GBTC Litigation: Oral Arguments Unofficial Transcript

Court Clerk: Case number 22-1142, Grayscale Investments, LLC, Petitioner vs. Securities and Exchange Commission. Mr. Verrilli, for the Petitioner. Ms. Parise for the Respondent.

Chief Judge Srinivasan: Good morning counsel. Mr. Verrilli, please preced— proceed when you’re ready.

Don Verrilli: Good morning, and may it please the Court, I’m Don Verrilli for Petitioner Grayscale. This appeal challenges an SEC order disapproving an exchange’s request to list an exchange-traded product that holds Bitcoin as its underlying asset. The fundamental problem with the order is that it contradicts previous SEC orders giving a green light to Bitcoin futures ETPs that pose the same risk of fraud and manipulation, and have in place the same CME surveillance mechanism to protect against those risks, as the spot Bitcoin ETP that the SEC disapproved here. That is the definition of arbitrary decision making.

And it’s worse than that because the decision actually disserves the policy set out in Section 6(b)(5) of the Exchange Act. This is not your typical APA appeal. We are asking to be regulated in this way, not to hold regulation at bay. And regulating us in this way would better protect consu- uh, investors because it would give them the benefit of oversight by NYSE Arca on the basis of the surveillance and sharing information from the CME. Disapproval leaves the investors in a situation in which trading will continue on an over-the counter market that is largely unregulated, and therefore they are less protected.

Beyond that, it hardly serves the statutory goal of removing impediments to a free and open market to leave $4 billion in value locked up in this fund uh, when— as a result of it not being an ETP. And of course, disapproval discriminates between issuers of futures ETPs and issuers of spot ETPs, which also the statute prohibits.

So, I think it might be helpful to take a minute at the outset to do a bit of a deeper dive on the contradiction between the two orders. The— and I think the place to start is with the language of the statute of 6(b)(5). The statute provides that, in order to approve um, an application, the SEC has to conclude that the rules of the exchange have in place measures designed to prevent fraudulent or manipulative activities. With respect to the spot ETP that’s at issue here, the Commission concluded that that standard wasn’t met. But Bitcoin futures ETPs that the SEC approved are going to be affected by manipulation of the spot markets. The SEC said that exact thing in the Teucrium order and it stands to reason. Bitcoin futures are derivatives of Bitcoin itself, and the undisputed record evidence shows that 99.9% of the time, the price of Bitcoin futures and Bitcoin spot market, uh Bitcoin spot market, correlate.

Um, and what they— And what the SEC also found um in the futures orders is that the existence of the surveillance sharing agreement would suffice to protect against fraud and manipulation of the spot market as well as of unregulated, other unregulated futures markets. And the reason for that is because the SEC concluded that manipulation of a spot market or manipulation of the other unregulated futures markets would show up in the price in the regulated futures market. [Inaudible]

Chief Judge Srinivasan: So how do we know that the Teucrium order in making the statements that you just paraphrased was specifically talking about manipulation of the spot market as opposed to manipulation of unregulated futures markets?

Don Verrilli: So I would direct the Court to pages 21679 and 680 of uh 87 Fed. Reg., which is the Teucrium order. Um, and I know the Commission makes that argument in its brief here— the Court can, of course, read for itself the relevant paragraphs on those pages. I think it’s extremely hard to read them as not addressing spot as well as unregulated futures markets. If one looks at the preceding paragraph, there’s a discussion— I think it comes up five or six times, the question of spot markets as well as uh as well as unregulated futures markets.

And then um you know if uh— and then with respect to that, uh, the exact phrase that we pointed to— where the— where the Commission says CME surveillance can reasonably be relied upon to capture the effects on CME futures markets, whether the attempt is made by directly trading on the CME Bitcoin futures market or by trading outside of the CME Bitcoin futures market. If I’m remembering correctly, I think the immediately preceding sentence is talking about spot markets. And so, and I think that the SEC must have concluded that that was the case because otherwise it couldn’t have concluded that the statutory standard was met. The statutory standard requires that the design of the exchange rules be sufficient to prevent fraud and manipulation. And so it had to have concluded that the existence of the CME surveillance mechanism was going to pick up spot market manipulation insofar as it affected the futures prices. And then that, an so and that exact mechanism is operating now with respect to the relationship between um NYSE Arca and— and uh— CME. [Inaudible]

Judge Rao: Mr.— Mr. Verrilli?

Don Verrilli: Yes?

Judge Rao: Um, previous SEC denials of spot Bitcoin ETPs, were those challenged in court?

Don Verrilli: I don’t believe they were. I believe this is the first one.

Judge Rao: I couldn’t find anything. So a lot of this really turns on the fact that the SEC has now decided to allow future Bitcoin— Bitcoin futures ETPs.

Don Verrilli: So—

Judge Rao: —and the failure to treat the two similarly?

Don Verrilli: I do think, I think our case is quite a bit stronger given the fact of— you know not the fact of, but the reasoning behind the approval of the futures ETPs.

Judge Rao: Mhmm.

Don Verrilli: Um, I think even if the SEC had not done so, we’d probably be here making a similar argument that CME surveillance would work in exactly the way that the SEC found that it worked in the Teucrium and Valkyrie orders. But you don’t have to take our word for it because they have made that finding in those orders.

