401k Plan Sponsors Must be Wary of Fiduciary Liability Associated With Bitcoin ETFs

401k Plan Sponsors Must be Wary of Fiduciary Liability Associated With Bitcoin ETFs

January 30, 2024

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401k Plan Sponsors Must be Wary of Fiduciary Liability Associated With Bitcoin ETFs
by Christopher Carosa January 30, 2024

The recent SEC approval of the creation of Bitcoin ETFs came about reluctantly. Does this signal a top in Bitcoin (since government action almost always means the investment fad is up – q.v., ESG) or does this mean the 401k plan sponsor fiduciary liability just went higher?

Clearly, the popularity of Bitcoin moved industry players to come up with imaginative ways to make cryptocurrencies more accessible to investors. In allowing the formation of Bitcoin-based ETFs, the SEC puts itself in the position of trying to tame this wild west.

“Bitcoin and other similar ‘currencies’ have now been around for over a decade and are unlikely to go away,” says Jason Grantz, managing director at Integrated Pension Services in Highland Park, New Jersey. “Better to securitize them for trading like any other security and ETFs, while they have their pros/cons, are more easily suited for broad trading use than investing directly into these ‘coins.’”

Still, truth be told, the SEC was brought kicking and screaming to this decision. There’s even a hint that politics may have been holding the effort back.

“The Biden regime is extremely anti-crypto since it challenges their ability to print infinite money and makes it harder to de-bank political opponents,” says James Koutoutlas, president and co-founder of the Commodity Customer Coalition in Miami Beach, Florida. “They approved it simply because they were forced to by the DC appellate court, which ruled that their rejection of the Greyscale BTC ETF conversion was ‘arbitrary and capricious.’”

The court loss triggered a series of maneuvers to make the ultimate outcome more palatable.

“The SEC approved the Bitcoin Spot ETC due to the landmark lawsuit victory by GBTC, which forced them to come up with an actual reason why they couldn’t become an ETF, not just rhetoric,” says Evander Smart, founder of Bitcoin University in Miami, Florida. “Since they could not field a legitimate argument, and they didn’t want GBTC, an outsider to the Wall Street establishment, to control this lucrative market, they had to come up with a scheme to protect the incumbents.”

Which led to the second part of this puzzle, according to Smart. “Chances are they tipped of the Wall Street establishment that they had to move positively on the Spot ETF, and asked who was interested. All of the sudden, Blackrock, with an almost 100% approval rate, was interested last summer. They were literally the last company on the ETF list. If Blackrock says it’s time for an ETF, that means they get one, first. And that’s exactly what happened. The SEC wasn’t budging until these two forces collided in 2023, forcing their hand. The SEC definitely wasn’t going to do it because it was the right thing to do. They proved that wasn’t happening, so the courts and the world’s largest money manager forced their hand.”

But not all financial institutions are on the same page. Some, most notably Vanguard, have come out against these products. And they may have a good reason to let others be pioneers. After all, it was the pioneers that ended up getting arrows in their backs.

“Financial institutions declining to create Bitcoin-based ETFs may be exercising caution due to the inherent volatility and regulatory uncertainties surrounding cryptocurrencies,” says Tyler Meyer, president/financial planner at QED Wealth Solutions in Kingman, Kansas. “Concerns about potential market manipulation and the unpredictable nature of digital assets might be factors influencing these institutions’ decisions to abstain.”

There’s no denying Bitcoin-based ETFs represent unchartered territory. That in itself means risk. Worse, it’s a risk that’s hard to quantify right now.

“‘Don’t invest in anything you don’t understand’ is solid advice,” says Ron Surz, president of Target Date Solutions in San Clemente, California. “The mechanics of cyber currencies are built on math that no one really understands, and has shortcomings—like losing your key is equivalent to losing your fortune—so there are reasons to fear a blow-up. Who says a blockchain is indestructible?”

Moreover, despite its apparent popularity, there remains some controversy surrounding cryptocurrencies in general.

“There is still a stigma around Bitcoin due to the various legal problems that it has faced,” says Grantz. “My assumption is that there is a reputational risk that some firms were comfortable with, and others were not. Clearly there will be a market demand for these, so money is to be made, so I don’t think it was a simple profitability decision.”

If financial professionals exhibit apprehension with Bitcoin-based ETFs, what does that mean to 401k plan sponsors?

Lawrence (Larry) Starr, executive vice president at Cornerstone Retirement/QPC in West Springfield, Massachusetts, contends introducing these products into ERISA plans will create an “enormous” fiduciary liability. “When it all implodes (as it no doubt will one day),” says Starr, “the participants who decided to ‘invest’ in it will be looking for someone to blame.”

Harold Evensky, founder of Evensky & Katz in Lubbock, Texas, agrees. He believes the prospect of increased fiduciary liability is “unquestionable.” “The volatile and speculative nature of Bitcoin could introduce higher risks for plan participants,” says Evensky. “Sponsors might face increased scrutiny in ensuring that the inclusion of such investment options aligns with the best interests of the participants and meets the standard of prudence under the Employee Retirement Income Security Act (ERISA).”

Plan sponsors need to think about it in these terms: Does it make sense to have a pork-belly ETF on a 401k investment menu? How about orange futures?

“Like many commodities, Bitcoin and other cryptocurrencies are known for their extreme volatility,” says Richard Bavetz, investment advisor at Carington Financial in Westlake Village, California. “The dramatic fluctuations in value that have occurred in the past can be partly attributed to a small number of individuals who own very large quantities of Bitcoin. One individual selling off a huge portion of any commodity creates large amounts of volatility and a subsequent drop in value. Under the Employee Retirement Income Security Act of 1974 (ERISA), fiduciaries must act in the best interests of plan participants so any dramatic fluctuation in value can be a major concern for plan sponsors, as fiduciaries are also required to make prudent investment decisions that minimize the risk of large losses. Even the Department of Labor (DOL) has urged plan fiduciaries to exercise extreme caution in deciding whether to include cryptocurrencies in 401k plans. They point specifically to the risks and challenges, including fraud, theft, and loss, as well as the speculative nature of these investments.”

Beyond ERISA, the SEC has gone out of its way to provide a warning about Bitcoin investments. While the SEC can only talk to individual investors, that doesn’t mean plan sponsors can ignore that agency. The very fabric of ERISA demands plan sponsors have a comprehensive due diligence process in place with selecting and monitoring plan investments.

“Plan fiduciary responsibilities under ERISA have not changed, and they were reiterated on March 10, 2022 in the Department of Labor’s (EBSA) Compliance Assistance Release No. 2022-01 on 401(k) Plan Investments in ‘Cryptocurrencies,’” says Michelle Capezza, of counsel at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. in New York City. “Plan sponsors and fiduciaries that seek to offer access to bitcoin ETFs or other cryptocurrency investments through their retirement plans must be extremely diligent in their diligence, decision-making and monitoring processes, and prepare for heightened scrutiny of their decisions. SEC Chair Gary Gensler noted in his January 10, 2024 Statement that while the listing and trading of certain spot bitcoin exchange-traded product shares were approved, bitcoin was not approved or endorsed and investors should remain cautious about the risks associated with bitcoin and products whose value is tied to cryptocurrencies.”

When plan participants come knocking on the door demanding Bitcoin-based ETFs be added to the 401k investment menu, plan sponsors better be prepared.

Christopher Carosa is an award-winning online news producer and journalist. A dynamic speaker, he’s the author of 401(k) Fiduciary Solutions, Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort, From Cradle to Retirement: The Child IRA.