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401(k) Providers on Edge as Warning on Crypto Faces Litigation

June 6, 2022, 9:20 AM

A lawsuit challenging the US Labor Department’s guidance on including cryptocurrency in 401(k) plans highlights the department’s warning that it will investigate retirement plan sponsors who offer such investments.

Guidance (CAR No. 2022-01) the Employee Benefits Security Administration issued in March instructed employers to use “extreme care” when considering digital asset investments and warned of a looming “investigative program” for crypto-invested plans. Even employers that let their workers choose digital assets could undergo heightened regulatory scrutiny, the guidance said.

That enforcement standard has the potential to leave businesses that offer 401(k) benefits scrambling to meet an evolving definition of what it means to be a prudent investor, exposing new avenues for future litigation and costing plans money.

“Threatening investigations is enough to put a plan sponsor on notice that you probably shouldn’t select this as an investment,” said Chantel Sheaks, vice president of retirement policy at the US Chamber of Commerce, which opposes the department’s move. “Why would any plan sponsor purposefully pick this type of investment knowing that they will be investigated? You just wouldn’t.”

Plan provider ForUsAll Inc. sued the Labor Department in federal district court for violating the Administrative Procedure Act (Pub.L. 79-404) when it issued its guidance effectively banning crypto investments outside a formal notice-and-comment rulemaking process. The company is arguing that the department’s warning of investigations exceeded its statutory authority.

The department’s threat of investigative action was the catalyst for the lawsuit. ForUsAll, which offers workers access to crypto holdings, says it stands to lose business because plan sponsors are too leery of drawing regulatory scrutiny.

‘Can of Worms’

The gravity of the Labor Department’s “investigative” language adds potency to other language in the guidance that it may have to defend in court, critics say.

Forcing plans to exercise “extreme care” suggests a new standard for making digital asset investment decisions. Implicating self-directed brokerage windows changes how plan sponsors have always treated those types of investment vehicles.

“They’ve opened a can of worms that they can’t close now,” Sheaks said.

The Chamber joined at least 10 trade organizations representing plan sponsors and retirement funds calling on the Labor Department to revoke its cryptocurrency guidance shortly after its release in March.

Fidelity Investments Inc. is going head-to-head with DOL’s employee benefits arm by launching its own 401(k)-tailored crypto product weeks after the guidance was issued.

Strict fiduciary investment selection standards laid out in the Employee Retirement Income Security Act (Pub.L. 93-406) can’t be modified for a single asset class alone using a three-page subregulatory guidance document, ForUsAll argues in its suit.

The company claims the department “invented” a new standard for choosing investments “heretofore unseen in the nearly 50-year history of ERISA and contradicted by the text of the statute.”

“What’s special about this case is that the Labor Department has essentially created a different standard of care for cryptocurrency investments,” said Josh Lichtenstein, a partner at Ropes & Gray LLP in New York. “They basically said that the bar for demonstrating a prudent process is higher, and that’s the question that a court needs to decide.”

The price of legal action is high, even if companies proved a careful, well-documented analysis of cryptocurrency investments and courts were to apply only a prudence standard under ERISA.

Plans face enormous pressure to settle suits challenging their investment selection process due to uncertain pleading standards and inconsistent appeals court decisions.

“This means we could realistically see plaintiffs firms going to court alleging companies breached an ‘extreme care’ standard,” Lichtenstein said. “That’s what needs to be reviewed the most by the courts.”

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Adversarial Tone

Dropping the threat of an investigation would eliminate the adversarial tone the employee benefits agency set in its guidance, said Matthew Eickman, national retirement practice leader at Prime Capital Investment Advisors LLC in Omaha, Neb.

The Labor Department has a history of using subregulatory guidance without investigative threats to set the parameters for how companies can harness an asset class and still protect their retirement plan participants and beneficiaries.

Regulators issued a tipsheet to demonstrate a safe way of implementing target-date funds in 2013. When 2012 guidance on plan participant disclosure rules misstated the agency’s position on brokerage windows, EBSA revised the guidance (FAB 2012-02R), clearly stating how brokerage windows could comply.

“The department has tried to facilitate the utilization of specific investments in a safe manner rather than creating the impression that there’s some new rule that prohibits its usage,” Eickman said. “That extra language included at the end about investigation overstated the Department of Labor’s position and weakened it as a result.”

The Labor Department didn’t immediately respond to a request for comment. Senior DOL officials have said they didn’t ban cryptocurrency in the guidance, nor did they intend it as a method for rewriting the rules on brokerage window investment monitoring.

The drama that has ensued since the department issued its guidance—including the lawsuit it faces in the US District Court for the District of Columbia may have been intentional, Eickman said. The department’s threat demonstrates its opposition to 401(k) cryptocurrency investing.

“I think the Department of Labor probably isn’t surprised that a small portion of people are really upset about its guidance, because I also believe the department is like the cop car sitting at the top of the overpass,” he said. “That’s what it’s doing right now; this is all about deterrence. It’s not about prohibition.”

Even if the court were to side with ForUsAll in its fight to undo the Labor Department’s guidance, its point has been made, and the mere threat of an investigation—real or otherwise—can have a desired effect.

“It’s not about stopping all the speeders on the road, but it’s about getting them to tap their brakes and be a little more prudent before they decide whether to speed,” Eickman said.

To contact the reporter on this story: Austin R. Ramsey in Washington at aramsey@bloombergindustry.com

To contact the editors responsible for this story: Keith Perine at kperine@bloomberglaw.com; Martha Mueller Neff at mmuellerneff@bloomberglaw.com