Judge Rao: I do wonder if we were to um agree with you that the SEC has behaved arbitrarily and capriciously in treating these two products differently, do you think the SEC will then have to approve the spot Bitcoin ETPs, or might the SEC simply reverse its determination about Bitcoin futures ETPs?

Don Verrilli: We’re asking for the standard remedy. We’re asking that the order be set aside, which means go back to the Commission, and it seems to me they would have three options available to them.

First, they could agree with us um that— that the prior reasoning really compels the conclusion that this also has to be approved because the risks aren’t any different and the protections are the same.

The other option, I suppose, we could try to come up with some different distinction. I don’t know what that would be.

Um, the third option would be to say, well, we’ve got to rethink the whole thing. Um I guess nothing would prevent them from doing that—

Judge Rao: I assume you don’t want the third thing.

Don Verrilli:—It would surprise me if they would do it, though. I mean, they have— they, you know, they have these futures ETPs that uh because of an oddity of the statute got through under the 1940 Act, you have additional futures ETPs that the Commission has approved under the 34 Act. They’re out there trading, there’s billions of dollars of assets wrapped up in them.

The Commission just made— these decisions were roughly contemporaneous. The Teucrium order was just a couple of months before ours. Uh so presumably— presumably they were thinking about these things together. Um and— and as I said, it would surprise me a great deal, um, if they decided to rethink the whole thing. But it’s not— it’s not, I don’t see anything that forecloses them from doing so.

Chief Judge Srinivasan: You think that second route’s available?

Don Verrilli: So—

Chief Judge Srinivasan: —Of the three that you just itemized? Which is that they could come up with an explanation? Because I— I understood your argument to be almost one of an economic identity.

Don Verrilli: Well, I think that’s why I said I can’t come up with— I mean— it’s theoretical, you know, this path is theoretically available. But I’m not sure what it would be. If you take as a baseline the approval of the futures contracts because of that— the unrebutted record evidence showing 99.9% correlation in the movement of the two, which of course stands to reason.

And I— if I— if I could just address one of the specific arguments the Commission has made in this regard, um namely that while the futures markets aren’t actually priced— uh— based on—uh— the spot prices. You know, I would point out first they said exactly— they rejected that exact argument in the Teucrium order. But beyond that, just as a matter of common sense, you know, on the day that um a futures contract expires, and you got to deliver, the price at which you have to deliver is the spot market value on that day.

And um— and Bitcoin futures are settled in cash. You don’t actually deliver a Bitcoin, you settle it in cash. It’s that kind of a contract. So by— by definition, the spot market is dictating the price of the futures on the day of settlement. And so of course movements in the spot market before the day of settlement are going to affect the price of— of what people anticipate the value of the futures contract to be.

Of course. It’s just— I mean, they suggest the contrary, but I don’t see how they can do so. And I will say with respect to the reasoning there, as I read the order at least, the sum total of their reasoning as to why you can’t make that assumption is in one sentence. In footnote 233 of the— of the order in this is where they say um we have shown correlation, but correlation doesn’t prove causation.

That’s it. That’s one unelaborated sentence. But I think the problem for them is that there is unrebutted expert uh analysis here. And I point the court to Dr. — to Professor Whaley’s submission— his— his comments. You know— he’s an esteemed professor, an expert in this area. He walked through the analysis of why it’s not random and of course it’s not random for the reason I just said. Of course, the prices are going to move together for the reason I just said. So that one sentence, seems to me, doesn’t come close to meeting the bar that they have to meet to demonstrate that this is— uh that this is reasoned decision making.

Judge Rao: Mr. Verrilli can you um— one of the things that the SEC seems to really emphasize in its briefing is this idea that it’s not focused on the potential for fraud, but only the regulatory detection of fraud.

Don Verrilli: Right—

Judge Rao: —what do you say to that argument?

Don Verrilli: So, um—

Judge Rao: —is that consistent with the statute?

Don Verrilli: It’s a little bit hard, right? You took the words out my mouth Your Honor, in that the statute requires them before approving to find that the exchange has rules in place um that are designed— I think design is the word in the statute, to prevent the fraudulent and manipulative practices that would affect the product for which approval is sought. So um in order to find that the statutory standard is met, which they did with respect to the futures ETPs, they have to reach the conclusion that the surveillance sharing mechanism meets that requirement and— and with respect to that, a couple of points I would like to make if I could.

Um, first one is that um what they concluded in Teucrium and Valkyrie is it’s just indisputable that there is a risk that fraud and manipulation on unregulated markets, unregulated futures markets and unregulated spot markets, could affect the price of the regulated the CME Bitcoin futures market. That risk is there. The— you know the sponsor of those funds came in and said you don’t have to worry about that risk, it’s not there.

The SEC said, oh, yes, it is there. It’s there. And they said but the CME surveillance agreement suffices to protect because it— because it’ll show up and then the information will be shared um to the— to the— with the exchange on which the ETP is listed and the exchange can use its enforcement mechanisms to deal with it. That— that’s the logic in the statement, on those paragraphs that I quoted, I cited previously in the Teucrium order. Now here, and— and I do think this is fundamentally arbitrary, and it’s not arbitrary in the sense of, you know, that gotcha sense that they did it one way in Teucrium and they did it another way here. It’s fundamentally arbitrary in our case they said no, no, you don’t meet our significant market test because you don’t have an agreement with the—a market that— you don’t have an agreement with a market that someone who wanted to manipulate the spot market would have to manipulate in order to do so. Right? That’s what they said and that’s really the core of their rejection of our— of our application.

