Employee Benefits & Executive Compensation Blog

The View from Proskauer on Developments in the World of Employee Benefits, Executive Compensation & ERISA Litigation

No Presence? No Problem: Temporary Relief for Witnessing Spousal Consent Further Extended Through Year-End

By Robert Projansky and Katrina McCann on Posted in IRS Guidance, Plan Qualification

Perhaps channeling the old adage of “if it ain’t broke, don’t fix it,” the IRS recently released Notice 2022-27 extending through December 31, 2022 its temporary relief from the requirement that spousal consent for plan distributions or loans be witnessed in person.

As discussed in greater detail in our earlier posts (here and here), in response to the COVID-19 National Emergency, the IRS issued guidance temporarily allowing a notary or plan representative to witness spousal consent electronically via live video, provided certain conditions are met.  This relief was originally issued in June 2020 and due to expire on December 31, 2020, but then was extended twice under the same conditions.

Following those two extensions, the relief was scheduled to expire at the end of this month.  Notice 2022-27 now further extends the relief through the end of 2022.  The conditions for obtaining relief (described in our first post) remain unchanged.

Although the IRS stated that it does not expect a further temporary extension (due to easing public health precautions in connection with the pandemic), the IRS is currently reviewing comments it previously received from stakeholders regarding whether to make the relief permanent.  The Notice reiterates that the IRS will use the formal regulatory process (including an additional notice and comment period) if it proposes permanent changes to the physical presence requirement.

Plan administrators should be aware of this guidance and should continue to ensure that electronic witnessing meets all of the conditions set forth in the temporary relief.

Tags: COVID-19, IRS guidance, Notary, Plan Distributions, Plan Loans, Retirement Plan, Spousal Consent, Temporary Relief, Witness

CEO Self-Evaluation: To Thine Own Self (Assessment) Be True

By Michael Album and Aaron Weiss on Posted in Executive Compensation

“Report cards” may bring to mind evaluating middle school students, not CEOs of multi-billion dollar companies. But over the last decade, some companies have adopted a CEO “self-assessment” for evaluating the performance of CEOs. This approach can take a myriad of forms, ranging from an informal discussion with the CEO to having the CEO prepare a formal report addressing performance issues.

Consider the following:  An Intelligize search completed in May 2022 for publicly filed proxy statements that contain “self-assessment” or “self-evaluation” within three words of “CEO” returns 623 results. While admittedly imprecise and anecdotal, this survey of proxy disclosures suggests that some public companies now incorporate CEO self-assessment as part of their review of CEO performance.

The proxy disclosure of the CEO self-assessment process varies, depending on the issuer. For example, consider the following disclosures from the 2022 proxy statements for International Business Machines Corporation (“IBM”), McKesson Corporation (“McKesson”) and Akamai Technologies, Inc. (“Akamai”):

  • IBM: “The Chair of the Compensation Committee works directly with the Committee’s compensation consultant to provide a decision-making framework for use by the Committee in determining annual incentive payouts [to the] Chairman and CEO. This framework considers the Chairman and CEO’s self-assessment of performance against commitments in the year, both qualitative and quantitative, and also considers progress against strategic objectives, an analysis of IBM’s total performance over the year and the overall Company incentive score. The Committee considers all of this information in developing its recommendations, which are then presented to the independent members of the IBM Board of Directors for further review, discussion, and final approval.”
  • McKesson: As part of the assessment of year-end results, the “CEO presents an assessment of his individual performance results to the Board and discusses his goals for the new fiscal year.”
  • Akamai: “With respect to his own compensation, the CEO conducts a self-assessment of prior year performance. The Board (without the participation of the CEO) then discusses and evaluates the Chief Executive Officer’s performance. The TL&C [Talent, Leadership & Compensation] Committee is the ultimate decision-maker with respect to the compensation of our Chief Executive Officer and other NEOs.”

The actual components of the CEO self-assessment vary from company to company.

  • Some companies may follow a “free form” approach, which allows the CEO to set forth the key metrics or goals he or she views as relevant and the extent of his or her achievement. Others provide a set of financial and non-financial goals (such as leadership milestones) that need to be addressed.
  • As to time frame, some focus on the most recently completed fiscal year; others focus on goals that stretch over a longer period (such as a three- or five-year budget period), and may include progress on succession matters if the CEO is approaching retirement.
  • In line with the current focus on ESG goals, the CEO may be expected to address progress on environmental and social issues.
  • There may be a “catch-all” category, where the CEO is expected to address “misses” or areas for improvement.

