SEC Releases Staff Accounting Bulletin on Accounting, Reporting, and Disclosure Obligations for Crypto-Assets | Nelson Mullins Riley & Scarborough LLP

The Securities and Alternate Fee (“SEC”) launched Workers Accounting Bulletin No. 121 (“SAB 121”)¹ on March 31, 2022. SAB 121 supplies SEC employees’s views relating to accounting therapy of obligations incident to a reporting firm’s custody of crypto-assets for its platform customers.² The employees notes that they’ve noticed a rise within the variety of corporations offering platform customers with the power to transact in crypto-assets and that performing these providers current distinctive dangers not in any other case broadly current with custody of non-crypto-assets. Particularly, the employees supplies examples of technological dangers, authorized dangers, and regulatory dangers—all of which the employees point out can have a major influence on the reporting firm’s operations and monetary situation. In an effort to make sure traders have all applicable data at their disposal to make knowledgeable choices, the employees requires sure measures that sure corporations (mentioned beneath) ought to take to acknowledge, measure, and disclose these dangers. To attain this finish, SAB 121 makes use of three fact-based eventualities, every with a associated query and an interpretive response.

To Whom SAB 121 Applies

SAB 121 applies to corporations that:

1. File reviews pursuant to Sections 13(a) or 15(d) of the Securities Alternate Act of 1934 (“Alternate Act”) (i.e., ’34 Act reporting corporations) or pursuant to Rule 257(b) of Regulation A (i.e., Regulation A issuers)
2. Have submitted or filed a registration assertion below both the Securities Act of 1933 (“Securities Act”) or the Alternate Act that’s not but efficient;
3. Have submitted or filed an providing assertion or post-qualification modification thereto below Regulation A; and
4. Are personal working corporations whose monetary statements are included in filings with the SEC in reference to a enterprise mixture involving a shell firm, together with a particular objective acquisition firm (“SPAC”).

What Does SAB 121 Require?

SAB 121 signifies that corporations coated by the steerage ought to:

1. Current a legal responsibility on its stability sheet to mirror its obligation to safeguard the crypto-assets held for its platform customers. Workers notes it’s applicable for an organization to acknowledge an asset on the similar time that it acknowledges the safeguarding legal responsibility, measured at preliminary recognition and every reporting date on the truthful worth of the crypto-assets held for its platform customers.
2. For monetary statements, embody clear disclosure of the character and quantity of crypto-assets that an organization is liable for holding for its platform customers, with separate disclosure for every vital crypto-asset, and the vulnerabilities an organization has as a result of any focus in such actions. As a result of the crypto-asset safeguarding liabilities and the corresponding belongings are measured on the truthful worth of the crypto-assets held for its platform customers, the corporate could be required to incorporate disclosures relating to truthful worth measurements. Additional disclosures for corporations to contemplate offering embody:
   1. Disclosures about who (e.g., the corporate, its agent, or one other third social gathering) holds the cryptographic key data, maintains the interior recordkeeping of these belongings, and is obligated to safe the belongings and defend them from loss or theft.
   2. Disclosures describing the sorts of loss or further obligations that might happen, together with buyer or consumer discontinuation or discount of use of providers, litigation, reputational hurt, and regulatory enforcement actions and extra restrictions.
   3. A dialogue of the evaluation of the authorized possession of the crypto-assets held for platform customers, together with whether or not they could be obtainable to fulfill normal creditor claims within the occasion of a chapter must be thought of.
   4. Disclosure of the potential influence that the destruction, loss, theft, or compromise or unavailability of the cryptographic key data must the continuing enterprise, monetary situation, working outcomes, and money flows of the corporate. As a part of this disclosure, an organization also needs to think about together with details about risk-mitigation steps the corporate has put in place (e.g., insurance coverage protection immediately associated to the crypto-assets held for platform customers).
3. Within the monetary statements that mirror the preliminary software of SAB 121’s steerage, the impact of the preliminary software must be reported within the carrying quantities of belongings and liabilities as of the start of the annual interval ending earlier than June 15, 2022 and may embody clear disclosure of the results of the preliminary software of SAB 121.

When Do SAB 121’s Necessities Turn out to be Efficient?

The employees expects ‘34 Act reporting corporations and Regulation A issuers to use SAB 121’s steerage no later than its monetary statements overlaying the primary interim or annual interval ending after June 15, 2022, with retrospective software as of the start of the fiscal 12 months to which the interim or annual interval relates. The employees expects all different corporations to implement SAB 121’s accounting, reporting, and disclosure tips starting with their subsequent submission with the SEC (e.g., registration assertion, proxy assertion, or Regulation A providing assertion), with retroactive software, at a minimal, as of the start of the latest annual interval ending earlier than June 15, 2022, supplied that the submitting additionally features a subsequent interim interval that displays SAB 121’s steerage as described within the previous sentence. If the submitting doesn’t embody a subsequent interim interval that additionally displays software of SAB 121’s steerage, then the employees expects it to be utilized retrospectively to the start of the 2 most up-to-date annual intervals ending earlier than June 15, 2022.

Commissioner Hester M. Peirce, generally known as “Crypto Mother” by members of the crypto group, issued an announcement in opposition of SAB 121, which she known as “yet one more manifestation of the [SEC’s] scattershot and ineffective method to crypto.”³ Commissioner Peirce notes that she doesn’t disagree with the substance of SAB 121, however with its timing and technique. Commissioner Peirce additional criticizes the employees’s use of an accounting bulletin to difficulty this steerage as an alternative of following an administrative rulemaking course of that permits for session with the general public.

Our Take

SAB 121 represents the SEC employees’s newest steerage on its evolving view on the regulation of and accounting for digital belongings. Though SAB 121 seems to initially have an effect on solely a restricted variety of corporations (i.e., people who function and safeguard digital belongings), it additionally displays the employees’s present place on the “technological, authorized, and regulatory dangers and uncertainties” distinctive to crypto-assets. Corporations ought to overview the total textual content of SAB 121 and seek the advice of with their advisors as they put together their upcoming monetary statements.

^{1 See SEC Workers Accounting Bulletin No. 121 (March 31, 2022), obtainable here. In SAB 121, the Workers reminded readers that “[t]he statements in employees accounting bulletins are usually not guidelines or interpretations of the Fee, nor are they revealed as bearing the Fee’s official approval. They signify employees interpretations and practices adopted by the employees within the Division of Company Finance and the Workplace of the Chief Accountant in administering the disclosure necessities of the federal securities legal guidelines.”}

^{2 For functions of consistency with SAB 121, on this Shopper Alert, we decide to make use of the time period “crypto-assets.” The Nelson Mullins attorneys authoring this consumer alert favor to make use of the time period “digital belongings” in reference to discussions and evaluation of cryptocurrencies, NFTs, or different comparable use circumstances of blockchain-based applied sciences. We use the time period “digital asset” in the identical method because the SEC to seek advice from “an asset that’s issued and transferred utilizing distributed ledger or blockchain expertise.” Assertion on Digital Asset Securities Issuance and Buying and selling, Division of Company Finance, Division of Funding Administration, and Division of Buying and selling and Markets, SEC (Nov. 16, 2018), obtainable here. Because the SEC has famous, digital belongings embody, however are usually not restricted to digital currencies, cash, and tokens. Id. A digital asset might in sure cases be deemed a safety below the federal securities legal guidelines. Whereas not outlined within the securities legal guidelines, the SEC typically refers to digital belongings which can be securities as a “digital asset securities.” Id.}

^{3 See Commissioner Hester M. Peirce, Response to Workers Accounting Bulletin No. 121 (March 31, 2022), obtainable here.}