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Case number 22-1142, Grayscale Investments LLC, petitioner versus Securities and Exchange Commission.

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Mr. Verli for the petitioner, Mr. E.C.

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for the respondent.

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Good morning, counsel.

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Mr. Verli, please proceed when you're ready.

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Good morning and may it please the court.

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I'm Don Verrilli for Petitioner of Grayscale.

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This appeal challenges an SEC order disapproving an exchange's request to list an exchange traded profit that holds Bitcoin as its underlying asset.

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The fundamental problem with the order is that it contradicts previous SEC orders, giving 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.

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as the spot Bitcoin ETP that the SEC disapproved here.

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That is the definition of arbitrary decision making, and it's worse than that because the decision actually disserves the policies set out in Section 6B5 of the Exchange Act.

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This is not your typical APA appeal.

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We are asking to be regulated in this way, not to hold regulation at bay.

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And regulating us in this way would better protect 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.

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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.

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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 as a result of it not being an ETP.

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And of course, disapproval discriminates between issuers of futures ETPs and issuers of spot ETPs, which also the statute prohibits.

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So I think it might be helpful if I take a minute at the outset to do a bit of a deeper dive on the contradiction between the two orders.

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And I think the place to start is with the language of the statute of 6b5.

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The statute provides that in order to approve an application,

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The SEC has to conclude that the rules of the exchange have in place measures designed to prevent fraudulent or manipulative activities.

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With respect to the Potspot ETP, that's an issue here, the Commission concluded that that standard wasn't met.

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But Bitcoin futures, ETPs that the SEC approved, are going to be affected by manipulation of the spot markets.

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The SEC said that exact thing in the two cream order, and it stands to reason.

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Bitcoin futures are derivatives of Bitcoin itself, and the undisputed record evidence shows that 99.9% of the time,

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the price of Bitcoin futures and the Bitcoin spot market correlate.

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And what the SEC also found in the futures orders is that the existence of the surveillance sharing agreement would suffice to protect against fraud manipulation of the spot market

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as well as other unregulated futures markets.

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And the reason for that was because the SEC concluded that manipulation of the spot market or manipulation of the other unregulated futures markets would show up in the price in the regulated futures market.

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So how do we know that the Tucurium order in making the statements that you just paraphrased was specifically talking about manipulation of the spot market

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as opposed to manipulation of unregulated futures markets.

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So I would direct the Court to pages 21, 6, 79, and 680 of the 87th Federal Act, which is the DuPrem order.

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And I know the Commission makes that argument in its brief here.

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The court can, of course, read for itself the relevant paragraphs on those pages.

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I think it's extremely hard to read them as not addressing spot as well as unregulated futures markets.

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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 unregulated futures markets.

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And then with respect to that,

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the exact phrase that we pointed to 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.

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If I'm remembering correctly, I think the immediately preceding sentence is talking about spot markets.

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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.

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The statutory standard requires that the design of the exchange rules be sufficient to prevent fraud and manipulation.

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And so it had to have concluded that the existence of the CME surveillance mechanism was going to pick up

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spot market manipulation insofar as it affected the futures prices.

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And that exact mechanism is operating now with respect to the relationship between NYSE ARCA and CME.

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The previous SEC denials of spot Bitcoin ETPs, were those challenged in court?

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I don't believe they were.

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I believe this is the first one.

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I couldn't find anything.

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So a lot of this really turns on the fact that the SEC has now decided to allow future Bitcoin futures, ETPs, and the failure to treat the two similarly.

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I do think, I think our case is

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quite a bit stronger given the fact, not the fact of, but the reasoning behind the approval of the futures ETPs.

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I think even if the SEC have not done so, we'd probably be here making

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a similar argument that CME surveillance would work in exactly the way that the SEC found that it worked in the two CREM and Valkyrie orders, but you don't have to take our word for it because they have made that finding in those orders.

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I do wonder if we were to agree with you that the SEC has behaved arbitrary and capriciously in treating these two products differently

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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?

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We're asking for the standard remedy.

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We're asking that the order be set aside, which means we go back to the commission.

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And it seems to me they would have

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the three options available to them.

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First, they could agree with us 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.

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The other option, I suppose we could try to come up with some different distinction.

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I don't know what that would be.

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The third option would be to say, well, we've got to rethink the whole thing.

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I guess nothing would prevent them from doing that.

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I assume you don't want the third thing.

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It would surprise me if they would do it, though.

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You know, you have these futures ETPs that, because of the oddity of the statute got through under the 1940 Act, you have additional futures ETPs that the Commission has approved under the 34 Act.

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They're out there trading.

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There's billions of dollars of assets wrapped up in them.

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The Commission just made this.

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These decisions are roughly contemporaneous.

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The Two Cream Order was just a couple of months before ours.

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So presumably they were thinking about these things together.

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And as I said, it would surprise me a great deal if they decided to rethink the whole thing, but I don't see anything that forecloses them from doing so.

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Do you think that second route is available?

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of the three that you've itemized, which is that they could come up with an explanation, because I understood your argument to be almost one of an economic identity.