How is the self-assessment used? Frequently for compensation purposes, often in connection with assessing CEO achievement of non-financial metrics underlying the annual incentive plan (“AIP”) and related payouts under the AIP (such as strategic and operational goals separate from earnings per share (“EPS”) growth, total shareholder return (“TSR”) and other financial metrics). Second, at a more general level, as a “reality check”—the fact is that the tone, candor and “feel” of a self-evaluation, in many cases reading “between the lines,” can provide the Board with a helpful overview of the CEO’s view of his or her performance and whether there is any “disconnect” between that view and the current operations and future prospects of the company. The audience for the CEO self-assessment is generally the Compensation Committee (but could include other Directors serving on committees that touch on CEO performance, a committee of independent Directors, or even the full Board). Issues relating to privilege also have to be considered when using CEO self-assessments, so counsel should be consulted as part of the implementation of a self-assessment protocol.

We close with some observations from Mark Nadler, a friend of the Firm and the founder of Nadler Advisory Services; Mark (along with his late brother David Nadler) has been a pioneer in advising CEOs and Boards. Mark warns against focusing only on the CEO’s achievement of financial metrics, particularly when the company has had a good year. In Mark’s view, financial metrics are “lagging indicators,” so regardless of how well the company has performed in any given year, it is important to focus on the future, and see how the CEO is contributing to the next year’s performance and the overall future of the company. As part of that non-financial “future oriented” emphasis, Mark recommends that the self-assessment take into account strategy, talent development, company culture and leadership—all factors that remain important for the long game.

IRS Unveils New Pre-Examination Compliance Pilot Program for Retirement Plans

By Robert Projansky and Jennifer Rigterink on Posted in Employee Plans Compliance Resolutions System

Ever wished you could predict the future? Or at the very least, predict the timing of a retirement plan audit? Well, you may be in luck on your second wish.

Last Friday, the IRS Employee Plans division announced a new pilot program whereby it will notify retirement plan sponsors 90 days in advance that their plan has been selected for upcoming examination.  The pilot program has three key features:

  • Advance Notice of an Upcoming Audit: Ninety days in advance of starting examinations, the IRS will notify plan sponsors by letter that their retirement plans have been selected for an upcoming audit. It is unclear from the announcement whether this 90-day review period will apply to all retirement plan audits (including those occasioned by a referral from another agency, like the Department of Labor), or only to retirement plans randomly selected for audit.
  • 90-Day Review Period to Self-Correct Errors: Plan sponsors are encouraged to use the 90-day period to review their plan document and operations to confirm compliance with current tax-qualification rules. Plan document and operational errors identified during this 90-day period, if eligible, may be self-corrected by the plan sponsor using the principles of the IRS’s voluntary compliance program set forth in Employee Plans Compliance Resolution System (EPCRS).  The IRS will review any proposed self-correction and documentation to confirm that it agrees with the resolution.  The IRS will then issue a closing letter or conduct a limited or full scope examination.
  • Reduced Fees for Errors Not Eligible for Self-Correction: If, within the 90-day period, a plan sponsor identifies errors that are not eligible for self-correction, it can request a closing agreement from the IRS.  In that process, the IRS will apply the VCP fee structure to determine the sanction amount, rather than the normal Audit CAP fees that would otherwise apply to errors identified in an IRS examination.  Because Audit CAP fees are far more unpredictable and can be significantly higher than the VCP fees, this pilot program provides a valuable opportunity for plan sponsors to get in front of costly errors not eligible for self-correction.

Although it is only a pilot and not (yet) part of the IRS’s compliance program, for as long as it lasts, this pre-examination pilot program marks a potentially helpful new tool for plan sponsors to ensure tax-qualification compliance for retirement plans.

So, what should plan sponsors do next?  The ability to predict the future is valuable only to those who use the information to change their proverbial destiny.  Sponsors and administrators who receive a 90-day pre-examination notice should immediately work with their attorneys and other advisors to conduct a self-audit to identify any compliance issues and address them within the 90-day window.

