What Does Fiduciary Review of Digital Assets Look Like?

David Kaleda

The issue of whether digital assets should be included in retirement plans covered by the Employee Retirement Income Security Act of 1974 has not gone away. President Donald Trump’s executive order issued last August and the Department of Labor’s proposed rule from April both support the notion that digital assets can be included in a participant-directed plan pursuant to the fiduciary provisions of ERISA.

Additionally, recent guidance from the Securities and Exchange Commission further provided a level of legal clarity that may encourage the inclusion of digital assets in investment portfolios. However, there continue to be substantial ERISA compliance and litigation risks associated with such investments. Plan advisers who understand the technology behind digital assets, the role digital assets may play in an investment portfolio and how ERISA applies will be invaluable to plan fiduciaries.

Trump’s executive order stated: “Every American preparing for retirement should have access to funds that include investments in alternative assets,” which include “holdings in actively managed investment vehicles that are investing in digital assets.” Notably, the order referred to the indirect investment in digital assets (i.e., through a fund), rather than a direct investment.

The order directed the DOL, in consultation with the SEC, to, among other things, issue regulations that establish “appropriately calibrated safe harbors” and other guidance that will enable plan fiduciaries to determine how digital assets and other alternative assets may be offered under plans in accordance with ERISA’s fiduciary requirements.

The DOL’s proposed rule provides a “safe harbor” pursuant to which a plan’s fiduciaries can comply with ERISA’s fiduciary duty of prudence under Section 404(a)(1)(B) of ERISA when making alternative assets available under the plan. The DOL referenced the definition of “alternative assets” in the order including the indirect investment in digital assets. However, the DOL intends that the proposed rule be investment neutral, in that it should apply to the selection of any designated investment alternative made available under the plan, regardless of the involvement of alternative assets.

The DOL’s Take

The DOL wrote that plan fiduciaries should evaluate possible DIAs in light of a “nonexclusive” list of six factors: performance, fees, liquidity, valuation, performance benchmark and complexity. Further, the DOL repeatedly noted that plan fiduciaries should engage appropriately qualified advisers to help them evaluate DIAs if they do not have the expertise to do so.

Remarkably, however, the DOL’s proposed rule did not speak to fiduciary review of direct or indirect investment in digital assets, by way of example or otherwise. Further, the DOL did not take an opportunity to further open the door to direct investment in digital assets through brokerage windows or similar features in 401(k) plans. The proposed rule stated that the brokerage window and the investments available through the window are not DIAs and thus not subject to the fiduciary analysis described therein.

The DOL also did not go so far as to say that a plan fiduciary has no ERISA fiduciary responsibility regarding investments available through the window. Thus, while the brokerage window is the most efficient way to introduce direct investment in digital assets in the near term, and some plans already avail themselves of this option, additional clarification by the DOL is needed to promote broader adoption. Hopefully, the DOL will further address these and other issues related to digital assets in the final regulation or other guidance.

SEC, CFTC Weigh In

The SEC and the Commodity Futures Trading Commission in March jointly issued a final interpretation, “Application of the Federal Securities Laws to Certain Types of Crypto Assets and Certain Transactions Involving Crypto Assets.” It did not provide guidance on whether investments in digital assets are under standards of conduct apart from ERISA applicable to investment advisers and other investment professionals (e.g., the Investment Advisers Act).

However, it addressed when certain digital assets may be a security and began to form a common nomenclature financial professionals can use to identify different types of digital assets, including digital commodities, digital collectibles, digital tools, stablecoins and digital securities. An understanding of the meaning of these terms and the underlying technologies associated therewith (e.g., the blockchain) is essential for advisers to properly guide their plan fiduciary clients on investments in digital assets or the use of digital assets in connection with plan investments.

Given the incredible growth of digital assets and related technologies, as well as the Trump administration’s promotion of the U.S. as a leader in digital assets, plan fiduciaries and participants will continue to express interest in digital assets. They will look to advisers to help them make appropriate investment decisions and, in fact, may have to do so to meet their ERISA fiduciary duties.

Unlike working with other assets, an adviser will have to be proficient in investment strategy and technology, as well as understand how to apply ERISA’s fiduciary principles. An adviser could not properly advise a plan fiduciary on direct or indirect investments in “digital commodities” with regard to the DOL’s proposed liquidity, valuation and complexity factors without understanding the differences in how cryptocurrency assets trade.

Digital assets have the potential to play a substantial role in retirement plans, but plan fiduciaries need advisers with appropriate expertise to help navigate substantial ERISA compliance and litigation risks.

David Kaleda is a partner in Eversheds Sutherland (U.S.) LLP.

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of ISS STOXX or its affiliates.