Paul Munter, Chief Accountant at the SEC, revealed in a speech earlier this week that the SEC has granted exemptions to rules relating to the custodying of crypto assets that have been widely reviled in the industry.
Posted September 13, 2024 at 1:32 pm EST.
Earlier this week, the SEC’s Chief Accountant revealed in a public speech that the agency had granted exceptions to SAB 121, the controversial accounting rule that’s been heavily criticized in the industry for making it impractical for financial institutions to custody crypto assets.
Issued in March 2022, SAB 121 requires that a bank custodying crypto put the assets on their balance sheet and create a corresponding liability equal to the worth of the crypto, which is unusual as other custodied assets are typically listed off the balance sheet. The result of this rule means that financial institutions must hold an enormous amount of capital just to custody crypto assets, making it prohibitively costly to do so.
In a speech at a conference on Monday, however, SEC Chief Accountant Paul Munter disclosed that certain companies had been granted exemptions from SAB 121, and did not need to create a liability on their balance sheets when custodying digital assets. Munter mentioned that several entities had received this exemption — including a bank and various brokerage houses and blockchains — without specifying who they were.
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In Munter’s speech, he described the different ways that the three types of entities could receive an exemption.
In the case of a bank, the pathway involved working with a state regulator first to ensure that crypto assets being custodied would return to the customer in the event of a bankruptcy, and that activity with customers would only comprise institutional custody with sufficient controls in place to manage risk. For a brokerage, an exemption could apply if the broker is not in possession of the cryptographic key and works directly with the customer — essentially, not custodying any crypto itself. Finally for a blockchain, Munter highlighted how a distributed ledger tracking holdings and transfers of digital assets, without custodying any crypto, could exempt it from SAB 121.
Political Backlash
Senator Cynthia Lummis (R-WY), a longtime supporter of the crypto industry, strongly criticized the moves in a statement to Unchained.
“The SEC is clearly trying to sidestep Congress and the Congressional Review Act by having one-on-one meetings to determine whether or not it will enforce SAB 121 on a case-by-case basis,” Lummis wrote.
Lummis has been trying to overturn SAB 121 reversed for some time, asking the Government Accounting Office (GAO) in early 2023 to determine whether the SEC did more than provide guidance and actually created a rule. The GAO subsequently released a report at the end of October 2023 agreeing with her, and Lummis then argued that the SEC had violated the Congressional Review Act (CRA) because it did not follow the correct process for establishing a rule (the CRA requires federal agencies to submit rules to the House and Senate before they take effect). Lummis subsequently worked with Rep. Mike Flood (R-NE) and Rep. Wiley Nickel (D-NC) on a resolution to overturn SAB 121 on the grounds that it violated the CRA.
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The resolution passed, but was then ultimately vetoed by President Biden on the grounds that overturning SAB 121 would jeopardize the well-being of consumers and investors.
On Wednesday, Lummis further noted that Munter’s speech “seems entirely political, as the SEC staff should be transparent with issuers, investors and Congress by revising or rescinding SAB 121 directly, not making policy through speeches. I am incredibly concerned with the approach the SEC is taking and will continue to ensure it is not unfairly targeting the digital asset industry.”
Industry Reaction
Aaron Jacob, CEO of TaxBit, a company that provides tax and accounting compliance solutions for digital assets, mockingly described the SEC as using a “ready, fire, aim” approach to accounting guidance for crypto custody. He pointed out the confusion initially caused by the release of SAB 121, and then the additional confusion created by Munter’s speech. “[SAB 121] is not very extensive guidance,” Jacob said. “It’s only about a page-and-a-half long, clearly targeted towards folks like Coinbase and…publicly-traded companies that are ‘safeguarding customer assets,’” said Jacob.
Jacob said he was shocked when he realized that Munter had revealed exceptions to SAB 121 in his speech. “A lot of people are scratching their heads saying, ‘Well, what was the point of this to begin with? Some banks argue with the SEC behind closed doors, and apparently get a free pass [from SAB 121].’” In Jacob’s view, the SEC’s exceptions were a way for the agency to acknowledge that it had overstepped.
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In a post on X on Friday, Alex Thorn, head of research at Galaxy, agreed that the exceptions seemed to be a way for the SEC to backtrack without totally abandoning SAB 121.
“If I’m being honest, it looks like the SEC never thought banks would want to play in crypto, intended this rule to apply only to crypto-native companies (perhaps punitively), and has now crafted a way to let traditional banks off the hook in a way that saves face by not reversing their posture of the last 2 years,” Thorn wrote.
Industry trade associations also expressed concerns with Munter’s speech.
“Unfortunately, SEC staff have reaffirmed their stance on SAB 121, but have now outlined certain scenarios they consider outside of its scope – with the announcement coming in a speech at a conference,” said Patrick Kirby, Policy Counsel for the Crypto Council for Innovation. “SAB 121 limits consumers’ options to safely custody their digital assets and upends decades of bank custody practices.”
Taylor Barr, Senior Policy Associate from the Digital Chamber, agreed. “The SEC’s cherry-picking of a few scenarios where firms fall outside the scope of SAB 121 doesn’t change the fact that SAB 121 is fundamentally flawed and untenable,” Barr said. “These exceptions only highlight how arbitrary and inconsistent the rule is,” said Barr.
One source from a bank who wished to remain anonymous because of ongoing discussions with regulators, agreed it is accurate to note there are scaling hurdles because of SAB 121, in that it has been difficult to grow and expand the business of digital asset custody due to the accounting requirements of SAB 121.
For his part, Jacobs suggested the SEC just needs to be clear about its stance on requirements for crypto custody. “I think they should, whether it’s repeal or amend [SAB 121], do something to make it more clear… and people will applaud those efforts,” Jacobs said.
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