And— and again, I know I’m doing this a bit but I think it’s useful, going back to the Teucrium order, CME surveillance can reasonably be relied— relied upon to capture the effects of— on CME futures markets, whether the attempt is made by directly trading on the CME Bitcoin futures market or by trading outside of a CME Bitcoin futures market. Then they go on to say accordingly, for present purposes, it is unnecessary for Arca to establish a reasonable likelihood that the would-be manipulator would have to trade on the CME itself to manipulate the proposed ETP.

So they said that because of the surveillance agreement that uh the sponsors of those futures ETPs didn’t have to demonstrate the existence of an agreement with a market on which it’s reasonably likely that a would-be manipulator would have to trade and manipulate. And here they insisted that we did. And so you just cannot put those two things together. That’s— that I think is at the core of the problem with their reasoning— that either they were right in Teucrium, or they’re right here. They can’t be right in both situations.

And that’s why you can’t defer to them. Um there just isn’t a basis for deference here, because you either have to defer to their expert judgment that the CME surveillance market— um agreement would pick up the off— the fraud on unregulated markets or you have to agree with them here that it wouldn’t. It can’t do both. You can’t do both.

Judge Rao: Has the SEC here waived reliance on deference?

Don Verrilli: I didn’t hear your question.

Judge Rao: —has the SEC here, do you think, um waived a reliance on deference?

Don Verrilli: You know, I think they made a gesture towards—

Judge Rao: —Mhmm

Don Verrilli: —deference, Your Honor, but with respect, at least to the statutory interpretation um question and I’ll just take a, if I’m over my time, but if I may just take a minute on that, um that I want to clarify what our statutory interpretation argument is. What— the essence of our argument there is, that— what the statute says is that— and of course the statute says that the SEC shall approve uh an application that meets— that it finds meets the standard.

So there’s discretion there, it says “it finds,” I understand that. But then what it finds is— what it has to find is that the design of the exchange’s rules is sufficient to prevent fraudulent and manipulative practices. That’s what it has to find. Now, I suppose if they, if the SEC has adopted the significant market test as a gloss on that statutory standard— I suppose if they apply it in the way that they applied it in the Teucrium and Valkyrie orders, you could say it’s consistent with the statute because they said, well, the CME surveillance actually works to pick up fraud and manipulation on unregulated markets that affects the regulated market um and because of that mechanism, we’re going to allow this to go forward.

Our position is that it is inconsistent with the statute to interpret it and apply it in the way they applied it here, because they’re saying that even though if you take uh what they found in Teucrium and Valkyrie, even though the CME surveillance would pick up the spot market fraud and manipulation and that information would be shared with the exchange, and so it could use its enforcement powers the way that both systems work. Even though that’s true, we’re not going to approve this. So even though there is, and the exchange does have rules designed to prevent fraud and manipulation and they’re operating in precisely the way the SEC approved in Teucrium and Valkyrie, we’re still going to disapprove it. So that’s not just an arbitrary and capricious problem. It seems to us that’s a problem of statutory interpretation.

Chief Judge Srinivasan: But your arbitrary and capricious argument is the one that you front, and on— that there is arbitrary discrimination. And as to that, there’s not a question about deference to the statutory interpretation—

Don Verrilli: —No.

Chief Judge Srinivasan: —That’s just a straight up—

Don Verrilli: Correct. But, but I guess what I would say, deference to expertise? I don’t see how you can defer to their expertise. In, you know, in the typical arbitrary and capricious review—

Chief Judge Srinivasan: —Yeah.

Don Verrilli: —in the sense that their expert judgment in the priorities and expert judgment in this sort of complete

Chief Judge Srinivasan: —Right. But that’s not Chevron deference, we’re—

Don Verrilli: Oh that’s correct.

Chief Judge Srinivasan: —we’re talking about arbitrary and capricious review.

Don Verrilli: —deference in respect to the views about the record.

Chief Judge Srinivasan: I have one, um fact— but I want to make sure that— I have just one factual question and it doesn’t have to do with the issues that are directly before us, but just for our own edification. So the briefing talks about this $4 billion delta between what could be captured, and what is captured, and that just immediately sends off flags about arbitrage. And I guess I’m just wondering, why— Is it the case that it’s because of the lack of the approval of your application that that exists? And what would happen the minute— suppose that the application is approved, then would it just immediately collapse? Why— why does that persist?

Don Verrilli: So it persists because if we don’t have— if the trust doesn’t have ETP status, it can’t engage in— doesn’t have the authority to engage in continuous redemption withdrawals, which is what would bring the value of the trust into line with the actual value of the assets.

Chief Judge Srinivasan: Mhmm.

Don Verrilli: And that’s— it’s a very substantial problem as the record shows. So uh ETP approval would eliminate that impediment, now I don’t know that means it and I— I do, I apologize, I probably should know this. I don’t know whether we jump immediately to uh—

Chief Judge Srinivasan: —But it’s the redemption mechanism that’s the key.

Don Verrilli: Correct. That’s the key.

