Dissent: SEC Commissioner Hester Peirce Disagrees with Commission’s Decision to Deny Bitcoin ETF

SEC Commissioner Hester Peirce has posted a statement dissenting from the Securities and Exchange Commission’s decision to, once again, decline to allow an exchange-traded product (ETP or ETF) for the world’s most popular cryptocurrency Bitcoin.

The Commission denied NYSE Arca’s request to offer a Bitcoin fund largely due to concerns that Bitcoin is open to pricing manipulation.  To quote the SEC’s document:

“The Commission concludes that NYSE Arca has not established that the relevant Bitcoin market possesses a resistance to manipulation that is unique beyond that of traditional security or commodity markets such that it is inherently resistant to manipulation. The Commission further concludes that NYSE Arca has not established that an actor trying to manipulate the proposed ETP would be reasonably likely to trade in the CME Bitcoin futures market. And the Commission concludes that NYSE Arca has not established that it has a surveillance-sharing agreement with the Constituent Platforms or that the Constituent Platforms constitute a regulated market, such that it has established that it has entered into a surveillance- sharing agreement with a regulated market of significant size with respect to Bitcoin. The Commission emphasizes that its disapproval of this proposed rule change does not rest on an evaluation of whether Bitcoin, or blockchain technology more generally, has utility or value as an innovation or an investment. Rather, the Commission is disapproving this proposed rule change because, as discussed below, NYSE Arca has not met its burden to demonstrate that its proposal is consistent with the requirements of Exchange Act Section.”

The entire document may be reviewed here.

Peirce criticized the Commission’s decision lamenting the “ever-shifting standards that this Commission insists on applying to Bitcoin-related products—and only to Bitcoin-related products.”

Other critics of Bitcoin-based ETFs have focused on the fact it is a single asset-based fund. Why do you need an exchange-traded product for a single asset when you can easily buy it on many regulated digital asset exchanges?

Additionally, a presentation by Bitwise in 2019 claimed that 95% of Bitcoin volume was fake while asserting that the real market for Bitcoin was far smaller and more orderly, as well as regulated, than one may anticipate.

Peirce, a leading advocate for financial innovation and sage voice in a challenging regulatory environment, said the Commission is at its best when it welcomes “innovation and that we will not interfere with the ability of our regulated entities to embrace innovation within our regulatory framework.”

Peirce added that the decision “evinces a stubborn stodginess in the face of innovation. The irony is that, in taking this approach, the Commission wanders into the unbounded, dangerous territory of merit regulation for which the Commission is ill-equipped.”

The statement by Commissioner Peirce is republished below.

Today the Commission once again disapproved a proposed rule change that would give American investors access to bitcoin through a product listed and traded on a national securities exchange subject to the Commission’s regulatory framework.[1] This order is the latest in a long string of disapproval orders that the Commission has issued regarding bitcoin-related products.[2] This line of disapprovals leads me to conclude that this Commission is unwilling to approve the listing of any product that would provide access to the market for bitcoin and that no filing will meet the ever-shifting standards that this Commission insists on applying to bitcoin-related products—and only to bitcoin-related products.

When I dissented from the Commission’s order disapproving a proposed rule change that would have permitted Bats BZX Exchange, Inc. to list and trade shares of the Winklevoss Bitcoin Trust,[3] I did so because I believed that the proposed rule change was consistent with the statutory standard for such rule filings. I also argued that the Commission’s approach to that product—and others like it—interfered with the continued institutionalization of the market and thus delayed improvements in market structure and investor protections, and that it deprived investors (particularly retail investors) of the ability to access bitcoin in markets within our regulatory framework. Finally, I warned that the Commission’s hesitancy to embrace new products and technologies impedes innovation in this country and threatens to drive entrepreneurs, and the opportunities they create, to other jurisdictions. The Commission’s actions in this area over the past eighteen months confirm these concerns. Meanwhile, investor interest in gaining exposure to bitcoin continues to grow.

I. The Commission Applies a Unique, Heightened Standard under Exchange Act Section 6(b) to Rule Filings Related to Digital Assets
Section 6(b)(5) of the Exchange Act requires, in part, that the rules of a national securities exchange be “designed to prevent fraudulent and manipulative acts and practices [and] to protect investors and the public interest.” As I explained in the Winklevoss Dissent, this provision requires the Commission to look to the rules of the exchange seeking to list the product, not the attributes of the assets or markets underlying the product to be traded. The statute says nothing about the underlying markets.

The Winklevoss Dissent set out my statutory analysis in full, and I will not repeat it here.[4] I am persuaded that NYSE Arca’s proposed rule filing to list and trade shares of the United States Bitcoin and Treasury Investment Trust (“the Trust”) satisfies the statutory standard for generally the same reasons that persuaded me the Bats BZX filing did so. Moreover, as in the Winklevoss Dissent, I would reach the same conclusion even if I agreed that the Commission could scrutinize the underlying market as part of this analysis.

