This is a transcript of the podcast episode Howard Fischer talks about spot bitcoin ETFs, from rollout to risks between GRIP’s US content manager, Julie DiMauro, and Moses Singer LLP and a former SEC litigator, Howard Fischer.
[INTRO]
Julie DiMauro: Greetings and welcome to a podcast offered by Global Relay Intelligence and Practice, or GRIP, as we call it. I’m Julie DiMauro, the US Content Manager in New York City.
Now you can find us at grip.globalrelay.com and follow us on LinkedIn, please. But for now, let me thank my amazing guest, Howard Fischer, for joining us today. Howard, can you please introduce yourself to our listeners?
Howard Fischer: Well, Julie, thanks for having me. I’m really looking forward to this. I am a litigation partner at the New York law firm of Moses Singer. Before that, I had been at the United States Securities and Exchange Commission for about 10 years as a senior trial counsel. And while I was at the agency, I had joined right after the financial crisis. So a lot of my tenure was involved in dealing with some of the more high profile credit crisis cases and dealing with some of the issues that the SEC was facing in the wake of the financial crisis.
Julie DiMauro: Thanks so much again, Howard, for joining us today. We want to talk about the spot Bitcoin ETFs, but I want to ask you first, Howard, what got you interested in cryptocurrency and the regulations surrounding it?
Howard Fischer: Well, it’s fascinating because what’s happened in the cryptocurrency world is what’s happened in the financial services world over the last thousand years, but compressed into a three to five-year period. We have developed the rules that govern our financial services world over literally hundreds and hundreds of years. People would be surprised to find out how old things like letters of credit are or bearer bonds or their roots in the Hanseatic League.
But we basically developed the regulatory underpinning of the way global commerce works over centuries of trial and error. And what is fascinating about digital assets is that although the world of cryptocurrency was originally presented as something outside the normal rules of the financial system, outside central government control and outside the rules and standards that govern traditional transactions, what we’ve learned in the last few years is that, no, in fact, these rules apply.
And as the sector continues to develop, we’re seeing a return to some of these traditional rules because we’re finding out they make sense.
Julie DiMauro: Go figure. Now, Howard, I want to get into the reason and impact of the SEC’s decision to greenlight several applications for spot-based bitcoin ETFs. Now, what’s the SEC’s attitude toward crypto in general?
Howard Fischer: Well, the SEC has been hostile to the world of digital assets for some years. And although there is a lot of criticism directed towards Chairman Gensler for this, the fact is, is that this this critical attitude predates the original prosecutions of crypto companies, of initial coin offerings that took place under Jay Clayton, who was a Trump appointee.
And as Gensler pointed out in his statement on the approval of the spot bitcoin ETFs, the original rejection of a spot bitcoin ETF took place under the Clayton SEC, not under Gensler. So the SEC has long had a history of hostility to digital assets. And I think it’s pretty easy to understand why. I mean, the SEC has two main purposes, first, promoting capital formation so that useful projects can get created that will build business, build industries, create employment.
The second purpose of the SEC is to protect investors. And in the digital assets space, both of those purposes are kind of crosscurrents with digital assets. In the first place, there is skepticism at the agency, and not just at the agency, that digital asset projects actually build anything other than a speculative bubble, that is.
The other concern is investor protection. One of the things we’ve seen in the last year or so is the high-profile collapse of multiple digital asset enterprises. We saw FTX collapse. We saw Sam Bankman Fried’s conviction. We saw the collapse of Three Arrows, of Voyager. We saw the criminal prosecution and civil prosecution of Binance. So it’s not like the sector has covered itself in glory.
A lot of people have made money, but a lot of people have lost a lot of money. So this recent history of significant investor losses is one of the things that’s motivating the SEC’s cynicism and skepticism towards the digital assets arena.
Julie DiMauro: Howard, that makes all the sense in the world. But when the spot bitcoin ETF was approved, it was bizarre world because you had Chair Gary Gensler siding with the two Republicans to greenlight it. Can you walk us through that?
Howard Fischer: Yes. Remember that this is not Chair Gensler saying, oh, you know, I’ve changed my mind. This was the SEC gritting its teeth and being forced to walk through the gauntlet of ETF approval for spot bitcoin ETFs. You know, the grayscale had challenged the initial denial by the SEC of its application to convert its, you know, the grayscale pool to an ETF. And the circuit court had rejected the SEC’s rejection and said that it was arbitrary and capricious and that the SEC needed to look at it again. I think that the SEC really didn’t have much of a choice here.