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Well, I think that's why I said I can't come up with a, I mean, it's theoretically, you know, it's path three, theoretically available, but I'm not sure what it would be if you take as a baseline the approval of the futures contracts, because

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of that un-rebutted record evidence showing 99.9% correlation in the movement of the two, which of course stands to reason, and if I could just address one of the specific arguments the Commission has made in this regard, namely that while the futures markets aren't actually priced based on the spot prices,

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I will point out first, they rejected that exact argument in the Supreme Order.

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But beyond that, just as a matter of common sense, on the day that a futures contract expires, you've got to deliver.

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The price of what you have to deliver is the spot market value on that day.

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And Bitcoin futures are settled in cash.

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You don't actually deliver a Bitcoin.

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You settle it in cash.

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It's that kind of a contract.

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So, by definition, the spot market is dictating the price of the futures on the day of settlement.

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And so, of course, movements in the spot market before the day of settlement are going to affect the price of what people anticipate the value of the futures contract.

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Of course, it's just, I mean, they suggest the contrary, but I don't see how they can do so.

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And I will say with respect to the reasoning there, as I read the order, at least,

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The sum total of their reasoning as to why you can't make that assumption is in one sentence in footnote 233 of the order in this.

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It's where they say, we have drawn correlation, but correlation doesn't prove causation.

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That's it.

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That's one unelaborated sentence.

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But I think the problem for them is,

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that there is unrobotted expert analysis here, and I point the court to Professor Whaley's submission, his comments.

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He's a esteemed professor, expert in this area.

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He walked through the analysis of why it's not random.

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And of course it's not random for the reason I just said.

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Of course the prices are gonna move together for the reason I just said.

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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 reason to decision making.

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Mr. Verley, can you, 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

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of fraud.

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What do you say to that argument?

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Is that consistent with the statute?

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It's a little bit hard, right?

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You took the words out of my mouth.

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The statute requires them, before approving, to find that the exchange has rules in place that are designed, I think design is the word in the statute, to prevent the fraudulent practices that would affect the product for which approval is sought.

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So in order to find that the statutory standards met, which they did with respect to the future ZTPs, they have to reach the conclusion that the surveillance sharing mechanism meets that requirement.

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And with respect to that, a couple of points I'd like to make, if I could.

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First one is that what they concluded in two agreement balkory is just indisputable that

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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 CME Bitcoin futures market.

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That risk is there.

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The sponsor of those funds came in and said, you don't have to worry about that risk, it's not there.

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The SEC said, oh yes, it is there.

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It's there.

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And they said, but the CME surveillance agreement suffices to protect because it'll show up and then the information will be shared with the exchange on which the ETP is listed and the exchange can use its enforcement mechanisms to deal with it.

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That's the logic, the statement on those paragraphs that I quoted, I cited previously in the true green water.

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Now here, and I do think,

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This is just fundamentally arbitrary, and it's not arbitrary in the sense of, in the gotcha sense, that they did it one way and two-primitively did it another way here.

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It's fundamentally arbitrary.

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In our case, they said, no, no, you don't meet our significant market test because you don't have an agreement with the market

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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.

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That's what they said and that's really the core of their rejection.

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of our application.

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And again, I know I'm not doing this a bit, but I think it's useful.

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Going back to the two-cream order, 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.

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And 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.

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So they said that because of these surveillance agreements that the sponsors of those futures ETPs didn't have to demonstrate the existence of

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an agreement with a market on which it's reasonably likely that a would-be manipulator would have to trade and manipulate.

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And here, they insisted that we did.

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And so you just cannot put those two things together.

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That, I think, is at the core of the problem with their reasoning.

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that either they were right into Grimm or they're right here.

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They can't be right in both situations.

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And that's why you can't defer to them.

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There just isn't a basis for deference here, because you have to defer to their expert judgment that the CME surveillance agreement would pick up off the fraud and unregulated markets, or you have to prove them here that it wouldn't.

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It can't do both.

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It can't do both.

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Has the SEC here waived our reliance on deference?

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I didn't hear your question.

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Has the SEC here, do you think, waived a rule on sound deference?

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I think they made a gesture towards deference, Your Honor, but with respect at least to the statutory interpretation question, and I just take this, I'm over my time, but if I may just take a minute on that.

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I want to clarify what our statutory interpretation argument is.

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The essence of argument there is that what the statute says is that the SEC shall approve an application that it finds meets the standard.

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So there's discretion there.

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It says it finds.

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I understand that.

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But then what it has to find is that the design of the exchange's rules is sufficient to prevent fraudulent manipulative practices.

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That's what it has to find.

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Now, I suppose if the SEC has adopted this significant market test as a gloss on that statutory standard,

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I suppose if they apply it in the way that they applied it in the Tuquineum and Valpery orders, you could say it's consistent with the statute, because they said, well, the CME surveillance actually works to pick up fraud manipulation on unregulated markets that affects the regulated market.

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And because of that mechanism, we're going to allow this to go forward.

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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 what they found in two agreement Valkyrie, even though the Sini surveillance would pick up the spot market fraud manipulation, and that information would be shared with the exchange, and so it could use its enforcement powers the way that whole system is supposed to work, even though that's true,

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We're not going to approve this.

