Ahead of today’s Congressional hearing on SEC oversight, Republicans urged Gensler to repeal SAB 121

Republican lawmakers have strongly demanded that the U.S. Securities and Exchange Commission repeal a controversial rule for banks that deal in cryptocurrencies.

Yesterday, September 23, a group of more than 40 members of Congress sent signed letters to the heads of four major U.S. regulators, requesting that the regulators communicate across agencies about a particularly controversial SEC bulletin due in 2022, known as SAB 121.

One of the letters was addressed to SEC Chairman Gary Gensler — just one day before Gensler was to join the rest of the SEC commissioners at a U.S. House Financial Services Committee hearing on the agency’s oversight. The timing and message were clear — ahead of today’s broader SEC oversight hearing, the letter had one specific focus for the SEC: “urging” Chairman Gensler to repeal Staff Accounting Bulletin No. 121.

The Fed Chair, the FDIC Chair, and the Acting Comptroller of the Currency also received letters from members of Congress regarding SAB 121.

The letters’ authors include House Financial Services Committee Chairman Patrick McHenry and crypto advocate Senator Cynthia Lummis. The letters’ signatories also include Republicans on the House Financial Services Committee and the Senate Banking, Housing and Urban Affairs Committee.

The letter to SEC Chairman Gensler contains clear and bold allegations that by issuing SAB 121, the SEC not only distorted its guidance guidelines, but also that the agency is stifling consumer protection and financial innovation in the United States with SAB 121:

“We urge you to repeal SAB 121 and work with Congress to ensure Americans have access to safe and secure custody arrangements for digital assets.”

What is SAB 121?

SAB 121 is an SEC staff bulletin published in April 2022. According to the SEC website, the bulletin does not represent official SEC guidelines or rules, but rather “staff interpretations.” The document makes it clear that the SEC views crypto custody as particularly high-risk compared to other assets. Given this risk, the agency argues in the bulletin that there should be specific rules for U.S. institutions that hold crypto custody.

The key guidance set forth in SAB 121 is that, first, any U.S.-regulated bank offering crypto custody must reflect cryptocurrency as a liability on its balance sheet. Second, as explained in the letter to Gensler yesterday, the bank must also maintain “a corresponding offset on its balance sheet measured at the fair value of the customer’s digital assets.” The letter continues with a scathing critique of the implications of the staff comment:

“This accounting approach, which deviates from established accounting standards, will fail to accurately reflect the custodian’s underlying legal and economic obligations and will place consumers at greater risk of loss.”

The “interpretive guidance” in SAB 121 also impacts banks’ accounting expenses (as it differs from their standard processes) and therefore prevents them from offering crypto custody services.

The result is particularly crippling for US crypto companies that need a banking partner that deals with crypto. As fewer banks are willing to work with crypto companies, it could be argued that US-based crypto startups are also being discouraged from doing business in the US, thereby weakening the potential for the US crypto industry to thrive.

SAB 121 draws criticism from crypto and Congress

In a letter to SEC Chairman Gensler yesterday, members of Congress outlined their criticism of the bulletin, echoing criticism from the broader crypto industry. The letter accuses the SEC of bureaucratic chicanery and claims that the regulator was able to bypass the notice and comment process required by the Administrative Procedure Act by issuing the rule under the guise of a “staff advisory”:

“SAB 121 was issued without consulting any of the prudential regulators.”

Moreover, the letter argues that requiring U.S. financial institutions to report liability for crypto custody specifically “deviates from established accounting standards.” As a result, the lawmakers argue that discouraging U.S. banks from storing crypto and working with crypto companies—given the high cost of complying with certain rules of SAB 121—puts U.S. consumers at risk.

The letter’s authors also note that rather than acknowledging the bulletin was a mistake and repealing it, the SEC’s Office of the Chief Accountant worked with certain agencies to evade balance sheet reporting requirements, leading to further backlash:

“These consultations, completed on a case-by-case and confidential basis, do not provide the transparency or certainty needed to ensure consistent application of SAB 121 requirements across institutions.”

Previous attempts to revise SAB 121 have failed

In February, four industry organizations asked the SEC to soften provisions of the document. The agency’s commissioner, Hester Peirce, called the bulletin and related management proposals a “noxious weed.”

In May, the Senate voted to repeal SAB 121. The bill also passed the House of Representatives. However, despite a bipartisan vote in Congress, in June President Joe Biden vetoed the bill that would repeal SAB 121, much to the dismay of the crypto community.

The House of Representatives attempted to override the veto on July 10, but fell short of the two-thirds majority of 60 votes needed to do so.

SEC introduces new rules of the game

Bloomberg reported, citing an SEC source familiar with the matter, that SEC staff have begun circulating advice among institutions and brokerages on how they can get around SAB 121 by avoiding reflecting cryptocurrencies as liabilities on their balance sheets.

Then this week, a sensational development emerged: The Bank of New York Mellon, the largest custodian bank in the United States, was reportedly granted an exemption from SAB 121. The report came from a legislative hearing in Wyoming last week. Politicians were quick to criticize the SEC’s Office of the Chief Accountant, accusing it of favoritism.

Bitcoin supporter MicroStrategy founder Michael Saylor also recently hinted that one or more mainstream banks could get the green light to store cryptocurrencies.

Is Operation Choke Point 2.0 coming to an end?

For years, under a Biden presidency, the crypto industry has been calling out U.S. regulators for pursuing what is widely known in the industry as Operation Choke Point 2.0 — a term coined by crypto VC and industry figure Nic Carter in 2022 to refer to the U.S. government’s unofficial assault on the crypto industry. The broad “operation” consists of a perhaps seemingly small set of policies, guidelines, and rules, such as SAB 121, which critics claim systematically discourages banks from dealing in cryptocurrencies.

While traditional financial institutions in the US are not explicitly prohibited from dealing in cryptocurrencies or crypto companies, the policies that make up Operation Choke Point 2.0 effectively discourage banks and other financial institutions from touching crypto. As a result of these policies, several banks that primarily deal in digital assets (most notably Signature Bank and Silvergate Bank) have been forced to close their businesses.

Rumors of the Bank of New York Mellon exemption and numerous calls to repeal SAB 121 (the latest example being yesterday’s letters) could mean that the easing of federal measures against cryptocurrencies in the US is gaining momentum.