Overview
In a win for the crypto industry, the Third Circuit this week issued a decision that sets the stage for broader success before the SEC. At first blush, Coinbase v. SEC might seem like a dry administrative law decision concerning the SEC's denial of Coinbase's rulemaking petition. One scrape below that surface reveals the decision is so much more.
The opinion, written by Judge Ambro, granted in part Coinbase's petition for review, holding that the SEC's order denying Coinbase's petition for rulemaking was conclusory and insufficiently reasoned. The court remanded to the SEC for a more complete explanation. The opinion included some wins for the SEC: the Third Circuit rejected Coinbase’s arguments that the SEC is presumptively required to engage in notice-and-comment rulemaking as opposed to regulating by enforcement when applying the securities law to crypto transactions. Additionally, the court disagreed with Coinbase's assertion that the SEC’s denial to engage in rulemaking deprives it of fair notice, finding the 2017 DAO report sufficient for fair notice purposes, and explaining that Coinbase’s arguments are more appropriate for challenges to enforcement actions. That said, the greatest impact of this case will likely come from Judge Bibas’s concurrence in which he faulted the SEC for "insist[ing] that its old rules apply to the novel crypto market but refus[ing] to spell out how."
Majority Opinion
The Third Circuit held that the SEC is not compelled by the Administrative Procedure Act or other administrative-law principles to start notice-and-comment rulemaking here—and, whether it does so is a matter of discretion to which courts will defer. The court, however, concluded that the SEC's short paragraph rejecting notice-and-comment rulemaking was not a sufficiently reasoned explanation to which the court here could defer.
The SEC's explanation was not sufficiently reasoned. The court concluded that the SEC's decision to reject rulemaking was arbitrary and capricious because the SEC's explanation was not sufficiently reasoned. The court looked to each of the three reasons the SEC gave for rejecting Coinbase's rulemaking petition, holding that any of these reasons could be a sound basis for denying a rulemaking petition, but the conclusory statements here did not provide a reasoned explanation to which the court could defer.
The SEC was not presumptively required to engage in notice-and-comment rulemaking. The court rejected Coinbase's argument that the SEC is presumptively required to engage in notice-and-comment rulemaking instead of regulating by enforcement. Looking at agencies' broad discretion to set their own agenda (and that the arbitrary-and-capricious standard is at its least demanding when a court evaluates an agency's decision not to engage in rulemaking), the court reasoned that failure to articulate an adequate legal basis for agency action is ground for setting aside an agency action, not a ground for mandating rulemaking. The proper posture for Coinbase to argue that the SEC's interpretation of existing securities rules lacks any basis in law is in an enforcement proceeding, not an appeal from an order denying a petition for rulemaking.
The court reasoned that the SEC was entitled to regulate through adjudication. As to the principle that an agency cannot use adjudication to promulgate and retroactively enforce rules that depart significantly from past agency practice, the court noted that a regulated entity can challenge the new rule defensively and have it set aside. That, however, is not a basis to compel an agency to begin notice-and-comment rulemaking.
There was no fundamental change in the factual premises such that the SEC's rejection of Coinbase's petition was arbitrary and capricious. The workability concerns that Coinbase highlighted about how digital assets were incompatible with existing securities regulations were not a fundamental change in the factual premises previously considered by the SEC such that the court should overturn the SEC's decision not to engage in rulemaking. The court noted, "[i]n the securities-law context, it is unremarkable that novel complex financial instruments may not always fit neatly within existing securities rules, especially if inherent attributes of those novel financial instruments may undermine the objectives of those rules."
Remedy. The court emphasized that the interests at stake are purely economic, and rejected Coinbase’s argument that the court order the SEC to proceed directly to rulemaking. Instead, the court remanded to the SEC for further explanation.
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Although the court's opinion described digital assets as "a growing part of the financial sector" that "are emerging as an increasingly important form of online payment," the opinion itself did not meaningfully grapple with the unique nature of the crypto industry. Judge Bibas's concurrence, however, elegantly detailed problems with the SEC's approach to crypto enforcement that have been invoked by the industry for years.
Judge Bibas concurrence
Judge Bibas agreed with the majority in full but wrote separately to highlight the due process issues on the horizon should the SEC continue regulating by enforcement. Judge Bibas explained that the SEC's "old regulations fit poorly with this new technology"—he faulted the SEC for "insist[ing] that its old rules apply to the novel crypto market but refus[ing] to spell out how." Notwithstanding repeated requests by the crypto industry for clarity, the SEC has not explained how crypto companies can comply with the law. Instead, the SEC sued companies individually. According to Judge Bibas, the SEC "wants to proceed with ex post enforcement without announcing ex ante rules or guidance."
