Coinbase Presses Fight for Regulatory Clarity at Appellate Court

Coinbase Inc. wants a federal appeals court to order the SEC to make specific rules for the $2 trillion cryptocurrency industry, arguing current regulations governing conventional securities just don’t fit.

The agency, maintaining its existing regs are just fine, denied Coinbase’s petition for a new slate of rules in December 2023.

The US Court of Appeals for the Third Circuit on Monday will hear from both sides on the merits of the cryptocurrency exchange’s contentions. But Coinbase’s quixotic effort may disappoint the company and its allies, legal observers say.

“I appreciate what Coinbase is trying to do, but it might not be the best avenue because we’re not going to get the rules that we want,” said Fred Rispoli of Hodl Law, a crypto-focused law firm that itself sued the Securities and Exchange Commission and lost. “You can only do that—get the rules you really want—from a solid congressional bill,” he said.

Republican presidential nominee Donald Trump has said the US should be a world leader in cryptocurrency, while Democrat Kamala Harris’ campaign said last month that she will back measures to help grow digital assets. She has not yet unveiled detailed plans. The likelihood of a near-term bill passage remains uncertain.

Coinbase argued in a brief that the SEC “is pursuing a punitive enforcement campaign against digital asset firms.” If the agency is going to assert authority over digital assets, “it must first articulate its position through rulemaking,” the company said.

The exchange also said it told the SEC in its petition that existing regulations are incompatible with digital assets. The requirement that securities can only be “held and used” by “a securities dealer, bank, or other qualified custodian” presents difficulties because digital assets are actively used on blockchain networks, Coinbase said.

Other “serious practical problems” include the question of who will register them, it said: “Existing registration and disclosure requirements were designed for traditional financial instruments managed by centralized companies, not for decentralized blockchain projects that are often run by decentralized groups of individuals.”

The SEC, for its part, said in a brief that its denial of the rulemaking request was reasonable. The commission “disagreed with Coinbase’s premise that the existing regulatory framework—statutes and rules carefully crafted to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation—is ‘unworkable’ for crypto asset securities,” it said.

What Is a Security...

Coinbase is just one of the blockchain companies that the SEC has targeted with enforcement actions. Coinbase failed to register as an exchange, a broker, and a clearing agency, the commission said in its suit, filed in June 2023.

The fundamental issue in that case—whether digital token offerings satisfy the test for investment contracts under the US Supreme Court’s 1946 opinion SEC v. W.J. Howey Co.—has also been fought in high-profile SEC suits against Ripple Labs Inc., Terraform Labs, and others, particularly in the US District Court for the Southern District of New York.

Judge Jed S. Rakoff ruled for that court in December 2023 that four Terraform cryptocurrencies constituted securities that were illegally offered and sold without registration. His decision conflicted with part of a ruling by Judge Analisa Torres in the same district that a Ripple token was not a security when sold to the public on secondary markets. Torres denied the SEC’s bid for an immediate appeal.

Meanwhile, crypto industry participants and advocates—including Hodl Law—have sued the SEC for clarity. Coinbase, by contrast, took the regulatory route, and it is before the Philadelphia-based Third Circuit on a request for review of agency action.

Coinbase’s pursuit of that route has some legal experts wondering about its envisioned endgame. “There is no chance that the SEC, if forced to promulgate a rule, will promulgate a rule that says anything other than crypto assets are securities,” and that crypto exchanges must comply with the Securities Exchange Act like any other exchange, said Erik Gordon of the University of Michigan’s Ross School of Business.

...And What Isn’t?

Coinbase wants a rulemaking procedure so it can participate and try to pressure the SEC to treat crypto exchanges differently, and it isn’t expecting an exemption, he said.

But that’s just a fallback, Gordon said. “What Coinbase really wants is somebody, somewhere to win a case saying that crypto is not a security.”

The company either needs Congress to act or needs “some split in the circuits as to whether crypto is a security so that the case will go to the Supreme Court,” which could modify Howey, he said.

Rispoli said the Third Circuit’s decision could go either way. “The SEC’s ultimate argument in this case is, ‘We got authority to do this in 1930 and we can do whatever we want, so stop trying to force us to make a decision,’” he said.

Coinbase, meanwhile, brings various legal arguments about the SEC’s regulatory authority, Rispoli said. “And there is case law authority that will let the judges go either way,” he said.

The case is “just one of many battles going on right now,” the Hodl principal said. “The likelihood is that Congress will step in after these elections, for good or bad, and address the issue.”

The case is Coinbase, Inc. v. SEC, 3d Cir., No. 23-3202, oral argument 9/23/24.