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So even though there is, the exchange does have rules designed to prevent fraud and manipulation, and they will operate in precisely the way the SEC approved the two-crime and Valkyrie, we're still going to disapprove it.

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So that's not just an arbitrary and capricious problem.

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It seems to us that's a problem of statutory interpretation.

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But your arbitrary and capricious argument is the one that you front.

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And on that there's arbitrary discrimination.

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And as to that, there's not a question about deference to statutory interpretation.

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That's just a straight up.

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Correct.

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But I guess what I would say, deference to expertise.

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I don't see how you can defer to their expertise in the typical arbitrary and capricious review in the sense that their expert judgment in prior orders and expert judgment in this sort of completely

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Right, but that's not Chevron difference.

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We're talking about arbitrage.

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I have one factual question, and it doesn't have to do with the issues that are directly before us, but just for our identification.

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So the briefing talked about this $4 billion delta between what could be captured and what is captured, and that just immediately sends off flags about arbitrage.

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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?

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Why does that persist?

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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.

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And that's a very substantial problem, as the record shows.

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So ETP approval would eliminate that impediment.

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Now, I don't know that that means that

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I apologize.

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I probably shouldn't know this.

[00:19:09] Speaker 01:
I don't know whether we jump immediately to... But it's the redemption mechanism that's the key.

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Correct.

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That's the key.

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And that's preconditioned on approval of the ETP.

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That's the key to the whole thing.

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And that's why I think denying approval does disserve investors and what everyone thinks about investors' interests themselves.

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The statute does say that one of the SEC's jobs in applying 6b-5 is to remove impediments to free and open market.

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And this is obviously, you know, lockup of $4 billion is obviously an impediment of that kind.

[00:19:43] Speaker 01:
Okay.

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We'll make sure our colleagues don't have additional questions for you.

[00:19:46] Speaker 01:
We'll give you some rebuttal time, Mr. Milley.

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Thank you.

[00:20:09] Speaker 01:
Ms.

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Parise.

[00:20:10] Speaker 03:
Thank you, Your Honors.

[00:20:12] Speaker 03:
And may it please the court, Emily True Parise for the Securities and Exchange Commission.

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The commission's order should be upheld because it was the product of recent decision-making, reasonably distinguished the prior approval of different products, and was faithful to the statutory scheme that Congress enacted in Section 19, which says that the commission shall disapprove SRO rule proposals

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where the commission cannot make a finding of consistency with the Exchange Act.

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And I want to get right to the point about why it was reasonable for the commission to treat different cases differently here.

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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,

[00:21:05] Speaker 03:
and where the exchange has a surveillance sharing agreement that gives it access to information like market trading activity, customer identification, the tools to investigate a fraud manipulation if it were to occur.

[00:21:16] Speaker 04:
Ms.

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Parisi, I understand that those distinctions that the commission has drawn, but it seems to me that what the commission really needs to explain is how it understands the relationship between bitcoin futures

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the spot price of Bitcoin because it seems to me that these things I mean you know one is just essentially a derivative of the other they move together in ninety nine point nine percent of the time so where's the gap in the Commission's view so your honor what the Commission said in its work is that

[00:21:49] Speaker 03:
The relationship between the spot and the futures 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?

[00:22:01] Speaker 03:
That is an empirical question for which petitioner bears the burden, and they did not show that.

[00:22:06] Speaker 03:
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.

[00:22:15] Speaker 03:
It says it's just an unsupported empirical leap.

[00:22:18] Speaker 03:
And this is a JA 172 and NO 223.

[00:22:22] Speaker 03:
It's an unsupported empirical leap to go from a correlation of once a day futures prices to any fraud manipulation in the spot market affects futures in the exact same way.

[00:22:34] Speaker 03:
The focus on once a day prices doesn't tell you what's happening to intraday prices.

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And importantly, it doesn't tell you the causal relationship.

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It doesn't tell you which direction the relationship is moving.

[00:22:44] Speaker 03:
And I think the way you can best see that this is a empirical question that petitioners just try to assume their way past is that in the reply brief at five to six, I take them as making the argument that you articulated, Judge Rao, which is that this is just a future.

[00:22:58] Speaker 03:
And so that necessarily by the nature of a future, the prices and futures market will just move to make the spot.

[00:23:04] Speaker 03:
But that is 180 degrees, precisely the opposite of the economic proposition that they argue before the commission.

[00:23:12] Speaker 03:
where they argued in the context of 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 will move to lead the futures.

[00:23:27] Speaker 03:
And they made that point at JA 187 in the notice and at JA 132 to 133 in the slide.

[00:23:34] Speaker 03:
So they have argued two opposite economic propositions.

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They're arguing here that the

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future prices will just move to meet the spot.

[00:23:43] Speaker 03:
They argue below that the spot will move to meet the futures because futures leads.

[00:23:47] Speaker 03:
I think the point is that that is an economic question, which they bear the burden of showing the data and we just don't have the data for that.

[00:23:55] Speaker 04:
So it isn't, it's- What kind of data would they have to show?

