I. Background

On December 8, 2022, the Division of Corporation Finance (the "Division") of the Securities and Exchange Commission ("SEC") issued a sample comment letter regarding issuers' crypto asset disclosures and urged issuers to evaluate their disclosures in view of recent volatility in crypto asset markets.1 Citing "[r]ecent bankruptcies and financial distress among crypto assets market participants,"2 the Division's "Sample Letter to Companies Regarding Recent Developments in Crypto Asset Markets" contains a non-exhaustive list of comments that the Division may issue to companies as part of its selective review and monitoring of company filings.

The recent market disruptions and the Division's sample letter have added focus to the growing regulatory scrutiny of disclosures regarding exposure to crypto assets and related risks. Previously in March 2022, the Division staff and the staff of the SEC's Office of the Chief Accountant had issued Staff Accounting Bulletin No. 121,3 which provides disclosure guidance to companies who hold crypto assets for others. On December 22, 2022, SEC Chair Gary Gensler criticized so-called proof-of-reserves reports issued by some crypto firms because such reports are "neither a full accounting of the assets and liability of a company, nor [do they] satisfy segregation of customer funds under the securities laws."4

II. Summary of the Division's Sample Letter

The Division's sample letter is divided into four sections: one general section and three sections that correspond to issuers' existing disclosure obligations. Within each section are a series of topics that the Division may include in comment letters to issuers. The Division indicated that actual comments to issuers will be tailored to specific companies and transactions.

Below is a summary of key points from the sample letter.

General. Under this heading, the letter requests that issuers disclose any significant crypto asset market developments that are material to understanding or assessing an issuer's business.

Description of Business (Regulation S-K Item 101). Under this heading, the letter requests disclosure regarding any material effects of specific bankruptcies on an issuer's business, financial condition, customers, and counterparties. In addition, the letter asks that issuers identify their exposure to other counterparties, customers, custodians, or other participants in the crypto asset markets that have filed bankruptcy, have experienced "excessive" redemptions or suspended redemptions, have not accounted for customers' crypto assets, or have experienced material corporate compliance failures. Finally, under this topic, the letter asks issuers to disclose steps they have taken to safeguard their customers' crypto assets and any policies and procedures they have adopted to prevent selfdealing and conflicts of interest.

Management's Discussion and Analysis of Financial Condition and Results of Operations (Regulation S-K Item 303). Under this heading, the letter requests that issuers disclose whether they have experienced "excessive" redemptions or withdrawals--or have suspended redemptions or withdrawals--of crypto assets and the resulting effects on the issuers' financial condition and liquidity.

The letter also requests disclosure regarding use of crypto assets issued by the issuer or held by the issuer on behalf of third parties. Specifically, the letter requests information, to the extent it is material, regarding whether these assets serve as collateral for a loan or other similar financing arrangement, and if so, the quantity of crypto assets involved and the nature of the issuer's relationship with the financing counterparty. The letter also requests that issuers explain whether current disruption in the crypto asset markets has affected the value of the collateral underlying these financing arrangements.

Risk Factors (Regulation S-K Item 105). Under this topic, the letter seeks information regarding material risks in the following areas:

  • Risks resulting from excessive redemptions, withdrawals, or a suspension of redemptions or withdrawals, of crypto assets;
  • Reputational harm the issuer might face in view of recent disruptions in the crypto asset markets;
  • Risks associated with unauthorized or impermissible customer access to the issuer's products outside of the jurisdictions where the issuer is authorized to offer its products;
  • Risks associated with regulatory developments related to crypto assets and crypto asset markets, including the potential material effects of pending legislation or regulation on the issuer's business, financial condition, and results of operations;
  • Risks associated with regulators and government entities asserting jurisdiction over crypto assets and crypto asset markets;
  • Risks associated with safeguarding the issuer's crypto assets or the crypto assets of the issuer's affiliates or customers, including the material risks the issuer could face if its policies and procedures for safeguarding crypto assets are not effective;
  • Risks associated with potential gaps the issuer's board or management have identified regarding risk management processes and policies in view of current crypto asset market conditions. The letter also requests that issuers explain any changes they have made to address these gaps; 
  • Risks associated with the effect of recent crypto asset market disruption on the value of crypto assets the issuer uses as collateral or the value of the issuer's crypto assets used by others as collateral; and
  • Risks in the following areas resulting from crypto asset market disruptions:
    • Risk of depreciation in the issuer's stock price;
    • Risk of loss of customer demand for the issuer's products or services;
    • Financing risk
    • Risk of increased losses or impairments in investments or other assets;
    • Risk of legal proceedings against or investigations of the issuer or its affiliates; and
    • Risk from crypto asset price declines or volatility.

III. Conclusion

Issuers who have exposure to crypto assets and crypto asset markets should review and evaluate the Division's sample letter carefully and assess whether their current disclosures should be updated. Similarly, companies preparing to make periodic or other disclosures should evaluate whether and to what extent they should address the issues raised in the Division's sample letter in those disclosures. Although the guidance set forth in the sample letter does not constitute a rule of, or statement by, the SEC, issuers with exposure to crypto markets who fail to include disclosures that address the issues raised in the sample letter could nevertheless face scrutiny from the Division and a referral to the SEC's Division of Enforcement for investigation and possible enforcement action.