The SEC's 'Arbitrariness and Capriciousness' Hurts Investors; It's Time for Clarity

The saga of the Grayscale Bitcoin ETF is far from over. This is despite an apparent victory for the investment firm in the DC Appeals Court, which slammed the Securities and Exchange Commission (SEC) for denying Grayscale permission to issue its Bitcoin product. In fact, that decision may actually become a setback for the crypto world, with the federal agency now stating that it is suspending discussion on all crypto ETF applications. The SEC hasn't said whether or not it will appeal the decision, but one thing is clear; Grayscale still has significant hurdles to overcome before its Bitcoin ETF is approved.

But regardless of Grayscale Bitcoin ETF's fate, one thing the case has done is to shine a light on the SEC's unfair and arbitrary decision-making — based not on facts and data, but on unpublished or unclear criteria. The consequences of this go way beyond crypto. That kind of decision-making has kept organizations that play by the rules from taking part in important emerging markets — like cryptocurrency — while enabling incompetency, or worse, leading to outright tragedies like the collapse of Silicon Valley Bank.

Denying Reality

Ostensibly, SEC rulings against crypto are designed to protect investors from falling prey to the shady characters who have been responsible for the scandals that have plagued crypto products and platforms. But by failing to regulate crypto in a fair and transparent manner — preferring to ostensibly ban crypto products altogether — the agency is doing the opposite and actually driving investors into the hands of thieves who will try to steal their money any way they can. Meanwhile, the good guys who want to play by the rules and add to productive innovation in finance are left without a clear path to market.

Crypto is a reality for investors; they are not likely to pass up a vehicle like Bitcoin, which has proven its worth and resilience. By denying that investment reality and preventing investors from working with accredited institutions that take heed of government rules ensuring investor safety, the SEC essentially throws them to the wolves — doing exactly the opposite of what a government regulatory organization is mandated to do.

Grayscale Case Highlights Arbitrariness

The Grayscale ETF case is a good example of the SEC's mandate failure. The Appeals Court that vacated the SEC decision against Grayscale called it "arbitrary and capricious" and ruled that the grounds for its decision were incorrect. The SEC's decision, as presented to the Court, revolved around the possibility, if not likelihood, of market manipulation, because of the presumed inability of Grayscale's surveillance partner (which is supposed to ensure that such manipulation be prevented) to do so. Yet this same partner, the Chicago Mercantile Exchange, successfully surveils Grayscale's Bitcoin futures fund, and that same group also surveils SEC-approved crypto ETFs for the NYSE and NASDAQ, approved in 2018. In other words, the CME is competent enough to supervise one set of crypto-based products, but not another one.

The SEC is thus failing to follow rules and examples that the agency itself set for the supervision of crypto products. Greyscale argued that it would be difficult to find a more blatant example of arbitrariness and capriciousness, and the Court agreed, demanding that the SEC revisit its denial — a demand the agency has yet to comply with.

A Pattern of Failure

Arbitrariness in the crypto sphere was also the complaint made by Coinbase in a lawsuit against the SEC filed last May, in which the platform said that it has repeatedly asked — begged, even — the agency to issue rules on trading cryptocurrency. "The SEC refuses to promulgate rules that would enable the industry to know the SEC's standards for determining whether digital assets may be securities or provide a workable path to register when required. That refusal should not evade judicial review," the petition stated, and in response, the Court ordered the SEC to inform it when those rules are ready; so far, no rules have been issued.

This pattern of behavior is ongoing. This week, the SEC's head of crypto enforcement, David Hirsch, yet again made vague threats about cracking down on DeFi and crypto players that he says are violating security laws. But regulatory guidelines are still sorely absent, making it nearly impossible for anyone to comply.

Overlooking Serious Issues in Other Sectors

Of course, the SEC could claim that crypto is an area that needs special care, given the number of scandals that have hit that industry. It makes sense to be ultra-conservative when it comes to investors' money. This, of course, is an excellent argument — except that the SEC has shown itself to be very unconservative in numerous instances, the latest being the fall of Silicon Valley Bank.

While the agency does not hold full responsibility for banks — that's in the purview of the Fed — the SEC clearly could and should have seen the bank's collapse, in light of the potential run on assets caused by higher interest rates, just as some journalists did. According to analysts, in filings in the third quarter of 2022, the bank's parent company disclosed to the SEC that "it was sitting on losses from its bond purchases big enough to swamp its total equity. That would have been a good time for supervisors to tell the bank to get its act together." Indeed, the analysts said, SEC regulators "didn't need any fancy analysis to detect the danger at Silicon Valley Bank. They just needed to notice its financial results." Why they did not is unclear — but what is clear is that the SEC is arbitrarily enforcing rules based on criteria that are unknown to the public, investors and institutions.

Clarity Is Badly Needed

Grayscale is hardly the only organization to sue the SEC over arbitrariness. In recent days, a coalition of investment firms filed a petition (possibly encouraged by the Grayscale decision) seeking court review of the SEC's newly-approved Private Fund Investor rule, which will have a significant impact on reporting procedures and fund relationships with clients. The rules, say the petitioners, "exceed the Commission's statutory authority, were adopted without compliance with notice-and-comment requirements, and are otherwise arbitrary, capricious, an abuse of discretion," and requests that the Court require the SEC to cancel the rule, as they are "simply not workable — as petitioners would have told the Commission had it actually put its revisions out for public comment."

The Industry Deserves Better

Regardless of the merits of that case, it's clear that the SEC has been acting in an arbitrary and irresponsible manner — and people are beginning to notice. In the case of crypto, institutions like Grayscale, which epitomize the "proper" fiduciary procedure, are being denied the opportunity to participate in a multi-billion dollar market, preventing investors who are interested in crypto from investing in safe, stable products — and instead driving them into the arms of speculative platforms that don't bother too much with regulations. In that sense, the SEC's over-cautiousness isn't protecting investors — it's hurting them. It's time for the SEC to be consistent, to make clear its rules and procedures — and the reasons the agency has for imposing them, whether for crypto, bank regulation or anything else.

Dmitry Gooshchin is the chief operating officer and co-founder of EndoTech, an AI trading platform.

(Opinions expressed in this article are the author's own.)