3rd Circuit Rules for Coinbase – Reasoned Analysis and Due Process Do Matter
On January 13, 2025, the U.S. Court of Appeals for the 3rd Circuit ruled on Coinbase's Petition for Review of the SEC's Order denying Coinbase's Petition for Rulemaking requesting that the Commission promulgate rules clarifying when the federal securities laws apply to digital assets. On balance, the opinion is a win for Coinbase because it requires the SEC to provide a reasonable explanation for its refusal to engage in rulemaking. Though the 3rd Circuit declined to order the agency to institute rulemaking proceedings, it described the reasoning offered by the SEC for its denial to engage in rulemaking as "conclusionary" and perhaps even "vacuous." However, on many substantive points the 3rd Circuit agreed with the SEC with respect to how it may exercise its rulemaking authority. It made clear that the SEC has wide latitude to proceed under the Administrative Procedure Act (APA)[1] via adjudication or rulemaking, and its ruling did not limit those powers. It did, however, take the SEC to task for its cavalier dismissal of Coinbase's Petition. The concurrence by Judge Stephanos Bibas went further and, through dicta, articulated a criticism of the SEC's litigation-based initiative against crypto by focusing on the due process and fair notice vulnerabilities of the Commission's approach to date. The combination of the mandate for a reasoned analysis, the due process difficulties with the Commission's current approach, and the advent of a new Commission strongly suggests an upcoming pivot toward rulemaking for the digital asset industry and a de-emphasis on litigation as an appropriate vehicle for setting industry standards and regulatory policy.
Background
The SEC's posture as to crypto asset trading and regulation has been inconsistent and confusing to the markets. Judge Bibas's concurrence described it as "fogginess." While, in crypto's early days, the SEC had adjudicated some of the more serious fraudulent schemes, it tried a form of guidance[2] but turned again to aggressive litigation around the time of the crypto crashes of 2022.
Coinbase had been diligent in making efforts to engage with the SEC and encouraged the staff to develop rules which could be followed by the industry. Those efforts were unsuccessful, and in July 2022 Coinbase filed a Petition for Rulemaking with the SEC under § 553 (e) of the APA. The SEC did not act on the Petition and nine months after the filing, Coinbase petitioned the 3rd Circuit for a writ of mandamus ordering the SEC to act on its request. In June 2023,[3] the Court ordered the SEC to provide an update on Coinbase's Petition by October 11, 2023. On that date, the SEC informed the Court that the staff had made a recommendation to the Commission but that the Commission had not made a final decision. On December 15, 2023, the Commission denied Coinbase's Petition, confining its reasoning to a single paragraph offering three reasons: (a) it disagreed with Coinbase's contention that the current regulatory scheme was unworkable; (b) whether to alter the regulatory framework would be informed by "data and information provided by numerous undertakings directly or indirectly relating to crypto asset securities that the Commission is currently pursuing"; and (c) the requested action might strain the Commission's resources and limit its choices regarding competing priorities.
Coinbase subsequently filed a Petition for Review in the 3rd Circuit, pursuant to §§ 706(2) and 555 of the APA, seeking an order compelling the SEC to commence the rulemaking process.
The Majority Opinion
The Court's opinion makes it clear that the threshold for a petitioner to mandate agency rulemaking is very high and the deference which courts must afford the SEC's decision to proceed via adjudication or rulemaking is very great: "The SEC is not compelled by the APA or other administrative law principles to start notice-and-comment rulemaking here. Whether it does so is a matter of discretion to which we afford great deference."[4] Nonetheless, the majority found fault with the SEC's one-paragraph denial of Coinbase's Petition and required the SEC to go back and provide a reasoned analysis with which the Court could engage on more substantive grounds "so that we can assure ourselves that its decision considered all important aspects presented by the petition and resulted from reasoned decision making." In short, the Court told the SEC that it's conclusive reasoning did not allow the Court to do its job, and the SEC must try again. It noted, for example, that the SEC's response to Coinbase's "workability" concern was:
[O]f the conclusory variety that [courts] have previously rejected as insufficient to sustain an agency's refusal to initiate a rulemaking. It has said that it believes the existing securities law framework is not unworkable for digital assets, but we have no basis in the record for determining why it believes that or how it arrived at that conclusion. This explanation is not "slim" – it is "vacuous."[5]
The Court was equally critical of the Commission's explanations for its other concerns. With respect to the Commission's explanation of whether it preferred to proceed by incremental action, the Court's opinion reflects some of the frustration felt by those defending the SEC's claims:
These are many words that mean very little – the SEC might take future action on digital assets, and if it does, it might consider the experience it accumulates from other agency actions that might deal directly with digital assets. This is not a sufficiently reasoned explanation because it does not allow us to understand why it prefers to proceed by incremental action, particularly considering the significant workability concerns identified by Coinbase in its petition.[6]
The Concurrence
Judge Bibas fully agreed with the Court's resolution, but wrote separately to discuss what he believed were significant due process issues with the SEC's "regulation by enforcement" approach. The judge was plainly puzzled and frustrated by the SEC's haphazard case-by-case trench warfare in developing standards for an innovative and rapidly developing technology. While his analysis is dicta, Judge Bibas appeared to be attempting to provide guideposts for the SEC in connection with its crypto enforcement program, perhaps in anticipation of the new administration at the Commission. The high points of Judge Bibas' analysis are as follows:
- Crypto assets are different: "Some resemble bank accounts, others seem like commodities, and still others defy traditional labels altogether. … [For example,] stable coins work a lot like demand deposits and their issuers are essentially unregulated banks. If it works like a bank account, then maybe it should be regulated by bank regulators, not the SEC. Other crypto assets lack central promoters and so look more like currencies or commodities." (Concurrence, Slip Op. at 9, internal quotation marks and citation omitted.)
