Author: Alex Thorn, Source: Twitter @intangiblecoins; Translated by: Baishui, Golden Finance
On Monday, September 9, Paul Munter, chief accountant of the U.S. Securities and Exchange Commission (SEC), gave a speech in which he revealed that the Commission does not object to banks evaluating that SAB 121 balance sheet accounting requirements do not apply to the bank. In the speech, Munter described the situation of bank holding companies and private transactions that established a fact pattern that, in the SEC's view, does not require SAB 121 accounting treatment for the bank. In short, this could pave the way for some banks to enter the crypto asset custody market.
background
The SEC proposed Staff Accounting Bulletin 121 (“SAB 121”) in 2022. Under SAB 121, public companies must account for digital assets held on behalf of customers on their corporate balance sheets. This could result in the custody customers of these companies becoming unsecured creditors in the event of the custodian’s insolvency. Because many banks are public companies, and because separate bank capital rules require banks to hold cash on their balance sheets at a 1:1 ratio with crypto assets, the effect of SAB 121 is to prevent any bank from custodial crypto assets on behalf of depositors.
In May 2024, both chambers of Congress passed a bill that would make SAB 121 a formal rule, asserting that the SEC violated the Administrative Procedure Act by issuing the rule without engaging in a formal rulemaking process (e.g., providing a comment period, publishing in the Federal Register, etc.). 21 House Democrats joined Republicans in passing the bill, which would effectively overturn SAB 121, despite a threatened veto from the White House, and 11 Democrats and 1 independent joined Senate Republicans in passing the bill. President Biden vetoed the bill on May 31, arguing that overturning SAB 121 “would inappropriately limit the SEC’s ability to enact appropriate guardrails and future issues” and “could potentially weaken the SEC’s broader authority over accounting practices.” Biden went on to say that his “administration will not support measures that jeopardize the well-being of consumers and investors.”
what happened
In his remarks Monday, Munter maintained that “the staff’s view on SAB 121 remains unchanged,” but he nevertheless outlined two different fact patterns that, if applicable to a company, would prevent the company from having to apply SAB 121.
First, bank holding companies have a path to relief under SAB 121 if they: 1) obtain “written approval from a state-level prudential regulator”; 2) customer crypto assets will be held in a bankruptcy-remote manner and that isolation is confirmed by a legal opinion; 3) the bank has negotiated clear prudential standards in its contracts with the institution’s depositors; and 4) regulatory, legal, and technical risks are continually mitigated and assessed.
Second, introducing brokers also have a path to relief under SAB 121 if they meet the following conditions: 1) they do not possess the cryptographic keys to customer assets; 2) the third party is the customer’s agent, not the introducing broker; and 3) the introducing broker obtains a legal opinion supporting its position with respect to cryptoasset activities.
analyze
In short, this appears to be good news. Banks that wish to custody crypto assets and clearly meet the described fact pattern have a clear path to avoid SAB 121 accounting. There are countless types of institutional investors who would like the highest form of qualified custody - bank custody. If the world's most trusted custodian bank can custody crypto assets - let alone tokenized assets - this could ease a huge barrier to adoption that has existed for years.
But there’s something odd about this speech. The private instruction and subsequent speech outlining the fact pattern for achieving relief effectively carves out a large portion of potential SAB 121 reporting companies. Indeed, if banks don’t need to do this, that would only leave Coinbase and a few publicly traded fintech companies. There’s perhaps some nuance, though — the fact pattern specifically mentions that banks “obtained written approval from state-level prudential regulators.” So, according to this speech, state-chartered banks (i.e., banks regulated by the OCC) may not meet the fact pattern and therefore need to go to the SEC and make their case. Given the current attitude of state bank regulators toward cryptocurrencies, it may be difficult to get written approval from the OCC given the agency’s current hostility toward digital assets. If national banks want to get involved, they may need to spend more time and money convincing the SEC that they, too, deserve relief. (This process reminds us of SEC Commissioner Hester Peirce’s eloquent speech about “The Secret Garden.”) However, there are still some very large state-chartered custodial banks. The two largest custodial banks in the world are state trusts (Bank of New York Mellon in New York and State Street in Massachusetts).
The presentation also repeatedly and specifically mentioned that bank holding companies would hold customer assets in a bankruptcy-remote manner, which was important to the SEC staff’s analysis, allowing banks to avoid SAB 121 accounting. But the impact of the accounting rule on those to whom it does apply may actually have the opposite effect. Coinbase itself disclosed after SAB 121 was issued in May 2022 that “customers may be treated as our general unsecured creditors.” So on the one hand, in order to avoid SAB 121 accounting, this unknown bank assured the SEC that the crypto assets it would hold for its customers would be bankruptcy-remote, but on the other hand, a public company like Coinbase explicitly warned that SAB 121 could mean that their customers’ crypto assets were bankruptcy-remote. This is really confusing.
Why can’t the SEC simply amend or revoke SAB 121? Why can’t the SEC take formal action through the normal process on a rule that both houses of Congress agree violates the Administrative Procedure Act? In a way, the SEC has painted itself into a corner on this issue — the Commission denies that SAB 121 is in fact a formal rule (even though both houses of Congress disagree), but they can’t provide formal relief (e.g., via a no-action letter) if it isn’t a formal rule. They can’t provide clarification through the formal rulemaking process because they’ve been so intransigent over the past two years that they needed a presidential veto to save them after being ostracized by both parties in Congress. Given this conundrum, it seems like the best the SEC can offer is guidance that removes entities from applicability. The crypto industry has been loudly calling for the SEC to develop formal rules and guidance, but apparently everyone is limited to behind-the-scenes conversations with staff, allowing the rules to be watered down in secret.
The SEC’s chief accountant said “staff’s views on SAB 121 have not changed,” but he just announced a loophole that allows a large number of companies that are subject to the act to ignore it. The convoluted nature of this logic makes it hard to believe that politics are not at the core of this issue. To be honest, the SEC never seemed to think that banks would want to get involved in crypto, originally intended this rule to apply only to crypto-native companies (perhaps punitively), and now they have figured out a way to let traditional banks off the hook in a way that saves face without changing their attitude over the past two years.
