Cryptocurrencies continue to capture attention and excitement among the investing public. Stakeholders in the retirement plan arena are responding. This is not a surprise.
The Department of Labor issued a Compliance Bulletin in March raising significant questions about the appropriateness of investing in cryptocurrencies within qualified retirement plans. In the meantime, Fidelity Investments recently announced its intention to offer a facility that would enable investments in Bitcoin within 401(k) plans.
The battle lines have been drawn. Unfortunately, plan fiduciaries are caught squarely in the middle.
To assess the appropriateness of cryptocurrencies within retirement plans, it is critically important to draw a distinction between investments entered in a personal or individual capacity and those entered into within the parameters of a qualified plan.
Qualified retirement plans were created in order to promote a retirement savings vehicle for American workers. They enjoy a unique and privileged tax status: Contributions to qualified retirement plans are tax-deductible for plan sponsors; the contributions to the plans are not taxable income to the plan participants upon contribution; and assets within the plan grow tax- free. These benefits are substantial.
However, to derive the benefits of these tax attributes, the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986 set forth numerous requirements regarding the structure, maintenance and investment of qualified retirement plans. A central feature of ERISA mandates that a fiduciary must determine that plan investments are prudent, and not simply prudent according to a random reasonable person, but prudent as determined by an expert.
Just because an asset might be a store of value doesn't necessarily mean that the asset is appropriate for a qualified plan. Fortunes have been accumulated in fine art, vintage collectables and wine collections. However, it is likely hard to find these asset classes in qualified retirement plans.
In a personal account, investors regularly can invest on a hunch or a gut feeling. ERISA explicitly states that this isn't the case for retirement plans. Therefore, even though cryptocurrency may turn out to be a vehicle of substantial wealth creation, when it comes to retirement plans, fiduciaries are going to have to determine that the investment is prudent.
The DOL’s bulletin attracted a healthy dose of criticism. Many highlight that the department did not engage in a comment period before issuing the bulletin. Others claim that the department exceeded its authority in commenting on a particular asset class; the argument is that the DOL isn't authorized to pick winners and losers among various asset classes.
Setting aside this criticism for a moment, the department has in fact raised legitimate questions about the custody, record keeping and valuation of cryptocurrencies. Referring back to the previously mentioned list of requirements governing qualified plans, both the DOL and the IRS have longstanding positions and requirements pertaining to the custody, record keeping and valuation of plan assets. Over the decades, trust banks, record keepers and mutual fund companies have developed technical competence in abiding by these standards for equities, bonds and even derivatives. In effect, the infrastructure supporting these various assets is well-established and is designed to safeguard and account for retirement assets. The system is prudent.
Digital currency, however, represents a whole different set of challenges. The DOL is simply questioning whether the current financial infrastructure supports cryptocurrency — arguably, not inappropriate concerns for a regulatory agency charged with the oversight of a statute and regulatory regime focused on “employee retirement income security.”
Beyond the systemic issues raised by the department, there are additional structural questions outstanding with respect to the mechanics of cryptocurrencies. Take Bitcoin (the cryptocurrency endorsed by the Fidelity program). Bitcoin authorizes Tether as one of the stablecoins for its platform. Tether claims that its stablecoin is backed (one for one ) by U.S. dollars as a reserve. However, as reported, Tether has yet to issue audited financial statements and has issued a non-specific commitment to issue financial statements at some indeterminate date in the future. Therefore, no one is able to evaluate whether its reserve claims are in fact accurate.
Think about that from the perspective of prudence. Tether facilitates transactions in Bitcoin. However, Tether has never been audited. That is, no auditor has signed off on whether Tether, in fact, holds the reserves that it claims.
Disclosure of audited financial statements are the backbone of investment markets. Any investor (or adviser or manager) if they choose can assess the audited financials of an issuer of securities (and, in the case of derivatives, the financials of any counterparty) for purposes of assessing whether an investment complies with their investment policy statement, guidelines or parameters. In effect, our entire financial system depends upon investors’ ability to rely upon audited financial statements.
And yet, Tether has not provided the marketplace with audited financials. Given this fact, any plan fiduciary considering an investment in Bitcoin will need to address the prudence of the decision in light of lack of audited financials. That is likely a very high hurdle to clear.
At the moment, plan fiduciaries are being forced into the position of balancing product availability and consumer demand with serious questions striking at the heart of their prudence obligation. Given the unknowns, it may be in the best interest of plan participants to forestall immediate investments in cryptocurrencies for six months to a year. Fortunately, the last 40 years have witnessed an explosion in the array of well-tested investment products and strategies that can capture returns and diversify risk. In today’s volatile market, it likely is prudent to stick with the tried and true.
On the other hand, any investor who has a few extra bucks lying around outside of a retirement account, and who wants to take a flyer on Bitcoin: go for it. Best of luck.
Mitchell Shames is founder and managing director of Harrison Fiduciary.
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