Risks of cryptocurrencies in 401k plans…from the plan auditor perspective

As an auditor of 401k plans, I not only make sure the numbers in the Plan’s financial statement are fairly stated…I am also looking for risks to the plan and to the plan sponsor, both from a financial perspective, and also from a regulatory perspective. 

Cryptocurrency (crypto). The word brings up thoughts of potential wealth, mystery, and hi-tech. It’s the sexy new kid on the block for a new generation of investors. It’s one of the current hot topics in the 401k plan industry. It also brings a lot of questions and investment risk.  Despite these questions and risks, the popularity of wanting cryptocurrency investments in 401k plans is growing. 

Before plan fiduciaries think about adding crypto to their 401k plan, they need to consider the following three risks and issues, which far outweigh any potential benefits to the plan participants.

1.      In March 2022, the Department of Labor issued Compliance Assistance Release No. 2022-01 Compliance Assistance Release No. 2022-01 | U.S. Department of Labor (dol.gov) addressing 401(k) Plan Investments in “Cryptocurrencies”. This release outlines the DOL’s concern with having cryptocurrency in 401k plan. 

The DOL’s key points of concern:

a.      Crypto is a speculative and volatile investment, which can have a devastating impact on participants, especially those participants approaching retirement.

b.      How do plan participants make informed investment decisions? Participants are less likely to have sufficient knowledge about these investments, as compared to traditional investments, or to have the technical expertise necessary to make informed decisions about investing in them. When plan fiduciaries, charged with the duties of prudence and loyalty, choose to include a cryptocurrency option on a 401(k) plan's menu, they effectively tell the plan's participants that knowledgeable investment experts have approved the cryptocurrency option as a prudent option for plan participants.

c.      Custodial & recordkeeping concerns. Cryptocurrencies exist as lines of computer code in a digital wallet. With some cryptocurrencies, simply losing or forgetting a password can result in the loss of the asset forever. Other methods of holding cryptocurrencies can be vulnerable to hackers and theft.

Based on the concerns noted from the DOL, a plan that has crypto as an investment option will most likely be a bright red flag waiving in the face of the DOL, saying “audit me!”. Most, if not all plan fiduciaries should be avoiding this risk.

2.      Crypto does not have any metrics to support its value, and no fund manager to monitor the value.  Unlike typical mutual fund or pooled separate account investments, crypto does not have any revenues, income or assets supporting its value. 

a.      Mutual funds and pooled separate accounts are invested in stocks of companies that have earnings to support the values of the underlying stock. The valuation of stocks is based on earnings multiples, projected earnings, other potential tangible events.

b.      The value of crypto is not based on any tangible or historical financial information, values or data. Crypto is valued purely on investor speculation and supply and demand. This does not make crypto an appropriate investment option for a retirement plan account.

c.      Typical mutual fund or pooled separate account investments have fund managers who are responsible for ensuring the fund investments meet the description in the prospectus and monitor net asset values. Crypto does not have a fund manager to monitor investments or its value.

Giving participants an investment option for their retirement account which has no tangible valuation metrics, and does not have trained managers to monitor the values is a significant risk which plan fiduciaries should avoid.

3.      The third issue plan fiduciaries need to consider with respect to crypto is their own legal liability. Plan fiduciaries are charged with duties of prudence and loyalty, to provide the participants in their 401k plan with safe and responsible investment options. Having crypto as an investment option in a 401k plan is not prudent, and does not provide a responsible investment option for the participants.

By providing participants with an investment option that is not prudent, plan fiduciaries expose themselves to increased risk of legal action by:

a.      Plan participants (when the participants lose money in their retirement account and blame the fiduciaries for allowing the investment).

b.      Or from the DOL against the fiduciaries for breach of fiduciary duty to select safe and sound investment options for the participants.

Plan fiduciaries who want to sleep better at night will avoid crypto in their 401k plans.

As a parent, despite how much my kid wanted to do something, I’ve had to tell my kids “no” on many occasions because something they want to have or do is not in their best interest. The fiduciaries of 401k plans are essentially the “parents” of their employees 401k accounts. The fiduciaries need to make decisions that are in the best interest of the long-term retirement benefits of the participants. This sometimes means telling participants “no” when they want something. 

The risks of having crypto in a 401k plan far outweighs the benefits. No matter the ask or the request from participants, plan fiduciaries need to steer clear of cryptocurrency in their 401k plans and tell participants “no”.

To summarize, for 401k plans… crypto is a no-no.