Of course, given what is involved in conducting a detailed review, identifying errors, coordinating internally and then fully correcting the errors, the 90-day period may feel shorter than it is.  That being the case, it is a good idea for plan sponsors and administrators to consider working with their professionals to conduct self-audits on a periodic basis even in the absence of an impending audit.

[Podcast]: Cross-Border Asset Deals

By David Teigman, Nicholas LaSpina and Nicola J. Bartholomew on Posted in Benefits Brief Podcast

proskauer benefits brief podcast

In this episode of The Proskauer Benefits Brief, partner David Teigman, senior counsel Nick LaSpina, and special international labor & employment counsel Nicola Bartholomew, discuss differences between asset sales in the US and the UK, with respect to transfers of employees.  In short, there are significant differences that are not necessarily intuitive to US practitioners.  In the US, parties will have commercial freedom to make offers of employment and negotiate terms, whereas in the UK employees will transfer automatically as a result of TUPE and a number of significant protections and obligations apply that will need to be factored into the deal. So be sure to tune into this informative discussion about employment and benefits issues in asset sales in the US and the UK.


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Tags: asset deals, Asset Purchases, TUPE, WARN, worker adjustment and retraining notification act

Sixth Circuit Rejects Arbitration for Proposed Fiduciary Breach Class Action

By Myron Rumeld, Tulio Chirinos and Sydney Juliano on Posted in 401(k) Plans, 403(b) Plans, Arbitration, Defined Contribution Plan Investment Litigation, Fiduciary

The Sixth Circuit, in a matter of first impression for that Circuit, held an arbitration clause contained in an individual employment agreement did not apply to ERISA fiduciary breach claims brought on behalf of a defined contribution plan.  The case is Hawkins et al. v. Cintas Corp., No. 21-2156, __ F.4th __, 2022 WL 1236954 (6th Cir. 2022).

Plaintiffs, former Cintas Corp. employees, sued the company and its investment committee under Section 502(a)(2) of ERISA on behalf of its 401(k) plan, alleging that defendants breached their fiduciary duties of prudence and loyalty with respect to the management of the plan.  Cintas moved to compel arbitration, arguing that an arbitration clause in plaintiffs’ employment agreements covered the claims they now sought to bring.

Last year, a judge in the Southern District of Ohio denied defendants’ motion to compel arbitration, reasoning that individual arbitration agreements could not cover claims under Section 502(a)(2) because such claims are brought on behalf of the plan.

The Sixth Circuit affirmed.  While the court stopped short of deciding whether Section 502(a)(2) claims could ever fall within the scope of an arbitration clause in an individual employment agreement, it held that plaintiffs’ claims did not fall within the arbitration clauses here.  The court reasoned that because such claims “belong” to the Plan, they cannot be forced into arbitration based on agreements that bind only individual participants.  Moreover, the court found that, in this case, the agreements established only plaintiffs’ consent to arbitration, but not the plan’s.

Proskauer’s Perspective

The Sixth Circuit’s decision is notable in several ways.  For one, it joins the Second, Seventh, and Ninth Circuits in rejecting arbitration of Section 502(a)(2) claims based on a clause in an individual employment agreement, though these courts reached the same result based on varied reasons, including that the clause did not reach ERISA claims (as opposed to typical employment-related claims) and that the clause violated the “effective vindication” exception to the Federal Arbitration Act where it would limit the relief authorized under Section 502(a)(2) (see our previous blog posts discussing the Second and Seventh Circuit decisions).

Additionally, the Sixth Circuit explicitly limited its decision to the arbitration clause contained in the employment agreements but left open the question of whether an arbitration clause in a plan document would lead to a different result, as it did in the Ninth Circuit in 2019 (see our previous post).  Given the increased use of arbitration clauses and frequency with which plaintiffs bring ERISA fiduciary breach claims, courts outside the Ninth Circuit may very well face this question in the near future.

