SEC’s Denial of Coinbase’s Petition

The U.S. Securities and Exchange Commission (SEC) must justify its denial of Coinbase’s request for crypto-specific rules, according to a recent opinion by the U.S. Court of Appeals for the Third Circuit. The court deemed the SEC’s dismissal of the request “arbitrary and capricious.”

While the court remanded the case for further explanation, it did not mandate the SEC to draft new rules. The court criticized the SEC’s reasoning for their decision, stating it was insufficient and lacked depth.

Coinbase and the SEC have been in a long-standing dispute regarding the necessity for crypto regulations, with Coinbase first seeking guidance in July 2022. Despite allowing Coinbase to go public in 2021, the SEC sued the exchange in 2023 for alleged violations of securities laws.

Before facing the lawsuit, Coinbase attempted to compel the SEC to respond to its petition for new rules and filed a lawsuit in April 2023. In response to the SEC’s denial, SEC Chair Gary Gensler asserted that existing regulations apply to crypto and emphasized the agency’s resource allocation decisions.

The appeals court demanded more clarity on this matter, asserting that resource considerations could not be a blanket excuse for agency inaction. However, the court rejected Coinbase’s claim that public comment rulemaking was essential for the SEC to justify its legal decisions.

Although the SEC hasn’t established specific crypto regulations, it has proposed regulations applicable to crypto assets, such as a custody rule requiring investment advisors to store crypto with qualified custodians. Coinbase criticized these rules as mismatched to the industry.

The court acknowledged that novel financial instruments may not fit existing regulations, noting that old regulations may not adequately address the challenges posed by new technologies. Judge Stephanos Bibas emphasized that the SEC’s enforcement might compromise constitutional due process by failing to provide sufficient notice to companies.

Coinbase’s Chief Legal Officer Paul Grewal likened the court’s opinion to sports officiating, emphasizing the need for clarity in penalties and procedures.

The SEC stated that it is reviewing the court’s decision and will determine appropriate next steps. In 2023, a D.C. appellate court also criticized the SEC’s rationale for denying Grayscale’s Bitcoin ETF proposal as “arbitrary and capricious.”