I think that the two Democrats on the commission who disproved it knew that and understood that they had the freedom to say no, because all you need is a three two vote to approve something at the SEC so they could stand on principle and the court mandated approval would go through nonetheless. But let’s not confuse that for full-throated enthusiasm. And in fact, let me actually just read something to you because I think it is very helpful.
When the SEC approved something or deny something, often each of the commissioners will put in a separate statement that goes on the record and goes on the SEC website. And these statements set out the priorities of each of those commissioners, as well as the general view of the SEC on these issues.
So when approving the spot bitcoin ETFs, Chair Gensler wrote: “It should in no way signal the commission’s willingness to approve listing standards for cryptoasset securities, nor does the approval signal anything about the commission’s views as to the status of other cryptoassets under the federal security laws or about the current state of noncompliance of certain cryptoasset market participants with the federal securities laws.”.
So Chair Gensler is basically saying here, yeah, I have to do this. We have to do this. The court has forced us, but we’re not going to be happy about it. And by the way, don’t look at this as the harbinger of any future approvals either.
Julie DiMauro: Right. Curb your enthusiasm. And remember that we’re watching to see how this unfolds.
Howard Fischer: Yes. One of the other things to note is that when Gensler led the approval by the SEC of spot bitcoin ETFs, he also noted in passing what he saw as one of the significant differences between cryptocurrencies and other assets like precious metals. And I’ll quote him because I think it’s worth reading this: “Though we’re merit neutral, I’ll note that the underlying assets in the metals, ETPs have consumer and industrial uses. While in contrast, bitcoin is primarily a speculative, volatile asset that’s also used for illicit activity, including ransomware, money laundering, sanction evasion and terrorist financing.”
This does not sound like the words of a man eager to approve additional digital currency.
Julie DiMauro: Good point! Now, there was also in this rollout period a rush by these businesses to have the lowest fees. Can you tell us about that?
Howard Fischer: Yeah. So this is something we’ve seen actually writ large over the last several decades when retail investors started to invest in mutual funds. You first saw load funds, you know, funds that had a one, two or three percent load fee. And gradually, as mutual funds became more popular with the public, there was more competition and competition typically takes the form of lower fees. So three percent became two percent, two percent became one percent.
And finally, one percent became zero percent for most mutual funds. We’re seeing the same thing in the ETF space for Bitcoin. I think Grayscale had something like a one-point five percent charge.
And the Grayscale converted ETF is actually one of the few funds, a few investment vehicles that actually has seen a net outflow of assets. And that’s because the other competitors, BlackRock, Fidelity, ARK 21 shares have very low rates, very low fees, something around one point nine to point two five percent.
And as a result, people are going to flock to the low-cost alternatives. And so I think we’re going to see a either funds will either have to offer similarly low fees or they’re just not going to get that much business.
Julie DiMauro: Absolutely. Now, Howard, I want to ask you about the compliance concerns here. What are the main compliance issues for businesses offering these Bitcoin ETFs? And how can businesses best craft guardrails to protect investors?
Howard Fischer: It’s very complicated. I mean, this is not a traditional asset class. It’s one that has seen significant volatility. You’ve seen doubling or having a price of prices within very short periods of time. So, you’re going to see a lot of significant compliance issues. One is going to be reluctance by advisors to even talk to customers about this.
Given the high levels of volatility in the industry, you’re going to see a heightened focus on whether or not a Bitcoin ETF is appropriate for certain consumers. Is it going to be appropriate for older consumers with a shorter investment timeframe? Is it going to be appropriate for investors with a low risk tolerance or those that want income?
So I think we’re going to see a lot of that as a concern. We’re going to see a lot of issues surrounding regulation, best interest or reg. B.I., as it’s known, are Bitcoin ETFs in the best interests of retail customers? And we’ll see that a lot in the advisory sector as well. There’s also a high chance of litigation risks in this sector as well.
Anything with high volatility can see significant short-term losses. One of the things that drives litigation is, well, when people lose money. I mean, this one of the hallmarks of the American justice system is that when people lose money, they will sue. And given the risks of significant losses, I think you’re going to see a significant litigation risk around these funds, around off running of these funds and around the administration of these funds. So those are some of the compliance risks. There are also operational risks as well.
Julie DiMauro: Now, I want to get into those operational risks. I am thinking of Vanguard, though, because they’ve been pretty outspoken about not offering these products. Is that, you know, their risk waiting in terms of the legal and compliance, reputational risks, et cetera, and operational that we’ll get into?