Tags: 401(k) Plans, 403(b) Plans, Arbitration, Defined Contribution Plan Investment Litigation, Fiduciary

Ninth Circuit Revives Second Excessive Fee 401(k) Plan Litigation

By Myron Rumeld, Russell Hirschhorn and Tulio Chirinos on Posted in 401(k) Plans, 403(b) Plans, Defined Contribution Plan Investment Litigation, Fiduciary, Fiduciary Breach

On Friday, for the second week in a row, the Ninth Circuit reversed dismissal of a 401(k) plan excessive fee litigation challenging the offering of retail share classes of mutual funds instead of cheaper institutional share classes.  As with its decision reviving the other 401(k) plan litigation (discussed in detail here), the Ninth Circuit declined to consider at the pleading stage defendants’ explanation that it offered the more expensive retail share classes because they paid revenue sharing to the plan’s recordkeeper, which helped offset plan recordkeeping and administrative fees. The case is Kong v. Trader Joe’s Co., No. 20-56415 (9th Cir. Apr. 15, 2022).

Tags: 401(k) Plans, 403(b) Plans, Defined Contribution Plan Investment Litigation, Fiduciary, Fiduciary Breach

Ninth Circuit Revives Fee Challenge to Salesforce.com 401(k) Plan

By Myron Rumeld, Russell Hirschhorn, Sydney Juliano and Tulio Chirinos on Posted in 401(k) Plans, 403(b) Plans, Defined Contribution Plan Investment Litigation, Fiduciary, Fiduciary Breach

On Friday, the Ninth Circuit became the first circuit court to rule in a 401(k) plan fee and investment litigation following the Supreme Court’s January 2022 decision in Hughes v. Northwestern University, 142 S. Ct. 737 (2022).  In Davis v. Salesforce.com, Inc., No. 21-15867 (9th Cir. Apr. 8, 2022), the Ninth Circuit, without discussing Hughes, upheld the viability of the types of claims that Hughes reinstated and remanded for further review.  A discussion of Hughes can be found on our blog here.

The Ninth Circuit’s decision in Davis addressed whether plaintiffs plausibly alleged that fiduciaries of Salesforce.com’s 401(k) plan breached their fiduciary duties by:  (i) offering and retaining more expensive share classes of mutual funds despite the availability of lower-cost share classes of the same mutual funds; (ii) offering actively managed funds instead of cheaper index funds; and (iii) offering mutual funds instead of available collective investment trusts.

A federal district court in California previously ruled (twice) that plaintiffs’ complaint did not meet the plausibility standard, by:  (1) accepting defendants’ “obvious explanation” that more expensive share classes were selected because they paid revenue sharing that was in turn used to offset recordkeeping and administrative fees; and (2) concluding that it was improper to compare the two management styles (passive versus active) and investment vehicles (mutual fund versus collective investment trust), and even if the comparisons were appropriate, plaintiffs did not allege long-term and/or material underperformance sufficient to state a plausible claim of imprudence.

In an unpublished opinion, the Ninth Circuit reversed the district court’s dismissal of two of the three claims and remanded the case, based on the following conclusions:

First, the Ninth Circuit found it inappropriate to consider, on a motion to dismiss, defendants’ argument that the challenged share classes were selected because they made revenue sharing payments to the plan that were used to pay for recordkeeping and administrative services, as opposed to the lower cost share classes that did not pay revenue sharing.  The Ninth Circuit explained that where there are two “alternative explanations, one advanced by defendant and the other advanced by plaintiff, both of which are plausible, plaintiff’s complaint survives a motion to dismiss under Rule 12(b)(6).”  The Ninth Circuit did not, however, cite to or try to reconcile its holding with its 2018 unpublished decision in White v. Chevron Corp., 752 F. App’x 453 (9th Cir. 2018), in which it upheld the dismissal of similar mutual fund share class claims and appeared to give weight to defendants’ alternative explanations by ruling that where there are “two possible explanations, only one of which can be true and only one of which results in liability, plaintiff[] cannot offer allegations that are ‘merely consistent with’ [its] favored explanation but are also consistent with the alternative explanation. . . . [s]omething more is needed, such as facts tending to exclude the possibility that the alternative explanation is true . . . in order to render plaintiffs’ allegations plausible within the meaning of Iqbal and Twombly.”

Second, the Ninth Circuit held that defendants’ reasons for not switching from mutual funds to collective trusts, or not doing so sooner, were factual issues not appropriate for resolution at this stage.

