SEC Releases Staff Accounting Bulletin on Accounting, Reporting, and Disclosure Obligations for Crypto-Assets | Nelson Mullins Riley & Scarborough LLP
The Securities and Exchange Commission (“SEC”) has issued Staff Accounting Bulletin No. 121 (“SAB 121”)1 on March 31, 2022. SAB 121 provides the staff of the SEC’s perspective regarding the accounting treatment of custodial obligations by a reporting firm of cryptoassets for users of its platform.2 Staff note that they have observed an increase in the number of companies offering platform users the ability to transact in crypto-assets and that performing these services presents unique risks that are not not widely present with custody of non-cryptographic assets. Specifically, Staff provide examples of technology risks, legal risks, and regulatory risks, all of which Staff believe can have a significant impact on the reporting company’s operations and financial condition. In order to ensure that investors have all the appropriate information to make informed decisions, the staff asks for certain steps that certain companies (see below) should take to recognize, measure and disclose these risks. To achieve this goal, SAB 121 uses three fact-based scenarios, each with a related question and interpretive answer.
To whom SAB 121 applies
SAB 121 applies to companies that:
- File reports pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934 (“Exchange Act”) (c. Regulation A Issuers)
- Have submitted or filed a registration statement under the Securities Act of 1933 (“Securities Act”) or the Exchange Act not yet in force;
- Have submitted or filed an offering statement or post-qualification amendment thereof under Regulation A; and
- Are private operating companies whose financial statements are included in filings with the SEC in connection with a business combination involving a shell company, including a special purpose acquisition company (“SPAC”) ).
What does the SAB 121 require?
SAB 121 states that companies covered by the guidance should:
- Present a liability on its balance sheet to reflect its obligation to safeguard the crypto-assets held for the users of its platform. Staff note that it is appropriate for an enterprise to recognize an asset at the same time as it recognizes the backup liability, measured at initial recognition and at each reporting date at the fair value of the crypto-assets held for its platform users.
- For financial statements, include clear disclosure of the nature and amount of crypto-assets a company is responsible for holding for its platform users, with separate disclosure for each material crypto-asset, and the vulnerabilities of a business as a result of any concentration in those Activities. Because crypto-asset protection liabilities and corresponding assets are measured at the fair value of the crypto-assets held for users of its platform, the company would be required to include information about fair value measurements. Other information companies may consider providing includes:
- Disclosures about who (for example, the company, its agent, or another third party) holds the cryptographic key information, maintains internal record keeping of those assets, and is responsible for securing the assets and protecting them from loss or flight.
- Disclosures describing the types of additional losses or liabilities that may arise, including interruption or reduction of Customer or User’s use of the Services, litigation, reputational damage, regulatory enforcement and additional restrictions.
- A discussion of the legal ownership analysis of crypto-assets held for platform users, including whether they would be available to satisfy general creditor claims in the event of bankruptcy, should be considered.
- Disclosure of the potential impact that the destruction, loss, theft, compromise or unavailability of cryptographic key information would have on the ongoing business, financial condition, results of operations and cash flows of the ‘business. As part of this disclosure, a company should also consider including information about the risk mitigation measures it has in place (e.g. insurance coverage directly related to crypto-assets held for platform users).
- In financial statements that reflect the initial application of SAB 121 guidance, the effect of the initial application should be reported in the carrying amounts of assets and liabilities at the beginning of the annual period ending before June 15, 2022 and must include clear information of the effects of the first application of SAB 121.
When do the requirements of SAB 121 come into effect?
Staff expects Bill ’34 reporting companies and Regulation A issuers to apply the SAB 121 guidance no later than in their financial statements covering the first interim or annual period ending after June 15, 2022, with retrospective application from the beginning of the financial year to which the interim or annual period relates. Staff expects all other companies to implement SAB 121 accounting, reporting, and disclosure guidelines beginning with their next SEC filing (e.g., registration statement, proxy statement, or Regulation A) offering statement, with retroactive application, at a minimum, as of the beginning of the most recent annual period ending before June 15, 2022, provided that the filing also includes a subsequent interim period that reflects the guidelines of the SAB 121 as described in the previous sentence. If the filing does not include a subsequent interim period that also reflects the application of the SAB 121 guidelines, staff expects them to be applied retrospectively to the beginning of the two most recent annual periods ending before June 15, 2022 .
Commissioner Hester M. Peirce, known as “Crypto Mom” to members of the crypto community, issued a statement against SAB 121, which she called “yet another manifestation of the [SEC’s] scattered and inefficient approach to cryptography.3 Commissioner Peirce notes that she does not disagree with the substance of SAB 121, but with its timing and method. Commissioner Peirce further criticizes staff’s use of an accounting bulletin to issue these guidelines instead of following a business rule-making process that allows for public consultation.
SAB 121 represents the latest guidance from the SEC staff on its evolving view on the regulation and accounting of digital assets. Although SAB 121 initially appears to only affect a limited number of businesses (i.e. those that operate and protect digital assets), it also reflects the current position of staff on “risks and uncertainties technological, legal and regulatory” specific to crypto-assets. . Companies should review the full text of SAB 121 and consult with their advisors when preparing their next financial statements.
1 To see SEC Staff Accounting Bulletin No. 121 (March 31, 2022), Available here. In SAB 121, the staff reminded readers that “[t]he statements in the staff accounting bulletins are not rules or interpretations of the Commission, nor are they published as bearing the formal endorsement of the Commission. They represent the interpretations and staff practices followed by staff of the Corporate Finance Division and the Office of the Chief Accountant in administering the disclosure requirements of federal securities laws.
2 For consistency with SAB 121, in this Client Alert we choose to use the term “crypto-assets”. The Nelson Mullins lawyers behind this client alert prefer to use the term “digital assets” when discussing and analyzing cryptocurrencies, NFTs, or other similar use cases of technology based on the blockchain. We use the term “digital asset” similarly to the SEC to refer to “an asset that is issued and transferred using distributed ledger or blockchain technology.” Statement on Digital Asset Securities Issuance and Trading, Division of Corporation Finance, Division of Investment Management, and Division of Trading and Markets, SEC (November 16, 2018), available here As noted by the SEC, digital assets include, but are not limited to virtual currencies, coins and tokens. Identifier. A digital asset may, in certain circumstances, be considered a security under federal securities laws. Although not defined in securities laws, the SEC often refers to digital assets that are securities as “digital asset securities”. Identifier.
3 To see Commissioner Hester M. Peirce, Response to Staff Accounting Bulletin No. 121 (March 31, 2022), Available here.