The question of cryptocurrencies and blockchain investments in retirement plans
In general, cryptocurrency is a medium of digital or virtual exchange, which uses encryption techniques to control the creation of monetary units and to secure transactions on a blockchain. This heightened awareness of cryptocurrencies has led some participants and plan sponsors to inquire whether 401(k) plans could offer cryptocurrencies in a 401(k) plan’s fund lineup, as a designated investment alternative (DIA), or as part of a plan’s self-directed brokerage account (if offered by the plan).
On March 10, 2022, the DOL issued the release, which displayed a heavy dose of skepticism surrounding the prudence of permitting such investments as a DIA in a 401(k) plan fund lineup. The DOL went further in relaying its doubt in including the addition of cryptocurrency in self-directed brokerage accounts as well. The guidance also discusses new DOL enforcement activity for fiduciaries who permit participants to invest in cryptocurrencies within a 401(k) plan.
Unsurprisingly, the DOL began its analysis with the underlying fiduciary duties of prudence and loyalty that are owed to plan participants and beneficiaries under the Employee Retirement Income Security Act of 1974 (ERISA). The release noted that fiduciaries must act solely in the interests of plan participants and adhere to the prudent expert rule, which must be followed after the initial selection of an investment in a plan’s fund lineup and in the fiduciary duty to monitor the appropriateness of that investment in the plan. These duties are especially important in a defined contribution plan, where account values depend on the investment performance of contributions. Courts have frequently cited the fiduciary duties of prudence and loyalty as the “highest known to the law.”
Since 401(k) plans typically offer a menu of DIAs to participants, there’s an underlying fiduciary obligation to ensure the prudence of the DIAs and evaluate them on an ongoing basis. The responsibility to identify and avoid imprudent investment options can’t be shifted to plan participants. The fiduciary must evaluate the DIAs that are made available to participants and undertake to ensure that they continue to be prudent offerings. As noted by the U.S. Supreme Court in “Hughes v. Northwestern University,”1 “even in a defined-contribution plan where participants choose their investments … plan fiduciaries are required to conduct their own independent evaluation to determine which investments may be prudently included in the plan’s menu of options.” In addition to being liable for a fiduciary breach, a sponsor, committee, or financial professional selecting the fund can also be subject to personal liability for any losses to a plan as a result of that breach.
Risks and challenges of cryptoassets
In the release, the DOL expressed “serious concern” and warned that fiduciaries and service providers should exercise “extreme care” before offering cryptocurrency as an investment option in a 401(k) plan. The release underscores five specific risks and challenges that the DOL believes these alternative investments present.
- Speculative and volatile investments—The DOL noted that the Securities and Exchange Commission warned that investing in cryptocurrency is highly speculative and that cryptocurrencies are highly volatile in nature and subject to notable market volatility. Given the relatively early stage in development, the DOL noted that cryptocurrencies have been subject to a number of troubling issues, such as extreme price volatility, uncertainties associated with valuation, speculative conduct, reporting of fictitious trading, and published incidents of theft/fraud.
- The challenge for plan participants to make informed investment decisions—The release noted DOL concerns that the manner in which cryptocurrencies are marketed and valued is very different than standard 401(k) DIAs. It noted that these types of investments would lead inexperienced—and, perhaps, even experienced—investors to expect high returns without a detailed analysis of the risk they pose as long-term investments in a retirement plan. It noted the particular risk posed for participants nearing retirement or who may otherwise invest large percentages of—or all of—their 401(k) account in cryptocurrencies. Moreover, the addition of cryptocurrencies into a 401(k) plan’s fund lineup or brokerage account may lead the average plan participant to believe that experienced plan fiduciaries have approved the cryptocurrency option as a prudent option.
- Custodial and recordkeeping concerns—Unlike traditional plan assets, cryptocurrencies aren't held in trust or in custodial accounts, making them more difficult to value and track. In the release, the DOL noted its concerns that simply losing a password can result in the permanent loss of assets and that other methods of holding cryptocurrencies can leave participant accounts more vulnerable to cybersecurity issues, such as hacking a digital wallet and theft.
- Valuation concerns—The release notes DOL concerns about the reliability and accuracy of cryptocurrency valuations. It also argues that currently, proposed models for valuations aren’t as sound or academically defensible as traditional valuation methods for DIAs and that there’s disagreement among experts about important aspects of the cryptocurrency market. Making matters worse, cryptocurrency market intermediaries might not adopt consistent accounting treatment and may not be subject to the same reporting and data requirements related to pricing and valuation as more traditional investments.
- Evolving regulatory environment—Given the relative immaturity of the cryptocurrency market, coupled with increased investor interest, the fact that there’s a lack of clear regulatory control and compliance motivated the DOL to state that plan fiduciaries should take into account how cryptocurrencies are issued, appropriately valued, and insured. The DOL also noted that trading and/or regulatory requirements might affect investments by participants in 401(k) plans and should be taken into account. Fiduciaries must ensure that they avoid participating in unlawful transactions, which could expose them to liability and plan participants to the risks of inadequate disclosures and the loss of protections that are guaranteed under securities laws and regulations.
Self-directed brokerage beware
In a surprising turn away from the DOL’s prior guidance and position, the release goes on to suggest that fiduciaries who are responsible for allowing cryptocurrency investments through self-directed brokerage windows may be subject to the fiduciary duties of prudence and loyalty with respect to such investments as well. This position appears to denote a significant departure from the current understanding related to self-directed brokerage accounts because many federal courts have held that self-directed investments through brokerage windows aren’t subject to ERISA’s fiduciary duties. If the DOL’s language in the release is enforced, plan sponsors will likely face a substantial new burden in demonstrating prudence and loyalty if cryptocurrency is added to a 401(k) plan’s self-directed brokerage account.
DOL guidance on crypto in 401(k)s as alternative investments
The release ends by stating that the Employee Benefits Security Administration (EBSA), which is tasked with enforcing ERISA, is expected to conduct an investigative program aimed at plans that offer cryptocurrencies as DIAs and for plans that offer them through self-directed brokerage windows. The DOL also notes that the EBSA will take necessary action to protect the interests of 401(k) participants and beneficiaries with respect to investments in cryptocurrencies. Based on the language of the release, the DOL has clearly voiced strong concern about the prudence of offering cryptocurrencies in any form in a 401(k) plan. For the time being, the prudent fiduciary would be wise to proceed carefully when you consider adding cryptocurrency-related investments to a 401(k) plan despite a small number of providers beginning to offer them as investments to sponsors in light of this DOL guidance and their underlying duties of prudence and loyalty to plan participants and beneficiaries.
1 Hughes v. Northwestern University, 595 U.S. 7373, 743 (2022).
There is no guarantee that any investment strategy will achieve its objectives.
This is not intended to be an exhaustive review of one’s fiduciary duties under ERISA. The objective is to highlight the key responsibilities of a plan fiduciary and present the challenges that plan fiduciaries may face in discharging their duties. John Hancock is not in a position to provide you with legal advice concerning your plan or your role as plan fiduciary, and the information included herein should not be taken as such. If legal advice or other expert assistance is required, please consult your legal counsel.
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