Chief Judge Srinivasan: And that, once, and that’s preconditioned on—

Don Verrilli: —ETP.

Chief Judge Srinivasan: —approval of the ETP.

Don Verrilli: That’s the key. That’s the key to the whole thing. And that’s why I think denying approval does disserve investors— and whatever one thinks about the investors’ interests themselves, the statute does say that one of the SEC’s jobs in applying uh 6(b)(5) is to remove impediments to a free and open market. And this is obviously, you know, a lock up of $4 billion is obviously an impediment of that kind.

Chief Judge Srinivasan: Okay. Make sure my colleagues don’t have additional questions for you. We give you some rebuttal time Mr. Verrilli.

Don Verrilli: Thank you.

[Pause]

Chief Judge Srinivasan: Ms. Parise?

Emily True Parise: Thank you, Your Honors. And may it please the Court, Emily True Parise for the Securities and Exchange Commission. The Commission’s order should be upheld because it was the product of reasoned decision making, reasonably distinguished the prior approval of different products, and was face— faithful to the statutory scheme that Congress enacted in Section 19, which says that the Commission shall disapprove SRO rule proposals where the Commission cannot make a finding of consistency with the Exchange Act.

And uh I want to get right to the point about why it was reasonable for the Commission to treat different cases differently here. It is undisputed that the spot markets in which the assets underlying Petitioner’s products trade are fragmented and unregulated in contrast to the situation of the approved futures products where the underlying assets trade only on the CME, which is regulated by the CFTC, and where the exchange has a surveillance sharing agreement that gives it access to information like market trading activity, customer identification, and the tools to investigate fraud and manipulation if were to occur.

Judge Rao: Ms. Parise, I understand that those distinctions that the Commission has drawn, but it seems to me that— that what the Commission really needs to explain is how it understands the relationship between Bitcoin futures and the spot price of Bitcoin—

[inaudible]

Judge Rao: —because it seems to me that these things, I mean, you know, one is just essentially a derivative of the other. They move together 99.9% of the time. So where’s the gap in the Commission’s view?

Emily True Parise: So Your Honor, what the Commission said in its order is that the relationship between the spot and the futures in— as to the relevant question that matters here, which is, does fraud and manipulation in the spot market affect the CME futures market in the same way? That is an empirical question for which Petitioner bears the burden and they did not show that.

And the 99% correlation, what the Commission’s order says about that is, it said, one of the things it said was that correlation doesn’t equal causation, but it did go much further than that. It says it’s just an unsupported empirical leap— and this is in JA-172 and note 223. It’s an unsupported empirical leap to go from a correlation of once-a-day futures prices to uh any fraud and manipulation in the spot market affects futures in the exact same way.

Uh the focus on once-a-day prices doesn’t tell you what’s happening to intraday prices, and importantly, it doesn’t tell you the causal relationship, doesn’t tell you which direction the relationship is moving. And I think the way you can best see that this is an empirical question that Petitioners just try to assume their way past, is that in the reply brief at 5 to 6, I take— I take them as making the argument that you articulated, Judge Rao, which is that this is just the future, and so that necess— necessarily by the nature of a future, the prices in the futures market will just move to meet the spot.

But that is 180 degrees, uh precisely the opposite of the arg— economic proposition that they argue before the Commission, where they argued in the context of uh the trying to say that they had a surveillance sharing agreement with a significant market, that in fact it’s the futures prices that lead the market. And that spot leads— and that spot will move to lead the futures.

And they made that point at JA-187 in the notice and at JA-132 and 133 in the slide deck. So they have argued two opposite economic propositions. Um they— first they, you know, they’re arguing here that the futures prices will just move to meet the spot. They argue below that the spot will move to meet the futures, because futures leads. I think the point is that that is an economic question which they bear the burden of showing the data, and— and we just don’t have the data for that. So it is—

Judge Rao: —What kind of data would they have to show? I mean, it— it seems like it’s fine for the agency to say, okay, we need some more information, but it seems there’s quite a bit of information here on, on how these markets work together. And the SEC has not offered any explanation of they’re actually— that the Petitioners here are wrong in how they are describing the relationship. And the SEC— you can say that they bear the burden. They do. But it seems the SEC has to explain why they are wrong um in the evidence that they have proffered.

Emily True Parise: Well Your Honor, I think the Commission very clearly laid out one way they could meet their burden. Uh and that’s at JA-171 to 172 of the order where they say— they say very explicitly one way that you could meet the Commission’s concern is if you could show um that the spot market price, if you do— you could do a lead/lag demonstration. You could show that the spot market prices don’t lead uh futures prices.

Um but uh the showing that Petitioners made on that uh central empirical question was inconclusive, is what the Commission found. But they have certainly laid out a path um for data that Petitioners could present. And they laid it out pretty clearly. It’s just that, you know, these Bitcoin futures have only been trading since 2017.

Uh and what you look at, when you look at the studies that the Commission, uh the economic—the economic evidence that the Commission considered, there were uh numerous studies in the record that the Commission looked at, and the evidence is just mixed at this point. It’s bi-directional sometimes. It depends on what period of time you’re looking at. So uh the fact that they haven’t been able to make that showing yet doesn’t mean that they won’t be able to in the future.

