Is Crypto Too Confidential for Your 401(k)?

    It started sometime last year and, in hindsight, was inevitable.  Clients with 401(k) plans and a crypto-savvy employee population began asking whether they could offer cryptocurrency as a plan investment option.  In the 401(k) world, where even a self-directed brokerage window with built-in investment limitations can be too risky, the answer seemed obvious – watch out!  Cryptocurrency is notoriously volatile and, quite frankly, confusing for many investors.  For that reason, it doesn’t seem to pair well with 401(k) retirement planning, where plan fiduciaries are charged with choosing investments that balance long-term growth with a certain level of stability and reasonable fees.

    Cryptocurrencies were first introduced in 2009 when Bitcoin software was released.  While there are many forms of cryptocurrency, they generally use blockchain technology and cryptography to secure transactions.  Likely due to the anonymity of transactions, the currency became attractive in the online black market, facilitating transactions for illegal drugs and false IDs.  It is also the currency of choice for threat actors, making seven-figure, sometimes eight-figure demands in connection with ransomware and other attacks.  However, some years later, Bitcoin, Ethereum, and other cryptocurrencies became more mainstream, valuations rose, and markets for trading these currencies emerged, such as Coinbase.

    Soon, the idea of offering cryptocurrencies as an investment option in a 401(k) plan gained traction.  After all, nothing under ERISA or the Internal Revenue Code expressly prohibits cryptocurrency from being included as a 401(k) plan investment option.  The Department of Labor is now weighing in, however, and recently released Compliance Assistance Release No. 2022-01 (Release), in which it “cautions plan fiduciaries to exercise extreme care before they consider adding cryptocurrency to a 401(k) plan’s investment menu for plan participants”.

    The Release expresses concern about the prudence of a fiduciary’s decision to expose participants to either direct investments in cryptocurrencies or other products tied to the value of cryptocurrencies for the following reasons:

    1. cryptocurrencies are highly speculative and volatile, which can have a devasting effect on participants—in particular those close to retirement;
    2. cryptocurrency is still new and can be confusing for plan participants who are hearing the anecdotes of big returns without necessarily understanding the risks involved;
    3. there are custodial and recordkeeping concerns since cryptocurrencies general exist as lines of computer code in a digital wallet, rather than in trust and custodial accounts like traditional 401(k) plan assets;
    4. there are concerns about the reliability and accuracy of cryptocurrency valuations—the methodology for which is still contested; and
    5. cryptocurrency regulation is still in flux—the Release provides the example that some cryptocurrency sales may constitute the unlawful sale of securities in unregistered transactions.

    The Release further indicates that the DOL expects to conduct an investigative program aimed at plans offering investments in cryptocurrency and related products and to “take appropriate action to protect the interests of plan participants and beneficiaries” regarding cryptocurrency investments.  Plan fiduciaries are put on notice that they must be ready to “square their actions with their duties of prudence and loyalty” in light of the risks set out by the Release.

    The stakes are high when plan fiduciaries make investment choices in any scenario, since a breach of their duties to, as the Release puts it, “act solely in the financial interests of plan participants and adhere to an exacting standard of professional care” can lead to personal liability for any losses to the plan resulting from that breach.

    This isn’t to say that cryptocurrency won’t eventually be accepted as a prudent 401(k) plan investment option.  But, for now, it’s probably wise for plan fiduciaries to hit the pause button.

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