Cryptocurrency in 401(k) plans? Might Look More Like “Crypto-nite,” Says DOL in Latest Release | Proskauer – Blockchain and the law

Kryptonite is a fictional substance that causes the mighty Superman to lose all of his strength. According to a recent release from the US Department of Labor Employee Benefits Security Administration (“DOL”), cryptocurrency could pose similar dangers to otherwise strong and healthy 401(k) plan accounts. In other words, according to DOL, the benefits of cryptocurrency in 401(k) plans can turn out to be just as fictitious as kryptonite, thus leading to significant risks of losses for retirement security.

On March 10, 2022, the DOL released Compliance Assistance Release #2022-01 (the “To free”) to warn plan trustees to exercise extreme caution before considering including investment options such as cryptocurrency on a 401(k) plan’s investment menu. In doing so, DOL raised five key concerns associated with offering these types of investment options.

DOL’s 5 reasons why cryptocurrencies could be like “Crypto-nite” for participants’ retirement accounts:

  1. Digital assets are highly speculative and volatile

After noting that the SEC has also warned of the highly speculative nature of cryptocurrency, DOL warned that the extreme price volatility of cryptocurrency investments can have a devastating impact on participants with large allocations. to cryptocurrency. According to DOL, this volatility could be attributable to the many uncertainties surrounding the valuation process, fictitious business practices and widely published reports of theft and fraud, among other factors.

  1. Barriers prevent participants from making informed decisions

The statement noted that cryptocurrencies are often presented to investors as “innovative investments” that offer “unique potential for outsized profits”; which results in participants having high return expectations with little appreciation for the unique risks and volatility associated with cryptocurrencies. DOL also pointed out that these investments lack the traditional types of data that novice and expert investors rely on to adequately assess potential future investment options.

Additionally, the statement claimed that the recent increase in social media and celebrity attention to digital assets poses additional challenges for investors and plan participants to separate fact from hype. When combined with a plan fiduciary’s decision to include cryptocurrency options in a 401(k) plan menu, according to the statement, the message effectively conveyed to plan participants is that “experts knowledgeable investors have endorsed the cryptocurrency option as a prudent option. . . [which can] easily mislead plan members and cause losses.

  1. Trustees Face Non-Traditional Custody and Record-Keeping Challenges

Unlike traditional plan assets that are held in trust or custodial accounts, DOL notes that cryptocurrencies typically exist as lines of computer code in a digital wallet. In addition to valuation and liquidity issues, cryptocurrencies “can be vulnerable to hackers and theft,” as well as losses from losing or forgetting a password. The DOL argues that these differences pose unprecedented challenges for trustees charged with highly regulated custody and recordkeeping requirements.

In a DOL blog post published the same day as publication, the blog’s author, Acting Deputy Secretary Ali Khawar, explained why the DOL considers these challenges so important:

“Assets held in retirement plans, such as 401(k) plans, are critical to the financial security of seniors — covering living expenses, medical expenses and more — and should be carefully safeguarded.”

  1. Experts lack industry standard valuation models or accounting requirements

The statement expressed concerns about the reliability and accuracy of cryptocurrency ratings. Experts are still grappling with the complex and difficult task of solving How? ‘Or’ What to value digital assets, and also admit that none of the existing proposed valuation models are as academically sound or defensible as discounted cash flow analysis or interest and credit models which are traditionally used.

  1. The regulatory landscape is unstable and rapidly changing

Finally, the statement warned that as the rules and regulations governing cryptocurrency markets continue to evolve, some market participants may find themselves operating outside existing regulatory frameworks or failing to comply with them. conform. Trustees considering including cryptocurrency investment options, depending on the version, should include in their analysis an explanation of the possible application of regulatory issuance, investment, trading or trading requirements. other activities, and the possible effects these requirements may have on participants’ investments in 401(k) plans. An example very similar to this much talked about ongoing litigation was provided in the release to illustrate the possible risks in this area.

A word to trustees who have already allowed cryptocurrency into the investment menu, including through brokerage windows

In addition to outlining the specific risks raised by cryptocurrency investments in 401(k) plans, the release announced that the DOL plans to conduct investigations specifically targeting plans that offer participants investments in cryptocurrencies. and “Related products.” Plan trustees should expect to be questioned about how their actions align with their fiduciary duties of care and loyalty in light of the risks discussed in the release.

These investigative warnings also extend to plans and plan trustees responsible for authorizing cryptocurrency investments through brokerage windows of 401(k) plans. This is concerning and may have wider implications because, as a recently published report by the ERISA Advisory Board explains, most experts believe that plan trustees have no obligation to monitor investments. underlyings in a brokerage window, in the absence of “extraordinary circumstances”. The statement’s reference suggests that DOL believes cryptocurrency investment options in brokerage windows may be the type of extraordinary circumstance that warrants further examination of brokerage windows.

Unanswered questions

After reading the release, trustees should also consider many unanswered questions in addition to the specific risks raised.

  1. Can a “sophisticated fiduciary” endorse an investment option that has a small allocation to cryptocurrency?

In previous guidance regarding private equity investments in 401(k) plans, the DOL noted investment risks, but offered trustees a pathway to manage the risks. In this context (see the June 2020 Information Letter and Supplementary Statement published in January 2022), although the DOL has expressed the need for caution, the DOL has also stated that such investment options potentially risks could be included in a diversified investment option if approved by a “sophisticated fiduciary”. The statement raises “serious concerns” about “direct investments in cryptocurrencies”, as well as “other products whose value is linked to cryptocurrencies”, but it leaves open the question of whether, and in extent, “sophisticated trustees” could approve funds. which include small allocations to cryptocurrency.

  1. How much indirect exposure to cryptocurrency is too much?

As noted above, the release not only targets “cryptocurrencies” but also “other products whose value is tied to cryptocurrencies.” The question remains unanswered whether “other products” would include funds that have any exposure to cryptocurrency as opposed to exposure above a particular threshold.

For example, the June 2020 newsletter called for private equity to be a small component — perhaps no more than 15% — of a designated investment alternative to potentially be allowed in 401(k) plans. ). Is it then possible that a target date fund that invests in collective investment funds, one of which contains a very small percentage (less than 15%) of its assets in cryptocurrency, is an “other acceptable? If this is not the case, it is possible that a number of diversified investment options will be grouped together in the broader category of “others”. Trustees should check to see if any funds in their plan queues are exposed to cryptocurrencies.

  1. What about defined benefit plans and other types of funds?

Finally, the release specifically focuses only on 401(k) plan investments in cryptocurrencies and related products. What about defined benefit investment funds? What about investments held by social welfare funds (VEBA)? Some, but not all, of the DOL’s five concerns expressed in the statement apply equally to these other types of plans; but the release did not focus on those types of plans.

For now, plan sponsors and trustees should keep an eye out for new developments. If the DOL launches a cryptocurrency investment investigation program, it is possible that this advice will take the form of audit questions for the scheme’s trustees. Regardless, trustees must be ever vigilant in monitoring the plan’s investments and in making investment decisions.

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