Third Circuit Chides SEC for Terse Refusal To Engage in Crypto Rulemaking

On Jan. 13, 2025, a unanimous panel of the U.S. Court of Appeals for the Third Circuit held that the Securities and Exchange Commission (SEC or the Commission) violated the Administrative Procedure Act (APA) when it offered only a one-paragraph explanation for its refusal “to promulgate rules clarifying how and when the federal securities laws apply to digital assets like cryptocurrencies and tokens.” Coinbase, Inc. v. SEC, No. 23-3202, 2025 WL 78330, at *1 (3d Cir. Jan. 13, 2025) (Ambro, J.). Although the panel stopped short of ordering the SEC to grant a rulemaking petition that had been made by Coinbase Global — and instead remanded to the agency for a more reasoned explanation of its refusal — a concurring opinion by Judge Stephanos Bibas stated that the SEC’s decision to regulate crypto only through enforcement actions and adjudications deprived crypto companies, like Coinbase, of constitutional fair notice. Id. at *20 – *29 (Bibas, J., concurring).

Although the SEC may seek rehearing en banc or file a petition for certiorari with the Supreme Court, the newly minted Republican majority at the SEC under Chairman-Designee Paul Atkins is expected to be far friendlier to the crypto industry than outgoing Chairman Gary Gensler was. That may lead the SEC to accept Coinbase’s petition and engage in the notice-and-comment rulemaking that many in the industry have been seeking in their quest to obtain regulatory certainty.

Factual Background

After taking a light touch to digital assets in crypto’s early years and mostly focusing on fraud cases that “incidentally involved Bitcoin,” the SEC took its first steps toward evaluating whether digital assets themselves are securities in 2017. Id. at *2. At that point, the SEC turned its attention to transactions like “Initial Coin Offerings” and “Token Sales,” to the extent that they involved the use of digital assets as “investment contracts,” which the SEC claimed made them subject to the federal securities laws under the Howey test. Id.^[1]  As Judge Bibas summarized in his concurrence, during this 2017 – 2022 period, the SEC mostly “focused on crypto assets that worked just like stock,” while bringing some enforcement actions against “a few utility tokens” under “[t]he premise . . . that utility tokens sold in initial coin offerings would appreciate.” Id. at *26 (Bibas, J., concurring).

In July 2022, Coinbase, a trading platform that facilitates the exchange of digital assets (including various cryptocurrencies like Bitcoin, Ethereum and Chainlink), petitioned the SEC “to propose new rules addressing how and when digital assets qualify as securities subject to existing securities laws.” Id. at *4. The petition followed multiple public pronouncements by the SEC in preceding years, in which the Commission expressed its belief that the federal securities laws apply to digital assets. Id. at *2 – *4.

In its petition, “Coinbase expressed its view that the existing securities-law framework is “fundamentally incompatible with the operation of digital asset securities” and urged the SEC to adopt new rules tailored specifically to digital assets.” Id. at *4. The SEC ultimately denied Coinbase’s petition in December 2023, confining its reasoning to a single paragraph that cited generalized responses about workability, resource allocation issues and preferences for incremental action:

The Commission disagrees with the Petition’s assertion that application of existing securities statutes and regulations to crypto asset securities, issuers of those securities, and intermediaries in the trading, settlement, and custody of those securities is unworkable. Moreover, the Commission has discretion to determine the timing and priorities of its regulatory agenda, including with respect to discretionary rulemaking such as that requested in the Petition. See Massachusetts v. EPA, 549 U.S. 497, 527 (2007). Any consideration of whether and, if so, how to alter the existing regulatory regime may be informed by, among other things, data and information provided by numerous undertakings directly or indirectly relating to crypto asset securities that the Commission is currently pursuing. Accordingly, the Commission concludes that it is appropriate to deny the Petition. The Commission is also engaged in many undertakings that relate to regulatory priorities extending well beyond crypto asset securities. The requested regulatory action would significantly constrain the Commission’s choices regarding competing priorities, and the Commission declines to undertake it at this time.

Id. at *5.

While the petition was pending at the SEC, the SEC “expanded its enforcement agenda” to companies in the crypto space, including digital-asset exchanges like Coinbase. Id. at *4. That included filing an ongoing enforcement action against Coinbase for operating as an unregistered broker, exchange and clearing agency in June 2023. Id. (citing the complaint at 96 – 100, SEC v. Coinbase, Inc., No. 23-cv-4738 (S.D.N.Y. June 6, 2023), ECF No. 1). As Judge Bibas noted in his concurrence, the SEC’s regulatory crackdown came in the aftermath of the mid-2022 “crypto crash” and the collapse of the FTX exchange. Id. at *26.

