Just shy of a month since FTX declared bankruptcy, the US Securities and Exchange Commission’s (SEC’s) Division of Corporation Finance (Division or staff) published informal guidance on how public companies could be asked to address the possible impact of financial distress in the cryptoasset market. The guidance includes a “sample” crypto-specific comment letter focused on disclosure that public companies should consider providing in filings made under the Securities Act of 1933 (Securities Act) and Securities Exchange Act of 1934 (Exchange Act), as applicable.
Although the Division’s guidance does not create new disclosure requirements, the sample letter provides insight into the staff’s scrutiny of the cryptoasset market and outlines its significant concerns about the possible impact of recent events on investors and reporting companies.
Similar to other sample comment letters that the Division has published, such as one addressing climate change, the staff stresses the importance of providing not only disclosure that is responsive to applicable disclosure requirements, but also “such further material information, if any, as may be necessary to make the required statements, in light of the circumstances under which they are made, not misleading.” See Securities Act Rule 408 and Exchange Act Rule 12b-20. Furthermore, the staff strongly encourages public companies to proactively review and consider disclosure that is responsive to market events and conditions in documents that are not generally subject to staff review, such as automatically effective registration statements or prospectus supplements for takedowns from existing shelf registration statements.
In general, the Division recommends that public companies provide specific, tailored disclosure about the direct or indirect impact that recent bankruptcies and financial distress in the cryptoasset market have had on companies and their potential impact on investors. This includes any cryptoasset market developments material to an understanding or assessment of a company’s business, financial condition, and results of operations, or its share price (including any material impact from price volatility of cryptoassets).
The Division identifies other considerations that appear to target identifying systemic risk issues posed by other market participants’ bankruptcies or other failures that may be material to a public company depending on its business and/or exposure to the cryptoasset market, including the following:
- The impact of recent crypto company bankruptcies and whether a company has material assets that may not be recovered as a result of any of these bankruptcies or may be otherwise lost or misappropriated.
- A company’s exposure to other counterparties, customers, custodians, or crypto participants known to have filed for bankruptcy, become insolvent, experienced excessive redemptions, suspended redemptions or withdrawals, not accounted for customer cryptoassets, or experienced material corporate compliance failures.
- Steps a company takes to safeguard customer cryptoassets, including policies and procedures addressing self-dealing and conflicts of interest.
- A company’s policies and procedures that address the commingling of assets and whether the company has made changes to these policies and procedures or its processes in light of recent events.
- Whether a company itself has experienced excessive redemptions or withdrawals, or suspended redemptions or withdrawals, and the potential effects on the company’s financial condition and liquidity.
- Whether a company owns or has issued cryptoassets or holds cryptoassets on behalf of third parties and, if material, whether any such assets serve as collateral for loans or similar activities to which the company or its affiliates are a party. Importantly, the company must identify and quantify cryptoassets used in financing arrangements and disclose the nature of the company’s relationships for loans with parties (other than third parties) and whether there are encumbrances on the collateral.
- Whether a company, to its knowledge, has issued cryptoassets that are used as collateral for loans, margins, rehypothecations, or similar activity. If so, and if the current market events have impacted the value of the underlying collateral, the company must explain the material financing and liquidity risk that it faces.
- Whether risk factors need to be updated or otherwise provided to address (1) a company’s reputational harm, (2) material risks from unauthorized or impermissible customer access to the company’s products and services from restricted jurisdictions, (3) material legislation or regulation and its effect on the company’s business, financial condition, and results of operations, (4) safeguarding customer, company, and company affiliate cryptoassets and whether policies and procedures regarding such safeguarding are not effective, (5) gaps the company’s board of directors identified in risk management processes, (6) material financing or liquidity risk on the value of cryptoassets used as collateral by the company or others, and (7) other risks.
The sample letter represents the first instance wherein the Division has provided explicit and detailed guidance on disclosure considerations related to the cryptoasset markets outside of its typical filing review process. In a similar vein, in April 2022, the SEC’s Office of Chief Accountant issued Staff Accounting Bulletin No. 121, providing guidance to entities on accounting for obligations to safeguard cryptoassets that an entity holds for platform users.
Given the continuing evolution of the cryptoasset market and increasing regulatory scrutiny, public companies should proactively consider the issues identified by the Division.