Remarks before the 2024 AICPA & CIMA Conference on Banks & Savings Institutions: Accounting for Crypto Asset Safeguarding Obligations—A Facts Based Analysis

Introduction[1]

Thank you to the AICPA for inviting me to speak with you today. Let me begin by saying that I am here in my official capacity as the Chief Accountant of the U.S. Securities and Exchange Commission and the views I express here are my own and do not necessarily reflect those of the Commission, the Commissioners or other members of the staff.

As many of you may know, in March 2022, the staff of the Division of Corporation Finance and the Office of the Chief Accountant published Staff Accounting Bulletin No. 121 ("SAB 121")[2] to communicate views of the staff regarding the accounting by entities that have obligations to safeguard crypto-assets held for their platform users. The views expressed in SAB 121 were the direct result of consultations from entities seeking the staff's views on their accounting for certain crypto-asset safeguarding arrangements. 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.

Since the issuance of SAB 121, entities have requested the views of the staff in the Office of the Chief Accountant on the accounting for a variety of other fact patterns involving the use of distributed ledger technology and the safeguarding of crypto-assets that present varying degrees of legal, technological, and regulatory risks and uncertainties. In certain cases, entities have demonstrated how the specific risks and uncertainties involved in their fact patterns are different than those contemplated in SAB 121. Today, I would like to highlight certain observations from recent accounting consultations with entities where the staff in the Office of the Chief Accountant has 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 an obligation to safeguard crypto-assets held for others. In each of the accounting consultations I'll describe, the staff's conclusion was based on the specific facts, circumstances, representations, and warranties by the entity and its outside advisers, including in legal opinions, with respect to the entity's arrangement. Those conclusions would not necessarily be the same for different fact patterns.

Bank Holding Companies

Starting with a recent accounting consultation from an entity that is a bank holding company, the entity requested the staff's views on the accounting for its obligations within a regulated bank subsidiary (the "Bank") to safeguard crypto-assets for institutional customers only. In this specific fact pattern, the Bank held the cryptographic private key information that provides access to the crypto-assets being safeguarded by the Bank. While no individual factor was determinative, the entity provided the following facts and representations, among others, to support its conclusion that it sufficiently mitigated the unique risks and uncertainties present in its arrangements to safeguard crypto-assets, such that it should not recognize a liability on its balance sheet for an obligation to safeguard crypto-assets:

• First, prior to the consultation, the Bank obtained written approval from its prudential regulator at the state level for its specific proposed crypto-asset safeguarding activities following the regulator's review of the governance and risk management practices designed for those activities. The Bank also engaged with its primary federal prudential regulator, consistent with the regulator's stated expectations.[3] The entity stated that the Bank has comprehensive operational controls in place to mitigate risks associated with holding a private key for its customers' blockchain wallets. The entity also stated that these controls and processes are subject to continuous supervision and oversight by the Bank's prudential regulators, including certain limitations on the types of crypto-assets that can be safeguarded for customers.

• The Bank will hold its institutional customers' crypto-assets in what it stated would be a bankruptcy-remote manner. Each customer's crypto-assets will be held in an individual blockchain wallet for which the customer is the beneficial owner. This wallet is segregated from wallets that hold crypto-assets for other customers or for the entity, and from other assets. The Bank also stated that it has entered into crypto-asset safeguarding contractual agreements with its institutional customers that limit the Bank's activities to holding and transferring crypto-assets based on customer instructions, with no ability for the Bank to use or otherwise rehypothecate its customers' crypto-assets.

• The entity obtained a legal opinion from outside counsel supporting its "bankruptcy-remote" conclusion that based on the manner and legal structure in which the Bank will safeguard the crypto-assets, in the event of insolvency, the crypto-assets should not be the property of the Bank receivership estate and should not be available for distribution by the FDIC as receiver to the Bank's creditors.

• The Bank negotiated with its institutional customers the contractual terms and conditions to be included in its crypto-asset safeguarding agreements that clearly set forth the standard of care the Bank will be responsible for exercising and the scope of the Bank's liability, thereby mitigating risks that the Bank will be exposed to liability for blockchain-specific risks that are outside of the Bank's direct control.

• And finally, the entity stated that it has a robust process for assessing regulatory, legal, and technological risks and uncertainties on an ongoing basis specific to each particular crypto-asset the Bank is considering safeguarding for its institutional customers.

Based on the specific facts and representations presented by the entity regarding the crypto-asset safeguarding activities to be performed by the Bank, the staff did not object to the entity's conclusion that the arrangement was not within the scope of SAB 121 and that it should not recognize on its balance sheet a safeguarding liability measured based on the fair value of the crypto-assets the Bank is responsible for holding for its institutional customers. The entity noted that it would provide disclosure in its SEC filings about the extent of crypto-assets safeguarded and the relevant risk factors and impacts to risk management, as well as the significant judgments made in reaching its accounting policy conclusion.

Introducing Brokers and Dealers

The staff has also addressed a number of fact patterns where a registered broker-dealer is involved in facilitating the purchase, sale, and holding of crypto-assets by others (i.e., an introducing broker-dealer). These registered introducing broker-dealers have generally entered into an arrangement with a third party (which may be an unaffiliated third party or an affiliate of the introducing broker-dealer) through which the third party will provide crypto-asset trade execution and safeguarding services for customers of the introducing broker-dealers. The introducing broker-dealer, or a related party of the introducing broker-dealer, typically provides an interface that allows the introducing broker-dealer's customers to submit crypto-asset transaction orders and then transmits those transaction orders to the third party for fulfillment.