The Panel Opinion

Writing for the panel, Judge Thomas Ambro stated that the SEC violated Section 706 of the APA because the Commission’s order denying the petition for rulemaking was arbitrary and capricious. Id. at *5; (see also 5 U.S.C. § 706(2)(A). This, the panel noted, was despite the fact that “denials of petitions to institute rulemaking proceedings . . . are scrutinized at the most deferential end of the arbitrary and capricious spectrum” under Third Circuit precedent. Id. (quoting Int’l Union v. Chao, 361 F.3d 249, 255 (3d Cir. 2004)).

In reaching its conclusion, however, the panel rejected several of Coinbase’s more far-reaching legal arguments — including that the SEC should be required to grant Coinbase’s petition and initiate rulemaking. First, the panel rejected Coinbase’s argument that there is a “presumption” in favor of rulemaking as a “foundational principle[] of administrative law.” Id. at *7. The panel further held that by failing to engage in rulemaking, the SEC did not fail to engage in the necessary “reasoned analysis” under the Supreme Court’s landmark State Farm precedent.^[2] Id. at *8.

In short, the panel rejected one of Coinbase’s central arguments as unsound because it appeared to “repeatedly confuse[] grounds for setting aside an agency’s rule with grounds for mandating rulemaking.” Id. at *10. The panel held that Coinbase argued for too stringent a standard for when Article III courts can require the executive branch to engage in rulemaking rather than proceed with adjudication. As the panel put it:

We are not persuaded that the SEC categorically lacks discretion to regulate digital assets through adjudication or individualized enforcement actions. And whether it has abused its discretion by proposing new and retroactive rules of widespread application in any particular enforcement action is not properly before us.

Id. at *12. The panel also rejected Coinbase’s argument that the incompatibility between existing federal securities laws and digital assets amounted to a changed factual predicate requiring the agency to reconsider its decision denying Coinbase’s rulemaking petition. Id. at *15. These “workability concerns,” which the panel stressed were “not frivolous,” id., include the following:

• “Digital assets, unlike securities, can be used for paying transaction, or ‘gas fees,’ as a medium of exchange for native applications and for helping secure a network.” at *13 (quotation marks and citations removed). As Coinbase argued, “[r]egistering digital assets would make these uses ‘impossible’ because all transactions would have to occur within a broker-dealer and registered-exchange framework.” Id. (quotation marks and citations removed).
  
  
• “Existing securities regulations require disclosures about the operation of the issuer, its financial statements, its leadership, what risks it may face, and information about various other parts of the business.” (quotation marks and citations removed). But Coinbase stressed that “many digital assets are created or managed by a diffuse group of individuals, who are not a central team and may not even know each other’s true identities.” Id. (quotation marks and citations removed).
  
  
• Coinbase argued that “[t]he information required by existing disclosure regulations is largely unhelpful to digital asset users who are far more likely to care about the details of the asset’s underlying protocol.” Id. (quotation marks and citations removed).
  
  
• Coinbase argued that “[r]equiring digital asset platforms to register as exchanges would limit them to offering only registered securities, even though the vast majority of digital assets are commodities, not securities.” Id. (quotation marks and citations removed).

Having rejected these more far-reaching legal arguments by Coinbase, the panel moved on to consideration of Coinbase’s more fact-bound arguments — specifically, that the SEC’s rejection of Coinbase’s rulemaking petition was insufficiently reasoned. Here, Coinbase scored a resounding victory. The panel held that the SEC’s response to Coinbase failed to adequately consider its workability concerns, did not adequately explain what other regulatory efforts the SEC is prioritizing instead of Coinbase’s petition and why, and did not sufficiently explain to Coinbase why the Commission was choosing to regulate digital assets through incremental action rather than through comprehensive rulemaking. Id. at *15 – *19.

As Judge Ambro noted, any of these three reasons could be independently sufficient bases for denying a rulemaking petition. But a federal agency’s denial of a rulemaking petition on any of these grounds requires a more substantial explanation than the SEC offered in this case. Id. at *19. The panel thus concluded that the appropriate remedy was to remand for the SEC to provide a “sufficiently reasoned disposition of Coinbase’s petition,” rather than grant the “extraordinary remedy” Coinbase had sought and require the SEC to initiate rulemaking and grant Coinbase’s petition in full. Id. at *19, *20.

Judge Bibas’ Concurrence

Judge Bibas, who joined the panel majority in full, also wrote his own lengthy concurrence to Judge Ambro’s opinion. Id. at *20 – *29. He did so to “consider a constitutional issue that is not yet teed up but that lurks beneath this statutory one.” Id. at *20. As Judge Bibas put it:

Crypto companies like Coinbase are confused about how to comply with the law and have repeatedly asked the SEC to clarify. Instead of doing so, the SEC sues the companies individually. It wants to proceed with ex post enforcement without announcing ex ante rules or guidance. As I explain, its old regulations fit poorly with this new technology, and its enforcement strategy raises constitutional notice concerns.

