SEC’s Grayscale Court Rout Puts Agency in Will-They, Won’t-They Role Starring Gensler

• A slap-down from federal courts means the Securities and Exchange Commission must now rethink bitcoin spot ETFs, though its old objections won’t work and the clock is ticking.
• Crypto industry insiders argue the most logical course of action is just giving in.

The crypto industry’s campaign to set up exchange-traded funds (ETFs) has now pushed the U.S. Securities and Exchange Commission against a wall with Grayscale Investments’ consequential court win, but it’s still up to the agency to decide whether to retreat or keep fighting.

“It’s back in the SEC's court,” said Dan Berkovitz, who was general counsel at the agency until early this year. If SEC officials wanted to deny Grayscale’s bitcoin ETF again, “they’d have to really think of some other reasons that they haven’t articulated yet. That would be a hurdle for them.”

The U.S. securities regulator, led by Chair Gary Gensler, now faces several options: appeal the decision; grant Grayscale’s application to list its bitcoin spot ETF; let it be automatically approved by doing nothing; or start up a new, second effort to reject the application based on fresh objections. Much of the industry celebrated Tuesday, assuming this is the beginning of the end of this particular SEC roadblock for crypto, and bitcoin’s 6.5% price climb offered evidence of that optimism. But Gensler has been famously skeptical of crypto and the dangers he says it poses to investors.

“‘Arbitrary and capricious’ are not words that Gary Gensler should want to hear from federal courts, but that’s what this unanimous panel of judges called his agency’s judgment,” said Pat Daugherty, a former SEC lawyer who now represents crypto clients with Foley & Lardner. “The SEC failed to explain why it could approve ETFs based on bitcoin futures but not an ETF based on bitcoin. Since like cases must be treated alike in America, the SEC lost.”

At stake is an investment product that could bring new investors to crypto but that the SEC has said is still too hazardous.

So far, the securities regulator said after the ruling that it’s “reviewing” the court action and will make a decision on its next steps. With the original rejection of Grayscale’s application now vacated by the court, it remains unclear when the clock starts counting down again to an SEC deadline, but observers are assuming the agency will soon make that timeline clear.

“After losing this case, the smart play for the SEC will be to approve Grayscale’s application speedily,” said Daugherty, who also teaches crypto and ETF innovation courses at Cornell Law School. “Will Chair Gensler back off and shift course? Perhaps a few Democrats on Capitol Hill will persuade him.”

One former Republican SEC commissioner told CoinDesk – on the condition he not be named – that he wouldn't be surprised if the agency works to come up with another rejection.

“One theory is that the SEC will just pick a different reason to deny Grayscale's proposal and force more long and costly litigation,” Jake Chervinsky, chief policy officer for the Blockchain Association – a crypto lobbying group – said in a series of tweets on the decision. “But another theory is that the SEC will take the DC Circuit's decision as a (semi-)graceful exit from their anti-ETF position. I'm in this camp. It's the right move.”

Grayscale is a unit of Digital Currency Group, which is also the parent of CoinDesk.

As with most federal agencies, the SEC has a long history of court defeats, including a tough loss on its 2010 "proxy access" rule and a couple of the specialized disclosure rules mandated by the Dodd-Frank Act. It kept fighting for much of a decade after defeats on a rule that says resource-extraction businesses, such as oil companies, must disclose their payments to foreign governments, but that effort was actually required by law. This time the court's repudiation is different, targeting a position born inside the agency that the SEC ought to reject a specific financial project that would be automatically approved if the agency instead chose to sit on its hands.

Court battles aren't getting any easier for the agency, Berkovitz said.

"The deference that the agency might have gotten in prior years is just not nearly as easily granted anymore," he said. And the more the SEC loses, the harder it gets, he added.

Two of the judges in the decision – Chief Judge Sri Srinivasan and Senior Circuit Judge Harry Edwards – were Democratic appointees, from the same party as Gensler, so their view can’t be characterized as a conservative backlash against the administration.

“I’ve never before seen a financial regulator’s denial of an application get slapped down by a bipartisan judicial panel of a moderate, a conservative, and a progressive like just happened in Grayscale,” said Justin Slaughter, who has worked at the SEC and is now the policy director at Paradigm. “The SEC has restored bipartisanship in DC.”

Whether or not Grayscale wins in the end, the ruling may lift the other ETF efforts.

“While it doesn’t guarantee that the SEC will approve Grayscale’s bitcoin ETF, it is likely they will approve all of the ETF applications with what they deem as sufficient information sharing agreements, specifically from Blackrock and Fidelity,” predicted Dave Weisberger, co-founder and CEO of CoinRoutes, who called the ruling a “huge win” for crypto.

Weak surveillance of trading information marked a chief complaint of the SEC regarding these ETF efforts as it rejected one after another. Weisberger suggested the SEC could now decide to approve the projects with good surveillance plans and call it a win for consumer protection.

Coinbase (COIN), the crypto exchange that would provide much of the required surveillance, noted Tuesday that “the courts are giving us regulatory clarity where the SEC has refused,” according to a statement from Paul Grewal, the publicly-traded company’s chief legal officer. “While we still believe comprehensive federal crypto legislation is the best way forward, decisions like this are an important step toward the clarity the industry needs.”

Gensler’s SEC still has supporters, however, who encourage the agency to resist.

“The decision does not change the fact that the Bitcoin market is subject to fraud and manipulation or that an ETF would be a serious threat to investors, which is why the SEC did and should deny Grayscale,” said Dennis Kelleher, CEO of Better Markets, a Washington-based group that often seeks to counter financial industry lobbying. “The SEC should consider rescinding the prior unwarranted Bitcoin futures ETF approvals.”

Helene Braun contributed reporting.