September 29, 2023

HFS Representatives Propose Bipartisan Bill on Custody of Crypto

Steven Lofchie Commentary by Steven Lofchie

House Financial Services Committee members Mike Flood (R-NE), Ritchie Torres (D-NY), French Hill (R-AR) and Wiley Nickel (D-NC) introduced the Uniform Treatment of Custodial Assets Act. The proposed legislation would prohibit financial institutions from including crypto assets held in their custody as a liability on their balance sheet.

In a Press Release, Representative Flood stated that the proposed legislation is aimed at rescinding the SEC Staff Accounting Bulletin No. 121 which provides that a custodian must take onto its books as both assets and liabilities the entire value of the crypto assets it holds (see previous coverage). Representative Flood added that the proposed legislation would "ensure that assets custodied by banks, credit unions and trusts are kept off-balance sheet in line with longstanding practice."

In a Letter to House Financial Services Committee Chairs Patrick McHenry (R-NC) and Maxine Waters (D-CA), SIFMA expressed support for the proposed legislation stating that it is a "commonsense and bipartisan solution to a problem manufactured by the SEC." SIFMA argued that the proposed legislation would prevent the SEC from requiring banks to recognize digital assets as liability on their balance sheets and "restore the ability for banks to provide digital asset-related custody services for their clients."

Virtual Seminar/CLE

On October 4 at 2 pm (EDT), representatives from Fried Frank, Morrison Cohen and DLx Law will host a complimentary webinar on recent CFTC enforcement actions against three protocols that facilitated the trading of digital assets and the legal impact for the crypto industry. This program has been approved in accordance with the requirements of the New York State CLE Board for a maximum of 1.0 credit hour in Professional Practice.

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The question of how digital assets held in custody should be treated for accounting purposes must begin with how the obligation to return the digital assets should be treated in the bankruptcy of the custodian. If the "owners" of the digital assets have a right to their return and the digital assets are not available to other creditors of the bankrupt custodian, then the presumption is that the digital assets should not go on the custodian's balance sheet. Conversely, if the digital assets are effectively loaned to the custodian which can use them freely in the custodian's business, then the presumption would be that the digital assets should go on the custodian's balance sheet.

SAB Accounting Bulletin No. 121 ignores these fundamental presumptions and asserts that "the technological mechanisms supporting how crypto-assets are [held] . . . create significant increased risks to" the custodian. According to the SEC, this increased risk justifies forcing custodians, including banks, to hold the custodian assets on the bank's balance sheet. This statement does not hold up to inspection. It also happens to be inconsistent with SEC Chair Gensler's repeated assertion that regulation should be "technology neutral." 

Is the holding of digital assets so risky that banks can not be trusted to hold them safely? One strong indicator that it is not so dangerous is that the U.S. government is actively pursuing the creation of a CBDC. No one has argued that such creation is unworkable because there would be no way to custody the assets. In fact, the greatest risk with respect to the custody of digital assets arises because U.S. government policy has forced the custody of the assets out of regulated banks and into unregulated entities, such as FTX.

On October 4, I will host a complimentary webinar with Lewis Cohen of DLx Law and Jason Gottlieb of Morrison Cohen on the legal significance of recent enforcement actions against three protocols that facilitated the trading of digital assets.

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