SEC Strikes Back in Grayscale Suit Over GBTC ETF Conversion

The U.S. Securities and Exchange Commission (SEC) filed a brief last week defending itself against claims its denial of Grayscale Investment’s application to convert its flagship Grayscale Bitcoin Trust (GBTC) into a spot bitcoin exchange-traded fund (ETF) was “arbitrary, capricious and discriminatory.

Grayscale filed suit against the SEC on June 29 – the same day the SEC rejected its application – and asked the U.S. Court of Appeals for the District of Columbia Circuit to review the SEC’s order. Grayscale is a sister company of CoinDesk.

The suit was followed by a flurry of support from the wider crypto industry and beyond, and five amicus curiae (friend of the court) briefs were filed in the case.

But the SEC is sticking to its guns. In the regulator’s first response brief since Grayscale filed suit, the SEC reiterated that its reasons for denying Grayscale’s applications were consistent with its earlier decisions to deny every other spot bitcoin ETF application it had received.

Read more: Unpacking the Latest Bitcoin ETF Rejections

‘No inconsistency’

In its lawsuit, Grayscale pointed to the SEC’s approval of several bitcoin futures ETFs to argue that greenlighting one type (futures ETFs) of instrument while rejecting the other (spot, or bitcoin-holding ETFs) was arbitrary, and thus a violation of the Administrative Procedure Act (APA).

The SEC pushed back in its filing, arguing that “the two products are not the same” and have “fundamental differences in the ability to detect and deter fraud and manipulation,” that “reasonably support treating the two products differently.”

Futures ETFs, unlike spot ETFs, are tradable only on the Chicago Mercantile Exchange, which the SEC pointed out is overseen by federal regulators and performs “extensive surveillance of the trading activity on its market.”

The SEC also pointed to prior statements made by the Commodity Futures Trading Commission (CFTC) that its permission to trade bitcoin futures “does NOT provide for … value judgements about the underlying spot market.”

An issue of surveillance

The SEC has long maintained that its denial of the ETF applications is largely due to the lack of regulatory oversight of the spot market, including surveillance-sharing agreements between a “regulated market of significant size” and a regulated exchange.

Without proper oversight, the SEC has argued, spot ETFs could be vulnerable to “fraudulent and manipulative conduct,” including wash trading, price manipulation by “whales,” “malicious control of the bitcoin network,” hacking, insider trading, “manipulative activity involving purported ‘stablecoins’” and fraud at crypto exchanges.

Grayscale and would-be spot ETF applicants that came before the SEC have argued the surveillance-sharing agreements the regulator wants aren’t necessary in the case of bitcoin, which they have argued has “novel protections” against fraud.

But the SEC disagrees. In the filing last week, it pointed to statements made by Grayscale itself in its registration statement, which warns customers of the “unregulated nature and lack of transparency” surrounding the operations of spot-trading platforms, the risks of hacking and the risk of “fraud and manipulative activity” at bitcoin trading platforms.

The SEC also highlighted a statement from the New York Stock Exchange that “fraud and manipulation may exist and that bitcoin trading on any given exchange may be no more uniquely resistant to fraud and manipulation than other commodity markets.”

“Given these prior statements and the risks the Commission identified, the Commission concluded that NYSE Arca failed to substantiate its assertions regarding bitcoin’s purportedly novel anti-fraud properties,” the SEC wrote.

Next steps

Grayscale’s reply to the SEC is due on Jan. 13. The SEC’s response to Grayscale is due on Feb. 3.

After all briefs have been submitted, the judge will review the SEC’s decision to reject Grayscale’s application and make a determination.

As the lawsuit progresses, shares of Grayscale’s largest fund, the Grayscale Bitcoin Trust (GBTC), are trading a record 47% discount to the value of the underlying cryptocurrency.