- The '33 and '34 Acts are an awkward fit for crypto:[7] Many of the disclosure requirements are not useful and some cannot be made at all. Many require "physical" possession. It is not certain who should register (if anyone) or who would qualify as a "clearing agency." (Concurrence at 11-13.)
- The SEC has sent contradictory signals (Concurrence at 17.) and has been evasive as to which assets are securities: "At oral argument in this very case, the SEC's lawyer refused to say whether Bitcoin and Ether are securities…. That evasiveness is puzzling." (Concurrence at 18.)
- Regulation by enforcement creates a fair notice problem: "The SEC repeatedly sues crypto companies for not complying with the law yet it will not tell them how to comply. That caginess creates a serious constitutional problem; due process guarantees fair notice. '[R]egulated parties should know what is required of them so they may act accordingly ….' FCC v. Fox TV Stations, 567 U.S. 239, 253 (2012)."[8] (Concurrence at 19.)
- The problem is compounded because the penalties the SEC seeks are criminal in nature, even though technically civil: "Due process's heightened notice requirements apply not only to criminal laws, but also to others that seek only to punish and deter … The SEC seeks regulatory penalties, which are usually called civil. But they are functionally criminal. They go beyond compensating victims to deter and punish. And when a defendant lacks notice of them, they cannot serve these purposes: one cannot deter or fairly blame the defendant who does not know what the law forbids." (Concurrence at 20.)[9]
Takeaways
Even before considering the advent of the Trump Administration and new management at the SEC, this is a significant victory for the digital asset and blockchain industry. This is also a fair decision. While it does validate a reasoned approach by the SEC (or other administrative agencies) to proceed to develop standards by way of adjudication, it does force the SEC to articulate sound reasons why choosing that approach over rulemaking is appropriate—giving the industry some basis to understand how the SEC views and interprets existing rules.
This decision should also breathe new life into the constitutional defenses raised by a number of crypto defendants, particularly related to the absence of fair notice. The concurrence seems to invite such defenses, which is particularly notable because this is the first ruling by a federal circuit on any major crypto issue. Indeed, the concurrence's characterization of the penalties being sought as criminal in nature has the potential to lead to stricter scrutiny of the SEC's approach at the District Court level.
We expect that new leadership at the SEC will be even more sympathetic to the request from the industry to establish standards (either by rulemaking or other guidance) and take a careful approach as to how it responds to non-compliance. The prior public statements by the Chair-designate, Paul Atkins, indicate a preference for robust economic analysis supporting rulemaking efforts.[10] Atkins is also a proponent of notice before action. Thus, we expect that the SEC will either use this as an instrument to begin a rulemaking process or identify to Congress the need for rulemaking elsewhere. Either way, it may also pause litigation that would be covered by the ultimate rulemaking and certainly not initiate new cases. Indeed, we suggested this potential in one of our earlier post-election insights.
We further expect there will be a robust, notice-and-comment process, perhaps including public hearings to emphasize the point of transparency.[11] In addition, given the preference of some Commissioners for regulatory sandboxes and the use of exemptive authorities,[12] we expect that the SEC will truly be open for innovation and responsible rulemaking in the crypto space. Indeed, on January 21, 2025, Acting Chair Uyeda announced the formation of a new Crypto Task Force, led by Commissioner Hester Peirce, which will "help the Commission draw clear regulatory lines, provide realistic paths to registration, craft sensible disclosure frameworks, and deploy enforcement resources judiciously." It will also coordinate its work with other federal departments and agencies, including the CFTC, as well as state and international counterparts.