This disapproval order is just the most recent in a series of such disapprovals in which the Commission applies Section 6(b)(5) in a manner contrary to the plain language of the statute.[5] The Commission has looked not to the rules of the listing exchange but instead to the quality (or, more accurately, the merits) of the underlying bitcoin spot or futures market. As exchanges refine their filings to address the Commission’s concerns, the Commission responds by requiring increasingly granular analyses of the relevant markets and by requiring exchanges to establish that these markets possess characteristics that the Commission has required in no other market. One might suspect that the Commission has found in the penumbras of Section 6 of the Exchange Act a heightened market quality standard—indeed, a mandate for merit regulation—that applies only to products based on bitcoin. One also might conclude that this standard will forever beckon, as a mirage on the horizon that tempts the entrepreneur to continue committing her limited resources to a quest that is, in the end, doomed to fail.

As I noted in the Winklevoss Dissent, prior to its orders disapproving Bitcoin-related products, the Commission had never articulated a standard that expressly required surveillance-sharing agreements with a regulated market of significant size.[6] Notwithstanding the Commission’s assertion in this order that “in every case,” regardless of the underlying commodity, it has required “at least one significant, regulated market for trading futures on the underlying commodity,”[7] that standard in fact appears to be unique to the bitcoin-related products the Commission has considered.[8] In a prior order, the Commission admitted that its pre-bitcoin orders “did not explicitly undertake an analysis of whether the related futures markets were of ‘significant size,’” but protested that such analysis was implicit.[9] In support, the Commission cited to a large number of pre-Bitcoin orders where the exchanges made representations regarding the trading volumes on the relevant regulated markets.[10] Tellingly, in none of these pre-bitcoin orders does the Commission appear to have performed any analysis of whether those volumes were significant when compared to the underlying commodity markets.[11] In some prior orders, the Commission does not even mention the size of any related market, much less conduct any analysis of the relevant markets.[12] In at least one case, the Commission approved a rule change to list shares of a product referencing a futures market that, at the time of approval, had no trading whatsoever.[13]

Prior to these bitcoin-related filings, the Commission also did not require an exchange to establish any relationship between pricing on the regulated market and the underlying futures or spot markets. Nor has the Commission previously demanded a lead-lag analysis, which considers the relationship between pricing in the markets with which the exchange has a surveillance-sharing arrangement or that will be used to price the listed product, and all other markets.[14] The Commission has not established that this test is consistent with, or reasonable in light of, its prior approval orders, and it is unclear whether this pricing relationship could ever be established to the Commission’s satisfaction for any product, including those previously approved.[15]

I also take issue with the Commission’s approach to determining whether the listing exchange has appropriate surveillance-sharing arrangements in place. Here, as in the prior bitcoin orders, the Commission faults the exchange for not having surveillance sharing agreements with the underlying spot markets and suggests such agreements would be insufficient in any event, as those markets are not “regulated” to a sufficient level.[16] Yet the Commission’s analysis in prior orders seldom focused on the regulatory status of markets that had surveillance-sharing arrangements with the listing exchange.

Indeed, in several cases, the Commission recognized—though again with little analysis—that effective surveillance-sharing arrangements can take different forms and need not be with a market at all, much less with a regulated one. For example, in the Palladium and Platinum Trust Orders, the primary surveillance-sharing arrangement was the exchange’s ability under its rules to obtain information from its own registered market makers in the approved product.[17] In an order approving the listing and trading of units of an oil-related fund that was designed to hold oil futures contracts, options on futures contracts, forward contracts, swaps, and over-the counter contracts for commodities, the exchange represented that most of these markets “may . . . be effectively unregulated.”[18] The Commission approved the proposed rule change on the condition that the exchange enter into a surveillance-sharing arrangement with any market on which oil derivatives are traded,[19] which suggests that the exchange did not need to enter into such agreements only with regulated markets (or that the regulatory status of related markets is not relevant for purposes of the surveillance-sharing arrangement). Yet the Commission consistently has imposed this condition in its bitcoin disapproval orders.[20]

