On March 10, 2022, the U.S. Department of Labor published Compliance Assistance Release No. 2022-01 (the "Release")1 and effectively put defined contribution plan fiduciaries on notice that their fiduciary obligations under the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), require an especially cautious approach when evaluating the prudence of offering a cryptocurrency investment option to participants in a self-directed 401(k) plan. Entitled 401(k) Plan Investments in "Cryptocurrencies," the Release both reminds plan fiduciaries of their general duty of prudence in evaluating investment alternatives under ERISA's fiduciary rules, and describes a number of significant risks and challenges to be evaluated by a fiduciary when considering either a cryptocurrency investment option or one whose value is tied to cryptocurrencies.
Duties of Plan Fiduciaries
The Release notes that plan fiduciaries are required under ERISA to act solely in the interests of plan participants and beneficiaries, and adhere to their statutory duties of prudence and loyalty when evaluating the suitability of a particular investment option for a self-directed 401(k) plan. Thus, these duties of prudence and loyalty attach to any fiduciary consideration to add a cryptocurrency investment option to the plan's investment platform. Fiduciaries who breach their duties under ERISA may be held personally liable for any financial losses to the plan as a result of the breach.
Risks Associated With Cryptocurrency Investments
The Release calls attention to the significant risks and challenges attendant with an investment in cryptocurrency, including significant risks of fraud, theft, and loss, that could negatively impact plan participants:
- Speculative and Volatile Nature of Cryptocurrency Investments. The Department, citing Securities and Exchange Commission staff concerns regarding the "highly speculative" nature of an investment in cryptocurrency, notes that cryptocurrency has been subject to extreme price volatility as a result of, among other things, uncertainty in accurately valuing cryptocurrency assets, speculative conduct, fictitious trading, and widely published incidents of fraud and theft.
- Challenges to Plan Participants in Making Informed Investment Decisions. Noting that promoters of cryptocurrency investments often tout the potential for "outsized" profits, the Release cautions that these investments could attract inexperienced investors seeking large returns. The Department contends that by offering a cryptocurrency investment option on the plan's platform, a plan fiduciary is, in effect, telling participants that investment experts have given their seal of approval to the investment. And, for participants who are unfamiliar with the risks inherent in cryptocurrency investments – risks that can be difficult even for seasoned investors to understand – the opportunity for loss may not be appreciated in the hunt for substantial gains.
- Custodial and Recordkeeping Concerns. The Department points to the non-traditional nature of cryptocurrency investments, reasoning that because they are not held in trust or custodial accounts like more traditional investments, they present greater valuation and liquidity challenges to both plan fiduciaries and participants. These challenges could be problematic when needing cash assets to pay benefits and/or plan expenses. The Department contends that the security of plan assets in a cryptocurrency investment can be compromised by simply losing or forgetting a password, or due to targeting of the investment by hackers. Therefore, many of the safety measures that have been developed around the traditional custody models don't apply to cryptocurrency investments, thus creating the potential for greater exposure and loss that must be considered by a responsible plan fiduciary.
- Valuation Concerns. The Department raises the issue of reliability and accuracy in valuing cryptocurrency investments, an exercise which it notes is often described by investment experts as both "complex and challenging" and subject to inconsistent views on valuation standards and accounting treatment. The Department also notes that cryptocurrency market intermediaries may not be subject to reporting and data integrity requirements with respect to investment pricing that are as stringent as those applied to intermediaries dealing with traditional investment products.
- Evolving Regulatory Environment. The Department highlights the uncertainty that may result from an "evolving" cryptocurrency market and the potential for some market participants to operate outside of the existing regulatory framework. Plan fiduciaries who wish to include a cryptocurrency investment option on a plan's platform will, in discharging their fiduciary obligations to plan participants, need to develop an expertise in, and analyze, the application of regulatory requirements (e.g., regarding issuance, trading, and investment activities in the cryptocurrency market). How such requirements impact plan participants, who may seek to invest in this market, will also have to be considered. The Department also cautions that fiduciaries must evaluate the potential for any unlawful transactions (e.g., securities transactions) as a result of investments by plan participants, and understand that any such transactions may result in liability to the fiduciary and losses to the participants.
Impact of Release on Plan Fiduciaries
While we are not aware of a significant movement of plan assets into the cryptocurrency and digital asset marketplace to date, the Department appears to be taking an unambiguously critical stance before the cryptocurrency craze gains a solid foothold in the 401(k) space. The Release concludes by stating that the Department expects to conduct an "investigative program aimed at plans that offer participants 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." It further provides that plan fiduciaries who are charged with the oversight of these types of investments, or who make decisions allowing access to the cryptocurrency market via a plan's self-directed brokerage feature, "should expect to be questioned about how they can square their actions with their duties of prudence and loyalty" to plan participants and beneficiaries in light of the risks addressed in the Release.
In our view, the Release reflects the Department's highly skeptical view as to whether cryptocurrency investments can be a prudent investment option in a self-directed 401(k) plan. The guidance effectively places plan fiduciaries on notice that, in the eyes of the Department, offering these types of investments necessarily invites substantial challenges and risk, and thus requires substantial scrutiny – both from the plan fiduciary in evaluating the prudence of the investment option and the Department in determining whether that plan fiduciary has discharged his or her fiduciary obligations to plan participants. Given the Department's statement that it has "serious concerns" about the prudence of a fiduciary's decision to include cryptocurrency investments, or products whose value is tied to cryptocurrencies, as an investment option in a self-directed plan, we would, based on the Department's tone, expect any such decision by a plan fiduciary to be met with an extremely critical eye.
Footnote
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