Judge Bibas described the SEC's current approach as "pouring new crypto wine into old regulatory bottles." His concurrence laid out the awkward fit between existing securities legislation and how crypto functions. For example, Judge Bibas noted that requirements that public companies disclose audited financial statements, the names of their corporate directors and officers, and whether those directors are independent makes little sense for crypto assets where "that information is nonexistent or meaningless." He also noted that the 1934 Act's definition of a "clearing agency" as anyone who facilitate settlement "without physical delivery of securities certificates" means that it is unclear who would count as a "clearing agency" for a crypto transaction because crypto assets do not have physical certificates.
Due process. Judge Bibas laid out the constitutional vulnerability of the SEC's approach to regulating the crypto industry (by enforcement). He explained that heightened notice requirements apply to efforts by agencies to punish and deter, and "the SEC is using the federal securities laws against the crypto industry to do just that." Judge Bibas explained, "the SEC's haphazard enforcement strategy of targeting entities that are trying to follow the law does not give potential defendants the notice that due process requires. That is especially true because the field is novel. The agency has offered no meaningful guidance on which crypto assets it views as securities." He also noted that because the SEC would face legal challenges if it promulgated a rule banning crypto assets, "the SEC has sidestepped the rulemaking process by pursuing a de facto ban through enforcement instead."
The concurrence also described the lack of predictability resulting from the SEC's actions: "When courts confront such enforcement-by-surprise in future cases, they must bar penalties that were not reasonably foreseeable. . . . The SEC may not play gotcha, and Article III courts must ensure that the SEC plays fair." In closing, he took aim at the SEC’s overall approach to the crypto industry: "[S]poradically enforcing ill-fitting rules against crypto companies that are trying to follow the law goes way beyond fighting fraud. It targets a whole industry and risks de facto banning it. On remand, the SEC must grapple with that problem."
Takeaways
- SEC Changes in 2025: Chair Gensler was the driving force behind the SEC's arbitrary and capricious denial of Coinbase's rulemaking petition, but he will not be around to remedy the problem. That burden will likely fall on the next Acting Chair, who will lead a 2-1 GOP majority commission, or perhaps upon the Chairman-designate Paul Atkins, who is expected to lead a 3-0 GOP majority commission upon his confirmation in the first half of 2025. The court did not direct the SEC to act by a certain date, which provides the agency flexibility in determining when to do so. Regardless of timing, the new GOP leadership at the SEC will likely reverse course on Coinbase’s rulemaking petition and signal its intention to promulgate rules clarifying how and when the federal securities laws apply to digital assets.
- SEC Resource Constraints May Limit Scope of Crypto Rulemakings: The scope of the new SEC's rulemaking efforts will be an open question. Coinbase's petition covers a broad range of subject matter and specific securities law issues. While all are worthy issues to be addressed, the new SEC must allocate limited resources to address each of Atkins’s priorities. We expect implementing workable crypto regulations to be a large part of Atkins's agenda, but it certainly will be only one of a number of priorities for the next Chairman.
- SEC Likely to Adopt Lighter-Touch Approach: We anticipate that the new SEC may seek to withdraw, or (at a minimum) stay ongoing litigation against crypto platforms that do not involve allegations of fraud. Judge Bibas's concurrence provides some judicial support for critiques of the SEC's enforcement approach to the crypto industry raised by Commissioners Peirce and Uyeda, and could be cited by the agency in explaining any change in approach.
- A Friendlier, but Still Slow SEC: The industry will face a new SEC willing to engage with it and provide a workable regulatory framework. As the SEC changes approach, the industry will have to change as well. In adopting a more collaborative attitude towards the SEC, industry participants must remember that it will take time for the regulatory framework to be stood up. Notice-and-comment rulemaking takes time; it requires meaningful engagement with the public and high quality economic analysis. Firm advocacy by the industry will need to be coupled with patience with the process.
- Coinbase-as-Blueprint: Given the Supreme Curt's overturning of Chevron deference and legal upheavals in administrative law principles, Coinbase's playbook to litigate the rulemaking petition process may be repeated in the future both at the SEC and at other agencies. Now is the time to explore viable challenges to other long-established agency norms and practices.
Please contact the authors if you are interested in developing a tailored SEC advocacy and administrative law strategy designed to achieve your goals during the new administration.
