But the hype about cryptocurrencies and private investment options in ERISA 401k pension plans has emerged, disappeared and then re-emerged for years. Now it’s back, apparently. Much of the buzz has been driven by the lure of potential investment returns. There is a downside, as well, though.
That has to do with the legal obligations of plan fiduciaries to act prudently and in the best interests of retirement savers. Pension plan participants have become particularly aware of these rules because they are at the heart of ERISA lawsuits focusing on the duty of 401k plan managers to evaluate the performance and cost of the investment choices they offer to participants.
Back to basics – the three-legged stool
For many years, the three-legged stool metaphor was used to describe how people should save for retirement. The three legs were:
- Social Security benefits, which are based on income over a working lifetime;
- employer-provided retirement plans; and
- personal savings and investment.
The idea was that all three approaches were needed to provide stable income security in retirement. A weakness or deficiency in one might, presumably, be compensated for by one or more of the others. The investment strategies for each leg of the stool are different. In ascending order of risk, they are as follows:
- Social Security benefits are held in the Social Security trust fund until an individual becomes eligible for payment, ordinarily at normal retirement age. Those funds are invested in U.S. Treasury bonds and agency securities. These are among the most secure investments possible, but in exchange for safety, the yield is generally less than might be made with other kinds of investment.
- ERISA section 404 sets out the basic rules of prudence and loyalty that fiduciaries must follow in the management and investment of funds held in an employer-sponsored plan. That money, after all, belongs to the participants.
The goal is to balance risk and reward. At a minimum, fiduciaries have a continuing duty to monitor the cost and performance of investments they make on behalf of participants or offer to participants in a self-directed 401k plan.
- The third leg of the stool – personal savings and investment – is where individuals have the greatest freedom to make their own decisions about risk. Go ahead. It’s your money.
Cryptocurrencies and private investments
For those of us who have only vague impressions or hesitations about crypto, here is the briefest of information about cryptocurrencies and private investments.
Cryptocurrency is a digital currency, which is an alternative form of payment created using encryption algorithms. The use of encryption technologies means that cryptocurrencies function both as a currency and as a virtual accounting system.
The encryption also means that there is very little publicly-available information about these digital currencies. This has allegedly made them the vehicle of choice for financial scammers and illegal businesses. In addition, even the legitimate ones are highly volatile. Bitcoin, Ethereum, Dogecoin and Litecoin are only a few of the cryptocurrencies available.
Private market investments include assets like private equity, private credit and real estate. These are not traded on public exchanges and not regulated by the SEC, which means that they have limited or no public disclosure requirements. Historically, these investments have been available only to wealthy individuals and large institutions that are presumed to be sophisticated investors. They offer opportunities to invest in companies and projects before they go public and can lead to higher potential returns.
ERISA duties of prudence and loyalty
The “loyalty and prudence” language of ERISA section 404 is aspirational. Recent 401k plan fiduciary duty lawsuits have done some to define what those words mean as applied to self-directed plans, where participants can choose from a menu of investment options. For the most part, those decisions focus on whether there is a regular process for evaluating the performance and cost of items on the plan’s investment menu.
But prudence is an evolving idea; it changes over time. How should these rules apply to options that would permit retirement savers to allocate some of their money to crypto and/or private investments?
READ MORE ERISA VIOLATION LEGAL NEWS
In 2020, the DOL issued guidance that would seem to permit the inclusion of private investments in the menu of options as long as sponsors carefully weighed the risks to plan participants. That is an answer that begs the question, however – what does it mean to “weigh the risks”?
Some observers argue forcefully that risks of volatility, lack of transparency, and relative illiquidity (especially with private investments) still outweigh the potential for spectacular gains. Crypto and private investments may have a place in overall personal strategies for retirement. But that place may be in the third leg of the three-legged stool – personal savings and investment – rather than in the second – employer sponsored retirement plans.
Source link