[00:23:58] Speaker 04:
I mean, it seems like it's, you know, it's fine for an agency to say, okay, we need some more information, but it seems there's quite a bit of information

[00:24:07] Speaker 04:
here on how these markets work together.

[00:24:09] Speaker 04:
And the SEC has not offered any explanation of their actually that, you know, that the petitioners here are wrong in how they are describing the relationship.

[00:24:19] Speaker 04:
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 in the evidence that they have proffered.

[00:24:30] Speaker 03:
well you know i think the commission very clearly laid out one way they can meet their burden and that's a j one seventy one one seventy two of the order where they say they see very explicitly one way that you could meet the commission's concern is if you could show that the spot market price that you do you could do a lead lag demonstration you could show that the spot market prices don't lead futures and prices but the showing that petitioners made on that

[00:24:55] Speaker 03:
central empirical question was inconclusive, is what the commission found.

[00:25:00] Speaker 03:
But they have certainly laid out a path for data that petitioners could present.

[00:25:07] Speaker 03:
They laid out the theory.

[00:25:08] Speaker 03:
It's just that these Bitcoin futures have only been trading since 2017.

[00:25:13] Speaker 03:
And what you look at, when you look at the studies that the commission, the economic

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evidence that the Commission considered.

[00:25:21] Speaker 03:
There were numerous studies in the record that the Commission looked at.

[00:25:26] Speaker 03:
The evidence is just mixed at this point.

[00:25:29] Speaker 03:
It's bi-directional sometimes.

[00:25:30] Speaker 03:
It depends on what period of time you're looking at.

[00:25:33] Speaker 03:
So, the fact that they haven't been able to make that showing up means that they won't be able to in the future.

[00:25:38] Speaker 04:
But what about the fact that the commission in the Toucreme order recognizes that the futures prices are influenced by the spot prices?

[00:25:46] Speaker 04:
And the commission concludes in approving the futures ETPs that any fraud on the SPARP market can be adequately addressed by the fact that the futures market is a regulated one.

[00:25:58] Speaker 04:
So I mean, that's a conclusion that the commission drew just a few months before it denied, you know, the spot Bitcoin ETPs.

[00:26:07] Speaker 03:
I'm not sure that's quite what the commission concluded, Your Honor, in the Tuprem order.

[00:26:11] Speaker 03:
If you look at footnote 46, it very clearly says that its reasoning in the order does not extend to spot Bitcoin ETPs.

[00:26:18] Speaker 03:
And the reason is because in Tuprem, there was a one-to-one relationship between the underlying market, the futures market, and the regulated market with which the exchange had a surveillance sharing agreement.

[00:26:31] Speaker 03:
So what the commission said there is,

[00:26:34] Speaker 03:
We can be reasonably confident that that surveillance will, if the fraud manipulation is targeted at the price of those underlying Bitcoin futures, that the CME surveillance will

[00:26:48] Speaker 03:
We'll catch that so we can reasonably rely on that.

[00:26:52] Speaker 03:
But it specifically said that reasoning does not extend.

[00:26:56] Speaker 04:
I understand that they want to reserve that because obviously the commission was looking ahead to these pending orders on the regulation of spot Bitcoin.

[00:27:04] Speaker 04:
But that still.

[00:27:05] Speaker 03:
me they say that's but but what's the logic behind it what the logic is because without and they they go on to say the key phrase that 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 at is directed at spot market they say they can't be as confident but in approving the futures ETPs the commission

[00:27:34] Speaker 04:
It seems to be that the commission has to have necessarily drawn the conclusion 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.

[00:27:56] Speaker 03:
Again, I think that the theory behind looking for the surveillance sharing agreement with 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?

[00:28:08] Speaker 03:
So for Tuprem, the exchange had the surveillance sharing agreement with the market where the underlying assets themselves trade.

[00:28:15] Speaker 03:
So again, the commission says it can be reasonably confident that manipulation owned at affecting prices of that Tuprem ETP holding CME Bitcoin futures, that would be caught by the surveillance.

[00:28:25] Speaker 03:
But without additional data about whether fraud and manipulation in the spot market impacts futures in the same way, that's the missing empirical piece.

[00:28:35] Speaker 03:
You can't 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.

[00:28:50] Speaker 01:
So can I ask, does this entire argument then

[00:28:55] Speaker 01:
rest on the proposition that both in the two cream 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 bitcoins future market but not the spot market i'm not sure it is has to be but not the smart it's not making any pronouncement one way or the other about the spot market it's saying whatever uh... wherever the off exchange

[00:29:26] Speaker 03:
or 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 for the CME Bitcoin futures, future surveillance.

[00:29:41] Speaker 01:
So again, it's about the... But let's suppose that it at least possibly encompasses, that phraseology at least possibly encompasses the spot market.

[00:29:53] Speaker 01:
Because I think you just said that it might.

[00:29:55] Speaker 01:
You don't have to show that it actually excludes it.

[00:29:58] Speaker 01:
So let's suppose that it does include the spot market.

[00:30:02] Speaker 01:
Then isn't the necessary upshot of what the commission said and did in Tucrim 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

[00:30:20] Speaker 01:
that the surveillance mechanism is going to be able to detect it.

