Explained: The SEC bulletin that fueled a crypto conspiracy

Critics of the Securities and Exchange Commission (SEC) are honing in on an obscure rule introduced in a staff accounting bulletin, labeled SAB 121, that made it unusually difficult for banks to custody crypto.

Believers in Operation Chokepoint 2.0, a conspiracy theory that the US government conspired to impede the crypto industry’s access to banks, believe SAB 121 is evidence to support their claims.

The SEC published the staff accounting bulletin on March 24, 2022, and it went into effect the following month. Critics say the guidance makes digital asset custody services untenable for banks. State Street has $40 trillion in digital assets in custody for customers. If it followed the rules outlined in SAB 121, according to believers in Operation Chokepoint 2.0, it would have to effectively put assets worth more than the US national debt on its balance sheet.

However, this sensational interpretation misses the language of SAB 121 which, in fact, does not specify how much of a liability crypto custody incurs. It merely says “a” liability.

SAB 121 includes the disclaimer that its contents are specific departments’ interpretation of SEC policy, including its Division of Corporation Finance and the Office of the Chief Accountant. Nevertheless, many banks do follow SAB guidance voluntarily.

Read more: New York finance regulator says Operation Choke Point 2.0 is ‘ludicrous’

What SAB 121 actually says

In particular, theorists focus on this sentence from SAB 121: “as long as [a company] is responsible for safeguarding the crypto-assets held for its platform users, including maintaining the cryptographic key information necessary to access the crypto-assets, the staff believes that [a company] should present a liability on its balance sheet to reflect its obligation to safeguard the crypto-assets held for its platform users.”

In other words, SAB 121 introduced novel interpretive guidance from the SEC that crypto companies — including, presumably, crypto custodians like banks — should add a liability to their balance sheet when custodying crypto assets.

Operation Chokepoint 2.0 believers think this means a 100% liability, but SAB 121 doesn’t say that. It merely advises that safeguarding crypto assets incurs unique risks to the corporation, which should be reflected on that corporation’s balance sheet.

According to SAB 121, this liability should reflect the corporation’s risk of hacks, forks, loss of private keys, blockchain outages, and other crypto-specific risks.

BNY Mellon comments on SAB 121 and other rule making

Believers in Operation Chokepoint 2.0, like Castle Island Ventures partners Nic Carter and Matt Walsh, bemoan this burden and claim it unduly penalizes crypto relative to other assets held by custodians like gold, stock certificates, or jewelry.

The world’s largest custodian, BNY Mellon, custodies tens of trillions of dollars worth of assets and has shown interest in providing its services to bitcoin holders. In regulatory filings it argued that SAB 121, alongside other proposed rules like Rule 204-2, would make this exceedingly difficult.

Read more: Gary Gensler hasn’t always believed everything but bitcoin is a security

BNY Mellon filed a comment with the SEC indicating its opposition to its reporting requirements. It told the SEC that the new suite of requirements would “directly and fundamentally impact day-to-day operations of our business segments.”

Specifically, BNY Mellon claimed that a liability on-balance sheet “undercuts all of the previously-described benefits of the Proposal as it relates to digital assets.”

In a Congressional committee hearing, SEC chief Gary Gensler didn’t want to answer questions about whether he had consulted banking regulators before the SEC issued SAB 121.