U.S. Security and Exchange Commission (“SEC”) Staff Accounting Bulletin No. 121 (“SAB 121”) was issued on March 31, 2022.  It requires reporting entities which perform custodial duties in relation to crypto assets to hold those assets on their balance sheet. Doing so means these entities would also be required to take on significant capital, liquidity, and other costs under the existing prudential regulatory framework.  SAB 121 thus represented a significant departure from decades of generally accepted off-balance sheet accounting treatment for custodied assets. 

The SEC position is that compliance with SAB 121 increases transparency to investors in companies which perform crypto asset custodial duty and address the situation seen in multiple crypto firm collapses over the last several years – that is, the company collapses and when the customers/investors attempt to regain their assets, it turns out the company no longer has them.

As has been the case with many SEC actions in the crypto asset space, Republican-appointed SEC Commissioner Hester Pierce raised concerns about the SEC’s actions, including a procedural one, implying that, by using an SAB, which is issued by SEC staff, the staff  circumvented the rulemaking process.  She said:

 A staff accounting bulletin may not be the appropriate vehicle through which to make this accounting change and communicate it to the public. SAB 121 is unusual among SABs in that it provides definitive interpretive guidance for a very specific, very limited number of public companies. SAB 121 is also unusual among SABs in the detailed description of disclosure the staff expects to see, including a full paragraph describing relevant disclosures that “may also be required outside the financial statements under existing Commission rules.”[3] While past SABs have included statements suggesting companies should consider the applicability of other disclosure requirements outside of the financial statements, SAB 121’s granular guidance is unique.[4] The SAB, as a staff statement, is not enforceable,[5] but much of the language in the document reads as if it is. For example, SAB 121 tells affected companies they do not have to issue a restatement and gives them a transition period so that they do not have to apply the guidance immediately.

She also said that “SAB does not acknowledge the Commission’s own role in creating the legal and regulatory risks that justify this accounting treatment. The Commission has refused, despite many pleas over many years, to provide regulatory guidance about how our rules apply to crypto-assets, so some of the responsibility for the lack of legal and regulatory clarity lies at our doorstep.”

At about the two year anniversary of SAB 121, the Bank Policy Institute, American Bankers Association, Financial Services Forum, and the Securities Industry and Financial Markets Association wrote a letter to SEC Chairman Gary Gensler requesting that the Commission consider targeted modifications to SAB 121.  One of the points made by the banks is that SAB 121 effectively precluded banking organizations from providing digital asset custody at scale.   This has resulted in driving digital asset custody services to non-banking organizations and, in their view, potentially compromising the financial system’s safety and stability due to a lack of regulatory oversight over these organizations.

On May 8, 2024, the U.S. House of Representatives passed H.J. Res. 109, which, if passed into law, would overturn SAB 121.  In speaking in favor of the legislation, Chairman of the House Financial Services Committee, Patrick McHenry, gave the following example to evidence the effects of SAB 121: “The SEC recently approved 11 Bitcoin ETFs, which allow everyday investors to gain exposure to this technology.  Of those 11, zero—I repeat zero—use banks as their primary custodian. Instead, all of that risk is now concentrated.”

Another aspect of the legislation concerns a larger political issue in Washington of regulators being accused of exceeding their authority and circumventing Congress.  As it relates to SB 121, because it was called “staff guidance,” the SEC avoided public comment and other parts of the rulemaking process included in the Administrative Procedures Act.  However, the General Accounting Office determined that SAB 121 was a “rule” for purposes of the Congressional Review Act, which thereby provided Congress with the opportunity to review SAB 121.

On the day of the House vote, President Biden’s office issued a Statement saying that he would veto H.R. 109 if it reached his desk.  It said: “SAB 121 was issued in response to demonstrated technological, legal, and regulatory risks that have caused substantial losses to consumers. By virtue of invoking the Congressional Review Act, it could also inappropriately constrain the SEC’s ability to ensure appropriate guardrails and address future issues related to crypto-assets including financial stability. Limiting the SEC’s ability to maintain a comprehensive and effective financial regulatory framework for crypto-assets would introduce substantial financial instability and market uncertainty.”

All 207 Republicans who voted on H.R. 109, voted in favor.  And, even in the face of President Biden’s stated opposition, 21 Democrats voted in favor as well.  The resolution now moves to the Senate.

The post <strong>U.S. House Passes Bill to Undo SEC Guidance That Limited Banks’ Ability to Custodian Crypto Assets</strong> appeared first on Blockchain.