[00:30:24] Speaker 01:
And therefore we're okay.

[00:30:26] Speaker 01:
Because if that weren't true, then the two cream couldn't have been approved.

[00:30:31] Speaker 03:
So what it, it didn't say that if manipulation in the spot market is occurring, it will show up.

[00:30:39] Speaker 03:
It said if manipulation is occurring off the CME, wherever that may be, and it is targeted at CME Bitcoin futures,

[00:30:47] Speaker 03:
Then the would-be manipulator is reasonably likely to have to trade on the CME, and we will catch it.

[00:30:53] Speaker 03:
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 Tukrem.

[00:31:01] Speaker 03:
And that is the question before the court today.

[00:31:03] Speaker 03:
And that is an empirical question that the Tukrem order doesn't address or doesn't answer, and that petitioner submissions have not answered.

[00:31:11] Speaker 03:
uh... in the in the relationship form spotmark spot market manipulation that is targeted at a spot underlying spot bit point product.

[00:31:18] Speaker 03:
That was not addressed in two grams.

[00:31:21] Speaker 01:
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 what your aim I mean you could aim to want to affect the

[00:31:35] Speaker 01:
futures ETP on the CME, you could aim to want to affect something else.

[00:31:40] Speaker 01:
It's just going to follow like the night follows the day that it affects both.

[00:31:44] Speaker 01:
Because the futures market, of course it turns on the spot market.

[00:31:49] Speaker 03:
Well, again, the causal relationship between futures and spot is the key empirical question that we don't know the answer to.

[00:31:56] Speaker 03:
It may be that spot leads future and that futures follows, but it may be that futures leads spot.

[00:32:03] Speaker 03:
depending on which one, that's sort of the key empirical question that we don't know.

[00:32:07] Speaker 03:
And it's also, the focus about the amount of risk is only sort of part of the story, like whether you can detect and deter fraud manipulation also has to do with where you're looking for it, and whether you have the tools to investigate it.

[00:32:19] Speaker 03:
And so that's what the surveillance framework is looking for, right?

[00:32:24] Speaker 03:
It's do you have the tools in place to investigate if a fraud manipulation occurs?

[00:32:28] Speaker 03:
For Two Freedom, there was a one-to-one relationship.

[00:32:31] Speaker 03:
the commission is confident that the exchange has the tools in place, they're looking in the right place to catch the fraud manipulation.

[00:32:37] Speaker 04:
Ms.

[00:32:37] Speaker 04:
Percy, if you don't, if the commission says it's an empirical question about which leads and lags, but they approved the futures product.

[00:32:46] Speaker 04:
So don't you have to have a view?

[00:32:47] Speaker 04:
Doesn't the commission necessarily have to have a view about the league and lag?

[00:32:51] Speaker 04:
If you don't know, then how could you conclude that the futures product is, you know, that it's sufficient to prevent fraud?

[00:32:59] Speaker 03:
So your honor, what the commission explained is, for 2 gram, the exchange had the surveillance chain agreement with the market where the underlying assets themselves change.

[00:33:09] Speaker 04:
But if you don't know which is leading and lagging, I mean, so what if there's surveillance?

[00:33:13] Speaker 04:
I mean, if there's all kinds of fraud on the spot market that is leading the futures market, then... Right, so what the commission explained is you don't need the lead-lag analysis in that context because

[00:33:23] Speaker 03:
The lead lag comes into play where you don't have the one-to-one relationship between the surveillance sharing and the underlying market.

[00:33:30] Speaker 03:
Instead, what you have is the case here.

[00:33:32] Speaker 03:
You have a surveillance sharing agreement with another proxy market, like a derivative market, and you're trying to say that that surveillance sharing, even though we don't have the one-to-one relationship,

[00:33:42] Speaker 03:
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 it would be manipulator of the ETP in question here, a spot market ETP.

[00:33:56] Speaker 03:
would be reasonably likely to trade in this proxy market to manipulate the ETP.

[00:34:00] Speaker 03:
So it comes into question when you're using a proxy market like here, you don't need the lead lag analysis for the two-prem order because of the one-to-one relationship.

[00:34:10] Speaker 04:
This also seems to go to this argument that the commission makes in its brief, that it's not concerned, that it's not focused on the actual potential for fraud, only the regulatory detection of fraud.

[00:34:23] Speaker 04:
That seems like a very peculiar

[00:34:26] Speaker 04:
thing for the commission to be focused on, given the language of the Exchange Act.

[00:34:31] Speaker 04:
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?

[00:34:41] Speaker 03:
Well, I'm not sure the commission said they're not contractual, but I think they said their focus was on detection of fraud, and I think it is a reasonable interpretation of the Exchange Act

[00:34:50] Speaker 03:
to focus on surveilling for fraud, it is hard to regulate what you cannot see, and so surveillance is the eyes and the ears to, and it's a deterrent so that the would-be manipulator knows that the exchange has the tools, should a fraud manipulation occur, to track it down and investigate it.

[00:35:08] Speaker 03:
So the focus on surveillance is certainly a reasonable interpretation of the Exchange Act because that is how you detect fraud and how you deter fraud.