Moreover, the Commission’s requirement of a formal agreement with a regulated exchange is not necessary to achieve the Commission’s stated objective for the requirement. The Commission explains that “a surveillance-sharing agreement with a regulated, significant market facilitates the ETP listing exchange’s ability to obtain the necessary information to detect and deter such manipulative conduct.”[21] It does not explain why this type of agreement is necessary if another arrangement can “facilitate” access to “necessary information.” As detailed in a submission by the exchange, both the exchange and the Chicago Mercantile Exchange (“CME”) are members of the Intermarket Surveillance Group (“ISG”). The Commission has previously noted that, when two or more exchanges belong to the ISG, their membership qualifies as a surveillance-sharing agreement with each other.[22] To be recognized as a constituent exchange for the Bitcoin Reference Rate,[23] a bitcoin spot exchange must both agree to cooperate with regulator inquiries and investigations and enter into a data sharing agreement with CME.[24] CME monitors the constituent exchanges for compliance and enforces these requirements, as illustrated by its previous removal of two platforms for non-compliance.[25] In other words, this arrangement enables the ETP listing exchange to obtain the information it needs from both CME and the underlying spot exchanges,[26] thereby “facilitat[ing] the [] listing exchange’s ability to obtain the necessary information to detect and deter such manipulative conduct,” as the Commission requires. The Commission’s dismissal of this mix of public and private regulation simply because it is not identical to the Commission’s regulation of national securities exchanges or SROs exalts form over function and disregards the important role that alternative forms of regulation always have played in the financial markets.[27]

These further refinements of the standard expressed in the Commission’s demands appear designed for one purpose: to keep bitcoin out of our markets, notwithstanding the ongoing development and increasing sophistication we have seen in the bitcoin market over the past several years. Absent a rational justification for subjecting bitcoin to a standard different from that applied in prior orders, the Commission should have approved this filing.

More than 116 years ago, Justice Holmes observed that hard cases make bad law.[28] The same might be said for efforts to make easy cases hard. A significant number of ETPs and other products that the Commission has approved for listing probably would not meet the standard the Commission is demanding of exchanges in connection with the listing of bitcoin-related products. That the Commission, in its efforts to keep bitcoin out of the markets we regulate, is impeding innovation in the market for bitcoin-related products is bad enough; that the Commission may be setting precedent that will make it more expensive to submit rule filings to bring other listed products to market, and more difficult for the Commission to approve them, only compounds the harm to investors.[29]

II. The Commission’s Approach Impedes Institutionalization and Innovation
The Commission’s three-part mission—protecting investors; maintaining fair, orderly, and efficient markets; and facilitating capital formation—is best-served when we make clear to the market that we welcome innovation and that we will not interfere with the ability of our regulated entities to embrace innovation within our regulatory framework. We do not protect investors by adopting standards that compel them to access novel products anywhere but in our markets; we do not promote fair, orderly, or efficient markets when we prevent institutional players from bringing to already vibrant markets the benefits of their participation; and we do not facilitate capital formation when we greet innovation in a defensive crouch.

As I noted in the Winklevoss Dissent, bitcoin is ripe for a more welcoming approach by the Commission. Investor demand remains strong. The markets are well-connected by active arbitrageurs, who regulate prices and markets.[30] Permitting institutional investors and regulated exchanges to enter this market would lead to more robust protections for retail investors (who, to be clear, are already active in the underlying spot market),[31] to better custody solutions for bitcoin, and to more effective surveillance for market manipulation and other fraudulent activity.

The potential benefits of increased institutionalization are apparent in the filing describing the exchange’s proposed rule change. As I have already described above, the CME, which is a Commodity Futures Trading Commission-regulated futures exchange that serves a largely institutional market, prices its U.S. dollar futures contracts using a bitcoin reference rate that is calculated using prices on several constituent bitcoin spot markets.[32] A spot market seeking to become—or continue as—a constituent exchange must satisfy a rigorous set of requirements that is designed to ensure a fair, transparent market, reduce fraud and manipulative activity, and facilitate regulatory oversight. A more receptive stance by the Commission toward similar involvement by our regulated entities would likely compound this effect, further promoting the maturation of the underlying bitcoin market.

Erecting impediments, limiting people’s liberty to choose for themselves, and resisting innovation achieves none of these benefits. They demonstrate instead that the Commission is unprepared to confront and embrace the new opportunities that we can expect entrepreneurs to develop. Meanwhile, American investors will still seek access to products they want, but without the vaunted protections of our securities laws, while American entrepreneurs will seek their fortunes elsewhere, taking their talents and ingenuity with them.

Investors are well served when innovation flourishes. I recognize that innovation involves risks, but it is investors who should get to choose the winners and the losers of the market. Regulators should not impede investor choice; rather, they should ensure that investors have access to accurate disclosures about the range of available products, including their risks.

III. Conclusion
The Commission’s approach to these bitcoin exchange-traded products is frustrating because it evinces a stubborn stodginess in the face of innovation. The irony is that, in taking this approach, the Commission wanders into the unbounded, dangerous territory of merit regulation for which the Commission is ill-equipped. Because the Commission’s order applies an inappropriate standard under Section 6(b)(5) of the Exchange Act, I respectfully dissent.

Hester M. Peirce, Commissioner

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