Investing in cryptocurrencies has seen a tidal wave of popularity since Bitcoin’s legendary genesis in 2009. This growth has been fueled by “extreme” investment returns (despite “extreme” volatility) and innovative ways to invest in cryptocurrencies. As the wave of interest in investing in cryptocurrency reaches the shores of 401(k) plans, including interest in cryptocurrency as an investment option within the plan or through plan brokerage windows, the US Department of Labor (DOL) is warning 401(k) plan trustees to exercise “extreme care” before giving plan participants the option to expose their retirement savings to crypto- change.

The compliance help version

The DOL released its first written guidance on cryptocurrency investments in Compliance Assistance Release #2022-01 (the Crypto Guidance) on March 10, 2022, noting that “cryptocurrencies” include a broad range of digital assets, including tokens, coins, crypto-assets, and all their derivatives (e.g., cryptocurrency futures) offered under 401(k) plans as direct investment options, through investment products and/or through brokerage accounts.

Largely consistent with DOL signaling last fall, the Crypto Guidance explains that 401(k) plan trustees should exercise “extreme caution” when considering offering investment options in cryptocurrency 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:

  1. Speculative and volatile investments: The DOL cites the comments of the United States Securities and Exchange Commission on the highly speculative nature of cryptocurrencies and believes that the volatility of cryptocurrency prices due to difficult valuations, speculation and other uncertainties could devastate participants’ accounts, especially those nearing retirement. or those with large cryptocurrency allocations.
  2. The challenge for plan members to make informed investment decisions: The DOL notes that cryptocurrency is often marketed as an innovative and successful investment and warns that plan participants may lack the knowledge and experience to make informed decisions. The DOL believes that “[w]When plan trustees, charged with the duties of care and loyalty, choose to include a cryptocurrency option on the menu of a 401(k) plan, they are effectively informing plan participants that knowledgeable investment experts endorsed the cryptocurrency option as a conservative option for plan participants. This can easily mislead plan participants and lead to losses.
  3. Custody and record keeping 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 points out that many methods of holding cryptocurrencies are also vulnerable to hackers, fraud, and theft.
  4. Assessment issues: Noting potentially unreliable and inaccurate cryptocurrency valuation methodologies, the DOL argues that no model currently proposed for valuing cryptocurrencies is as robust or academically defensible as traditional valuation methods . The DOL also points out that valuation may be affected when cryptocurrency market intermediaries fail to adhere to consistent reporting, accounting, or data integrity requirements.
  5. Changing regulatory environment: The DOL further recognizes that cryptocurrency is at an early stage in its history and laws, rules and regulations are evolving. Emphasizing that plan trustees 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 compliant. laws. The DOL also cites comments from the Financial Industry Regulatory Authority on the potential for cryptocurrencies to be used in illegal commerce (e.g., drug trafficking or money laundering) to harm investors if an agency charged with law enforcement closes or restricts the use of cryptocurrency exchanges.

Change of tide for self-directed brokerage?

The rise of cryptocurrency investing has spawned cryptocurrency brokerage platforms that offer direct cryptocurrency investments and new investment products (such as investment trusts and currency-traded funds). exchange) 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 investment options and/or through windows of the plan’s self-directed brokerage.

In a surprise departure from previous guidance, the DOL suggests in the Crypto Guidance that plan fiduciaries who are responsible for authorizing cryptocurrency investments through 401(k) brokerage windows may be subject to the fiduciary duties of prudence and loyalty with regard to these investments. Most federal courts that have faced the issue have agreed that investments offered through self-directed brokerage windows are generally not investment options subject to the fiduciary obligations of ERISA. There is no specific DOL guidance on this issue, and previous DOL statements on self-directed brokerage windows have generally not been interpreted to impose a fiduciary duty with respect to proposed investments in a window. brokerage. If the Crypto Guidance indicates a change in the DOL’s stance on this issue, there could be far greater implications beyond cryptocurrency investments.

DOL Signal Investigations

The DOL ends the Crypto Guidance with a statement that the Employee Benefits Security Administration plans to conduct investigations into 401(k) plans that offer investments in cryptocurrencies and related products. The DOL warns that plan fiduciaries who offer cryptocurrency investments as part of their 401(k) plans should expect scrutiny by the DOL of their fiduciary decision to offer these investments amid the swell of risks and unknowns.

How Morgan Lewis can help you

We will continue to monitor any additional DOL guidance and investigative efforts and 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 , it may be necessary to consider the views of the DOL. Please contact the authors or your primary benefits contact at Morgan Lewis if you have any additional questions.