Crypto in 401(k) Plans: Why Trustees Need to Be Careful

The legal landscape surrounding the Employees Retirement Income Security Act of 1974 (ERISA) is somewhat tricky at present. Employers are facing an increase in litigation alleging ERISA fiduciary breach claims based on investment options and administrative fees in 401(k) plans.

“Employers these days are being sued for offering the wrong so-called target date funds, when a different fund with a lower expense ratio could perhaps be offered. It’s one of the more vanilla investment offerings out there,” said Wendy Von Wald (pictured), head of fiduciary liability products at Travelers. “Crypto is an incredibly volatile investment and there are huge concerns about how it is priced and regulated, so you can see why plan sponsors might be hesitant to add it to their 401(k) investment lineup ( k).”

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Under ERISA, trustees are required to make “prudent” investment decisions that minimize the risk of large losses and act in the best interests of plan participants. Courts have commonly characterized ERISA’s duties of care and fairness as “the highest known to law.” The volatility of cryptocurrencies and the potential for negative valuation fluctuations might be deemed too risky to be prudent investment choices.

“Trustees should be careful in monitoring not only the investment, but also the provider of that investment, and because crypto can be offered in both regulated and unregulated forms, trustees should be careful to ensure that ‘they know which entity is actually offering the crypto, which can be tricky these days,’ Von Wald said.

“It’s not just a volatility issue; it is also a valuation issue because there are many different ways to value crypto. Trustees need to determine what valuation they are applying and whether it could be challenged later. One of the duties of a fiduciary is to ensure that they act in the best interest of the participants, which includes deferring costs as well as suppressing volatility. Crypto does not seem to lend itself well to fiduciaries fulfilling their obligations under ERISA.

In March 2022, the US Department of Labor (DoL) released “Compliance Assistance” for companies marketing cryptocurrency investments to 401(k) plans as potential investment options for participants. to the plan. The DoL has warned plan trustees to “exercise extreme caution” before adding crypto to a 401(k) plan’s investment menu.

“At this early stage in the history of cryptocurrencies, the department has serious concerns about the prudence of a fiduciary’s decision to expose participants in a 401(k) plan to direct investments in cryptocurrency. -currencies or other products whose value is tied to cryptocurrencies,” the DoL warned. “These investments present significant risks and challenges to participants’ retirement accounts, including significant risks of fraud, theft and loss.”

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ERISA does not dictate which specific types of investment options should be included in a 401(k). Employers are allowed to offer crypto investments if they have performed due diligence and are ERISA compliant. They may be subject to audit if they actively support and encourage plan participants to invest in crypto.

Many employers use an investment policy statement (IPS) to help govern 401(k) management by plan trustees. If they are considering offering crypto as an investment option, Von Wald said it would be wise to have the IPS reviewed by an outside attorney to ensure it supports crypto. This is an important risk management practice.

“Putting parameters on the amount of investment in an individual in crypto could be a way for plan sponsors to hedge against risk. Only allowing crypto to be offered as part of a brokerage window could be another way to protect some of their actions and decisions,” Von Wald added.

“It is also important that plan trustees make clear disclosures and educate plan participants about the risks of crypto and, at an even more fundamental level, the purpose of a 401(k). The 401(k) is not meant to be a day trading account; it’s supposed to be something that people fund so they have an income to live on in retirement. I think basic education on the purpose of a 401(k) is important right now.

Currently, fiduciary liability insurance policies generally do not exclude specific investment options. However, if there is an increase in litigation around 401(k) plan investments in cryptocurrencies, underwriters can manage that exposure in a variety of ways, according to Von Wald, including crypto exclusions, longer retentions higher, lower coverage limits and higher premiums.

“It’s still relatively new, so I haven’t seen a lot of law enforcement activity in the market,” she said, “but those are all things that could happen…if there is a frequency of litigation alleging ERISA violations due to the offering of crypto under a 401(k) plan.”