Cryptocurrency in DC Plans
Fred Reish and Joan Neri (Art by Tim Bower)
Question: I’m a registered investment adviser who advises 401(k) plan committees about the investment options to be offered in their plan lineup. Some committee members are asking whether funds that invest in cryptocurrencies should be included among the offerings. Does the Employee Retirement Income Security Act permit 401(k) plans to offer such investment options?
Answer: ERISA does not explicitly limit the kinds of investments that may be offered for participant direction. However, plan fiduciaries, such as committee members, must satisfy the act’s duties of prudence and loyalty. In recent guidance, the Department of Labor has indicated that it has concerns about the prudence of offering cryptocurrency funds in 401(k) plans.
Under ERISA, the committee must act prudently in selecting investment options to be offered on the plan lineup. In Compliance Assistance Release 2022-01, the DOL explains its view of the prudence standard in the context of selecting investments in cryptocurrencies or in investment products whose values are tied to cryptocurrencies. Incidentally, a CAR does not constitute a law or a regulation. Instead, it is an expression of the DOL’s opinion.
In the CAR, the DOL says its view is that plan fiduciaries should exercise “extreme care” in selecting such investments; it observes that fiduciaries need to understand and evaluate the risks associated with cryptocurrency-related investments and should have the experience or expertise to evaluate those investment strategies, or should work with advisers who do.
In the CAR, the DOL lists and explains a number of risks and challenges that such investment products present, including the following:
Difficulty understanding and evaluating the cryptocurrency investment.
Evaluating and understanding these nontraditional investments without the requisite technical knowledge is challenging for most plan participants—even for expert investors. This means participants may be less able to make informed decisions about those investments.
Valuation issues.
There is disagreement among experts about the appropriate valuation methodology for cryptocurrencies. This challenge is compounded by the fact that cryptocurrency market intermediaries may not adopt the same accounting, reporting and data integrity requirements with respect to pricing. As a result, the DOL indicated, it has concerns about the reliability and accuracy of cryptocurrency valuations.
Custodial and recordkeeping challenges.
Cryptocurrencies are not held in a trust or custodial account, but instead generally exist as lines of computer code in a digital wallet; this may expose plans holding such investments to loss, hackers or theft.
Volatility.
Cryptocurrencies have been subject to extreme price volatility which could have a significant impact on participant accounts, especially for those participants who are close to retirement.
Evolving regulatory framework.
The evolving regulatory landscape regarding cryptocurrencies requires that fiduciaries consider the potential application of a wide range of regulatory requirements—e.g., those that apply to investments, issuance of such investments, trading and other activities.
In concluding, the DOL indicated that it would be conducting an investigative program aimed at plans that offer investment options in cryptocurrency and related products and take “appropriate action” to protect plan participants’ interests. In a surprising statement, the agency added that plan fiduciaries that allow such investments through brokerage windows “should expect to be questioned about how they can square their actions with their duties of prudence and loyalty in light of the risks” it has described.
This statement about brokerage windows is inconsistent with earlier DOL guidance, from 2012. In that guidance, which was issued in connection with the 404a-5 participant disclosure rules, the DOL stated that investments in brokerage windows are not designated investment alternatives. The agency explained that, while there’s a fiduciary duty to evaluate the provider of the brokerage window by taking into account the nature and quality of the services supplied in connection with the window, there is no fiduciary duty to monitor or evaluate the underlying investments as would be the case with designated investment alternatives.
Certainly, to monitor, track and prevent investment in cryptocurrencies and related products through a brokerage window would be burdensome and present significant challenges for plan fiduciaries. As stated above, the CAR is not a law but merely the DOL’s view. Hopefully, the agency will issue further guidance on this issue.
Fred Reish is chairman of the financial services ERISA practice at law firm Faegre Drinker Biddle & Reath LLP. Joan Neri, a nationally recognized expert in employee benefits law, is counsel in the firm’s financial services ERISA practice.