Howard Fischer: Yeah, I think you have to look at several factors if you want to offer these kinds of investments. The first is, as you pointed out earlier, we’re seeing a rush to low fees. So given the low fee environment, there is a question as to whether these are going to the more profitable funds. I mean, it’s always been the case that you are if you are picking investments, picking stocks, picking equities or investment vehicles, you could charge a higher rate.
So the question is, what is the profit potential for these kinds of investment products? Is the purpose of this to offer someone exposure to Bitcoin or is the purpose of this to attract someone to your investment platform? So you have to measure that with as what Vanguard, which is what Vanguard is doing with the potential litigation risks as well as the compliance issues as well as the operational concerns. And I think for all that’s a judgment that every adviser or investment vehicle is going to have to make for themselves.
Julie DiMauro: Perfect. Well, let’s get into operational risk. What are some of the operational risks you would advise businesses to be mindful of? I mean, there’s still a lot of regulatory uncertainty here, plus skepticism from lawmakers in Congress. Can you walk us through those operational risks?
Howard Fischer: Yes. So, in addition to the ones that you mentioned, there are other risks as well. One of those are security risks. One of the hallmarks of the digital asset space is that accounts get hacked.
Exchanges collapse. I mean, if you want to go back into the prehistory of digital assets to the era of Mount Gox or Quadriga, you know, one of the hallmarks of a Bitcoin exchange is that either it is subject of multiple hacks or there are problems with its operations. FTX, of course, and Binance being the most the most recent examples of that right now, I think eight of the eleven approved Bitcoin ETFs are custody at Coinbase.
That’s a very high concentration in one entity. I mean, as a result, it’s been great for Coinbase. Their stock has gone up. Their profits have gone up. Their trading activity has gone up. But what if something happens to Coinbase?
I mean, right now, Coinbase looks terrific. It looks to be a well-run organization that is trying to be compliant, that has staffed up its compliance and legal departments. It is working with Congress to try to get a regulatory framework to govern exchanges. It might well win its SEC case, but it is just one company.
You know, if you look at a standard investment fund and their use of prime brokers, many funds have multiple prime brokers, partly for this reason. So there is the operational risk of having, I think, a large majority of funds of the Bitcoin assets custody at Coinbase. So that that’s one issue. Another issue is potential litigation risks.
Let’s say there’s a run on the Bitcoin market for whatever reason. People start to sell. That selling pressure will require Bitcoin ETFs to sell off to be able to satisfy customer redemption requests. That may well create the equivalent of a run on the bank. That is an issue and a concern that exists in the Bitcoin ETF space to a much larger degree than it exists in traditional investment markets.
Julie DiMauro: Terrific overview, thank you. Now, I’m trying to think ahead. What’s next on the agenda for a probable green light from the SEC in the crypto space?
Howard Fischer: I don’t think we are likely to see a rush by the SEC to approve other similar vehicles. Perhaps for ETH, there may be something because the SEC has been cagey about saying whether or not that is a security or not. I think that the SEC is not going to act to approve additional spot ETFs for other digital currencies unless several of the following things happen.
First, the SEC could lose some of the cases it has currently pending in which it is trying to assess and assert that digital assets are in fact securities and are supposed to be regulated as securities. There could be a series of circuit court opinions or a Supreme Court opinion. There could be a Supreme Court opinion saying that either that’s not the case or that the SEC doesn’t have the authority to make that determination.
There could also be a congressional determination. Right now, Congress is not exactly the most functional institution in our country, but there’s going to be an election that might change. There is a lot of interest towards creating some kind of regulatory framework for digital assets.
It’s not skeptical that that may happen, but there is a lot of interest on it. This cuts across some traditional partisan lines and we may see some kind of congressional action. I think that absent though a court determination against the SEC on these issues or congressional action, I don’t see the SEC jumping into the fray to approve other similar ETFs for other digital assets unless it is forced to.
Julie DiMauro: Well, OK. I thought we’d see an Ether one soon!
Howard Fischer: We may see Ether – it’s the only one that I think is the most likely — and that’s because it has more similarities to Bitcoin than to other digital assets.
Julie DiMauro: Right. OK, perfect. Howard, this was great. Terrific overview. Thank you so much for joining us today.
Howard Fischer: My pleasure. My pleasure.
Julie DiMauro: And thanks so much to everyone for joining us as well. Again, please check us out at grip.globalrelay.com. We have an array of articles, podcasts, thought leadership pieces by outsiders and our internal experts. We would invite you also to like us on LinkedIn and again tune in for other podcasts. Howard, thank you again.
Howard Fischer: My pleasure. Thank you so much.
Julie DiMauro: Have a wonderful day.