In early January, Coinbase achieved a partial victory in the Third Circuit Court of Appeals. Thus, there is hope among crypto companies that the Securities and Exchange Commission (“SEC”) will provide guidelines for compliance with the federal securities laws. Coinbase had petitioned the SEC to promulgate rules clarifying “how and when” the federal securities laws would apply to digital assets. The SEC denied Coinbase’s petition for rulemaking in a single paragraph order. Coinbase challenged the order, claiming the agency was required to give a more detailed explanation pursuant to the Administrative Procedure Act (“APA”). The Third Circuit agreed, finding the order was “conclusory and insufficiently reasoned, and thus arbitrary and capricious.”
Passed in 1946, the APA supplies a set of background rules that federal administrative agencies are generally required to follow. Included in these background rules is the notice-and-comment rulemaking process adhered to by the SEC. Coinbase petitioned the SEC to promulgate new rules for the digital asset space as it believed the federal securities laws are “fundamentally incompatible with the operation of digital asset securities.” Specifically, some of the difficulties Coinbase identified are the registration of digital assets on a decentralized blockchain network, where no one person can register the asset; the encumbrance of non-investment uses of digital assets if transactions were required to occur in a broker-dealer framework; and the application of the “Net Capital Rule” to a digital asset broker-dealer.
While the Court shared some of Coinbase’s “workability” concerns, that is, how the federal securities laws can apply to digital assets, the Court rejected Coinbase’s request to require the SEC to engage in notice-and-comment rulemaking. Instead, the Court remanded the issue to the SEC to better explain why those concerns are unfounded.
Addressing another concern for digital asset companies, the Court touched on the SEC’s preference to announce crypto policy through enforcement actions. The Court rejected Coinbase’s contention the SEC is required to create a regulatory framework for digital assets through agency rulemaking, as opposed to adjudications. Citing several canonical Supreme Court opinions, the Court held the SEC may continue to announce policy via adjudication, sometimes referred to as ‘regulation by enforcement’, as the “choice between rulemaking and adjudication lies in the first instance within the [agency]'s discretion.” However, the Court noted specific, individual enforcement actions may be challenged in circumstances where the agency uses adjudication to “promulgate and retroactively enforce rules that depart significantly from past agency practice.”
Judge Bibas, while joining and referring to the majority opinion as “excellent”, filed a separate concurrence. Chiefly, he wrote about a potential due process issue that may arise in what he called the SEC’s “haphazard enforcement strategy.” Sympathizing with Coinbase’s attempts to comply with the law, Judge Bibas called on courts to bar future SEC penalties that are not “reasonably foreseeable.”
The Court stopped short of requiring the SEC to formally promulgate rules relating to digital assets. The SEC order that may eventually be released because of this case, however, could shed light on the SEC’s thought processes. After all, a detailed explanation of the “workability” of the federal securities laws to digital assets may itself clarify SEC policy. In a separate litigation between the SEC and Coinbase, a court in the Southern District of New York opened the door for crypto asset transactions to be classified as investment contracts, and therefore securities. The court in the Southern District permitted Coinbase to appeal its decision. The Second Circuit Court of Appeals may now hear the appeal, and perhaps provide guidance as to when the federal securities laws can apply to digital assets at all.
Moreover, it is believed that the Trump administration will strongly consider an overhaul to the SEC’s cryptocurrency practices. Coinbase did achieve a victory in the Third Circuit, but the fight over digital asset policy is nowhere close to completion.
The case discussed in this alert is Coinbase, Inc. v. SEC, __ F.4th __ (3rd Cir. 2025).