SEC’s Relaxed Stance on Crypto Guidance Fails to Appease Critics

The SEC has moderated its stance on accounting for certain crypto assets, but not enough to satisfy critics who say its two-year-old guidance is still confusing and hampering wider adoption of digital currencies.

The Wall Street regulator last week said that it has told some large banks and even brokerages they could offer certain crypto products without adding to their balance sheets, effectively bypassing current requirements outlined in Staff Accounting Bulletin 121.

Crypto advocates, however, remain unimpressed with the Securities and Exhange Commission’s workaround.

“Instead of engaging in open conversation with enterprise digital asset leaders, Congress and the SEC have opted for closed-door discussions that lead to potential uncertainty for businesses,” said Amy Kalnoki, co-founder and chief operating officer of Bitwave, an accounting and finance platform for digital assets.

Banks are among firms seeking greater clarity from the regulator and they’ve turned to their allies on Capitol Hill for help, though a recent legislative attempt to overturn the 2022 staff bulletin failed.

The SEC’s accounting guidance effectively threw a wrench in the bank industry’s aims to grab a piece of the over $2 trillion digital asset market. But it also raised critical questions about how companies would secure customer holdings while courts and regulators grappled with thorny issues posed by the new asset class.

The SEC hasn’t provided any exceptions to the accounting bulletin; rather, some entities provided use-cases and circumstances that differ “from those described” in the guidance, the agency said in a statement Monday.

An Evolution

Much has changed since the SEC released its crypto bulletin in March 2022. Eight months later, crypto exchange FTX collapsed and exposed gaping holes in basic protections for customers common for securities and other investments.

A wave of “bad apples” that year spooked the industry, said Aaron Jacob, head of accounting solutions at TaxBit, which provides crypto accounting products for exchanges and investors.

Through its accounting guidance, the SEC pushed for better security of digital assets, what Bitwave’s Kalnoki called a “critical element for building trust and mainstream adoption.”

Companies have discussed with the SEC security measures they have in place to address risks that concern the regulator—an education that helped open the door to banks serving crypto holders, said Kell Canty, co-founder and CEO of Ledgible, a tax platform for digital assets.

Banks and other entities are beginning to put in place measures to address ongoing regulatory uncertainty and the risk of hacks and theft. The regulator has encouraged companies to meet with staff to determine whether those guidelines could apply to them, said an SEC source familiar with the agency’s approach.

Still the bulletin had a chilling effect on the industry by blocking some of the most well-regulated entities that were best-positioned to address those technical and legal challenges from serving the market, Canty said.

“We have clients who their plans for participating in the digital asset world were changed and put on hold because of SAB 121,” Canty said.

The politics of crypto have also shifted, grabbing the attention of presidential candidates. Former President Donald Trump has embraced crypto and plans to address an industry event later this month. The Republican Party in its 2024 platform has pledged to reverse what it calls the Biden administration’s “crackdown” on crypto.

Under Chairman Gary Gensler, the SEC has sued crypto firms over compliance with US securities laws. But the agency has also approved exchange-traded funds that invest in Bitcoin.

In May, the House and Senate passed a bipartisan measure that would have rescinded the controversial guidance. A presidential veto preserved the policy, however.

Rather than caving to political pressure, an SEC source said that the agency had been working with banks to address their concerns since the bulletin’s issuance.

In late 2023 staff began telling large banks and some brokerages through private consultations that with proper safeguards, certain services wouldn’t require them to book the value of customer assets as a liability on the balance sheet.

The agency shared with an accounting industry group in February examples of protections that would address its concerns such as ensuring customers retain access to their holdings during a bankruptcy. Companies also must not have access to the private keys to the cryptocurrency, according to a document published by the American Institute of CPAs.

“As long as their customers receive the same protection for the safeguarding of crypto assets as they do in custody arrangements, their balance sheet treatment is also the same as custody arrangements,” the SEC said in its Monday statement.

The new guidelines open a path for banks to begin serving the crypto market and avoid bigger balance sheets that could trip capital reserve requirements set by banking regulators.

Balance Sheet Fallout

Corporate accountants typically follow SEC guidance, meant to ensure public companies consistently apply rules set by the Financial Accounting Standards Board, a Connecticut non-profit. Other recent bulletins addressed stock compensation and credit losses.

But some of the risks the SEC has highlighted could be addressed in the company’s internal control disclosures, said Vivian Fang, a finance professor at Indiana University.

Disclosures buried in corporate financial reports could provide details about the size of customer crypto holdings, trends over time or how the firm secures customer assets. But booking the value of customer-held crypto on the balance sheet served as a bright neon sign, directing analyst and investor attention to the size and possible risks of that business.

The balance sheet for Coinbase Global Inc. was five times its prior size after the company adopted the SEC accounting treatment.

Credit analysts strip out the customer liability and related assets to avoid distorting key leverage ratios, Fang said.

Critics have long questioned why the SEC didn’t turn to the US accounting standard setter to address customer holdings. The Financial Accounting Standards Board recently completed a narrow project enabling companies to book the fair value of their own crypto assets, allowing the values to rise and fall with the market.

It’s not too late for the standard setter to get involved and consider whether customer assets are a liability, said Suzanne Morsfield, global head of accounting solutions for Lukka Inc.

“The tried-and-true approach of turning accounting standard setting questions to the FASB, I think, is just the way we get the best outcome for all the stakeholders,” Morsfield said.