Finally, we expect the new Commission will be reluctant either to engage in aggressive litigation to set industry standards or to abdicate its rulemaking authority to the courts, who are ill-suited to grapple with the policy issues which accompany the development of new financial services technology. Again, underscoring the fairness of this decision—if the courts are asked to untangle this web, they deserve some understanding of why the SEC thinks it does not need to do so itself. In stark contrast to the current SEC's "haphazard enforcement strategy,"[13] the CFPB recently published a "Notice of Proposed Interpretive Rule" in the Federal Register proposing to apply Regulation E to stablecoins and digital assets, asserting that they involve electronic funds transfers ("EFTs"). And by way of comparison, courts largely stayed out of the development of internet stock trading at the turn of the 21st century. Rather, a collaborative effort between the SEC and the industry resulted in the passage of Reg ATS.[14] We expect a return to that period of collaboration.
Conclusion
Combined with other losses recently suffered by the Commission, we expect this ruling signals a definite change in the direction of the wind related to crypto policymaking. It will be easier for the incoming Commission to say that the prior approach has failed and that the SEC must re-set its compass toward a direction more open to innovation and experimentation, while continuing its strong commitment to reasonable and transparent regulation for the protection of investors and market integrity.
If you have questions about the policy priorities and potential impact of the Trump Administration's actions on your crypto activities, plans, or pending matters before a federal financial agency or court, please contact the authors or your DWT attorney contact.
[1] 5 U.S.C. § 551 et seq.
[2] See Report of Investigation Pursuant to Section 21(a) of the Securities Act of 1934: The DAO, Exchange Act Release No. 81207, 2017 WL 7184670 (July 25, 2017) (the "DAO Report") and Framework for "Investment Contract" Analysis of Digital Assets (2019) (the "Digital Asset Framework").
[3] Also in June of 2023, the SEC sued Coinbase and others for operating as unregistered exchanges.
[4] Slip Opinion at 37-38.
[5] Slip Opinion at 41, emphasis in original (internal quotations and citations omitted).
[6] Id. at 46, emphasis in original.
[7] To have a sense of how the context of 1934 is far from today's, it may be helpful to consider that, of the Senators who voted on the 1934 Act, some were born during the Civil War and all were alive before the commercialization of both the telephone and automobiles.
[8] This is very much in sync with how the prior Trump Administration approached fair notice issues. In his first letter to the CFPB (Jan. 23, 2018), then-Acting CFPB Director Mick Mulvaney noted that "the people we regulate have the right to know what the rules are before being charged with breaking them." Congress more recently expressed similar concerns: "Without clear rules of the road, your push for firms to 'come in and register' is a willful misrepresentation of the SEC's non-existent registration process." (April 18, 2023, Letter from Republican Members of House Financial Services Comm. to SEC Chairman Gary Gensler). Bank regulators have expressed similar views. In remarks at a Washington, D.C., fintech conference in October 2024, FDIC Vice Chair Travis Hill stated that it would be "generally a better approach, rather than just starting to go bank-by-bank, issuing enforcement actions … instead to put out some sort of overarching policy statement that says to the industry 'here's what the expectations are ….'"
[9] This also is consistent with Justice Gorsuch's recent analyses and efforts to apply the rule of lenity, which teaches that "any reasonable doubt about the application of a penal law must be resolved in favor of liberty." Wooden v. United States, 142 S. Ct. 1063, 1081 (2022) (Gorsuch, J. concurring); Bittner v. United States, 143 S. Ct. 713, 724-25 (2023) (applying lenity to civil penalties).
[10] For example, Chair-designate Atkins has pointed out that the SEC "historically has been an agency of, by, and for lawyers ... The endemic problem is that economic analysis at the SEC has been performed as a post-hoc exercise ... only near the end of the process are the economists brought in to justify the actions on a cost-benefit basis." For that reason, he supported a prior bill to direct the SEC "to utilize economists to decide whether or not to propose or adopt a regulation – and to do so only after considering the costs and benefits." Statement of Hon. Paul S. Atkins before the House Committee on Financial Services (September 15, 2011).
[11] It will be of interest to see if the newly announced "Crypto Advisory Council" will weigh in on any proposed rules.
[12] See Comm'r H. Peirce, "Comment on Digital Securities Sandbox Joint Bank of England and Financial Conduct Authority Consultation Paper" (May 29, 2024). https://www.sec.gov/newsroom/speeches-statements/peirce-boe-fca-comment-05302024
[13] Concurrence at 21.
[14] See, Com'r H. Peirce, "Rendering Innovation Kaput: Statement on Amending the Definition of Exchange" (April 14, 2023). https://www.sec.gov/newsroom/speeches-statements/peirce-rendering-inovation-2023-04-12