‘Arbitrary and capricious’ strikes again

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A federal appeals court took on elements of the SEC v. Coinbase legal battle yesterday, but we’ll need a bit more time to determine the decision’s exact impact.

The SEC sued Coinbase in June 2023 for alleged securities violations. It later denied the crypto exchange’s petition for rulemaking that December. The petition essentially argued that the SEC’s strategy of using existing securities laws to enforce crypto regulation is “unworkable.”

The agency’s response was a single paragraph, the court pointed out. Basically the SEC said it disagreed, noting it “has discretion to determine the timing and priorities of its regulatory agenda.” 

Put simply: Agencies can choose between rulemaking and adjudication, Judge Stephanos Bibas wrote in a court order filed Monday.

“But they must explain their choice, and the SEC failed to do so,” he added.

The court isn’t ordering the SEC to institute rulemaking proceedings, giving the SEC what some might consider a partial win. The filing adds that the SEC has “reasonably explained that the existing securities law framework is not predicated on the assumption that it will never burden any potential new market participants.”

But the court does believe the SEC’s order was “conclusory and insufficiently reasoned, and thus arbitrary and capricious.” 

The solution? Bibas has asked the SEC to explain itself, adding: “It should not give yet another poor explanation in an already-long line of them.”

“We’re reviewing the decision and will determine next steps as appropriate,” an SEC spokesperson told me.

Did you catch that “arbitrary and capricious” phrase in paragraph seven? It’s seldom used in everyday life, but you may recognize it from another case dealing with the Administrative Procedure Act (APA).

Grayscale Investments won that case after the court ruled that the SEC’s rejection of the Grayscale proposal to convert its Bitcoin Trust to an ETF (but approving bitcoin futures funds) was, you guessed it, “arbitrary and capricious.” The agency did not properly “explain its different treatment of similar products,” judges argued at the time.

A former communications VP at Coinbase worked the legalese into her blunt reaction to the latest court filing:

The Third Circuit’s thoughts come after Coinbase last week won its motion for an interlocutory appeal on whether crypto assets constitute investment contracts.

Despite the court on Monday not forcing SEC rulemaking at this time, Coinbase execs count the latest opinion as another victory. 

Uniswap Labs chief legal officer Katharine Minarik (and ex-deputy general counsel at Coinbase) called it a “hugely deserved result” that forces the SEC “to truly consider it and respond with some substance. As it should.”

Coinbase chief policy officer Faryar Shirzad wrote on X: “It’s not everyday that the courts issue a damning rebuke of a federal agency like [the SEC].” Chief legal officer Paul Grewal applauded Judge Bibas’ forceful concurrence, calling it “an impressive piece of work.”

Bibas noted the “caginess” of SEC enforcement against crypto firms without telling them how to comply with the law. He argued such action “creates a serious constitutional problem.” 

Sporadically enforcing “ill-fitting rules” against industry entities trying to follow regulations goes beyond fighting fraud, he added.

“It targets a whole industry and risks de facto banning it,” Bibas wrote. “On remand, the SEC must grapple with that problem.”

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