Cryptocurrency: Fiduciary Investment Considerations

June 2022

The Department of Labor (DOL) is the principal executive office responsible for administration of retirement plan assets. The DOL, like other executive agencies, issues rules, regulations, opinions, and guidance, to help employers sponsoring qualified plans conform to the onerous requirements of ERISA. As we informed you in March, the DOL recently issued guidance, “Compliance Assistance Release No. 2022-01 401(k) Plan Investments in Cryptocurrencies,” reprimanding utilization of cryptocurrency as a potential investment within retirement plan menus.  The DOL’s fiduciary investment considerations for cryptocurrency inclusion should be taken seriously and highlight several issues associated with this type of investment.

What is Cryptocurrency?

One of the nation’s largest qualified plan recordkeepers caused commotion not only in the private investment industry but also at the DOL when it recently announced the availability of an interesting investment: a Cryptocurrency exchange traded fund (ETF) available to 401(k) plans. Cryptocurrencies have become a popular type of speculative investment. At its core, a cryptocurrency is a purely digital form of currency. A currency, or money, is meant to be a universal means of exchange in order to facilitate the trading of goods and services and also to serve as a store of value.  Some of the most important characteristics of a monetary based system are: ease of reduction to the commodity (coin); an understanding of its value related to other goods; and trust in the stability of the system. To this latter aspect, add in a governmental-legal framework that regulates and enforces “legal tender” as the medium of exchange, and the system creates stability.

Cryptocurrencies use a public ledger and computer code system to provide peer-to-peer transactions without the need for a third-party overseer.  Most cryptocurrencies introduce a fixed amount of currency into circulation every year up to a pre-determined cap on the total supply.  An appeal of cryptocurrency is two-fold: (1) removal of governmental actors to manipulate monetary supply policy; (2) ease of reduction and exchange of the electronic commodity without transaction fees. 

Summary of DOL’s Guidance

The DOL has taken a harsh stance on cryptocurrencies. “The [DOL] cautions plan fiduciaries to exercise extreme care before they consider adding a cryptocurrency option to a 401(k) plan’s investment menu for participants” iterating the standard for investment review for 401(k) fiduciaries is the “‘highest known to the law.’”  As if the recitation of the DOL’s warning and a restatement of the law was not enough to dissuade would-be 401(k) plans adopting a cryptocurrency investment, the DOL explains—in detail—five reasons why cryptocurrencies make for inadequate investments in 401(k) plans:

1. Speculative and Volatile Investments — including fraud, theft, and misreporting of transactions can occur, greatly impacting the value of the investment;
2. The Challenge for Plan Participants to Make Informed Investment Decisions—generally participants do not understand all the risks associated with cryptocurrencies;
3. Custodial and Recordkeeping Concerns—illiquidity and virtual wallet codes create vulnerability that the investment can be lost simply with the loss of an access number;
4. Valuation Concerns—there is currently no reliable accurate valuation methodology for cryptocurrency; and
5. Evolving Regulatory Environment—a cryptocurrency’s potential non-compliance (and potential utilization for unlawful activity) may draw the ire of regulatory authorities resulting in a permanent shut down in trading (rendering the currency worthless).

 Finally, the DOL reminds plan sponsors—and their advisors—that any and all potential enforcement measures will be taken for plans that maintain a cryptocurrency investment including litigation and audits. Plan sponsors should be prepared to explain to the DOL how, given this guidance, they may “square their actions with their duties of prudence and loyalty[.]” Powerful words of extreme caution.

Summary

Cryptocurrency is likely to remain a hot topic in the coming years. As development and regulations progress, some of the noted risks may dissipate. L&H will continue to review the ongoing regulatory environment and make recommendations where appropriate. If you have any questions regarding cryptocurrency, please feel free to contact our team.

Sources

Employee Benefits Security Administration, Compliance Assistance Release No. 2022-01

Lebel & Harriman Retirement Advisors does not offer advice or planning services that involve the purchase or sale of cryptocurrencies. The information provided is a general educational piece and is not intended to be a solicitation or offer to consult on cryptocurrencies. The topic of cryptocurrency is a common question and while we understand the attraction to the product, we do not make recommendations related to cryptocurrency.

The information presented here is for educational purpose only and is not intended to provide specific advice or recommendations for any individual, nor does it take into account the particular investment objectives, financial situation, or needs of individual investors. All examples are hypothetical and are for illustrative purposes only.