The U.S. Department of Labor has sounded a warning regarding 401(k) plan investments in cryptocurrencies. In Compliance Assistance Release No. 2022-01 (issued March 10, 2022), 401(k) plan fiduciaries are urged to “exercise extreme care before they consider adding a cryptocurrency option to a 401(k) plan’s investment menu for plan participants.” Because of the risks and uncertainties associated with cryptocurrencies, the guidance document raises “serious concerns about the prudence of a fiduciary’s decision to expose a 401(k) plan’s participants to direct invest in cryptocurrencies or other products whose value is tied cryptocurrencies.”
Under federal laws governing retirement plans (commonly known as ERISA), the investment manager of a 401(k) plan is considered a fiduciary, who must act solely in the financial interests of the plan participants. Courts hold fiduciaries to very high standards of professional care and prudence. When these standards are breached, the asset manager can be held personally liable for the losses resulting from the breach. For 401(k) plans, the fiduciary is obligated to evaluate independently which investments are suitable to include in the investment options from which plan participants may choose. Offering imprudent investment options to participants is considered a breach of duty.
The Department of Labor identified several areas of concern that make cryptocurrencies and cryptocurrency-tied products exceptionally risky investments for 401(k) participants.
- Cryptocurrencies are highly speculative and volatile investments—in their short history, cryptocurrencies have been subject to extreme price volatility which may be due to uncertainty regarding valuing these assets, speculative and fictitious trading, and reports of theft, and fraud. Such wild and unpredictable fluctuations can be devastating for retirement accounts, and investors near retirement age.
- The Challenge for Plan Participants to Make Informed Decisions—the newness of cryptocurrency and unfamiliarity of investors with how it differs from traditional investments can make it difficult for them to make an informed decision as whether it is right for them. With crypto being held out as an innovative product that offers the possibility of high returns, its inclusion in a 401(k) plan’s offering can wrongly lead participants to conclude that it is a suitable risk for them.
- Custodial and Recordkeeping Concerns. Cryptocurrencies are not like traditional investments where assets are held in a trust account and are available to pay out benefits. Rather cryptocurrencies exist as lines of code on a computer, where in some cases simply losing a password can result in losing the asset, and where they are also susceptible to theft by hackers. This makes these assets difficult for plan fiduciaries to reliably safeguard.
- Valuation Concerns. There is still no industry consensus on how to appropriately value cryptocurrencies, nor are there standards for reporting or maintaining data integrity by market intermediaries.
- Evolving Regulatory Environment. Rules and regulations regarding cryptocurrency are evolving such that there may be market entities that are not operating in accordance with existing regulatory frameworks or who will not be if the rules change. Plan fiduciaries must stay abreast of the ever-changing regulatory framework to ensure that their recommendations do not run afoul of securities’ laws. For example, the sale of some cryptocurrencies could constitute the unlawful sale of securities in unregistered transactions, according to the Labor Department. Regulatory bodies and law enforcement are also scrutinizing the industry for illegal activities including money laundering, drug dealing and other illegal forms of commerce, which could result in future limitations on the accessibility of these platforms.
If you have experienced losses as a result of your financial advisor’s recommendation to invest in cryptocurrency, please contact Scott Greco for a free attorney consultation.