The Securities and Exchange Commission (“SEC”) released Staff Accounting Bulletin No. 121 (“SAB 121”)¹ on March 31, 2022. SAB 121 provides SEC staff’s views regarding accounting treatment of obligations incident to a reporting company’s custody of crypto-assets for its platform users.² The staff notes that they have observed an increase in the number of companies providing platform users with the ability to transact in crypto-assets and that performing these services present unique risks not otherwise widely present with custody of non-crypto-assets. Specifically, the staff provides examples of technological risks, legal risks, and regulatory risks—all of which the staff indicate can have a significant impact on the reporting company’s operations and financial condition. In an effort to ensure investors have all appropriate information at their disposal to make informed decisions, the staff calls for certain measures that certain companies (discussed below) should take to recognize, measure, and disclose these risks. To achieve this end, SAB 121 utilizes three fact-based scenarios, each with a related question and an interpretive response.

To Whom SAB 121 Applies

SAB 121 applies to companies that:

1. File reports pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934 (“Exchange Act”) (i.e., ’34 Act reporting companies) or pursuant to Rule 257(b) of Regulation A (i.e., Regulation A issuers);

2. Have submitted or filed a registration statement under either the Securities Act of 1933 (“Securities Act”) or the Exchange Act that is not yet effective;
    
3. Have submitted or filed an offering statement or post-qualification amendment thereto under Regulation A; and
    
4. 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 SAB 121 Require?

SAB 121 indicates that companies covered by the guidance should:

1. Present a liability on its balance sheet to reflect its obligation to safeguard the crypto-assets held for its platform users. Staff notes it is appropriate for a company to recognize an asset at the same time that it recognizes the safeguarding liability, measured at initial recognition and each reporting date at the fair value of the crypto-assets held for its platform users.

2. For financial statements, include clear disclosure of the nature and amount of crypto-assets that a company is responsible for holding for its platform users, with separate disclosure for each significant crypto-asset, and the vulnerabilities a company has due to any concentration in such activities. Because the crypto-asset safeguarding liabilities and the corresponding assets are measured at the fair value of the crypto-assets held for its platform users, the company would be required to include disclosures regarding fair value measurements. Further disclosures for companies to consider providing include: 
    
   1. Disclosures about who (e.g., the company, its agent, or another third party) holds the cryptographic key information, maintains the internal recordkeeping of those assets, and is obligated to secure the assets and protect them from loss or theft. 
       
   2. Disclosures describing the types of loss or additional obligations that could occur, including customer or user discontinuation or reduction of use of services, litigation, reputational harm, and regulatory enforcement actions and additional restrictions. 
       
   3. A discussion of the analysis of the legal ownership of the crypto-assets held for platform users, including whether they would be available to satisfy general creditor claims in the event of a bankruptcy should be considered. 
       
   4. Disclosure of the potential impact that the destruction, loss, theft, or compromise or unavailability of the cryptographic key information would have to the ongoing business, financial condition, operating results, and cash flows of the company. As part of this disclosure, a company should also consider including information about risk-mitigation steps the company has put in place (e.g., insurance coverage directly related to the crypto-assets held for platform users).
       
3. In the financial statements that reflect the initial application of SAB 121’s guidance, the effect of the initial application should be reported in the carrying amounts of assets and liabilities as of the beginning of the annual period ending before June 15, 2022 and should include clear disclosure of the effects of the initial application of SAB 121.

When Do SAB 121’s Requirements Become Effective?

The staff expects ‘34 Act reporting companies and Regulation A issuers to apply SAB 121’s guidance no later than its financial statements covering the first interim or annual period ending after June 15, 2022, with retrospective application as of the beginning of the fiscal year to which the interim or annual period relates. The staff expects all other companies to implement SAB 121’s accounting, reporting, and disclosure guidelines beginning with their next submission with the SEC (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 SAB 121’s guidance as described in the preceding sentence. If the filing does not include a subsequent interim period that also reflects application of SAB 121’s guidance, then the staff expects it 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” by members of the crypto community, issued a statement in opposition of SAB 121, which she called “yet another manifestation of the [SEC’s] scattershot and ineffective approach to crypto.”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 the staff’s use of an accounting bulletin to issue this guidance instead of following an administrative rulemaking process that allows for consultation with the public.

Our Take

SAB 121 represents the SEC staff’s latest guidance on its evolving view on the regulation of and accounting for digital assets. Although SAB 121 appears to initially affect only a limited number of companies (i.e., those that operate and safeguard digital assets), it also reflects the staff’s current position on the “technological, legal, and regulatory risks and uncertainties” unique to crypto-assets. Companies should review the full text of SAB 121 and consult with their advisors as they prepare their upcoming financial statements.

^{1 See SEC Staff Accounting Bulletin No. 121 (March 31, 2022), available here. In SAB 121, the Staff reminded readers that “[t]he statements in staff accounting bulletins are not rules or interpretations of the Commission, nor are they published as bearing the Commission’s official approval. They represent staff interpretations and practices followed by the staff in the Division of Corporation Finance and the Office of the Chief Accountant in administering the disclosure requirements of the federal securities laws.”}

^{2 For purposes of consistency with SAB 121, in this Client Alert, we opt to use the term “crypto-assets.” The Nelson Mullins attorneys authoring this client alert prefer to use the term “digital assets” in connection with discussions and analysis of cryptocurrencies, NFTs, or other similar use cases of blockchain-based technologies. We use the term “digital asset” in the same manner as 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 (Nov. 16, 2018), available here. As the SEC has noted, digital assets include, but are not limited to virtual currencies, coins, and tokens. Id. A digital asset may in certain instances be deemed a security under the federal securities laws. While not defined in the securities laws, the SEC often refers to digital assets that are securities as a “digital asset securities.” Id.}

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