[00:35:23] Speaker 04:
But it's only about surveillance of fraud to the extent that it actually prevents fraud and manipulation, which is the statutory standard.

[00:35:32] Speaker 03:
Correct, Your Honor.

[00:35:33] Speaker 03:
The statutory standard is the exchange's rules must be designed to prevent fraud manipulation.

[00:35:38] Speaker 04:
So if you can see something, OK, that's fine.

[00:35:41] Speaker 04:
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.

[00:35:50] Speaker 03:
Certainly, Your Honor.

[00:35:50] Speaker 03:
But what the commission has said is there are different ways you could satisfy that statutory language of preventing fraud manipulation.

[00:35:59] Speaker 03:
One way.

[00:36:00] Speaker 03:
A tried and true way that the commission has approved for decades is to focus on surveillance, because we are confident that having a surveillance sharing agreement with a significant market of regulated size will provide adequate surveillance that will serve the purposes of the statute.

[00:36:16] Speaker 03:
But the commission has never said that is the only way to satisfy that statutory language.

[00:36:23] Speaker 03:
There is a possibility that other means could also satisfy that language as well.

[00:36:29] Speaker 04:
I have another question.

[00:36:32] Speaker 04:
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 look to approve the spot product or would it go back on its approval of the futures product?

[00:36:54] Speaker 04:
I don't know if you can say.

[00:36:54] Speaker 03:
I mean, I cannot speak to what the commission would do when I don't want to prejudge what the commission would do.

[00:37:01] Speaker 03:
But certainly, if you disagreed with the commission's position here and sent it back, the commission would have to think about the issues anew.

[00:37:13] Speaker 03:
But what it would do with the prior orders, I can't speak to that, Your Honor.

[00:37:15] Speaker 03:
But I would like to answer your question.

[00:37:17] Speaker 00:
I see my time is up.

[00:37:18] Speaker 03:
But you had a question about Chevron deference, Your Honor, that I wanted to briefly touch on.

[00:37:22] Speaker 03:
I think it's clear from Net Coalition 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.

[00:37:36] Speaker 03:
The situation was very similar there.

[00:37:39] Speaker 03:
It was an order.

[00:37:40] Speaker 03:
There was an SRO approval order by the Commission.

[00:37:43] Speaker 03:
This was very clear that the Commission gets Chevron deference in those types of situations where it's... Does it preserve that argument here?

[00:37:50] Speaker 04:
Have you preserved that argument here?

[00:37:52] Speaker 03:
I certainly, Your Honor, the Commission consistently applied its interpretation and its orders, and we raised the Chevron issue.

[00:38:02] Speaker 03:
We cited a net coalition in our brief and said that we get Chevron deference, so I don't see that there's been any waiver.

[00:38:08] Speaker 00:
I want to ask you, before we stop, you've mentioned several times that they carry the burden of proof.

[00:38:16] Speaker 00:
You emphasize that, it's a way to deflect from a judge's instinct to say, wait, this was your call, what's your explanation?

[00:38:26] Speaker 00:
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?

[00:38:40] Speaker 00:
Specifically, what is it they have not put into evidence

[00:38:44] Speaker 00:
for the commission to be able to consider and rule in their favor?

[00:38:50] Speaker 03:
Sure, Your Honor.

[00:38:50] Speaker 03:
I think the commission highlighted this in its order at J.A.

[00:38:53] Speaker 03:
172 and note 223.

[00:38:56] Speaker 03:
But the key empirical question where there's insufficient data for the commission to make its required finding is that the key empirical question is whether fraud and manipulation in the spot market impacts CME futures in the same way.

[00:39:13] Speaker 03:
And there's just, we don't have conclusive data.

[00:39:15] Speaker 00:
Say that again, in the same way?

[00:39:17] Speaker 03:
Right.

[00:39:17] Speaker 03:
The fraud 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 spot product at issue here.

[00:39:33] Speaker 03:
And one way that applicants have tried to make that showing before is with a lead lag analysis, because if you could show that SPOT doesn't lead, then you could be reasonably confident that the would-be manipulator of the underlying SPOT product would be reasonably likely to trade in the futures market.

[00:39:52] Speaker 03:
So we could rely on that future, CME futures market surveillance.

[00:39:56] Speaker 03:
But without that missing empirical piece,

[00:39:59] Speaker 03:
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 been, the same way we were when we approved the Bitcoin futures products.

[00:40:13] Speaker 01:
Okay.

[00:40:13] Speaker 01:
What do I glean from the statement in the two premium order on 21680

[00:40:21] Speaker 01:
that says, in addition, the commission is not persuaded that the market for CME Bitcoin futures contracts stands alone, has a lack of connection with, and is not specifically materially influenced by other Bitcoin markets.

[00:40:34] Speaker 01:
That last part talks about a connection in a particular direction.

[00:40:38] Speaker 03:
Yes, Your Honor, and we addressed this in the order and brief, but that was in response to an argument from the applicant in that case that said that there was

[00:40:49] Speaker 03:
that the CME market stands alone, and the commission said, well, we're not convinced that we can go that far.

[00:40:55] Speaker 03:
But there is a large delta between not convinced it stands alone and futures that fraud and manipulation in the spot market impacts CME futures in the same way.

