Gensler Grilled: House Committee Questions SEC’s Crypto Custody Guidance and SAB 121

The heat was on for Gary Gensler, Chairman of the Securities and Exchange Commission (SEC), as he faced a grilling from the House Financial Services Committee on September 27th. Despite Gensler’s opening remark about enjoying these testimonies, the four-hour session was anything but enjoyable for him, dominated by sharp criticism of the SEC’s cryptocurrency policies and actions.

SAB 121 Under Scrutiny: Was the SEC Overreaching on Crypto Custody?

Among the barrage of concerns, Representative Mike Flood zeroed in on a particularly contentious issue: Staff Accounting Bulletin (SAB) 121. This bulletin, issued in March 2022, dictates how public companies—think banks, Robinhood, and Coinbase—should account for and disclose crypto assets they hold for customers.

Flood’s questioning brought to light some uncomfortable facts for the SEC:

• No Consultation: Gensler confirmed that the SEC didn’t consult with other financial regulators before releasing SAB 121.
• FASB Lagged Behind: The Financial Accounting Standards Board (FASB), the body setting accounting standards, hadn’t addressed digital asset custody when SAB 121 was issued. In fact, FASB only added digital asset accounting to its agenda after SAB 121 was published.

The Rulebook Riddle: What Existing Rules Justified SAB 121?

Flood pressed Gensler on the justification for SAB 121. Gensler had previously stated it was simply guidance on existing SEC rules. But what rules were those, Flood wanted to know?

Gensler pointed to:

• A 2009 rule about custody of digital assets by investment advisors.
• A rule finalized around special purpose broker-dealers in April 2021.

However, Flood countered with a critical point: “There were no SEC rules on the books that directly addressed the topic of custody of digital assets” at the time SAB 121 was issued. He highlighted that a specific rulemaking on custody, including digital assets, was only proposed in February 2023—after SAB 121—and is still not finalized.

In a nutshell, Flood argued:

“At the time when the bulletin was issued, there was no action by FASB, nor rulemaking by the SEC on this topic. […] The SEC’s justification for issuing the bulletin is based on accounting guidelines that did not exist when the bulletin was issued.”

This led Flood to a stark conclusion: either the SEC knowingly issued guidance without proper justification, or it was a significant error.

SAB 121: Regulation in Disguise or Necessary Guidance?

SAB 121 mandates companies to disclose technological, legal, and regulatory risks associated with holding digital assets for customers. It faced immediate backlash.

Even within the SEC, Commissioner Hester Peirce voiced strong dissent right after its release. A bipartisan group of senators, including crypto advocate Cynthia Lummis, sent a letter slamming SAB 121 as “regulation disguised as staff guidance.” Lummis and House Financial Services Committee Chair, Representative Patrick McHenry, further argued that SAB 121 actually increased risks for crypto holders.

Adding to the pressure, just a day before the hearing, Representatives Flood, Wiley Nickel, Tom Emmer, and Ritchie Torres urged Gensler to approve spot Bitcoin ETFs. While this wasn’t a central focus of the hearing, it underscored the broader tension surrounding crypto regulation.

Bitcoin ETF and Broader Concerns

Representative Nickel questioned Gensler about the Grayscale case, where Grayscale won an appeal against the SEC’s rejection of its Bitcoin ETF application. Gensler stated the SEC is “still under advisement” on the matter.

Representative Warren Davidson voiced concerns about the SEC’s approach to spot Bitcoin ETF applications following the Grayscale victory, fearing they wouldn’t be approved in the order received. Gensler simply reiterated that applications were under “active consideration.”

Further criticism came from Representative Emmer, who accused Gensler of being biased towards traditional financial institutions. Representative Torres challenged Gensler on his interpretation of the Howey Test, a crucial legal standard for determining if an asset is a security.

Key Takeaways from the Gensler Hearing

Gensler’s appearance before the House Financial Services Committee highlighted the growing tension between regulators and the crypto industry. Here are the main points:

• SAB 121 Controversy: The SEC’s crypto custody guidance faces significant pushback, with questions raised about its legal basis and impact.
• Regulatory Overreach?: Critics argue SAB 121 is an example of regulation by enforcement, bypassing proper rulemaking procedures.
• Bitcoin ETF Uncertainty: Despite a court ruling favoring Grayscale, the SEC’s stance on spot Bitcoin ETFs remains unclear.
• Broader Crypto Regulation Debate: The hearing underscored the ongoing struggle to establish clear and balanced crypto regulations in the US.

The hearing made it clear that the debate around crypto regulation is far from over. As the SEC navigates the complexities of digital assets, expect continued scrutiny and challenges from lawmakers and the crypto industry alike. The future of crypto regulation in the US hinges on finding a path that balances investor protection with fostering innovation.