A Fair Warning: 401(k) Plan Sponsors May be Hard-Pressed to Defend Addition of Cryptocurrency Investment Option

The U.S. Department of Labor (DOL) published guidance earlier this year warning fiduciaries who administer retirement plans to “exercise extreme care” when considering whether to include cryptocurrency as a plan investment option. The guidance states further that fiduciaries should be prepared on audit to “square their actions with their duties of prudence and loyalty in light of the risks described.” Around the same time, Fidelity, one of the largest 401(k) plan asset managers, announced that it would begin offering cryptocurrency investment options for inclusion in a 401(k) plan’s investment menu. A statement on the Fidelity website refers to crypto as the “new frontier” and encourages plan sponsors to invest through Fidelity’s exchange traded products. Plan sponsors are left to reconcile the DOL’s warning with an apparent endorsement from the 401(k) giant.

The Rise of Crypto. “Bitcoin”, considered by most to be the first cryptocurrency, increased in value from $1.00 in 2011 to around $20,000 in 2017 before its first fall in value. Its highest value to date reached more than $68,000 per share. Bitcoin’s rapid appreciation has led to an explosion in competing varieties of digital assets and a marketing frenzy. Celebrities and other “influencers” endorsing particular flavors of crypto have found themselves subject to scrutiny and fines by the Securities and Exchange Commission. The value of bitcoin has again fallen to around $20,000 in the period following Fidelity’s announcement. The recent fall is considered the latest “crypto-winter”.

Not a Great Fit. The obvious volatility is not the only thing that has the DOL worried. Crypto is considered extremely difficult to value, even by experts. Digital assets are marketed as innovative high-growth investments that can prove irresistible to inexpert 401(k) plan investors looking for a fast return. Crypto cannot be held in a custodial account like most retirement plan investments but rather is stored as lines of code in a “digital wallet”. The typical 401(k) investor may be hard pressed to explain “blockchain”, a complex decentralized system used to track crypto transactions. Crypto is currently unregulated but that may soon change. It is unclear what effect any regulation will have on the value of existing investments. While not explicitly stated in the DOL guidance, it is clear that the DOL believes the risks cited likely make cryptocurrency of any kind an inappropriate addition to a 401(k) plan investment menu.

The Highest Duty. The Employee Retirement Income Security Act of 1974 (ERISA) imposes a duty of loyalty and a duty of prudence on 401(k) plan sponsors who administer and control plan assets (fiduciaries). The U.S. Supreme Court has ruled that it is a breach of that duty to offer an investment that is less than prudent, even if it is one choice among otherwise appropriate investments.  Individuals acting as fiduciaries can be held personally liable for losses suffered by plan participants as a result of imprudent actions, e.g. bad investments. The same is true for fiduciaries that engage in self-dealing. Plan sponsor’s acting in this capacity must put the interests and wellbeing of plan participants above all else and do everything possible to protect participants from their own lack of judgment.

Read the complete article on page 6 of the September/October 2022 edition of Corp! Magazine.

About the Author:

Liam K. Healy helps clients maintain compliance with the myriad of state and federal tax laws and regulations that govern individuals and businesses. His broad range of experience is in business law and business tax matters. Liam’s experience includes: choice and formation of business entities, partnership and shareholder agreements, buy sell agreements, franchise agreements, mergers and acquisitions, business succession planning, real estate, tax free exchanges, non-profit organizations and tax audits. Liam counsels business owner clients through every stage, from formation to the sale of the business.

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