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. Neither the introducing broker-dealer, nor a person or entity acting as agent for the introducing broker-dealer, has rights to, or controls or possesses in any manner, the cryptographic private key information (or any part or portion of the information) necessary to transfer any crypto-assets held by the third party on behalf of the customer.

• The Third Party is the Agent of the Customer. The third party is the agent of the customer and does not act as an agent of the introducing broker-dealer with respect to the safeguarding, transfer, or disposition of the crypto-assets or funds the third party holds on behalf of the customer, and both the third party and the introducing broker-dealer acknowledge the absence of an agency relationship. In these consultations, the staff has found the combination of the following factors persuasive evidence that the third party is acting as an agent of the customer rather than the introducing broker-dealer:
  • First, the introducing broker-dealer has an express written agreement with the customer that the broker-dealer will not serve as agent for the customer with respect to the safeguarding, transfer, or disposition of the crypto-assets or funds held by the third party on behalf of the customer.
  • The introducing broker-dealer has clear and prominent disclosure (e.g., in marketing materials, on customer interfaces) that safeguarding, transfer, or disposition services are provided by the third party and not by the broker-dealer or its agents.
  • The third party treats the customer as a direct accountholder and is solely responsible for providing account information, including statements and confirmations, directly to the customer with respect to the crypto-assets and funds the third party holds on behalf of the customer.
  • The customer has a contractual relationship with the third party whereby the customer has the legal authority and practical ability to transmit instructions directly to the third party (without the intermediation of the broker-dealer) with respect to the safeguarding, transfer, or disposition of any crypto-assets or funds held by the third party on behalf of the customer, including instructions to move a crypto-asset to another location or wallet outside of the third party's control, and to transfer funds derived from the sale of a crypto-asset or otherwise held by the third party to the customer's bank account without any involvement of the introducing broker-dealer.
  • The third party provides the customer with up-to-date information (e.g., phone number, email address, web-portal) with which the customer can contact the third party directly.
  • The third party is responsible for resolving any complaints or disputes that the customer may have relating to the safeguarding, transfer, or disposition of the crypto-assets or funds that the third party holds on behalf of the customer.
  • And finally, the customer's crypto-asset account at the third party will continue to exist and the third party will continue to take instructions from the customer with respect to the safeguarding, transfer, or disposition of the customer's crypto-assets even if: (a) the customer closes its securities account at, or otherwise terminates its commercial relationship with, the introducing broker-dealer; or (b) the introducing broker-dealer ceases to operate or is subject to a formal liquidation proceeding or receivership.

• Legal Opinion. The introducing broker-dealer obtains an opinion from outside legal counsel that supports the following three assertions:
  • First, the third party is acting as an agent for the customer, and not the introducing broker-dealer, with respect to the safeguarding, transfer, or disposition of the crypto-assets or funds the third party holds on behalf of the customer;
  • Second, the broker-dealer has no contractual obligation under applicable law to compensate the customer for any loss arising from the third party's safeguarding, transfer, or disposition of crypto-assets or funds it holds on behalf of the customer; and
  • Third, crypto-assets or funds that the third party holds on behalf of the customer would not be included in the estate of the broker-dealer if the broker-dealer were subject to a formal liquidation proceeding or receivership.

Other Uses of Distributed Ledger Technology

In addition to the fact patterns I've just described regarding an entity's involvement in the safeguarding of crypto-assets for others, the staff of the Office of the Chief Accountant has also received accounting consultations from entities where distributed ledger or blockchain technology is used to facilitate certain types of transactions. For example, the staff has seen fact patterns where distributed ledger technology is utilized by entities to track holdings and transfers of traditional financial assets. In some fact patterns, these traditional financial assets have been issued in "tokenized" form representing a bond or fractional share of a bond on a distributed ledger.

While the staff's determination is based upon specific facts and circumstances, in many cases the staff has 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 on its balance sheet to reflect an obligation to safeguard crypto-assets for others. 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. Additionally, the staff has seen fact patterns where entities were able to attribute legal ownership of the traditional assets to their specific customers, which can also involve interoperability of the distributed ledger with traditional recordkeeping systems that are maintained by the entity (for example, reconciliation with customer databases and non-distributed ledger systems for customers to submit instructions to purchase, sell, or transfer their assets).

Conclusion

In summary, the staff's views in SAB 121 remain unchanged, and absent particular mitigating facts and circumstances, the staff believes an entity should record a liability on its balance sheet to reflect its obligation to safeguard crypto-assets held for others. I believe that such financial reporting provides relevant, timely information that investors need to assess the unique risks and uncertainties related to safeguarding crypto-assets for others. As I've highlighted today, the staff has recently addressed particular fact patterns related to crypto-assets and distributed ledger technology that were not contemplated by SAB 121. In those instances, given the specific facts and circumstances of different arrangements, the staff has not objected to entities' conclusions that the particular arrangement was not within the scope of SAB 121 and that they should not record a crypto-asset safeguarding liability on-balance sheet.

As always, we remain available for consultations[4] with any entity who requests the staff's views on their accounting conclusions, including those related to obligations to safeguard crypto-assets for others.

Thank you for your time today.

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