The SEC released Staff Accounting Bulletin No. 121 (SAB 121) on March 31, 2022, which provides interpretive accounting, disclosure, and transition guidance for entities that have a responsibility to safeguard crypto-assets for others. This may be a service provided by the entity or by an agent acting on the entity’s behalf. Typically, these services are through a platform but it is not a specific requirement of SAB 121. The ability of platform users to generate future benefits from the crypto-assets may be dependent upon the actions of these entities over safeguarding the assets, such as the entity maintaining the cryptographic key information. The Staff believes that the obligation of entities to secure crypto-assets involves unique risks and uncertainties related to technology, legal, and regulatory challenges, as discussed in the SAB 121, that are not usually present in arrangements to safeguard non-crypto assets.
What are the new accounting and disclosure requirements?
The SEC believes that as long as these entities are responsible for safeguarding the crypto-assets on behalf of their platform users, including maintaining the cryptographic key information necessary to access the crypto-assets, the entities should present a liability on their balance sheet to reflect the obligation to safeguard the crypto-assets held for the platform users. In addition, it would be appropriate for these entities to record a corresponding asset at the same time. Subsequent to the initial recognition of the obligation, the asset and liability should be remeasured and recognized at the fair value of the crypto-assets held for the platform users on each reporting date. The determination of fair value for crypto-assets is challenging and can often involve significant judgment for the impact of multiple markets for crypto-assets that operate differently than traditional regulated markets. Management should carefully consider its policy for determining the fair value and the need for valuation specialists. Further, the recorded asset may not equal the recorded crypto-asset safeguarding liability because the asset would need to evaluate whether any potential loss events, such as theft, impact the measurement of the asset.
The SEC listed the following requirements for financial statement disclosure under SAB 121:
- Describe the nature and amount of crypto-assets that entities are responsible for holding for their platform users;
- Describe the vulnerabilities that entities have due to any concentration in such activities;
- Discuss the fair value measurements surrounding the crypto-asset safeguarding liabilities and the corresponding assets;
- Discuss the “accounting for the liabilities and corresponding assets”; and
- Disclose “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”.
The SEC further provided the following disclosures that may be required outside the financial statements (i.e. description of the business; risk factors or MD&A):
- Describe the significant risks and uncertainties associated with the entities holding crypto-assets for their platform users;
- Describe “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”;
- Discuss “the analysis of the legal ownership of the crypto-assets held for platform;
- Disclose “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 these entities; and
- If material, describe the “information about risk-mitigation steps the entity has put in place”.
Applicability and effective date
SAB 121 applies to financial statements prepared under US GAAP or IFRS Accounting Standards for existing registrants, entities that have submitted or filed not-yet-effective registration statements, and other entities and financial statements as specified by SAB 121. This includes 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.
Registrants apply SAB 121 to financial statements for interim and annual periods ending after June 15, 2022, with retrospective application to the beginning of the fiscal year.
Questions to consider
- How many customers’ crypto-assets are currently transacting on my platform? Are these assets active or inactive?
- Do I have a formal agreement with my crypto-asset customers?
- Who is holding the cryptographic key information, maintaining the internal recordkeeping of the assets, and obligated to secure the assets and protect them from loss or theft?
- What are the actions and controls over safeguarding the crypto-assets and the related cryptographic key information held for my platform users?
- How should I determine the fair value of the crypto-asset safeguarding liabilities and the corresponding assets?
- Should the crypto-asset safeguarding liabilities and the corresponding assets be classified as current or non-current on my balance sheet?
- Should the assets recognized on my balance sheet related to the crypto-asset safeguarding liabilities be evaluated for impairment on each reporting date and upon the occurrence of a triggering event?
- What are the significant risks and uncertainties associated with holding crypto-assets for my platform users? Are there any concentration risks?
- What are the potential impacts to my company financially and operationally if the crypto-assets held for my platform users are compromised?
- How does safeguarding crypto-assets currently fall within my company’s internal control over financial reporting and what third parties are used?
How can I prepare?
We understand that navigating existing and emerging financial reporting requirements can be a complex and time-intensive process. Companies should continue to monitor developments related to SAB 121 and follow the SEC’s current guidance on safeguarding crypto-assets. CFGI is prepared to help you conform to these new requirements. Reach out to us today to learn more.