Third, the Ninth Circuit found plaintiffs’ allegation that defendants should have invested in passively managed funds instead of actively managed funds was not sufficient to state a claim, for the same reasons provided by the district court.

Proskauer’s Perspective

While the decision is unpublished (and technically non-precedential under Ninth Circuit appellate rules), the Ninth Circuit ruling furthers the increasing concern among plan sponsors and fiduciaries that even the most bare-bones claims challenging the fees and investment offerings of 401(k) plans will withstand motions to dismiss.  Of particular concern is the courts’ increasing tendency to allow claims challenging the use of higher-cost share classes to proceed, even where the complaint makes no effort to consider the likelihood that these share classes generate revenue sharing payments that offset any higher fees to plan participants.  If, at the motion to dismiss stage, courts will refuse to consider even the most obvious explanations for the challenged decisions, defense practitioners may want to consider holding their power on motions to dismiss and instead filing summary judgment motions in the early stages of discovery, when the courts may be more likely to evaluate these explanations.

Tags: 401(k) Plans, 403(b) Plans, Defined Contribution Plan Investment Litigation, Fiduciary, Fiduciary Breach

Ninth Circuit Defers to Plan Design and Administrative Discretion on Bounds of Mental Health Coverage

By Joseph Clark, Seth Safra and Aaron Weiss on Posted in ERISA Coverage, Mental Health Parity

A recent decision by the U.S. Court of Appeals for the Ninth Circuit (Wit et al. v. United Behavioral Health and Alexander et al. v. United Behavioral Health) exemplifies the challenge in balancing a desire to cover evolving treatments for mental health and substance abuse disorders against plan sponsors’ and insurers’ general authority over plan design and the administrator’s discretion to interpret the plan and decide claims.  The case involved United Behavioral Health’s (“UBH”) complete or partial denials of claims related to treatment for mental health and substance abuse.

A federal district court (see here and here) had ordered UBH to reprocess over 50,000 claims on the ground that UBH’s guidelines for making coverage determinations did not comport with generally accepted standards of care (“GASC”).  The district court concluded that UBH’s guidelines improperly applied cost-benefit analysis to reject coverage for more comprehensive treatments.  For example, the district court concluded that UBH’s guidelines overly emphasized treatment of acute symptoms over treatment of underlying conditions and inappropriately did not include level-of-care criteria specifically tailored to children.

Among other things, UBH argued on appeal that: (1) the ERISA beneficiaries lacked standing to pursue their claims; and (2) the trial court had failed to correctly apply the abuse of discretion standard in connection with its reprocessing order.

In an unpublished decision, a Ninth Circuit panel rejected UBH’s standing argument, but still reversed the order to reprocess claims, because—

  • Under the applicable plans, compliance with GASC was required but not sufficient to justify coverage—e., services could be covered only if they were within the scope of both GASC and what the plan covered; and
  • The plan administrator’s application of the plan’s standards could be reviewed only for abuse of discretion. This meant that, even if the court disagreed with UBH’s balancing of costs and benefits or its final decision, the court could not overturn the administrator’s decision unless it was unreasonable.

The Ninth Circuit also held that an alleged conflict of interest based on UBH serving as both plan administrator and insurer/payer was not sufficient to change the outcome on the facts of the particular case.

The Ninth Circuit’s decision illustrates how claims for coverage, especially for mental health services, are inherently fact-specific because they require analysis of the patient’s medical needs, medical necessity, and sufficiency of alternative treatments.  Rather than address the merits of any particular claim, the Ninth Circuit simply concluded that in light of the discretion conferred to UBH to interpret the plans, it was not appropriate to send over 50,000 claims back to UBH for review en masse.

Tags: ERISA litigation, Mental Health Parity, Standard of Review

Congress Reopens Door For HSA With No-Deductible Telehealth, But With a Hole

By Aaron Weiss and Seth Safra on Posted in Coronavirus, HSA

Effective April 1, 2022, high-deductible health plans can once again offer first-dollar coverage for telehealth and other remote services without making participants ineligible for health savings account (“HSA”) contributions.  The relief runs only through the end of 2022, and the regular high-deductible health plan requirements generally apply for the months of January through March 2022.  (But there is no gap if the plan’s current plan year started before January 1, 2022.)

