SEC Wind Chill During “Crypto Winter”

The so-called “crypto winter” that started this past summer and has continued with vigor—most recently with the bankruptcy of FTX—has potential to have widespread impact in the financial services and investment communities. Yesterday, the staff of the US Securities and Exchange Commission’s (SEC) Division of Corporation Finance (CorpFin) urged public companies to assess how recent crypto developments have impacted their business and to disclose those effects to investors. While this guidance has no legal force or effect, it offers CorpFin’s interpretation of compliance with current applicable law.

In its announcement, the CorpFin staff acknowledged “recent bankruptcies and financial distress among crypto asset market participants have caused widespread disruption in those markets” and noted that “[c]ompanies may have disclosure obligations under the federal securities laws related to the direct or indirect impact that these events and collateral events have had or may have on their business.” They further advised companies to provide investors with a “specific, tailored disclosure about market events and conditions, the company’s situation in relation to those events and conditions, and the potential impact on investors.” Notably, the staff indicated that companies with ongoing reporting obligations also should consider if their existing disclosures need to be updated. We believe that SEC staff will focus on steps taken (or not taken) by companies to update disclosures as necessary in the aftermath of recent events.

CorpFin also posted to its website a sample letter that it may send to reporting companies with illustrative questions and guidance about their crypto asset disclosures. The letter breaks down CorpFin’s questions among the following key sections of a reporting company’s periodic reports: Business, MD&A and Risk Factors, with a significant focus on a variety of risk-related matters. In particular, CorpFin asks companies, for instance, to disclose their relationship with other firms, including any direct or indirect exposures to, among others, counterparties and customers, that have filed for bankruptcy, have experienced excessive redemptions or suspended redemptions or withdrawals of crypto assets, have crypto assets unaccounted for, or experienced “material corporate compliance failures.” While CorpFin’s guidance stated that its list of questions is not exhaustive, it nevertheless urged companies to take the sample letter into consideration when preparing disclosure documents. CorpFin also said companies should discuss taking steps to further safeguard customer crypto assets and governance protocols set in place to prevent self-dealing and other potential conflicts of interest. CorpFin further recommended that companies discuss whether recent market conditions have affected how their reputation is perceived, whether gaps have been identified in risk management process and procedures in light of current market conditions, how pending crypto regulation could affect financial conditions, and how disruptions in the crypto asset markets could lead to such things as share price depreciation, loss of customer demand, increased losses or impairments to investments or other assets, legal proceedings “pending or known to be threatened,” or crypto asset price declines or volatility.

CorpFin’s announcement and sample letter is the latest in a series of moves by the agency to highlight its disclosure expectations applicable to corporations, investment companies, funds, managers and advisors in the context of the crypto asset markets. In March 2022, the SEC issued Staff Accounting Bulletin No. 121, which provided interpretive guidance from the staff in CorpFin and the SEC’s Office of the Chief Accountant for entities to consider when they have obligations to safeguard crypto-assets held for their platform users. In September 2022, Chair Gensler spoke at length about crypto regulation during the annual SEC Speaks event, which was followed shortly thereafter by the addition of an Office of Crypto Assets to CorpFin’s Disclosure Review Program.

Reporting companies should expect the staff of CorpFin to review the next round of annual reports for responses to the items raised in the SEC letter. The CorpFin announcement and sample letter also may signal that the SEC is gearing up to bring enforcement actions for materially misleading disclosures over the impacts of recent crypto asset events, after the agency announced that it renamed and nearly doubled the size of its Enforcement Division’s Crypto Assets and Cyber Unit in May 2022. That announcement reminded companies that they “must disclose ‘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.’” In light of recent developments, steps should be taken now to consider if revisions are necessary to current disclosures to prevent potential future enforcement inquiries as well.

With former senior SEC enforcement officials Dan Hawke, Jane Norberg and Christian Schultz, our firm has been monitoring these developments and is well-positioned to assist in preparing required disclosures and responding to inquiries and requests from government agencies about connections to recent bankruptcies and other financial distress in the crypto space.

We will continue to monitor and report on the key enforcement and regulatory developments at the SEC. In the meantime, please reach out to any author of this Advisory or your regular Arnold & Porter contact with any questions about the issues discussed herein or the state of play at the Commission. 

© Arnold & Porter Kaye Scholer LLP 2022 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.