Cryptocurrency investing has experienced a tidal wave of popularity since the fabled genesis of Bitcoin in 2009. This growth has been fueled by “extreme” investment returns (despite “extreme” volatility) and innovative means of investing in cryptocurrency. As the wave of interest in cryptocurrency investing reaches the shores of 401(k) plans, including interest in cryptocurrency as a plan investment option or through plan brokerage windows, the US Department of Labor (DOL) warns 401(k) plan fiduciaries to exercise “extreme care” before providing plan participants with the opportunity to expose their retirement savings to cryptocurrency.
The Compliance Assistance Release
The DOL issued its first written guidance on cryptocurrency investments in Compliance Assistance Release No. 2022-01 (the Crypto Guidance) on March 10, 2022, noting that “cryptocurrencies” include a wide range of digital assets, including tokens, coins, crypto assets, and any derivatives thereof (e.g., cryptocurrency futures) offered under 401(k) plans as direct investments options, through investment products and/or through via brokerage accounts.
Largely consistent with DOL signaling from last fall, the Crypto Guidance explains that 401(k) plan fiduciaries must exercise “extreme care” when considering offering cryptocurrency investment options to plan participants.
Expressing “serious” concerns about the prudence of offering cryptocurrency investments to 401(k) plan participants, the Crypto Guidance outlines five significant risks and challenges that the DOL believes cryptocurrency investments present:
- Speculative and Volatile Investments: The DOL cites comments by the US Securities and Exchange Commission on the extremely speculative nature of cryptocurrencies and takes the view that price volatility in cryptocurrency due to difficult valuations, speculation, and other uncertainties could devastate the accounts of participants—especially participants close to retirement or those with large cryptocurrency allocations.
- The Challenge for Plan Participants to Make Informed Investment Decisions: The DOL notes that cryptocurrency is often marketed as an innovative and outperforming investment and warns that plan participants may not have the knowledge and experience to make informed decisions. The DOL takes the view that “[w]hen plan fiduciaries, charged with the duties of prudence and loyalty, choose to include a cryptocurrency option on a 401(k) plan's menu, they effectively tell the plan's participants that knowledgeable investment experts have approved the cryptocurrency option as a prudent option for plan participants. This can easily lead plan participants astray and cause losses.”
- Custodial and Recordkeeping Concerns: The DOL explains that cryptocurrencies pose unique custodial and recordkeeping issues because cryptocurrencies are not held in trust or custodial accounts. Observing that cryptocurrency investments can sometimes be lost if an investor forgets their password, the DOL also highlights that many methods of holding cryptocurrencies are also vulnerable to hackers, fraud, and theft.
- Valuation Concerns: Noting potentially unreliable and inaccurate cryptocurrency valuation methodologies, the DOL argues that no current proposed models for valuing cryptocurrencies are as sound or academically defensible as traditional valuation methods. The DOL also points out that valuation can be impacted when cryptocurrency market intermediaries do not follow consistent reporting, accounting, or data integrity requirements.
- Evolving Regulatory Environment: The DOL further recognizes that cryptocurrency is in an early stage of its history and that laws, rules, and regulations are evolving. Emphasizing that plan fiduciaries have a responsibility to ensure that all investment options comply with legal and regulatory requirements, the DOL points out that not all cryptocurrency market participants are currently regulated or law abiding. The DOL also cites comments by the Financial Industry Regulatory Authority about the potential for the use of cryptocurrencies in illegal commerce (e.g., drug dealing or money laundering) to harm investors if a law enforcement agency shuts down or restricts the use of cryptocurrency exchanges.
Changing Tides for Self-Directed Brokerage?
The surge of cryptocurrency investing has spawned cryptocurrency brokerage platforms that offer direct investments in cryptocurrency and novel investment products (such as investment trusts and exchange-traded funds) that offer exposure to cryptocurrency. Cryptocurrency brokerage platforms and cryptocurrency investment products are now available to be offered to plan participants as 401(k) plan investments options and/or through plan self-directed brokerage windows.
In a surprise break from previous guidance, the DOL suggests in the Crypto Guidance that plan fiduciaries who are responsible for allowing cryptocurrency investments through 401(k) brokerage windows may be subject to the fiduciary duties of prudence and loyalty with respect to such investments. Most federal courts that have faced the issue have agreed that investments offered through self-directed brokerage windows are typically not investment options subject to ERISA’s fiduciary duties. There is no specific DOL guidance on this issue, and the DOL’s previous statements on self-directed brokerage windows have generally not been read as imposing a fiduciary duty with respect to the investments offered in a brokerage window. If the Crypto Guidance indicates a change in the DOL’s stance on this issue, there could be much more far-reaching implications beyond cryptocurrency investments.
DOL Signals Investigations
The DOL ends the Crypto Guidance with statement that the Employee Benefits Security Administration expects to conduct investigations of 401(k) plans that offer investments in cryptocurrencies and related products. The DOL forewarns that plan fiduciaries who offer cryptocurrency investments under their 401(k) plans should expect DOL scrutiny of their fiduciary decision to offer these investments among the swell of risks and unknowns.
How Morgan Lewis Can Help
We will continue to monitor any additional DOL guidance and investigatory efforts and will provide updates as we learn more. Given the DOL’s interest in this topic, if you are considering adding cryptocurrency exposure to your 401(k) plan as an investment option or through your plan’s self-directed brokerage window, care may need to be taken to consider the DOL’s views. Please reach out to the authors or your primary contact on benefits matters at Morgan Lewis if you have additional questions.