By way of background, to be eligible to make or receive contributions to an HSA, an individual must be covered by a high-deductible health plan.  Subject to limited exceptions, coverage under a health plan before the minimum deductible is satisfied would make plan participants ineligible to make or receive HSA contributions.  If contributions are made while a participant is ineligible, the contributions would have to be included in the participant’s income (i.e., subject to income tax) and the contributions would be subject to a 10% additional tax.

Section 223 of the Internal Revenue Code includes exceptions to the minimum deductible requirement for preventive care, employee assistance programs, and certain other “permitted insurance.”   The 2020 CARES Act (Coronavirus Aid, Relief, and Economic Security Act) added an exception for telehealth and other remote services, but that exception applied only from enactment of the CARES Act through the last plan year that started before January 1, 2022.

The Consolidated Appropriations Act of 2022 (signed into law on March 15th) restores the exception for telehealth and other remote services, but only for the period from April 1 through December 31, 2022.  This means that if a plan’s year started at any time from January 1, 2022 through March 31, 2022, and the plan did not impose the minimum deductible for telehealth or other remote services from the start of the plan year through March 31, 2022, the plan would not be a high-deductible health plan for that period.  Consequently, participants covered by the plan would be ineligible to make or receive HSA contributions for that period.

Plan sponsors who were expecting the telehealth exception to be restored back to January 1st should consult with counsel on practical ways to ensure that participants retain their eligibility for HSA contributions.

Tags: coronavirus, HSA

Cryptocurrency in 401(k) Plans? Might be More Like “Crypto-nite,” Says the DOL in Its Latest Release

By Paul M. Hamburger and Andrea Ewalefo on Posted in Department of Labor

Kryptonite is a fictional substance that causes the mighty Superman to lose all his strength. According to a recent release from the U.S. Department of Labor Employee Benefits Security Administration (“DOL”), cryptocurrency might carry similar dangers for otherwise strong and healthy 401(k) plan accounts. That is, in DOL’s view, the benefits of cryptocurrency in 401(k) plans may prove to be just as fictional as kryptonite, thereby causing significant risks of losses for retirement security.

On March 10, 2022, DOL issued Compliance Assistance Release No. 2022-01 (the “Release”) to caution plan fiduciaries to exercise extreme care before considering whether to include investment options like cryptocurrency as part of a 401(k) plan’s investment menu. In so doing, DOL raised five key concerns associated with offering these types of investment options.

DOL’s 5 Reasons Why Cryptocurrencies Might be Like “Crypto-nite” to Participant Retirement Accounts:

  1. Digital Assets Are Highly Speculative and Volatile

After noting that the SEC has also warned of the highly speculative nature of cryptocurrency, DOL cautioned that the extreme price volatility of cryptocurrency investments can have a devastating impact on participants with significant allocations to cryptocurrency. According to DOL, this volatility might be attributable to the many uncertainties surrounding the valuation process, fictitious trading practices, and widely published reports of theft and fraud, among other factors.

  1. Obstacles Inhibit Participants From Making Informed Decisions

The Release noted that cryptocurrencies are often presented to investors as “innovative investments” that provide “unique potential for outsized profits;” resulting in participants having high return expectations with little appreciation for the unique risks and volatility associated with cryptocurrencies. DOL also pointed out that these investments do not have the types of traditional data that novice and expert investors alike rely on to adequately evaluate future potential investment options.

Moreover, the Release asserted that the recent rise of social media and celebrity attention received by digital assets poses additional challenges for investors and plan participants to separate the facts from the hype. When combined with a plan fiduciary’s decision to include cryptocurrency options on a 401(k) plan menu, according to the Release, the message effectively conveyed to plan participants is that “knowledgeable investment experts have approved the cryptocurrency option as a prudent option . . . [which can] easily lead plan participants astray and cause losses.”

  1. Fiduciaries Face Non-Traditional Custodial and Recordkeeping Challenges

Unlike traditional plan assets that are held in trust or custodial accounts, DOL notes that cryptocurrencies generally exist as lines of computer code in a digital wallet. In addition to valuation and liquidity issues, cryptocurrencies “can be vulnerable to hackers and theft,” as well as loss from losing or forgetting a password. DOL contends these differences pose unprecedented challenges for fiduciaries charged with highly regulated custodial and recordkeeping requirements.