[00:41:07] Speaker 03:
There's a wide gulf between those two, and it's that empirical gulf in the middle where there's insufficient data here.

[00:41:16] Speaker 01:
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 interest?

[00:41:33] Speaker 01:
Because the way that the prong is articulated, it indicates that it's bad if there is,

[00:41:44] Speaker 01:
if the market that's at issue, the market that's being surveilled, is unduly affected by the product at issue.

[00:41:53] Speaker 01:
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... So I think if I'm understanding your honest question correctly, it's not that the market underlying the spot product,

[00:42:12] Speaker 03:
The second prong is about trading in the ETP itself, and if it predominates, then there is a concern that the fraud manipulation could be in that, and that you wouldn't see it in the market that you're surveilling.

[00:42:27] Speaker 03:
Because it's not the underlying market.

[00:42:28] Speaker 03:
It's trading in the ETP itself.

[00:42:30] Speaker 03:
That's the distinction.

[00:42:31] Speaker 01:
But why wouldn't the treaty, 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?

[00:42:43] Speaker 03:
I think because you could be trading in the ETP itself, and it wouldn't necessarily show up in the futures market if you were trying to manipulate the ETP itself.

[00:42:53] Speaker 01:
Oh, I see.

[00:42:54] Speaker 01:
It's the futures of the ETP.

[00:42:57] Speaker 01:
Right.

[00:42:57] Speaker 01:
Got it.

[00:42:57] Speaker 01:
OK.

[00:42:58] Speaker 01:
I see.

[00:42:59] Speaker 01:
So the underlying asset is the ETP.

[00:43:01] Speaker 01:
It's trading in the ETP itself, and it wouldn't.

[00:43:04] Speaker 03:
It would not necessarily show up.

[00:43:07] Speaker 03:
So that's why there's two problems to the test, if I'm understanding your honors.

[00:43:10] Speaker 01:
Even if there's a dominant influence, it wouldn't show up?

[00:43:13] Speaker 03:
If it predominates, then there could be trading in the ETP as opposed to, that we're not, and so you could be trying to manipulate the ETP itself.

[00:43:23] Speaker 03:
It would not necessarily show up.

[00:43:24] Speaker 03:
in the surveilled market such that we have it.

[00:43:28] Speaker 03:
What the significant market test is really about is is there this other market for the, you know, here it's futures that is significant and real.

[00:43:35] Speaker 03:
So if the trading in the asset itself here, the spy ETP can predominate in that market, then we're not sure if surveilling that other market will capture all manipulations because you could just be doing it on the ETP itself.

[00:43:47] Speaker 01:
Okay.

[00:43:51] Speaker 03:
Thank you for any other questions.

[00:43:54] Speaker 03:
Thank you very much.

[00:43:56] Speaker 01:
Thank you, Miss Tracy.

[00:43:58] Speaker 01:
Mr. Really will give you three minutes for rebuttal.

[00:44:02] Speaker 02:
Thank you, Your Honor.

[00:44:02] Speaker 02:
A few points.

[00:44:04] Speaker 02:
First of all, with respect to the description of the analysis in Tucrim versus here, my friend from the SEC said,

[00:44:12] Speaker 02:
that the point of Trucarion was to find fraud that was targeted at manipulating the CME futures market.

[00:44:22] Speaker 02:
Again, the orders, the Trucarion order speaks for itself.

[00:44:26] Speaker 02:
One can read it.

[00:44:27] Speaker 02:
It doesn't say anything like that.

[00:44:29] Speaker 02:
It's all about whether fraud and 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

[00:44:42] Speaker 02:
the CME futures market.

[00:44:43] Speaker 02:
And that stands to reason, because you're trying to protect investors from fraud or manipulation.

[00:44:49] Speaker 02:
And if there's a fraud manipulation in unregulated market and it affects the regulated market, why does it matter whether it's targeted?

[00:44:57] Speaker 02:
It has the same adverse impact on investors.

[00:44:59] Speaker 02:
And so you just won't see that there.

[00:45:01] Speaker 02:
And that gets to the point that my friend is trying to draw this distinction between the one to one relationship and proxies.

[00:45:08] Speaker 02:
But the whole analysis in Duke Green was about proxies.

[00:45:11] Speaker 02:
There were all these unregulated Bitcoin futures markets as well as the spot markets.

[00:45:17] Speaker 02:
And the issue being addressed was whether fund manipulation in those unregulated and therefore unsurveilled markets would have an effect.

[00:45:25] Speaker 02:
That was the essence of it.

[00:45:27] Speaker 02:
Now, my friend says we made a 180 in our arguments about the relationships between the CME futures market and the spot market.

[00:45:36] Speaker 02:
A little context here.

[00:45:38] Speaker 02:
The two premium order came out while the commission was considering our order.

[00:45:44] Speaker 02:
If one reads 4946, which my friend referred to, you'll see that basically it says bring us the broomstick of the wicked witch of the west.

[00:45:50] Speaker 02:
There's one and only one way we'll let you in, and that's if you prove that seeing the futures leads the spot mark.

