On March 10, 2022, the Department of Labor’s Employee Benefits Security Administration (EBSA) released compliance guidance that cautions plan fiduciaries to exercise extreme care before they consider adding a cryptocurrency option to a 401(k) plan’s investment menu for plan participants. The guidance would apply to a wide range of cryptocurrencies and digital assets, including those marketed as tokens, NFTs, coins, crypto assets and any derivatives thereof. These investments present significant risks and challenges to participants’ retirement accounts, including significant risks of fraud, theft and loss. The compliance effort is aimed at protecting the retirement savings of workers, EBSA Acting Assistant Secretary Ali Khawar said in a news release.
Under ERISA, fiduciaries must act solely in the financial interests of plan participants and adhere to an exacting standard of professional care. Fiduciaries who breach prudence and loyalty duties are personally liable for any losses to the plan resulting from that breach. 401(k) plan fiduciaries must evaluate the designated investment alternatives made available to participants and take appropriate measures to ensure that they are prudent.
EBSA detailed at least five concerns about the prudence of a fiduciary’s decision to expose 401(k) plan participants to investment products whose value is tied to cryptocurrencies. Compliance Assistance Release No. 2022-01 outlined reasons why cryptocurrencies can present serious risks to retirement savings, including:
- Speculative and volatile investments. Prices can change quickly and dramatically. Extreme volatility can have a devastating impact on participants, especially those approaching retirement and those with substantial allocations to cryptocurrency. The Securities and Exchange Commission (SEC) named crypto assets among the areas it believes present the highest risks to investors for 2022.
- Making informed decisions—Challenges for participants. Cryptocurrencies can easily attract investments from inexperienced plan participants with expectations of high returns and little appreciation of the risks the investments pose. It can be very hard for ordinary investors to separate fact from hype. Case in point: Having clear knowledge about cryptocurrency was a financial education gap across all generations, according to the 2022 Investopedia Financial Literacy Survey. When asked what asset they expect to yield the greatest returns for them over the next decade, Millennials, Gen Z and Gen X said cryptocurrency, followed by stocks. When fiduciaries, charged with the duties of prudence and loyalty, include a cryptocurrency option on a 401(k) plan menu, it signals to participants that knowledgeable investment experts have approved it as a prudent option. This can mislead participants about the risks and cause big losses.
- Recordkeeping concerns. Cryptocurrencies are not held like traditional plan assets in trust or custodial accounts, readily valued and available to pay benefits and plan expenses. Instead, they generally exist as lines of computer code in a digital wallet. With some cryptocurrencies, simply losing or forgetting a password can result in the loss of the asset forever. Cryptocurrency holders can be vulnerable to hackers and theft.
- EBSA is concerned about the reliability and accuracy of cryptocurrency valuations. Experts have described the question of how to appropriately value cryptocurrencies as complex and challenging. Experts have fundamental disagreements about important aspects of the cryptocurrency market, noting that none of the proposed models for valuing cryptocurrencies are as sound or academically defensible as traditional discounted cash flow analysis for equities or interest and credit models for debt. These concerns are compounded by the fact that cryptocurrencies are not typically subject to the same reporting and data integrity requirements that apply to more traditional investment products.
- Evolving regulatory landscape. Rules governing the cryptocurrency markets may be evolving, and some market participants may be operating outside of existing regulatory frameworks or not complying with them. Fiduciaries who are considering whether to include a cryptocurrency investment option will have to include in their analysis how regulatory requirements may apply to issuance, investments, trading or other activities as well as how they might affect investments by participants in 401(k) plans. For example, the sale of some cryptocurrencies could constitute the unlawful sale of securities in unregistered transactions. Plan fiduciaries must take care to avoid participating in unlawful transactions, exposing themselves to liability and plan participants to the risks of inadequate disclosures and the loss of investor protections that are guaranteed under the securities laws.
What’s Next? Upcoming EBSA Investigations and SEC Examinations.
Based on the above concerns, 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. The plan fiduciaries responsible for overseeing such investment options or allowing such investments through brokerage windows should expect to be questioned about how they can square their actions with their duties of prudence and loyalty, the guidance said.
Meanwhile, the SEC will conduct examinations of broker/dealers and advisers using crypto assets and emerging financial technologies to review whether they considered the potential risks involved when designing their compliance programs. The SEC Division of Examinations will conduct examinations of mutual funds and exchange-traded funds (ETFs) offering exposure to crypto assets to assess compliance, liquidity and operational controls around portfolio management and market risk.
We will be closely monitoring and analyzing this week’s rapid developments in the crypto-retirement space and updating this post with key takeaways.
Developed by International Foundation Information Center staff. This does not constitute legal advice. Please consult your plan professionals for legal advice.
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Our Defined Contribution Plans Committee was just reviewing information about cryptocurrencies with our Investment Consultant and discovered our participants are able to invest in cryptocurrencies indirectly within our Self-Directed Brokerage Account. We are very concerned about participants investing in cryptocurrencies with their retirement savings and are considering issuing an educational notice. However, we do not want to give advice or unintentionally pique interest in using the self-directed brokerage account for this purpose. I’m wondering if anyone else has considered this issue and has any suggestions?
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