Beware Crypto Firms Using Proof of Reserves “Audits”, Warns SEC

The Securities and Exchange Commission (SEC) is taking a firm stance against crypto accounting firms that are promoting their work as a substitute for proper audits. In a warning issued by Paul Munter, the principal advisor to the SEC on accounting and auditing matters, he highlighted the potential pitfalls of purported crypto “assurance” work and its misleading nature. This article delves into the significance of the SEC’s warning, the concerns surrounding Proof of Reserves (PoR) reports for crypto exchanges, and the implications for accountants and investors alike.

In his statement titled “The Potential Pitfalls of Purported Crypto ‘Assurance’ Work,” Munter emphasized that some crypto accounting firms were marketing their services as being at “parity” with financial statement audits, which is simply not true. Non-audit arrangements lack the rigorous and comprehensive nature of a financial statement audit, and therefore, they may not provide reasonable assurance to investors.

Understanding Proof of Reserves (PoR) Reports

PoR is a blockchain-based accounting method that certain crypto exchanges have adopted to verify the number of crypto assets they hold. While it can serve as a transparency measure, the Public Company Accounting Oversight Board (PCAOB) issued a warning about PoR reports, stating that they are not audits. One of the significant limitations of PoR reports is their failure to account for a crypto firm’s liabilities and other essential factors.

The SEC’s warning highlights the risks that investors may face when relying on misleading assurance work offered by crypto accounting firms. Investors could be under the false impression that their investments have undergone a thorough and independent examination when, in reality, they have not. This lack of scrutiny may expose investors to potential fraud or misrepresentation, undermining the integrity of the crypto market.

Liabilities Under Securities Laws

Paul Munter’s statement also draws attention to the potential liabilities that accounting firms servicing crypto clients may face if their work misleads investors. Under securities laws, accountants could be held accountable for any misleading statements made by their clients. This puts additional pressure on accounting firms to ensure that their services are accurately represented and do not overstate their level of scrutiny.

The Office of the Chief Accountant (OCA) recommends a “noisy withdrawal” strategy for accounting firms whose clients make misleading statements. This approach involves publicly disassociating themselves from the client and the inaccurate claims made by the client. By doing so, accounting firms can maintain their credibility and demonstrate their commitment to adhering to the highest standards of professional conduct.

The warning from the SEC serves as a reminder of a similar incident involving Mazars Group in December 2022. The firm distanced itself from all crypto firms shortly after releasing a PoR report on Binance. This withdrawal was likely driven by concerns about the potential risks and liabilities associated with PoR reports.