Judge Rao: What about the fact that the Commission in the Teucrium order recognizes that the futures prices are influenced by the spot prices, and the Commission concludes in approving the futures ETPs that any fraud on the spot market can be adequately addressed by the fact that the futures market is a regulated one? So I mean, that’s a conclusion that the Commission drew just a few months before it denied, you know, the spot Bitcoin ETPs.

Emily True Parise: I’m not sure that’s quite what the Commission concluded, Your Honor, in the Teucrium order. If you look at footnote 46, it very clearly says um that its reasoning in the order does not extend to spot Bitcoin ETPs and the reason is because in Teucrium there was a one-to-one relationship between the underlying market there, the futures market, and the regulated market with which the exchange had a surveillance sharing agreement.

So what the— the Commission said there is, we can be reasonably confident that that surveillance will— if the fraud and manipulation is targeted at those— at the price of those underlying Bitcoin futures that the CME surveillance will uh— will catch that. So we can reasonably rely on that. But it specifically said in footnote 46, that reasoning does not extend to spot Bitcoin—

Judge Rao: —I understand that they wanted to reserve that because obviously the Commission was looking ahead to these pending orders on the regulation of spot Bitcoin. But that still— I mean, they say that, but what’s the logic behind it?

Emily True Parise: Well, the logic is because without— they go on to say, the key phrase there I think is “without additional data,” right? Without additional data, we cannot be as confident that surveilling the CME futures market will pick up fraud and manipulation that is aimed, that is directed at spot market— spot market manipulation—

Judge Rao: They say they can’t be as confident, but in approving the futures ETPs, the Commission seems— it seems to be that the Commission has to have necessarily drawn the conclusion that this, um you know, that this arrangement would prevent fraud and manipulation on the underlying spot market because they recognize the relationship between the two markets and they approve the rule for the futures market. So, for the futures product.

Emily True Parise: Again, I think that the theory behind looking for this surveillance sharing agreement, significant market, is, is it reasonably likely that a person attempting to manipulate the ETP in question is also going to have to trade in that significant market? So for Teucrium, the exchange had the surveillance sharing agreement with the market where the underlying assets themselves trade.

So again, the Commission says it can be reasonably confident that manipulation aimed at affecting prices of that Teucrium ETP holding CME Bitcoin futures, that would be caught by the surveillance. But there— without additional data about whether fraud and manipulation in the spot market impacts futures in the same way, that’s the missing empirical piece. You cannot make that— you cannot have that reasonable confidence when the case here is, you have a spot Bitcoin product and they’re trying to rely on a proxy market here, the CME futures market, for their surveillance sharing agreement.

Chief Judge Srinivasan: So can I ask, does this entire argument then rest on the proposition that both in the Teucrium order and in the order under review, when the Commission refers to trading outside of the CME Bitcoin futures market, that means trading outside of the CME Bitcoin future market but not the spot market?

Emily True Parise: I’m not sure it is— has to be but not the spot market. It’s not making any pronouncement one way or the other about the spot market. It’s saying whatever uh— wherever the off-exchange— uh manipula— wherever the off-CME manipulation is occurring, if it’s targeted at, if it’s aimed at the CME Bitcoin futures, then we have a hook, a surveillance hook uh for the CME Bitcoin futures— futures surveillance. So again, it’s about the—

Chief Judge Srinivasan: But let’s suppose that um that it at least possibly encompasses— that phraseology at least possibly encompasses the spot market, because I think you just said that it might. I don’t have to— you don’t have to show that it actually excludes it. So let’s suppose that it does include the spot market. Then isn’t the necessary upshot of what the Commission said and did in Teucrium and then repeated in this order that if there’s manipulation in the spot market that’s going to show up in the futures market, and in CME in particular, enough that this surveillance mechanism is going to be able to detect it, and therefore we’re okay? Because if that weren’t true, then Teucrium couldn’t have been approved.

Emily True Parise: So what it— it didn’t say that if manipulation in the spot market is occurring it will show up. It said if manipulation is occurring off the CME, wherever that may be, and it is targeted at CME Bitcoin futures then we are— then a would-be manipulator is reasonably likely to have to trade on the CME and we will catch it.

But it’s not talking about all the spot market manipulation that may not be targeted at CME Bitcoin futures because that was not an issue in Teucrium, and that is the question before the Court today. And that is an empirical question that the Teucrium order doesn’t address— doesn’t answer— and that Petitioner’s submissions have not answered. The relationship for spot— spot market manipulation that is targeted at a spot— underlying spot Bitcoin product, that was not addressed in Teucrium.

Chief Judge Srinivasan: But why—why wouldn’t it necessarily— what’s the delta? Why— why isn’t it always the case that manipulation of the spot market, regardless of what your aim, I mean, you could aim to want to affect the futures ETP on the CME. You could aim to want to affect something else. It’s just going to follow like the night follows the day that it affects both because the futures market, of course it turns on the spot market. It—

Emily True Parise: Well, again that, the causal relationship between futures and spot is the key empirical question that we don’t know the answer to. We don’t— it may be that spot leads future and that futures follows, but it may be that futures lead spot and— if, depending on which one, that’s sort of the key empirical question that we don’t know and it’s also uh— the focus about the amount of risk is only sort of part of the story.

