United States: Disclosing Cryptocurrency Risks: SEC Comment Letter Puts Companies On Notice

The U.S. Securities and Exchange Commission (SEC) Division of Corporation Finance (CorpFin) recently issued guidance (Guidance), including a "Dear Issuer" Sample Letter (Sample Letter) to assist companies in meeting their statutory disclosure obligations in light of the recent crypto downturn.

Key Takeaways

• Public companies may have disclosure obligations under federal securities laws relating to the recent crypto market downturn and widespread bankruptcies in that industry. [1]
• Public companies with exposure to the crypto asset market should clearly disclose to their shareholders material impacts including:
  • overall exposure to the crypto market;
  • any risks related to liquidity; and
  • any risks related to legal proceedings or investigations.
• The Sample Letter can be used as a guide by companies when drafting or revising existing disclosure documents, including documents that are not typically subject to CorpFin's review, such as (i) automatically effective registration statements and (ii) prospectus supplements for takedowns from existing shelf registration statements.
• This Guidance provides insight into how CorpFin will assess the adequacy of public disclosures in light of the crypto downturn and, importantly, how the SEC's Division of Enforcement will likely evaluate such disclosures when bringing enforcement actions against public companies.

Summary

On December 8, 2022, in the midst of massive upheaval across crypto asset markets, CorpFin issued Guidance, together with a "Dear Issuer" Sample Letter, directed at companies with filing obligations under the Securities Act of 1933 and the Securities Exchange Act of 1934. The Guidance warns that the recent crypto asset downturn may require companies to disclose the direct or indirect material impact that such events may have on their business. The Sample Letter provides comments that CorpFin may send to companies during its selective review process of public filings. In sum, CorpFin urges companies to evaluate their current and ongoing public disclosures to better reflect crypto asset market exposure and risk.

Sample Letter

Broadly, the Sample Letter advises that companies should be transparent regarding their crypto asset market exposure and include in any public disclosures their (i) exposure to third-party crypto market participants, (ii) risks related to liquidity or ability to obtain financing, (iii) risks related to "legal proceedings, investigations, or regulatory impacts" within the crypto markets, and (iv) reputational harm that may result from recent market disruption. While the Sample Letter does not provide an exhaustive list of issues, it does provide the following areas that companies should consider including in disclosures, to the extent such information is material:

General

• Significant crypto asset market developments that are material to understanding or making an assessment of the company's business, financial condition, or share price.

Business Description

• Material impact that the bankruptcies of specific third-party crypto market businesses have had or may have on the company.
• Exposure to counterparties, customers, custodians, or other participants in crypto asset markets known to have:
  • filed for bankruptcy, been declared insolvent, had a receiver appointed, or made any assignment for the benefit of creditors;
  • experienced excessive redemptions or suspension of redemptions of crypto assets;
  • unaccounted for customer crypto assets;
  • experienced material corporate compliance failures.
• Steps taken to safeguard customers' crypto assets, including procedures put in place to prevent self-dealing, conflicts of interest, and commingling.

Management's Discussion and Analysis of Financial Condition and Results of Operations

• Whether the company has experienced excessive redemptions/suspensions of crypto assets and the effects of such on the company's financial condition and liquidity.
• The purpose of crypto assets issued or held on behalf of third parties (e.g., collateral) and the identity/quantity of the assets used, the nature of the relationship, any encumbrances on collateral, and whether current market events have materially affected collateral value.
• Whether company-issued crypto assets serve as collateral for a third party's loan, margin, or similar activity, and what, if any, impact crypto asset market disruption has had on the value of such collateral.

Risk Factors

• Reputational harm resulting from recent crypto asset market disruption, and whether this may impact the operations or financial condition of the company.
• Material risks the company may face from:
  • excessive redemptions, withdrawals, or suspensions of redemptions of crypto assets
  • impermissible customer access to the company's products/services outside of jurisdictions where the company is licensed/authorized to conduct business
  • crypto asset market regulatory developments (including pending regulation and legislation) and the assertion of jurisdiction by regulators or government entities over crypto assets
  • safeguarding affiliates' and customers' crypto assets
  • impact of crypto asset market disruption on the value of assets the company uses as collateral or the company's crypto assets used by others as collateral, and any material financing, liquidity, or other risks related thereto
  • any of the following due to crypto asset market disruption:
    • depreciation in stock price, crypto assets, or any other financing risk
    • loss of customer demand for products/services
    • increased losses or impairments in investments/assets
    • legal proceedings or government investigations
    • risk from price declines or price volatility of crypto assets
• Gaps identified in risk management as well as any proposed changes to address gaps.

Conclusion

With this Guidance, CorpFin has indicated that for companies to meet their disclosure obligations, they must analyze whether developments in the crypto asset market materially affect their business such that their public filings generally, and their business descriptions, risk factors, and management's discussion and analysis specifically, should be updated. The Sample Letter suggests that companies should be transparent with their filings and consider updating disclosures in light of information provided in prior disclosures. CorpFin further reminds companies that they are "responsible for the accuracy and adequacy" of their disclosures and that the actual details of disclosures depend on the companies' particular facts and circumstances.

Taken together, the Guidance and Sample Letter serve as an indication of what CorpFin will focus on in its review of public filings. Further, they may also serve as a strong harbinger of what the SEC's Division of Enforcement will be evaluating when deciding whether to bring disclosure-related enforcement actions.

Footnote

1. See Securities Act Rule 408 and Exchange Act Rule 12b-20, which provide that companies may need to make "such further material information as may be necessary to make the required statements, in light of the circumstances under which they are made, not misleading."

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.