[00:45:57] Speaker 02:
So we tried.

[00:45:58] Speaker 02:
But we also argued in the alternative all of the points that we're making here.

[00:46:02] Speaker 02:
Nothing inconsistent here.

[00:46:04] Speaker 02:
That's what anyone would do in that situation.

[00:46:06] Speaker 02:
And it does get to the point, I submit,

[00:46:09] Speaker 02:
This focus on lead lag is really a red herring.

[00:46:12] Speaker 02:
If one takes a step back, there are really three possibilities.

[00:46:16] Speaker 02:
Lead lag, if a market leads, it means that's where the price is set.

[00:46:19] Speaker 02:
And then the other market follows.

[00:46:21] Speaker 02:
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.

[00:46:34] Speaker 02:
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.

[00:46:43] Speaker 02:
And if it's an arrow points both ways kind of situation where there isn't one consistent leader and one consistent lagger, same point.

[00:46:50] Speaker 02:
It's going to be picked up when it shows up.

[00:46:53] Speaker 02:
And I do think getting to Judge Edwards, your question about what the data is,

[00:46:58] Speaker 02:
We only put the data in.

[00:46:59] Speaker 02:
It's the 99.9% correlation.

[00:47:02] Speaker 02:
It's the expert comments from experts in the field.

[00:47:06] Speaker 02:
That's in there.

[00:47:08] Speaker 02:
And part of the reason that we submit that this is an unreasoned order is that they just kind of went like this.

[00:47:13] Speaker 02:
They just shrugged at that.

[00:47:15] Speaker 02:
They said, well, it's not enough.

[00:47:16] Speaker 02:
But they didn't say why it isn't enough.

[00:47:18] Speaker 02:
in the face of, and that happened a number of times, but nobody came in and said anything else in this proceeding.

[00:47:24] Speaker 02:
They have to explain why that isn't enough to satisfy the demands of reasoned decision making, and a shrug doesn't get you there.

[00:47:31] Speaker 02:
And then, let me just make sure I've got everything covered here.

[00:47:39] Speaker 02:
Yeah, no, I think that's just one final point, if I could.

[00:47:43] Speaker 02:
you know they say in that footnote 46 of the two cream order they say and then twice in this order they say

[00:47:49] Speaker 02:
there's reason to question whether the surveillance, semi-surveillance, will pick up spot market fraud.

[00:47:58] Speaker 02:
They never actually say why there's a reason to question.

[00:48:01] Speaker 02:
And that's the whole problem, given what they said in the Tupri border.

[00:48:05] Speaker 02:
They can't just say, well, maybe it'll be different in the face of our evidence.

[00:48:09] Speaker 02:
They've got to explain why it's different.

[00:48:11] Speaker 02:
And they've completely failed to do that.

[00:48:13] Speaker 02:
And the reason is because they can't.

[00:48:16] Speaker 01:
I have one question that is on 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.

[00:48:36] Speaker 01:
The way the commission framed it is thus the CME surveillance can reasonably relied upon to capture the effects on the CME Bitcoin futures market caused by a person attempting to manipulate the proposed futures ETP.

[00:48:48] Speaker 01:
So it does, in that sense certainly, but that's a subset of what it catches.

[00:48:53] Speaker 02:
It's not the sum total of what it catches and it can't be because

[00:48:57] Speaker 02:
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, that the rules of the exchange are designed to prevent fraud manipulation that will affect the product that's being applied for.

[00:49:19] Speaker 02:
And that's why I said the intent to target doesn't matter if you could show that there is fraud or manipulation and it would affect the underlying asset and it isn't provided.

[00:49:32] Speaker 02:
There's nothing in the design of the exchange that protects against it.

[00:49:34] Speaker 02:
You can't satisfy the statutory standard, but they found the statutory standard satisfied.

[00:49:39] Speaker 02:
That's the key thing, they found it satisfied and that's why I think their targeting argument doesn't really get them anywhere.

[00:49:46] Speaker 02:
Oh, I'm sorry, I did have one point about the second prong, because Your Honor raised it, if you don't mind me indulging on that.

[00:49:53] Speaker 02:
I think Your Honor was getting at something.

[00:49:54] Speaker 02:
There are some points we may not brief about the inconsistency of the trooperium on that, et cetera, but there's a basic point here.

[00:50:00] Speaker 02:
It's another one of the contradictions in the sword, if you think about it, and I think Your Honor's questions were getting at it.

[00:50:05] Speaker 02:
They say on the one hand that we haven't made a sufficient record that fraud manipulation that occurs in the coin spot market will show up.

[00:50:19] Speaker 02:
On the other hand, they're saying there's an undue risk

[00:50:22] Speaker 02:
that the Bitcoin spot market, that our ETP for Bitcoin spot will have such a powerful effect on the price of the CME futures market that we won't be able to discern.

[00:50:35] Speaker 02:
You can't say both of those things at the same time that completely contradict each other.

[00:50:41] Speaker 01:
Thank you.

[00:50:41] Speaker 01:
Thank you, Council.

[00:50:42] Speaker 01:
Thank you to both Councils.

[00:50:43] Speaker 01:
We'll take this case under submission.