Like, whether you can detect and deter fraud and manipulation also has to do with where you’re looking for it and whether you have the tools to investigate it. And so that’s what the surveillance uh framework is looking for, right? It’s: “Do you have the tools in place to investigate if a fraud and manipulation occurs?” For Teucrium, there was a one-to-one relationship so the Commission is confident that the exchange has the tools in place and we’re looking in the right place to catch the fraud and manipulation.

Judge Rao: Ms. Parise, If you don’t, if the Commission says it’s an empirical question about which leads and lags, but they approved the futures product.

Judge Edwards: Right.

Judge Rao:  So don’t you have to have a view? Doesn’t the Commission necessarily have to have a view about the lead and lag— if you don’t know, then how could you conclude that the futures product is, you know, that there— it’s sufficient to prevent fraud?

Emily True Parise: So Your Honor, what the Commission explained is for Teucrium, the exchange had the surveillance sharing agreement with the market where the underlying assets themselves change so that— .

Judge Rao: But if you don’t know which is leading and lagging, I mean, so what if there’s surveillance? I mean, if there’s all kinds of fraud on the spot market that is leading the futures market, then—

Emily True Parise: Right. So what the Commission explained is you don’t need the lead-lag analysis in that context because the lead-lag comes into play where you don’t have the one-to-one relationship between the surveillance sharing agreement and the underlying market. Instead, what you have is the case here. You have a surveillance sharing agreement with another proxy market, like a derivative market, and you’re trying to say that that surveillance sharing agreement, even though we don’t have a one-to-one relationship, is enough and we can be reasonably sure that our proxy market surveillance will be sufficient.

And one way to demonstrate that sufficiency is a lead-lag analysis that shows that a would-be manipulator of the ETP in question, here a spot market ETP, would be reasonably likely to trade in this proxy market to manipulate the ETP. So it comes into question when you’re uh using a proxy market like here, you don’t need the lead-lag analysis for uh the Teucrium order because of the one-to-one relationship.

Judge Rao: This also seems to go to this argument that the Commission makes in its brief that it’s not concerned, um that it’s not focused on the actual potential for fraud, only the regulatory detection of fraud. That seems like a very peculiar thing for the Commission to be focused on, given the language of the Exchange Act. I mean, can you explain why that is the Commission’s view that they’re concerned only about regulatory detection of fraud, but not actual fraud?

Emily True Parise: Well, I’m not sure the Commission said they’re not concerned [inaudible]— I think they said their focus was on detection of fraud. And I think it is a reasonable interpretation of the Exchange Act to focus on surveilling for fraud. It is hard to regulate what you cannot see. And so surveillance is the eyes and ears uh to uh— it is a deterrent. So that the would-be manipulator knows that the exchange has the tools, should fraud and manipulation occur, to track it down and investigate it. So the focus on surveillance is certainly a reasonable interpretation of the Exchange Act um uh because that is how you detect fraud and how you deter fraud.

Judge Rao: Well it’s only about surveillance of fraud to the extent that it actually prevents fraud and manipulation, which is the statutory standard.

Emily True Parise: Correct, Your Honor. The statutory standard is, the exchange’s rules must be designed to prevent fraud or manipulation— fraud and manipulation [Inaudible].

Judge Rao: So if you can see something, okay, that’s fine. But if that thing is affected by lots of things you cannot see, I mean, surely the Commission needs to be concerned with the things they cannot see.

Emily True Parise: Certainly Your Honor, but what the Commission has said is, there are different ways you could satisfy that statutory language of preventing fraud and manipulation. One way, the tried and true way that the Commission has approved for decades, is to— is this is— to focus on surveillance, because we are confident that having a surveillance sharing agreement with a significant market of regulated size will uh provide adequate surveillance that will serve the purposes of the statute, but that is not— the Commission has never said that is the only way to way uh to satisfy that statutory language. And it has held up the possibility that other means could also uh satisfy that language as well.

Judge Edwards: Go ahead.

Judge Rao: I have one other question. So if we were to agree with the petitioners here and hold that the Commission has to treat these two products— or that they have not treated the like products alike, would the Commission um look to approve the spot product or would it go back on its approval of the futures product? I don’t know if you can say.

Emily True Parise: I mean I can’t speak to what the Commission— um no, I cannot speak to what the Commission would do, and I don’t want to prejudge what the Commission would do. But certainly, you know, if you disagreed with uh the Commission’s position here and sent it back, then the Commission would have to— to think about the issues anew. Um well, what it would do with the prior orders, I can’t speak to that, Your Honor. But I would like to answer your— I see my time is up— but you had a question about Chevron deference, Your Honor, that I wanted to briefly touch on. I think it’s clear from NetCoalition at 533 that the Commission does get Chevron deference here, where Congress has expressly delegated to the Commission the power to determine if a proposed rule is consistent with the Exchange Act.

Um the situation was— was very similar there. It was an order, uh there was an SRO approval order by the Commission. This Court was very clear that the Commission gets Chevron deference in those types of situations where it’s interpretive.

Judge Rao: Has it preserved that argument here? Have you preserved that argument here?

Emily True Parise: Certainly, Your Honor, the Court, I mean, the Commission consistently applied its interpretation, its orders. I mean, we raised the Chevron issue. We claimed— we cited NetCoalition in our brief and said that we get Chevron deference. So I don’t see that there’s been any waiver.

