Long SEC Reviews Quarterly Update # 3
Yet another crypto company reported unresolved SEC comments related to revenue recognition practices, suggesting that revenue recognition is an industry-wide concern flagged by the SEC.
What are unresolved SEC comments, and why are they important?
SEC comment letters refer to issues or concerns the U.S. Securities and Exchange Commission raised during the regulatory review of publicly traded companies' financial reports, particularly in their 10-K and 20-F filings. The routine reviews aim to enhance transparency, accuracy, and compliance in these companies' accounting and disclosure practices.
When the SEC identifies deficiencies or unclear aspects in a company's financial reports, it issues comment letters to request clarification or corrections. Companies are expected to address these comments promptly within ten business days of receiving the comments. The number of comments received, and the time taken to address them (duration) are often used as metrics in academic literature to evaluate the significance of concerns raised by the SEC (Cunnigham and Leidner, 2022). While SEC comments are typically resolved within 40 to 60 days and through one or two rounds of comments, some inquiries remain unresolved for an extended period, sometimes up to a year.
Companies are generally not required to disclose ongoing SEC reviews. However, "Item 1B Unresolved Staff Comments" of 10-K filings requires companies to report unresolved SEC comments issued at least 180 days before the fiscal year-end. This extended duration of unresolved comments could indicate more complex or significant issues that require additional time and effort to rectify (see further discussion of outcomes of unresolved SEC comments here).
Item 1B Unresolved SEC comments – quarterly update # 3 for the quarter ending June 30, 2024
Three companies disclosed unresolved SEC comments during the June 30, 2024, quarter.
Greenidge Generation Holdings Inc. (Ticker: GREE) disclosed on April 10, 2024, that during fiscal 2023, the company received SEC comments on recognizing Bitcoin revenue using fair value on the day of receipt versus contract inception, and on using a price-tracking website CoinMarketCap as a designated principal market for fair value measurement purposes. In both cases, the Company acknowledged that the existing policy violates accounting rules but noted that the misstatements were immaterial to previously filed financial statements.
The company previously recognized cryptocurrency data center revenue measuring the fair value of the consideration received on the date of the liquidation. This accounting method violates paragraph ASC 606-10-32-21, which requires fair value measurement at the inception date. While the company agreed to change the policy prospectively, it noted that the misstatement is quantitatively immaterial to the previously filed financial statements because it amounts to less than 0.5% of the data center’s revenue.
In a separate set of comments, the SEC requested more clarity about which market is used as the principal market in determining quoted prices of the digital assets. The company previously used a price-tracking website, CoinMarketCap, to determine prices. The SEC noted that CoinMarketCap does not qualify as a principal market because the pricing website “…is not a market where digital assets can be traded but instead is a website where exchange/trading platform market information is aggregated”. The Company agreed to designate a trading platform, Coinbase, as a principal market but noted that using Coinbase would not result in material differences in fair value for impairment purposes.
Based on my review of SEC comment letters to GREE, which were publicly released on EDGAR on May 22, 2024, the SEC also requested:
A more detailed risk factor discussion related to the impact of turmoil in the crypto industry after the FTX bankruptcy;
More clarity around calculations of certain KPIs;
An enhancement of disclosure related to impairments of long-term equipment;
An explanation of how the cash flow from digital activity is reflected on the statement of the cash flow.
The conversation with the SEC span over 316 days and included 19 back-and-forth letters.
Notably, each of my past four Long SEC Reviews alerts featured at least one crypto company that was unable to resolve SEC revenue recognition concerns within 180 days.
See my previous updates for a discussion of SEC comments to Stronghold Digital Mining, Inc. (Ticker: SDIG), Marathon Digital (Ticker: MARA), and Cleanspark, Inc. (Ticker: CLSK).
Terawulf also received SEC comments on revenue recognition practices but did not have to provide Item 1B disclosure because the comments were resolved in 93 days.
The second company, SMC Entertainment, Inc. (Ticker: SMCE), disclosed on April 15, 2024, that the SEC had concerns about an incorrect set of financial statements of Fyniti Global Equities EBT Inc. included by the Company in its Form 10-12g registration statements. Additionally, Corp Fin noted that, based on the information disclosed, the SEC was unable to recalculate the consideration paid for Fynity.
Finally, CIM Opportunity Zone Fund, L.P. disclosed on April 22, 2024, that in the process of reviewing the Company’s Form 10-12G registration statement, the SEC identified an incorrect application of ASC 946. The accounting errors were related to a presentation of the Fund’s assets and liabilities at fair value versus historical costs. The comment letters were publicly released on EDGAR on June 6, 2024.
Longest SEC reviews and limitations of Item 1B Unresolved SEC Comments requirements
Item 1B disclosure is important because it alerts investors about material outstanding issues raised by the regulators while the review is still ongoing and before SEC comments are publicly released on EDGAR. Yet, Item 1B has several limitations: