Fidelity's cryptocurrency plan raises red flags at DOL

The Department of Labor has many questions about Fidelity Investments' decision to offer cryptocurrency investments to 401(k) plans, having received a heads-up on the retirement giant's plans only one day before the company announced its strategy.

The volatility of cryptocurrencies "is troubling to us," said Ali Khawar, the DOL's acting assistant secretary for the Employee Benefits Security Administration, in an interview.

The fact that the Fidelity program would allow up to 20% of a participant's retirement account be invested in cryptocurrency is unsettling because "that is a lot to allocate to a single asset," he said. Earlier guidance from the IRS noted: "If you invest more than 20% of your retirement savings in any one company or industry, your savings may not be properly diversified."

Mr. Khawar said the DOL needs to learn more details about Fidelity's plan, whose broad outline was discussed in an April 26 news release. Fidelity's program will be available to clients in mid-2022.

Mr. Khawar said he wasn't contacted by Fidelity. A senior DOL official declined to say which Labor Department official received the notice, the name of the Fidelity executive who provided it or how the information was transmitted to the DOL. Representatives of Fidelity and EBSA are scheduled to meet this week to discuss the matter.

Fidelity's announcement came six weeks after the Labor Department issued a March 10 "compliance assistance release" telling 401(k) plan fiduciaries to "exercise extreme care" before selecting cryptocurrency as an investment option. The report said EBSA will conduct "an investigative program aimed at plans that offer participant investments in cryptocurrencies and related products."

EBSA will take "appropriate action to protect the interests of plan participants and beneficiaries with respect to these investments," the report said.

The senior DOL official said in an interview that the compliance guidance reflects the unanimous January ruling by the U.S. Supreme Court that plan fiduciaries have a duty to monitor all investments in a plan lineup. "They have the burden to make prudent investments," said the DOL official, referring to the case of Hughes et al. vs. Northwestern University et al.

In his interview, Mr. Khawar said EBSA issued the guidance in part because cryptocurrency is still a young investment option, marketplace regulations are evolving and some promotions soft-pedal the risks of cryptocurrency.

"We are not banning" cryptocurrencies in retirement plans, Mr. Khawar said. "This is not necessarily forever guidance. As the context changes, it's entirely possible our answers will change."

Meanwhile, the Securities and Exchange Commission recently announced it is expanding the size of a unit designed to protect consumers in crypto markets. And legislators recently introduced a bill in the U.S. House of Representatives that would give more crypto monitoring power to the Commodity Futures Trading Commission.

Fidelity acknowledged the volatility of crypto investing in its April 26 news release. "Digital assets are speculative and highly volatile," the company wrote. Such investments "are for investors with a high risk tolerance. Investors in digital assets could lose the entire value of their investment."

However, in a response to questions, a top Fidelity executive said his company was responding to a demand by defined contribution sponsors.

"As part of our ongoing communication with our plan sponsor community to discuss how to improve the retirement savings efforts for their employees, Fidelity has seen growing interest from plan sponsors in providing their employees access to digital assets in defined contribution plans," Dave Gray, Boston-based head of workplace retirement offerings and platforms, said in an email.

"To address this growing interest, we have launched the Digital Assets Account that will enable individuals to have a limited portion of their retirement savings allocated to bitcoin through the core 401(k) plan lineup," Mr. Gray said.

This account is "a custom plan account that holds bitcoin and short-term money market investments to provide the liquidity needed for the account to facilitate daily transactions on behalf of the investor," said Fidelity's April 26 news release. "Bitcoin in the Digital Assets Account (DAA) will be held on the Fidelity Digital Assets custody platform to ensure institutional-grade security."

The DAA will charge 75 to 90 basis points per account depending on the assets in the account, and a trading fee "is being finalized," Mr. Gray said.

"Participants can invest up to 20% of their total 401(k) savings in DAA, but their employer will determine the percentage for their particular plan," he said. "Contributions are limited to 20%, but the total percentage of your savings can exceed 20% (for instance, if bitcoin increases in value) and you can continue to contribute."

Mr. Gray also explained how Fidelity will trade bitcoin. "Rebalancing of the DAA to purchase or sell bitcoin is reviewed daily, and similar to other unitized investment options," he said.

"If the balance of bitcoin or cash has exceeded the tolerance bands directed by the plan sponsor, Fidelity's digital funds business will place the necessary orders to buy and sell for bitcoin trades and money market investments as applicable," he said.

A few weeks after EBSA issued its March 10 compliance assistance report — but before Fidelity's announcement — a group of 11 trade associations, including the American Benefits Council, ERISA Industry Committee and Securities Industry and Financial Markets Association, wrote to Mr. Khawar asking that EBSA withdraw its crypto guidance and "instead develop guidance in this area through notice-and-comment rule-making."

"We are very aware that the line between helpful sub-regulatory guidance and indirect rule-making is not a clear one," the letter said. "But we respectfully suggest that recent sub-regulatory guidance has been more in the nature of rule-making in need of notice and comment" and review by the White House's Office of Information and Regulatory Affairs.