Judge Edwards: And I want to ask you uh before we stop, you’ve mentioned several times that they carry the burden of proof. You emphasized that. It’s a way to deflect from a judge’s instinct to say why this was your call. What’s your explanation? So tell me so I have it straight in my head, what data is it that you think they have failed to introduce to make the claim that they’re advancing now? Specifically, what is it they have not put into evidence for the Commission to be able to consider and rule in their favor?

Emily True Parise: Sure, Your Honor. I think the Commission highlighted this in its order at JA-172 and note 223. But the key empirical question where there’s insufficient data for the Commission to make its required finding— uh, is that— the key empirical question is whether fraud and manipulation in the spot market impacts CME futures in the same way. And there’s just, we don’t have conclusive data.

Judge Edwards: Say that again. “In the same way?”

Emily True Parise: Right. They— fraud and manipulation in the spot market would affect futures in the same way so that we can rely on the surveillance of the futures market as a proxy for the underlying ETP uh spot product at issue here. And one way that uh applicants have tried to make that showing before is with a lead-lag analysis, because if you can show that spot doesn’t lead, uh then you can be reasonably confident that the would-be manipulator of the underlying spot product would be reasonably likely to trade in the futures market.

So we could rely on that futures CME, futures market surveillance. But without that missing empirical piece, we can’t be sure we can rely on that CME futures surveillance for a Bitcoin spot product in the same way we could have— the same way we were in, when we approved the Bitcoin futures products.

Judge Edwards: Okay.

Chief Judge Srinivasan: What do I glean from the statement in the Teucrium order on 21680 that says “in addition, the Commission is not persuaded that the market for CME Bitcoin futures contract stands alone, has a lack of connection with, and is not specifically materially influenced by other Bitcoin markets.” That last part talks about a connection in a particular direction.

Emily True Parise: Yes, your Honor, and we uh address this in the order and in brief, but uh that was in response to an argument from the applicant in that case that said that there was um— that the CME market stands alone and the Commission said, well, we’re not— we’re not convinced that we can go that far. But there is a large delta between not convinced it stands alone and futures— fraud and manipulation in the spot market impacts CME futures in the same way. There’s just a wide gulf between those two, and it’s that empirical gulf in the middle where uh there’s insufficient data here.

Chief Judge Srinivasan: And I have one last question, which is— and this is unrelated to anything we’ve been talking about so far, and that’s just, can you just explain succinctly how the second prong of the test actually furthers the interests? Because the way that the prong is articulated indicates that it’s bad if there is um— if the market that’s at issue, the market that’s being surveilled, is unduly affected by the product at issue. And to me, it feels like it should be the opposite because the more that the product at issue affects the market, the more you’d be able to detect manipulation because of—

Emily True Parise: So I think if I’m understanding Your Honor’s question correctly, it’s not that the market underlying the spot product, it’s um— the second prong is about trading in the ETP itself and if it predom— if it predominates, then there is a concern that the fraud and manipulation could be in that, and then you wouldn’t see it in the market that you’re surveilling because it’s not the underlying market, it’s trading in the ETP itself. That’s the distinction.

Chief Judge Srinivasan: But why wouldn’t the trading— if the trading in the ETP itself has a dominant influence in the surveilled market, why wouldn’t it show up in the surveilled market?

Emily True Parise: I think because you— you could be trading in the ETP itself—

Chief Judge Srinivasan: Uh huh.

Emily True Parise: —and it wouldn’t necessarily show up in the futures market if you were trying to manipulate the ETP itself.

Chief Judge Srinivasan: Oh, I see, it’s the futures of the ETP.

Emily True Parise: Right.

Judge Edwards: Right.

Chief Judge Srinivasan: Got it. Okay. I see. So the underlying asset is the ETP. It’s trading in the ETP itself. And it wouldn’t—

Emily True Parise: Would not— we don’t— it would not necessarily show up. So that’s why there’s two prongs to the test. If I’m understanding Your Honor’s question.

Chief Judge Srinivasan: Even if there’s a dominant influence, it wouldn’t show up?

Emily True Parise: If it predominates, then there could be trading in the ETP as opposed to, um that wouldn’t that, we’re not. And so you could be trying to manipulate the ETP itself. It would not necessarily show up in the surveilled market such that, we have, it. What the significant market test is really about— it’s there’s this other market for the, you know— here it’s futures, that is significant and real, so if the trading in the asset, asset itself, here the spot ETP, can predominate in that market, then we’re not sure if surveilling that other market will capture all the manipulation, because you could just be doing it on the ETP itself.

Chief Judge Srinivasan: Okay. Okay, thank you.

Emily True Parise: Unless this court has any other questions then we would simply like to ask the court to uphold the order under review. Thank you very much.

Chief Judge Srinivasan: Thank you, Ms. Parise. Mr. Verrilli, we’ll give you 3 minutes for a rebuttal.

Don Verrilli: Thank you, Your Honor. A few points. First of all, with respect to the description of the analysis in Teucrium versus here, my friend from the SEC said that the point of Teucrium was to find um fraud that was targeted at manipulating the CME futures market. Again, the orders, the Teucrium order, speaks for itself. One can read it. It doesn’t say anything like that.

