Federal Courts Rule for Coinbase in SEC Actions

01/28/2025

(Westlaw) The US Court of Appeals for the Third Circuit and the US District Court for the Southern District of New York (SDNY) issued noteworthy opinions in two separate actions between the SEC and major crypto platform Coinbase:

Coinbase, Inc. v. Securities and Exchange Commission (Third Circuit Opinion)

On January 13, 2025, the Third Circuit issued an opinion in Coinbase, Inc. v. Securities and Exchange Commission holding that the SEC must explain its rationale for refusing to articulate a clear and consistent position about when a digital asset is a security and consequently subject to federal securities laws.

Background

In July 2022, Coinbase petitioned the SEC to propose new rules addressing how and when digital assets qualify as securities subject to existing securities laws. Nine months after Coinbase issued its petition, Coinbase petitioned the Third Circuit for a writ of mandamus ordering the SEC to act on Coinbase’s request (see Legal Update, Updated: Coinbase Files Mandamus Action to Compel SEC to Write Crypto Regulations). The SEC ultimately denied Coinbase’s request, and Coinbase petitioned the Third Circuit to:

  • Review the SEC’s decision.
  • Order the SEC to institute a notice-and-comment rulemaking proceeding to explain its denial of Coinbase’s petition.

In support of its petition to the Third Circuit, Coinbase argued that the SEC’s order denying Coinbase’s petition for rulemaking was arbitrary and capricious because:

  • The SEC’s decision to apply the securities laws to digital assets in enforcement actions constitutes a significant policy change that presumptively requires rulemaking.
  • The emergence of digital assets removes a fundamental factual predicate underlying the entire existing regulatory framework – that compliance by all potential market participants is possible.
  • The SEC’s explanation for its decision was conclusory and insufficiently reasoned.

Outcome

The Third Circuit disagreed with the Coinbase’s first two arguments, finding that:

  • The SEC was not presumptively required to engage in notice-and-comment rulemaking, and the Third Circuit was not persuaded that the SEC categorically lacks discretion to regulate digital assets through adjudication or individualized enforcement actions.
  • Coinbase’s workability concerns are not fundamental changes in the factual predicates underlying the existing securities-law framework.

However, the Third Circuit agreed with Coinbase’s argument that the SEC’s order denying Coinbase’s petition was insufficiently reasoned because:

  • A single sentence disagreeing with the main concerns of a rulemaking petition is conclusory and does not provide the Third Circuit with any assurance that the SEC considered Coinbase’s workability objections, nor does it explain how it accounted for them.
  • The SEC’s order did not adequately explain which other regulatory efforts it is prioritizing or why; it only cited all of its ongoing rulemakings, which is insufficient.
  • Although the SEC is correct as a general matter that it may justifiably decide to proceed by incremental rulemaking or adjudication before undertaking more comprehensive action, the SEC still must explain a decision in a way that allows the Third Circuit to understand and defer to the SEC’s reasoning.

In the order, the Third Circuit states that if an agency denies a petition for rulemaking, the agency must adequately explain the facts and policy concerns it relied on and such factual explanation must have some basis in the record.

The Third Circuit concluded that the appropriate remedy was to remand to the SEC for a sufficiently reasoned disposition of Coinbase’s petition. According to the Third Circuit, it would be improper to order the SEC to institute notice-and-comment rulemaking because the interests at stake in this matter are primarily economic and do not present the unusual or compelling circumstances required to justify such an order.

Securities and Exchange Commission v. Coinbase, Inc. (SDNY Opinion and Order)

On January 7, 2025, the SDNY issued an opinion in Securities and Exchange Commission v. Coinbase, Inc. granting Coinbase’s motion for interlocutory appeal.

Background

On June 6, 2023, the SEC filed a complaint against Coinbase alleging that:

  • Coinbase’s business of intermediating transactions in cryptocurrency amounts to the operation of an unregistered brokerage, exchange, and clearing agency in violation of federal securities laws.
  • Coinbase acts like a traditional securities intermediary by, among other things, soliciting customers, recruiting new investors, displaying promotional and market information useful for trading crypto-assets, holding customer funds and crypto-assets, and providing services that enable customers to place various types of orders and settle their trades while charging fees for trades executed through its platform.

(see Legal Update, SEC Charges Crypto Exchange Coinbase with Registration Failures).

Coinbase filed a motion for a judgment on the pleadings, pursuant to which the SDNY concluded that certain transactions involving crypto assets qualified as investment contracts within the SEC’s regulatory purview. Coinbase then filed a motion to certify an order for interlocutory appeal under 28 U.S.C. § 1292(b), which allows a district court to certify an order for interlocutory appeal where it finds that:

  • Such order involves a controlling question of law as to which there is substantial ground for difference of opinion.
  • An immediate appeal from the order may materially advance the ultimate termination of the litigation.

Even if the above criteria are met, district courts have unfettered discretion to deny certification of an order for interlocutory appeal of other factors counsel against it, such as docket congestion and the system-wide costs and benefits of allowing the interlocutory appeal.

Outcome

The SDNY certified Coinbase’s order for interlocutory appeal because it agreed that a controlling question of law had arisen in the case regarding the reach and application of the test established by the Supreme Court in SEC v. W.J. Howey Co., 328 U.S. 293 (1946) (see Practice Note, Determining Whether Digital Assets Are Securities). Specifically, the SDNY found the issue ripe for interlocutory appeal because:

  • It is a pure question of law as it can be decided by an appellate court quickly and cleanly without having to study the record.
  • Reversal on this question would significantly affect the course of litigation and would materially advance the ultimate termination of the litigation.
  • It has precedential value for many other cases.
  • There is a substantial ground for difference of opinion because:
    • conflicting authority exists regarding the application of the Howey test to crypto assets; and
    • the application of the Howey test to crypto assets raises a difficult issue of first impression for the US Court of Appeals for the Second Circuit.

The SDNY clarified that it does not appreciate and will not co-sign Coinbase’s efforts to “cast aspersions on” the SEC’s approach to crypto assets, but the conflicting decisions on an important issue such as this one necessitate the guidance of the Second Circuit.

plugins premium WordPress