Id. As Judge Bibas went on to write, the SEC’s changing positions on how to “pour[] new crypto wine into old regulatory bottles” shifted substantially between 2017 and 2023, and remains unclear to this day. Id. at *23, *25. The SEC’s “caginess” when it comes to crypto regulation, Judge Bibas wrote, creates serious constitutional due process problems because “[t]he SEC repeatedly sues crypto companies for not complying with the law, yet it will not tell them how to comply.” Id. at *27. The SEC’s decision to “combin[e] regulatory uncertainty with unpredictable enforcement against the infrastructure for trading crypto” has allowed it to “get near-total deterrence” from the industry, Judge Bibas wrote, thus running afoul of constitutional requirements. Id. at *28.

Judge Bibas’ concurrence may have significant long-term implications for federal agencies’ ability to rely on the Supreme Court’s opinion in Chenery II, in which the Court held that federal agencies have discretion to choose between rulemaking and adjudication to effect a policy change, even though the “function of filling in the interstices of [statutes] should be performed, as much as possible, through th[e] quasi-legislative promulgation of rules to be applied in the future.” SEC v. Chenery Corp. (Chenery II), 332 U.S. 194, 202 – 03 (1947). Summarizing his view, Judge Bibas stated that “while the APA lets agencies choose enforcement, the Constitution’s due-process requirements still protect defendants. Laws that punish and deter must meet due process’s heightened notice requirements.” Id. at *28. This view would limit agencies’ ability to rely on Chenery II and policymaking through adjudication in areas where the regulatory landscape is uncertain by raising the specter of constitutional due process concerns. Thus, agencies would have less discretion about when they use adjudication to effect regulatory change, with “ex-post enforcement” limited to more “‘specialized problems’ whose solutions cannot ‘be cast immediately into the mold of a general rule.’” Id. at *27.

Moreover, Judge Bibas highlighted his view that the SEC’s regulatory penalties, “which are usually called civil . . . are functionally criminal” because “[t]hey go beyond compensating victims to deter and punish.” Id. at *28. “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.” Id.

Hence, “the SEC’s haphazard enforcement strategy of targeting entities that are trying to follow the law does not give potential defendants the notice that due process requires. That is especially true because the field is novel. The agency has offered no meaningful guidance on which crypto assets it views as securities.” Id. Quoting financial journalist Matt Levine, Judge Bibas wrote that “SEC Chairman Gary Gensler is practically saying: ‘I should be the main regulator of crypto, and as the main regulator my plan is mostly to ban it.’” Id.^[3]  But, as Judge Bibas wrote, an SEC attempt to ban crypto assets under existing securities laws may face legal challenges, including under the Major Questions Doctrine. Id.; see West Virginia v. EPA, 597 U.S. 697, 744 (2022) (Gorsuch, J., concurring) (“[A]n agency must point to clear congressional authorization when it seeks to regulate a significant portion of the American economy . . . . ” (internal quotation marks omitted)).

Finally, offering some guidance to future cases, Judge Bibas stated his view that “[w]hen courts confront such enforcement-by-surprise in future cases, they must bar penalties that were not reasonably foreseeable.” Id. at *29 (citing Franklin v. Navient, Inc., 534 F. Supp. 3d 341, 347 – 48 (D. Del. 2021), in which the court “allow[ed] compensatory damages but barr[ed] civil penalties for actions that violated an unforeseeable change in the law”). As Judge Bibas concluded, “[t]he SEC may not play gotcha, and Article III courts must ensure that the SEC plays fair.” Id.

Key Takeaways

Coinbase’s petition is now headed back to a much friendlier SEC for further consideration of its rulemaking request. While it is uncertain what path the Republican SEC majority will take on remand, the Third Circuit’s opinion has set a precedent that makes it much harder for agencies to wave off industry requests for rulemaking by citing generalized responses about workability, resource allocation issues and preferences for incremental action. The opinion reaffirmed that federal courts will take such short, conclusory statements from agencies with substantial skepticism, even under an extremely deferential standard of review. Judge Bibas’ concurrence may also be seen as a shot across the bow by a prominent and well-respected Trump appointee against federal agencies that cultivate regulatory uncertainty while bringing enforcement actions against regulated parties.

Kramer Levin will continue to monitor Coinbase’s rulemaking petition on remand at the SEC as well as other regulatory actions taken by the SEC during the ongoing presidential transition period. We urge our clients to reach out to members of our Litigation, Restructuring, and Fintech and Blockchain teams as we continue to assess these and related developments.

^[1]_{The Howey test refers to the seminal Supreme Court decision in SEC v. W.J. Howey Co., 328 U.S. 293, 301 (1946), in which the Supreme Court defined an investment contract that is subject to the securities laws as “an investment of money in a common enterprise with profits to come solely from the efforts of others.”} 

^[2]_{See Motor Vehicle Mfrs. Ass’n of U.S., Inc. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 57 (1983).} 

^[3]_{See Matt Levine, Gary Gensler Wants to Regulate Crypto, Bloomberg (Sept. 8, 2022), https://perma.cc/C8KX-DX6S.}