It’s all about whether fraud or manipulation on other unregulated markets will affect the price, not whether it’s a scheme to manipulate some other unregulated market in order to manipulate the CME futures market. And that stands to reason because we’re trying to protect investors from fraud and manipulation. And if there’s fraud and manipulation on an unregulated market that affects the regulated market, why does it matter whether it started— it has the same adverse impact on investors?

And so you just won’t see that there. And that gets to the point that my friend is trying to draw this distinction between the one-to-one relationship and proxies, but the whole analysis in Teucrium was about proxies. There are all these unregulated, seem— unregulated Bitcoin futures markets as well as the spot markets. And the issue being addressed was whether fraud and manipulation in those unregulated and therefore unsurveilled markets would have an effect, that that was the essence of it.

Now, my friend says we made a 180 in our arguments about the relationships between the CME futures market and the spot market. A little context here, the Teucrium order came out while the Commission was considering our order. If one reads footnote 46, which my friend referred to, you’ll see that basically it says “bring us the broomstick of the Wicked Witch of the West.” There’s one and only one way we’ll let you in. And that’s if you prove that CME futures leads the spot market.

So we tried. But we also argue that in the alternative, all the points that we’re making here, nothing inconsistent here. That’s what anyone would do in that situation. And it does get to the point, I submit, that this focus on lead-lag is really a red herring.

Because if one takes a step back, there are really three possibilities. Lead-lag— if a market leads, it means that’s where the price is set and then the other market follows. So if the futures market is leading the spot market, then the surveillance here is going to pick up any fraud or manipulation because the surveillance is of the futures market. If the spot market is leading the futures market, the surveillance is going to pick it up because the effects will show up for all the reasons that we talked about earlier.

And if it’s a, you know, “arrow points both ways” kind of situation where there isn’t one consistent leader and one consistent lagger, same point. It’s going to be picked up when it shows up. And I do think I need to, Judge Edwards, your question about what the data is? It’s— we already put the data in. It’s the 99.9% correlation. It’s the expert, comments from experts in the field. Um that’s in there.

And I— part of the reason that we submit that this is an unreasoned order is that they just kind of went like this. They just shrugged at that. They said, well, it’s not enough, but they didn’t say why it isn’t enough in the face of— and that evidence is unrebutted. Nobody came in and said anything else in this proceeding. They have to explain why that isn’t enough to satisfy the demands of recent decision making. And a shrug doesn’t get you there.

And then let me just make sure I’ve got everything covered here. Yeah. No, no, I think that’s it, just one final point, if I could. You know, they say in that footnote 46 of the Teucrium order they say, and then twice in this order, they say there’s reason to question whether the surveillance, CME surveillance, will pick up spot market fraud. They never actually say why there’s a reason to question. And that’s the whole problem, given what they said in the Teucrium order. They’ve got to— they can’t just say “well maybe it’ll be different” in the face of our evidence. They’ve got to explain why it’s different. And they’ve completely failed to do that. And the reason is because they can’t.

Chief Judge Srinivasan: I have one question, is— just in the body of the order near this footnote 46, on the question of whether the order is predicated around the idea that it’s all about whether there’s targeting as opposed to just an effect, whether there’s targeting. The way the Commission framed it is, thus the CME surveillance can reasonably be relied upon to capture the effects— effects on the CME Bitcoin futures market caused by a person attempting to manipulate the proposed futures ETP. So it does—

Don Verrilli: But that— certainly, but that’s a subset of what it catches. It’s not the sum total of what it catches, and it can’t be because uh, you know, this has come up repeatedly in the Court’s questioning. But in order to have approved the futures product, they have to have decided the statutory standard was met, which is that it prevents fraud and abuse, with— that the rules of the exchange are designed to prevent fraud and manipulation uh that will affect the product that’s— that’s being applied for.

And that’s why I said the intent to target doesn’t— it doesn’t matter if you could show that there is fraud and manipulation and it would affect the underlying asset and it isn’t provided, there’s nothing in the design of the exchange that protects against it. You can’t satisfy the statutory standard. But they found the statutory standard satisfied. That’s the key, they found it satisfied. And that’s why I think their targeting argument doesn’t really get them anywhere.

Chief Judge Srinivasan: Okay.

Don Verrilli: Oh, I’m sorry, I did have one point about the second prong because Your Honor raised, it if you don’t mind.

Chief Judge Srinivasan: Yeah.

Don Verrilli: [Inaudible] I think Your Honor was getting at something. I mean, there are some points we made in our brief about the inconsistency of Teucrium on that, etcetera. But this basic point here— it’s another one of the contradictions in this order, if you think about it, and I think Your Honor’s questions were getting at it.

Um they say on the one hand that we haven’t shown that there’s a sufficient— we show, haven’t made a sufficient record that— that fraud and manipulation that occurs in a Bitcoin spot market will show up. Alright. On the other hand, they’re saying there’s an undue risk that the Bitcoin spot market that, that our ETP for Bitcoin spot, will have such a powerful effect—

Chief Judge Srinivasan: A predominant effect.

Don Verrilli: —on the price of— on the price of the CME futures market that we won’t be able to discern. You can’t say both of those things at the same time. They completely contradict each other. Thank you.

Chief Judge Srinivasan: Thank you, Counsel. Thank you to both counsel. We’ll take this case under submission.