"The department's new cryptocurrency position is inconsistent with current law, and adopted retroactively without notice or comment or OIRA review," the letter said.

The trade groups asserted that EBSA's comment about fiduciaries needing to exercise "extreme care" in evaluating the prudence of offering crypto investments "creates confusion to which fiduciaries are subject."

Fidelity also complained. In an April 12 letter to Mr. Khawar, the company asserted that the compliance assistance report "does not provide any constructive guidance on how plan fiduciaries can address the issues identified by the Department and fulfill their fiduciary duties in assessing cryptocurrencies."

The guidance document "should be withdrawn and/or clarified," said the Fidelity letter, which was written by Mr. Gray.

Fidelity accused the department of going beyond informing fiduciaries of their responsibilities regarding cryptocurrency in 401(k) plans. Instead, the letter argued, the department seeks "to deem the selection of cryptocurrencies imprudent."

On the other hand, 13 consumer and labor groups applauded the guidelines in an April 26 letter to Mr. Khawar. The guidance is "entirely consistent" with ERISA's imposing "strict fiduciary duties on plan fiduciaries," said the letter, whose signatories included the Consumer Federation of America and the AFL-CIO.

"We all agree that it is entirely appropriate at this stage in the market's evolution that the Department caution plan fiduciaries to exercise extreme care when considering exposing plan participants to cryptocurrency assets," the letter said.

Two U.S. senators wrote to Fidelity Investments CEO Abigail Johnson on May 4, asking why the company decided to offer cryptocurrency as a stand-alone investment in clients' 401(k) plans.

"Investing in cryptocurrencies is a risky and speculative gamble, and we are concerned that Fidelity would take these risks with millions of Americans' retirement savings," said the letter from Sens. Elizabeth Warren (D-Mass.) and Tina Smith (D-Minn.).

They also asked Ms. Johnson to respond by May 18 to a series of questions including, "Why did Fidelity ignore DOL's 'serious concerns regarding the prudence of a fiduciary's decision to expose a 401(k) plan's participants to direct investments in cryptocurrencies?'" and "What risks does Fidelity assess that bitcoin presents to its customers?"

Fidelity will respond directly to the senators, a company spokesman said in a May 5 email. "We look forward to continuing our respectful dialogue with policymakers to responsibly provide access with all appropriate consumer protections and educational guidance for plan sponsors as they consider offering this innovative product," he wrote.

About the only agreement, so to speak, among the consumer groups, Fidelity and the trade associations, is that self-directed brokerage windows will provide a challenge to fiduciaries and regulators concerning cryptocurrency investments in retirement plans.

EBSA's March 10 announcement mentioned the words "brokerage windows" once, but it triggered a spirited response.

Plan fiduciaries offering crypto investments "or allowing such investments through brokerage windows should expect to be questioned about how they can square their actions with their duties of prudence and loyalty in light of the risks" of crypto, the guidance document said.

The trade groups worried that EBSA's approach would create havoc among sponsors.

"While there may be a fiduciary duty to evaluate the brokerage window provider, there does not exist a fiduciary duty to monitor or evaluate the underlying investments that plan participants make in the window," they wrote.

"Most windows are not set up to even monitor or block investments" at the "level of specificity" described by the EBSA report, the trade groups added.

"The issued guidance is thus not only inconsistent with current law and current established practices, but would also modify the law retroactively, such that a past failure to monitor brokerage window investments in a newly announced specified manner will be investigated as a likely violation of ERISA," they wrote.

Fidelity's letter to EBSA said the agency's guidance "improperly implies that fiduciary duties apply to investments in brokerage windows."

Although plan fiduciaries have a responsibility to evaluate designated investment alternatives, brokerage windows fall outside a fiduciary's duty to review each investment, the Fidelity letter said. EBSA's statement implies that fiduciaries must assess the prudence of cryptocurrencies "even if they are not designated investment alternatives and are instead available through a brokerage window," Fidelity said.

Sen. Tommy Tuberville, (R-Ala.) announced May 5 he was introducing a bill to prohibit the DOL "from issuing a regulation or guidance that limits the type of investments that self-directed 401(k) account investors can choose through a brokerage window," according to a news release. The DOL's March 10 guidance "attempts to bar 401(k) investors from investing in cryptocurrency and undermines the ability of 401(k) plans to offer brokerage windows." Details of the legislation weren't available at press time.

By contrast, consumer and labor groups said the EBSA guidance properly raised concerns about self-directed brokerage windows.

They fear some sponsors "may be providing exposure" to crypto investments via a brokerage window "without first undertaking a thorough and impartial investigation of the risks," they wrote in their April 26 letter to the DOL. "While some plan fiduciaries may be under the impression that their fiduciary duties don't apply if the transaction is structured in this manner, this view is at odds with the objective of ERISA."