This article should be helpful to trustees looking to understand how virtual currency related markets work in the context of retirement planning. Virtual currency is being embraced by more and more institutional investors, some of whom work with pension plans subject to the Employees Retirement Income Security Act of 1974 (ERISA).
Virtual currency or cryptocurrency (crypto) is a digital asset that can be traded freely without a central monetary authority such as a financial institution or government entity. Instead, cryptocurrencies are created using cryptographic methods so traders can transact securely.
Cryptocurrency exchanges (e.g. Coinbase) are popular platforms where people go to trade. These platforms often provide their users with their own “wallet” – where traders can store the private keys (passwords) that provide access to their crypto.
Crypto is used to buy goods and services, but it is sometimes used to participate in software programs, including financial products.
A plan subject to ERISA must have an “appointed trustee” (usually an employer) in charge of the plan. The appointed trustee should prudently appoint a certified “investment manager” (eg, a bank) to manage the plan’s investment portfolio and oversee the investment manager’s decisions regarding the plan.
More frequently, investment managers are asked about the pros and cons of virtual currency as an investment asset in retirement planning. Here are some of the key takeaways from these crypto-specific risks.
Plans under ERISA must have all assets based in the United States. Although there are some exceptions for foreign currency, there is no exception for cryptocurrency at this time. To comply with this ERISA rule, Appointed Trustees and Investment Managers should diligently review the crypto exchange (wallet) they wish to use and confirm that neither the trading platform nor the currency itself are based outside of the United States.
The most attractive feature of virtual currency – its non-regulation – is also a feature that gives it increased risk as an investment asset. At present, it is unclear which government agencies are primarily responsible for protecting the public in the exchange of virtual currencies.
The Securities and Exchange Commission (SEC) appears to be leading the charge as a regulator. There have been some SEC interventions in crypto trading, including allegations of wire fraud against some platforms. However, only an uncertain number of virtual currency exchanges have been identified by the SEC as required to be registered under federal securities laws. The SEC maintains a list of its enforcement actions involving digital assets on its website.
Although there are no clear guidelines for investors in assessing the legitimacy of a type of crypto or a trading platform, it is wise for investors to confirm the veracity of the statements of the trading platform and/or engage legal counsel to determine, for example, whether an initial coin offering would be subject to federal securities laws.
The crypto market is vulnerable to complex and unpredictable security attacks. There have been disturbing reports of data breaches resulting in millions in losses for exchanges and their customers, and some victims have still not been compensated.
ERISA plan investors engaged in virtual currency should understand that at any time (due to a hack, for example), assets may become inaccessible, trading may be suspended, and the exchange may not offer to reimburse the investors for any loss. Investors should therefore be diligent in choosing the crypto exchange they want to use.
As mentioned above, valuation of US-based investments is required for ERISA compliance purposes. However, it could also ensure that the exchange will be subject to US anti-money laundering (AML) and customer due diligence (KYC) laws.
Michael Pollock is an associate attorney at Wright Lindsey Jennings who advises and represents corporations and individuals in tax and commercial matters. The opinions expressed are those of the author.