Securities and Exchange Commission (SEC) Chief Accountant Paul Munter at a conference on September 9, 2024, provided the staff’s views on the accounting for a variety of fact patterns that were not specifically addressed by Staff Accounting Bulletin (SAB) No. 121 on the use of distributed ledger technology and the safeguarding of crypto assets.
In particular, his remarks focused on instances when the staff in the Office of the Chief Accountant (OCA) have not objected to an entity’s conclusion that its arrangement was not within the scope of SAB 121 and that it should not recognize a liability for obligation to safeguard crypto assets held for others. And these are related to bank holding companies, introducing broker-dealers, and other uses of distributed ledger technology.
His speech at the AICPA’s banking conference in National Harbor, Maryland, follows consultations by entities asking for the SEC’s accounting staff’s views for instances that do not neatly fall under SAB 121, which was published in March 2022.
“The staff views communicated in SAB 121 remain unchanged—the staff believes that an entity with safeguarding arrangements that align with the fact pattern described in SAB 121 should present a liability on its balance sheet to reflect its obligation to safeguard the crypto-assets held for others, along with a corresponding asset that is separate and distinct from the crypto-assets held for others,” Munter said via prerecorded video as he was overseas at the time of the conference.
Bank Holding Companies
The staff’s views are based on a specific bank holding company which held cryptographic private key information that provides access to the crypto assets being safeguarded by the bank.
The bank sufficiently mitigated the unique risks and uncertainties to safeguard cypto assets and argued that it should not have to recognize a liability on its balance sheet for its obligation to safeguard the virtual asset.
The bank first obtained written approval from banking supervisor at the state level for its crypto safeguarding activities after the regulator reviewed the governance and risk management practices for those activities.
The bank also said that it has comprehensive operational controls to mitigate risks of holding a private key for its customers’ blockchain wallets.
The bank will hold its institutional customers’ crypto assets in a bankruptcy-remote manner. Each beneficial owner of blockchain wallet is segregated from wallets that hold cryptos for other assets.
Further, the bank said that it has contracts with customers that limit the bank’s activities to holding and transferring cryptos based on customer instructions with no ability for the bank to use the cryptos.
Moreover, the bank obtained a legal opinion from outside counsel that supports its bankruptcy-remote conclusion in the event of insolvency. The crypto will not be the property of the bank receivership.
The bank also negotiated with its customers the terms and conditions in its crypto safeguarding agreements that set forth the standard of care.
In addition, the bank has a continuous process for assessing regulatory, legal, and technological risks and uncertainties specific to each crypto asset.
Munter said that in this specific fact pattern, the OCA staff did not object to the bank’s conclusion that the cryptos it is safeguarding is not within the scope of SAB 121.
Introducing Broker-Dealers
Munter said that the staff have also addressed a number of instances in which a broker-dealer facilitates the purchase, sale, and holding of cryptos of by others.
These introducing broker-dealers generally have an arrangement with a third party, which provides crypto trade execution and safeguarding services for customers of the introducing broker-dealers. Munter said: “In these entity-specific consultations, and in similar fact patterns where an introducing broker-dealer is involved in arrangements through which customers invest in or hold crypto-assets, the staff has communicated that it would not object to a conclusion that, for the introducing broker-dealer, the arrangement is not within the scope of SAB 121 and the introducing broker-dealer should not recognize a liability on its balance sheet to reflect an obligation to safeguard crypto-assets related to the crypto-assets held for its customers at the third party given the existence of the following facts and circumstances”:
- No Possession of the Cryptographic Key;
- The Third Party is the Agent of the Customer; and
- Legal Opinion From Outside Counsel.
Among other facts and circumstances, the third party must treat the customer as a direct account holder and is solely responsible for providing account information.
Other Uses of Distributed Ledger Technology
Munter said that the OCA has also gotten consultations from entities where distributed ledger or blockchain technology is used to facilitate certain types of transactions.
For example, entities are using distributed ledger technology to track holdings and transfers of traditional financial assets. In some cases, these traditional financial assets are issued in tokenized form representing a bond or fractional share of a bond on a distributed ledger.
He said that in many cases, the staff have objected to an entity’s conclusion that its arrangements do not fall under SAB 121.
“In this regard, the staff has seen fact patterns where the design of the distributed ledger technology system allows the entity to control recording issuances and/or transfers of assets, including the ability for the entity to correct errors, if needed,” Munter said.
SAB 121 Remains the Same
In the meantime, Munter stressed once again that the staff’s views in SAB 121 remained unchanged.
While he did not elaborate, SAB 12—which has been heavily criticized by the crypto and banking industries and quietly opposed by some banking regulators—has been the subject of congressional efforts to repeal it. And some in the spring said that Munter was considering modification of SAB 121. But the SEC said in the summer that it will not revise it.
A failed legislative effort to override President Biden’s veto of legislation to kill SAB 121 has meant that the staff guidance remains in effect.
It is unclear what will happen with a different administration following the election. But investor protection advocates believe SAB 121 is important.
“In exchange for campaign funds from crypto and banking companies, members of Congress are putting the interests of these companies ahead of the needs of investors for transparency and adequate capital,” said Lynn Turner, former SEC chief accountant who has been a vocal investor advocate.
This article originally appeared in the September 11, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.
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