The recent news that Fidelity, one of the nations largest 401(k) recordkeepers, will allow Bitcoin as a 401(k) investment in their client accounts has generated quite a bit of buzz with proponents and adversaries of cryptocurrencies alike. Prior to adding Bitcoin (or any other asset) to a plan's investment menu, plan fiduciaries must determine that adding the investment is not only permissible under the terms of the plan but also that it is a prudent investment alternative for plan participants. While there is no doubt that the cryptocurrency market, along with the broader digital assets market, has experienced tremendous growth in recent years, its popularity alone does not make it a prudent investment for 401(k) participants. Below are some things for fiduciaries to consider before adding cryptocurrencies to their plan menu.
What kind of asset is this? While cryptocurrencies are, at face value, a form of currency, regulators have struggled in determining whether they are currencies, commodities or securities. While Bitcoin has been determined to be a digital commodity by the CFTC, many other cryptocurrencies may be securities. While this may seem like a minor consideration, regulatory ambiguity carries substantial risks, which must be considered by prudent plan fiduciaries. In consideration of the asset class, what type of alternatives should the plan consider - centralized currencies? gold? other commodities? One of the significant challenges with these assets is the uniqueness of the asset class itself relative to other similar mechanisms available in the marketplace. Assuming this is added, how will you monitor it?
Are speculative assets appropriate for plan participants? The Securities and Exchange Commission, Department of Labor(1), and even Fidelity(2) have cautioned that cryptocurrencies are highly speculative and volatile. Fiduciaries of 401(k) plans have a duty to consider the risk and return characteristics of each investment alternative. In Compliance Assistance Bulletin 2022-01, the Department of Labor noted that it "has serious concerns about the prudence of a fiduciary's decision to expose a 401(k) plan's participants to direct investments in cryptocurrencies, or other products whose value is tied to cryptocurrencies" and "cautions plan fiduciaries to exercise extreme care before they consider adding a cryptocurrency option to a 401(k) plan's investment menu." While they didn't go so far as to prohibit the assets, plan fiduciaries considering adding cryptocurrencies to their plan menu would be well served consulting with ERISA counsel to ensure their due diligence is bulletproof before moving forward.
How will it be valued? Cryptocurrency is an intangible asset and intrinsically difficult to value. Not only will plan fiduciaries be responsible for their decision to allow cryptocurrency as an investment alternative, but they will also need to understand the nuances and risks associated with the valuation process and the attendant risks. While a third party may be pricing the asset, it's the plan fiduciaries who have a duty to ensure that those services are done properly, which will be quite a challenge for many.
Will participants understand the risks they are taking? There may not be a more alluring asset in the marketplace today. Will participants, even with comprehensive disclosures, be able to understand the extent of the risks that they are taking by allocating retirement assets to a cryptocurrency? The plan administrator will need to provide participants with materials to help them understand the nature of each investment, including cryptocurrency, which may not be readily available as it is for other investments.
It's critical for plan fiduciaries to understand that the availability of an asset on a platform does not mean that it's prudent; it simply means it's available. The burden of showing that the investment is prudent will fall on the plan fiduciaries making the decision to add and retain the asset, not the plan record keeper.
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