Coinbase lawsuit leads to SEC grilling in appellate court

Catch up fast: In 2022, Coinbase, the country's leading digital asset exchange, petitioned the SEC for fresh rules to enable companies in its industry to conduct business in a compliant fashion.

• The SEC denied the request in 2023, prompting Coinbase to sue.

The latest: Coinbase's counsel, Eugene Scalia, of Gibson Dunn, argued that it is not possible to register a cryptocurrency business with the agency, and yet the agency still takes enforcement actions against companies for failing to register.

• In other words, he argued, the agency is acting as if there are rules, but there are not.
• "They are demanding registration but have no answer to the explanation that it's not possible," Scalia said.
• Judges in the case asked Scalia what is the minimum the agency could do. Scalia said he's asking that the court order it to begin rulemaking for cryptocurrency businesses.
• "That's an extraordinary remedy," one of the judges replied.

Between the lines: The key point, for Coinbase, based on Scalia's arguments today, seemed to be the question of which assets are securities and which are not, because the SEC, he argued, forbids exchanges from listing both.

• However, the SEC's counsel was unclear on this point when the court raised it.

Friction point: When the SEC attorney Ezekiel Hill took the stand following Coinbase, the tone sounded much tougher.

• As Hill began, judges drove straight to the question of the possibility of registration and whether new rules are needed to make it possible.
• The court acknowledged that an agency doesn't have to provide much justification to deny rulemaking, but prior case law has said it needs some. One judge said of the SEC's denial, "There's an argument here that this is pretty darn close to vacuous."
• The court seemed to particularly object to the SEC's refusal to get specific about any crypto asset, even bitcoin and ether, the coins that run the two most valuable blockchains.

• Hill said it isn't necessarily the digital asset itself that's subject to the SEC's review, but transactions involving those assets.

Reality check: Hill argued that it's not unusual for companies to be forbidden from arranging their business in a non-compliant way. It's not, he argued, the business of the SEC — or any agency — to conform to applicants' wishes.

Zoom out: A few digital assets have been successfully registered, but mostly at the end of enforcement actions that eliminated their issuers as going concerns.

💭 Our thought bubble: It sounded like the court was very tough on the SEC, but it could be that judges are critical of the side they lean toward supporting, in order to help it to submit the best possible follow-up filings.

• On the other hand, the agency has had quite a few losses on related issues over the last couple of years.

The bottom line: In his rebuttal, Scalia noted that he was surprised to hear the SEC refuse to speak on bitcoin or ether before the court.

• "I leave this court understanding the SEC's views on this topic even less than when I entered," he said. "We ask that the court direct them to conduct rulemaking."