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The Court of Appeals for the DC circuit finally issued (what may be, at least judged by interest on X — fka Twitter) one of the most eagerly awaited opinions in its history. The question: did the SEC violate the requirements of the Administrative Procedures Act (APA) by “arbitrarily and capriciously” rejecting Grayscale’s application (and by extension, applications from other issuers) for a spot Bitcoin ETF while approving applications for Bitcoin ETF’s based on CME futures.
The Court, comprising 3 judges of diverse political persuasions, ruled unanimously that the SEC did indeed violate the APA; furthermore, it ordered the SEC to rescind its rejection of the Grayscale proposal and to review its decision in a way that is consistent with the requirements of the APA.
There is a lot to unpack here but let’s go step by step:
What did the Court Decide?
I think it is important to first explain what the Court did not decide. It did not opine:
- On the merits of the Grayscale application;
- On the merits of the SEC’s concerns about fraud and manipulation;
- On the need for surveillance sharing agreements;
- On any of the SEC’s previous decisions rejecting applications for spot BTC ETFs.
Rather, the Court held that the SEC had not adequately distinguished its reasoning for favouring a futures-based ETF over the similar spot products, and that its inability or unwillingness to do so represented a violation of the APA. In its own words: “To avoid arbitrariness and caprice, administrative adjudication must be consistent and predictable, following the basic principle that similar cases should be treated similarly. NYSE Arca presented substantial evidence that Grayscale is similar, across the relevant regulatory factors, to bitcoin futures ETPs. The Commission 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.”
“Hoist on its own Petard”
To some extent, the SEC is a victim of its own attempts to seek a compromise with the crypto industry. Indeed, it was Commissioner Gensler’s early support, expressed in various public speeches back in 2021, of futures backed ETFs that trapped the SEC in an APA maze of its own making. Back then, Commissioner Gensler expressed support for futures-backed products registered under the Investment Company Act of 1940 (essentially, proper funds) that could provide “significant investor protection” and stated publicly that he was looking “forward to Staff’s review of such filings.” Having approved the ’40 Act product, the Staff then extended those approvals to Grantor trust structures similar to the spot-backed proposals (which are registered under the Securities Act of 1933). It is that extension that the Court has used against the SEC in this opinion. Essentially, the Court used the SEC’s decision to approve futures-based bitcoin ETFs against it.
So the question now remains: how will the SEC react?
What Can the SEC Do?
The SEC can appeal. The Court’s review was done by 3 judges and the SEC can ask for an “en banc” review, which would then be reviewed by all 17 judges of the Court. They have 45 days to request an “en banc” review. Given the decision was 3–0 against the SEC, the chances of winning on appeal are not particularly good.
The SEC can rescind its previous rejection and then re-review Grayscale’s application (or review an amended application assuming Grayscale files one). That review would then have to comply with the Court’s ruling. If the SEC can find a way to distinguish spot and futures markets “across the relevant regulatory factors” and that distinction is meaningful, then there is a good chance it could survive further review. It is worth noting that the SEC did not try (either in its written briefs or during oral arguments) to provide any evidence contradicting Grayscale’s assertions of the 99% correlation between spot and futures markets. This failure to provide evidence was a crucial part of the Court’s reasoning in favour of Grayscale. If such evidence exists, that could provide adequate defence for the SEC’s position.
The SEC can look at rescinding approvals for futures backed ETFs that use the Grantor trust structure. AUM there is low relative to the ’40 Act product that dominates the market, but it would be a fairly churlish move and not particularly wise from a regulatory perspective.
Finally, the SEC can just concede defeat. Framing their decision as a commitment to the “rule of law,” despite disagreement, offers a diplomatic way to retreat from a losing position. There will likely be additional political impetus to approve spot bitcoin ETFs, given the broader financial industry’s interest, including heavyweight firms like Blackrock. This is not just about Grayscale; the entire traditional financial sector is poised for a spot bitcoin ETF. With other key players proposing their own ETFs, SEC Chair Gensler has the opportunity to reshape the agency’s narrative. The SEC has faced criticism for its perceived “regulation-by-enforcement” approach to crypto; approval of a spot bitcoin ETF would serve as a counter-narrative, showcasing their willingness to endorse suitable products.
No matter what happens, the Court’s decision has definitely put the SEC on the back foot and dramatically improved chances for the approval of a spot bitcoin ETF.
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