Cryptocurrency And 401(k) Plans: DOL Implores Fiduciaries To Exercise Extreme Care – Employment and HR

On March 11, 2022, the U.S. Department of Labor (DOL) published
Compliance Assistance Release No. 2022-01 (CAR 2022-01) in order to
provide guidance for 401(k) plan fiduciaries who are considering
plan investments in cryptocurrencies. The strongly worded statement
reveals the agency’s heightened level of concern surrounding
cryptocurrency as plan investments, with the DOL cautioning
fiduciaries to “exercise extreme care” before they
consider adding a cryptocurrency option to a 401(k) plan lineup for
plan participants. Although CAR 2022-01 was released just one day
after President Biden signed an Executive Order outlining a
whole-government strategy to ensure responsible innovation in
digital assets, the use of cryptocurrency in 401(k) plan lineups
has been on the DOL’s radar at least since the summer of 2021.
At that time, there were statements from the Acting Assistant
Secretary for the DOL’s Employee Benefits Security
Administration (EBSA) that the agency viewed the use of
cryptocurrencies in the retirement plan context as a “very
troubling” development given its high volatility and limited
transparency.¹

According to CAR 2022-01, the DOL’s concerns about the
prudence of a fiduciary’s decision to expose a 401(k)
plan’s participants to direct investments in cryptocurrencies
or other products whose value is tied to cryptocurrencies stem from
the significant risks of fraud, theft and loss that have been
endemic to these asset classes at least as of this early stage in
their evolution. CAR 2022-01 elaborates on several aspects of
cryptocurrencies that are at the heart of the DOL’s
apprehensions:

• Cryptocurrencies’ highly speculative and volatile
  nature  – CAR 2022-01 cites investor education
  materials prepared by SEC staff that describe how cryptocurrencies
  have been subject to extreme price volatility, which may be due to
  the many uncertainties associated with valuing these assets,
  speculative conduct, the amount of fictitious trading reported and
  widely published incidents of theft and fraud, among other
  factors.




• Difficulty for participants to make informed
  decisions  – As the DOL explains, cryptocurrencies
  are substantially different from typical retirement plan
  investments, and it can be extraordinarily difficult-even for
  expert investors-to evaluate these assets. The DOL is concerned
  that participants will be less likely to have sufficient knowledge
  about these investments or will lack the technical expertise
  necessary to make informed decisions about investing in them.
  Moreover, CAR 2022-01 describes how a fiduciary’s decision to
  include a cryptocurrency option on a 401(k) plan’s menu may be
  misconstrued by participants as an endorsement of these asset
  classes as prudent options for plan participants.




• Custodial and recordkeeping issues
  presented – Unlike traditional plan assets that are
  held in trust or custodial accounts, readily valued and available
  to pay benefits and plan expenses, cryptocurrencies generally exist
  as lines of computer code in a digital wallet. In that sense, it is
  unclear how ERISA’s indicia of ownership and trust requirements
  can be satisfied with these assets, because with some
  cryptocurrencies, losing or forgetting a password can result in
  permanent loss of the assets, and other methods of holding
  cryptocurrencies can be vulnerable to hackers and theft.




• Valuation concerns – CAR 2022-01 also
  describes the difficulty of generating accurate and reliable
  valuations for cryptocurrencies. In particular, the release
  mentions how there is expert disagreement about important aspects
  of the cryptocurrency market, noting that none of the proposed
  models for valuing cryptocurrencies are as sound as traditional
  discounted cash flow analysis for equities or interest and credit
  models for debt. Furthermore, cryptocurrency market intermediaries
  may not adopt consistent accounting treatment, and they may not be
  subject to the same reporting and data integrity requirements with
  respect to pricing as other intermediaries working with more
  traditional investment products.




• Evolving regulatory landscape – According
  to the DOL, the current regulatory landscape governing the
  cryptocurrency markets is rapidly evolving, and some participants
  may be operating outside of existing regulatory frameworks or not
  complying with them. CAR 2022-01 makes clear that the DOL expects
  fiduciaries who are considering whether to include a cryptocurrency
  investment option to analyze how regulatory requirements may apply
  to issuance, investments, trading, or other activities and how
  those regulatory requirements might affect investments by
  participants in 401(k) plans. Moreover, given the widespread use of
  Bitcoin and other cryptocurrencies in illicit activities,
  fiduciaries must take into consideration the real possibility that
  law enforcement agencies could shut down or restrict the use of
  platforms and exchanges, thereby limiting or shutting off the
  ability to use or trade Bitcoins.

Key Takeaways

CAR 2022-01 concludes by indicating that EBSA expects to conduct
an investigative program aimed at plans that offer participant
investments in cryptocurrencies and related products, and to take
appropriate action to protect the interests of plan participants
and beneficiaries with respect to these investments. Furthermore,
as part of this probe, the DOL will examine how plan fiduciaries
responsible for overseeing such investment options or allowing such
investments through brokerage windows are satisfying their duties
of prudence and loyalty under ERISA in light of the significant
concerns the DOL articulates in CAR 2022-01.

While there has been increasing demand on the part of individual
investors to add cryptocurrency exposure to their retirement
accounts,² the DOL’s unequivocal position in
CAR 2022-01 on the riskiness of cryptocurrencies as plan investment
options will likely have a chilling effect on this nascent market.
That said, CAR 2022-01 focuses on the use of cryptocurrencies in
401(k) plans-how exactly the agency’s position will apply to
the defined benefit plan space is unclear. Additionally, the
guidance appears to home in on a 401(k) plan fiduciary’s
decision to expose participants to direct investments in
cryptocurrencies. Whether some of the agencies’ concerns can be
mitigated by indirect investments in funds that have cryptocurrency
exposure-perhaps even minimal exposure that would be subject to a
strict cap-is also unclear at this time.

While the DOL has not created a flat prohibition on offering
401(k) participants exposure to cryptocurrency and digital assets,
in light of the DOL’s strong wording and warning of new
investigative efforts, plan fiduciaries who remain interested in
pursuing these investment options are advised to exercise a very
high level of care in all decision-making, and to produce
sufficient documentation of that decision-making process.

Footnotes

1. Ted Godbout, “Khawar: Cryptocurrency Guidance on
the Horizon” National Association of Plan Advisors, July 28,
2021, available at https://www.napa-net.org/news-info/daily-news/khawar-cryptocurrency-guidance-horizon.

2. Anne Tergesen, “Saving for Retirement? Now You
Can Bet on Bitcoin,” Wall Street Journal, June 25, 2021,
available at https://www.wsj.com/articles/saving-for-retirement-now-you-can-bet-on-bitcoin-11624613435.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.