SEC Disapproves Proposal to List and Trade Bitcoin Shares on NYSE | Practical Law

SEC Disapproves Proposal to List and Trade Bitcoin Shares on NYSE | Practical Law

The SEC issued an order disapproving proposed amendments to Rule 8.201-E of the New York Stock Exchange (NYSE) Arca, Inc. regulations that would have permitted the listing and trading of shares of the United States Bitcoin and Treasury Investment Trust.

SEC Disapproves Proposal to List and Trade Bitcoin Shares on NYSE

Practical Law Legal Update w-024-2920 (Approx. 5 pages)

SEC Disapproves Proposal to List and Trade Bitcoin Shares on NYSE

by Practical Law Finance
Published on 05 Mar 2020 • USA (National/Federal)
The SEC issued an order disapproving proposed amendments to Rule 8.201-E of the New York Stock Exchange (NYSE) Arca, Inc. regulations that would have permitted the listing and trading of shares of the United States Bitcoin and Treasury Investment Trust.
On February 26, 2020, the SEC issued an order disapproving proposed amendments to Rule 8.201-E of the New York Stock Exchange Arca, Inc. regulations (NYSE Arca) that would have permitted the listing and trading of shares of the United States Bitcoin and Treasury Investment Trust (bitcoin trust). The SEC concluded that the NYSE did not meet its burden under Section 6(b)(5) of the Exchange Act, which requires that the rules of a national security exchange be:
  • Designed to prevent fraudulent and manipulative acts and practices.
  • Consistent with the protection of investors and the public interest.
NYSE Arca submitted the proposal to the SEC in June 2019 and amended the proposal in October 2019. The proposal, as modified, provided for:
  • The listing and trading of shares of the bitcoin trust under NYSE Arca Rule 8.201-E, which governs the listing and trading of commodity-based trust shares.
  • Amendments to Rule 8.201-E(c) that would:
    • provide that the commodity-based trust shares may be issued and redeemed for the underlying commodity and/or cash. Under the current rule, commodity-based trust shares may only be redeemed for the underlying commodity.
    • define "commodity" as the term is defined in Section 1(a)(9) of the Commodity Exchange Act (CEA). Current Rule 8.201-E(c)(2) states that "commodity" is defined in Section 1(a)(4) of the CEA.
The bitcoin trust's assets would include bitcoin held by Coinbase Custody Trust Company, LLC, as the bitcoin custodian, and short-term US Treasury securities with a maturity of less than one year (T-bills).
The SEC stated in prior orders regarding the listing of commodity-based exchange-traded products (ETPs), including bitcoin-based commodity trusts and bitcoin-based trust-issued receipts, that exchanges listing ETPs can meet their Section 6(b)(5) obligations by demonstrating either that:
  • There is a comprehensive surveillance-sharing agreement with a "regulated market of significant size" relating to the underlying assets of the commodity-based ETP. According to the SEC, a surveillance-sharing agreement would "assist in detecting and deterring misconduct" since a person attempting to manipulate the ETP would be "reasonably likely to also engage in trading activity on that significant market."
  • The underlying market inherently possesses a resistance to manipulation beyond the protections that are utilized by traditional commodity or securities markets (in which case a surveillance-sharing agreement with a regulated significant market would not be necessary).
NYSE Arca asserted that its proposal was consistent with the SEC standard for exchanges to list commodity-based ETPs, as set forth in prior SEC orders, since:
  • The pricing mechanism for the proposed ETP would be based on the Chicago Mercantile Exchange (CME) CF Bitcoin Reference Rate (bitcoin reference rate), which is derived from trade prices of bitcoin on certain bitcoin spot platforms (constituent platforms) and is inherently resistant to manipulation.
  • The relevant segment of bitcoin spot market is composed of the constituent platforms that are inherently resistant to manipulation, as evidenced by:
    • their registration with the Financial Crimes Enforcement Network (FinCEN) as money services businesses (MSB) and compliance with the various regulatory requirements that are required of MSBs (see Practice Note, FinCEN Regulation of Virtual Currency: Overview);
    • their oversight, by virtue of being constituent platforms for calculation of the bitcoin reference rate, by the CME, the CFTC (in its oversight of CME), CF Benchmarks, Ltd. (the administrator of the bitcoin reference rate), and the UK Financial Conduct Authority (FCA) (in its oversight of CF Benchmarks); and
    • assessments of the trading activity on these platforms that show that the constituent platforms consistently exhibit closely aligned prices.
  • NYSE Arca has entered into a surveillance-sharing agreement with the CME bitcoin futures market, which is a regulated bitcoin market of significant size, and each of the constituent platforms have data-sharing agreements with CME.
NYSE Arca also contended that approving the proposal would be consistent with Section 6(b)(5) of the Exchange Act because it would protect investors and the public interest.
The SEC disagreed, concluding that NYSE Arca did not demonstrate that its proposal was designed to prevent fraudulent and manipulative acts and practices since:
  • It did not establish that the relevant bitcoin market possesses a unique and inherent resistance to manipulation such that a surveillance-sharing agreement would not be necessary, reasoning that:
    • the bitcoin reference rate is not inherently resistant to manipulation, as is evidenced by the CFTC's heightened review specific to bitcoin futures (see Legal Update, CFTC Announces Heightened Review of Bitcoin Futures Products);
    • the level of regulation on the constituent platforms is not equivalent to the obligations and oversight of national securities exchanges or futures exchanges;
    • the CFTC does not have regulatory authority over bitcoin spot trading platforms, including the constituent platforms;
    • CF Benchmarks does not exercise governmental regulatory authority and its oversight, which is contractual in nature, is fundamentally different as compared to the regulation of national securities exchanges; and
    • fraud and manipulation are present in the broader bitcoin market, and the record does not indicate that this fraud and manipulation would not affect the constituent platforms.
  • The CME bitcoin futures market, with which NYSE Arca has a surveillance-sharing agreement, is not a "regulated market of significant size" such that an actor trying to manipulate the proposed ETP would have to trade on the CME bitcoin futures market in order to successfully manipulate the proposed ETP.
  • NYSE Arca does not have a surveillance-sharing agreement with the constituent platforms, and the constituent platforms do not constitute a regulated market.
Since NYSE Arca failed to demonstrate that the proposal was designed to prevent fraudulent and manipulate acts, the SEC stated that it also did not demonstrate that the proposal was consistent with the protection of investors and the public interest.
In addition, since the SEC determined that the proposal was not consistent with Section 6(b)(5) of the Exchange Act, it did not reach the question of whether the proposed amendments to Rule 8.201-E were consistent with the Exchange Act.
The SEC noted in the order 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."
Commissioner Hester Peirce issued a dissenting statement in response to the order, stating that "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."
This order follows several other SEC orders disapproving the listing of bitcoin-related ETPs on security exchanges, including:
These orders may be distinguished from two exchange-traded funds (ETFs) that came to market on the NYSE and Nasdaq on November 17, 2018 after receiving SEC approval (see Legal Update, Blockchain ETFs Launch After Name Change). The approved ETFs invest in companies that use blockchain-based technology in their business, rather than investing in blockchain-based cryptocurrency such as bitcoin.
Since the beginning of 2018, the SEC has requested that a dozen bitcoin ETFs and two cryptocurrency mutual funds retract their applications for registration.
For details on SEC regulation of digital assets, see Practice Note, Understanding the SEC's Digital Asset Framework and Approach to Digital Asset Regulation.