s largest digital asset management firm filed its opening legal brief on Oct. 11 in the U.S. Court of Appeals in the District of Columbia Circuit, in which it claimed the SEC’s knockback to be ‘arbitrary, capricious and discriminatory.’

[Lindrea, B. Grayscale fires first salvo in case against SEC over Bitcoin ETF refusal. (Accessed October 13, 2022)].

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[Note: You may access a copy of Grayscale’s Brief by clicking here].

“Grayscale informed Twitter users about the same by posting it on its personal Twitter wall” [Anderrson, S. Grayscale Filed Preliminary Brief Against SEC Refusal Over Bitcoin ETF. (Accessed October 13, 2022)].

Likewise via Twitter, Grayscale has provided a Timeline for the Appellate Phase of this litigation as it proceeds through the US Court of Appeals:

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“The ruling under review is the Securities and Exchange Commission’s June 29, 2022 final order titled Order Disapproving a Proposed Rule Change, as Modified by Amendment No. 1, to List and Trade Shares of Grayscale Bitcoin Trust Under NYSE Arca Rule 8.201-E (Commodity-Based Trust Shares), Release No. 34-95180, 87 Fed. Reg. 40299 (July 6, 2022)” [Grayscale Investments, LLC. BRIEF OF PETITIONER GRAYSCALE INVESTMENTS, LLC. (Accessed October 13, 2022)].

Grayscale’s Legal Argument

Generally, Grayscale claims "the SEC’s knockback to be arbitrary, capricious and discriminatory” [Lindrea, supra].

Grayscale more specifically "reasoned that the SEC treats spot bitcoin exchange-traded products (ETPs) with ‘particular rigor’ and is doing so 'exceeding its statutory authority” [Anderrson, supra). In this regard, “Lawyers for Grayscale argued that several Bitcoin futures ETFs previously approved by the SEC generate their prices based on the same indices as Bitcoin ETFs. They stated that the SEC could not reasonably conclude that Bitcoin Futures ETFs do not take the same risks ‘in the same market’ as the Bitcoin ETF position” [CCN.LK. Grayscale files its opening brief for the first time in its lawsuit against the SEC over its rejection of a Bitcoin ETF. (Accessed October 13, 2022)].

Just months earlier, however, the Commission had approved two separate proposals for ETPs that hold as assets bitcoin futures (a derivative of bitcoin), after finding that those ETPs did not present an unacceptable risk of susceptibility to fraud
or manipulation. But the price of bitcoin futures is subject to the identical risk of fraud and manipulation as is the spot price of bitcoin. That is because bitcoin futures represent the market’s prediction of future spot bitcoin prices, and prices in the bitcoin spot and futures markets align more than 99% of the time. If, as the Commission has concluded, bitcoin futures ETPs do not pose an unacceptably high risk of fraud and manipulation, then by definition neither do spot bitcoin ETPs. But the Commission has treated them as categorically different—a result that violates the bedrock requirements of the Administrative Procedure Act (“APA”) as well as the express statutory command that a national securities exchange’s rules not discriminate among securities issuers.

[Grayscale Investments, LLC, supra].

Nonetheless, the SEC has advanced the justification for this discrimination on the ground that the BTC Futures trade in a secondary market (the Chicago Mercantile Exchange) which disseminates the ‘market surveillance’ gathered with the national securities exchanges. But Grayscale’s lawyers maintain “[…] that is a distinction without a difference: the Commission acknowledged that bitcoin futures ETPs may be affected by fraud or manipulation in non-CME markets, yet found the surveillance sharing between the CME and national securities exchanges sufficient to address such fraud or manipulation” [Id].

The lawyers’ further note:

In this case, the Commission has offered no coherent explanation why CME surveillance is sufficient to address the risk of non-CME fraud for bitcoin futures ETPs but insufficient to address the same risk for spot bitcoin ETPs. If any fraud
were to occur in the spot bitcoin markets, it would equally affect bitcoin futures ETPs and spot bitcoin ETPs. Although bitcoin may be a relatively new asset, the legal issue here is
straightforward. The Commission has violated the APA’s most basic requirements by failing to justify its vastly different treatment of bitcoin futures ETPs and spot bitcoin ETPs. (emphasis added)

[Id].

Simply put, “Grayscale says that if the SEC can approve Bitcoin futures ETFs, it can also approve spot market ones as they carry ostensibly the same risks” [Rohky, M. Grayscale Investments Makes Move Against SEC, Files Opening Legal Brief in ETF Rejection Lawsuit. (Accessed October 13, 2022)].

In a separate argument that finds its basis in the foregoing, Grayscale maintains: “the SEC ‘critical-market test’ that assesses whether the exchange proposal to list ETP was ‘designed to prevent fraudulent and manipulative acts and practices - Flawed’ and that the SEC 'set the bar so high which can’t easily be satisfied. Grayscale’s lawyer noted that this kind of significant market test only applies to Bitcoin-related ETPs, which led them to believe that they have been discriminated against” [Anderrson, supra].

Indeed, the Commission’s decision is not merely discriminatory and unreasoned: it harms the 850,000 investors who own shares in the Trust. Given that the Commission did not approve the Trust to trade as an ETP on the Exchange, the value of its shares cannot closely track the value of the Trust’s underlying bitcoin assets — depriving Trust shareholders of billions of dollars in value. There is simply no justification for continuing to inflict such serious investor harms.

[Grayscale Investments, LLC, supra].

Final Thoughts

What has been presented herein is basically a brief summary of Grayscale’s legal arguments in this case. A read of the full brief is fascinating and illuminative.

“Grayscale is far from the only company whose spot bitcoin ETF application has been rejected – over the last year, the SEC has denied over a dozen similar applications from other major players in the crypto space, including WisdomTree and Ark21Shares, citing a lack of investor protections and the potential for fraud and manipulation” [Ligon, C. In SEC Lawsuit, Grayscale Calls Spot ETF Rejection ‘Arbitrary, Capricious and Discriminatory’. (Accessed October 13, 2022)].

Parenthetically, “Grayscale’s filing came the same day that the SEC rejected a proposed rule change that would have given the go-ahead to ETF specialist WisdomTree to list and trade shares of its planned bitcoin trust on the Cboe BZX Exchange. It marked WisdomTree’s second attempt to launch a spot bitcoin ETF” [Hernandez, O. Grayscale Fires Back at SEC’s Veto of Spot Bitcoin ETF. (Accessed October 13, 2022)].