US court orders SEC to explain why it denied Coinbase's request for crypto-specific rules

The U.S. Securities and Exchange Commission must explain why it denied Coinbase's petition for specific rules for crypto, the U.S. Court of Appeals for the Third Circuit said in an opinion posted on Monday. The court called the SEC's decision to ignore this request for crypto-specific rulemaking as "arbitrary and capricious."

At the same time, the court did not require the SEC to actually draft these rules.

"Because we believe the SEC’s order was conclusory and insufficiently reasoned, and thus arbitrary and capricious, we grant Coinbase’s petition in part and remand to the SEC for a more complete explanation," the court said. "But we decline at this stage to order the agency to institute rulemaking proceedings." 

Coinbase and the SEC have argued for years over the need for rulemaking. The San Francisco-based exchange first asked the SEC to "provide guidance for the crypto industry" in July 2022.

The securities watchdog, which allowed Coinbase to go public via a direct listing in 2021, sued the exchange about two years later for allegedly violating securities laws.

Before the SEC brought its lawsuit against Coinbase, the exchange attempted to force the agency to respond to its rulemaking petition and sued the SEC in April 2023. The SEC later denied the request for new rules, and SEC Chair Gary Gensler said that existing rules already apply to crypto. Gensler also said at the time that an important part of the SEC's responsibility is figuring out how to divvy resources. He emphasized that the crypto market is small compared to the rest of the capital markets, which the agency oversees. 

On that last point, the court said more explanation was needed. 

"But resource allocation is not a talisman that an agency may invoke to escape judicial review," the court said. "It is one explanation for agency inaction among many. It is an explanation entitled to a high level of deference, to be sure, but like any other explanation for agency action, it must be sufficiently reasoned." 

However, the appeals court said it was "unpersuaded" by Coinbase's assertion that "notice and comment rulemaking" — a process that allows the public to comment on proposed regulations before they're finalized — was the only path for the SEC to "explain the legal basis for its actions." 

Although the securities watchdog has not introduced crypto-specific regulations, it has proposed rules in the past year that apply to crypto. For instance, the SEC revisited a custody rule, mandating that registered investment advisors store crypto with a qualified custodian that must adhere to specific requirements. However, Coinbase has said the SEC's rules are "ill-fitting."

The appeals court pointed to that tension on Monday's opinion. 

"In 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," the court said. 

Attached to Monday's opinion, Judge Stephanos Bibas wrote a separate piece arguing "old regulations fit poorly with this new technology" and said the SEC's enforcement actions raise constitutional notice concerns. "The SEC repeatedly sues crypto companies for not complying with the law, yet it will not tell them how to comply," the judge, who was appointed to office during Donald Trump's first presidential term, wrote. "That caginess creates a serious constitutional problem; due process guarantees fair notice." 

Coinbase Chief Legal Officer Paul Grewal compared the opinion to sports, saying in a post on X — "you can't just throw the yellow flag and penalize. You have to lay out the why and what happens next." 

The SEC said in an emailed statement that it was reviewing the court's decision and "will determine next steps as appropriate."

In 2023, a three-judge panel of the District of Columbia Court of Appeals in Washington said the SEC's reasoning to deny Grayscale's spot Bitcoin ETF proposal was "arbitrary and capricious."