In a DOL blog post issued on the same day as the Release, blog author, Acting Assistant Secretary, Ali Khawar, provided further insight into why DOL considers these challenges so significant:

“The assets held in retirement plans, such as 401(k) plans, are essential to financial security in old age – covering living expenses, medical bills and so much more – and must be carefully protected.”

  1. Experts Lack Industry Standard Valuation Models or Accounting Requirements

The Release expressed concerns about the reliability and accuracy of cryptocurrency valuations. Experts are still grappling with the complex and challenging task of solving how to value digital assets, and also admit that none of the existing proposed valuation models are as sound or academically defensible as the discounted cash flow analysis or interest and credit models that are traditionally used.

  1. Regulatory Landscape is Unstable and Swiftly Evolving

Last, the Release warned that, as the rules and regulations governing cryptocurrency markets continue to evolve, some market participants could find themselves operating outside of existing regulatory frameworks or not complying with them. Fiduciaries who are considering whether to include cryptocurrency investment options, according to the Release, must include in their analysis an explanation of the possible application of regulatory requirements on issuance, investments, trading, or other activities, and the possible effects those requirements may have on participant investments in 401(k) plans. An example that is very similar to this highly talked about pending litigation was provided in the Release to illustrate possible risks in this area.

A Word to Fiduciaries Who Have Already Allowed Cryptocurrency on the Investment Menu, Including Through Brokerage Windows

In addition to outlining specific risks raised by cryptocurrency investments in 401(k) plans, the Release announced that DOL expects to conduct investigations specifically targeting plans that offer participant investments in cryptocurrencies and “related products.” Plan fiduciaries should expect to be questioned over how their actions aligned with their fiduciary duties of prudence and loyalty in light of the risks addressed in the Release.

These investigatory warnings also extend to plans and plan fiduciaries responsible for allowing cryptocurrency investments through 401(k) plan brokerage windows. This is concerning and may have broader implications because, as explained in a recently released report by the ERISA Advisory Council, most experts believe that plan fiduciaries do not have an obligation to monitor the underlying investments in a brokerage window, absent “extraordinary circumstances.” The Release’s reference suggests that DOL believes cryptocurrency investment options in brokerage windows may be the type of extraordinary circumstance that warrants a closer look at brokerage windows.

Unanswered Questions

After reading the Release, fiduciaries should also consider many unanswered questions in addition to the specific risks raised.

  1. Can a “Sophisticated Fiduciary” Approve an Investment Option That Has a Small Allocation to Cryptocurrency?

In prior guidance involving private equity investments in 401(k) plans, DOL noted the investment risks but offered a path for fiduciaries to manage the risks. In that context, (see the  June 2020 Information Letter and Supplemental Statement issued in January 2022), although DOL expressed the need to exercise caution, DOL also stated that such potentially risky investment options could be included within a diversified investment option if approved by a “sophisticated fiduciary.” The Release raises “serious concerns” with “direct investments in cryptocurrencies,” as well as “other products whose value is tied to cryptocurrencies,” but it leaves open the question of whether, and to what extent, “sophisticated fiduciaries” could approve funds that include small allocations to cryptocurrency.

  1. How Much Indirect Exposure to Cryptocurrency is Too Much?

As noted above, the Release targets not only “cryptocurrencies” but also “other products whose value is tied to cryptocurrencies.” Left unanswered is whether “other products” would include funds that have any exposure to cryptocurrency as opposed to exposure above a particular threshold.

For example, the June 2020 Information Letter provided that private equity must be a small component – perhaps not more than 15 percent – of a designated investment alternative to potentially be permissible in 401(k) plans. Is it possible, then, for a target date fund that invests in collective investment funds, one of which contains a very small percentage (less than 15 percent) of its assets in cryptocurrency, to be an acceptable “other product”? If not, it is possible that a number of diversified investment options could be swept into the broader “other” category. Fiduciaries should review whether any funds in their plans’ lineups have exposure to cryptocurrencies.

  1. What About Defined Benefit Plans and Other Fund Types?

Finally, the Release specifically focuses solely on 401(k) plan investments in cryptocurrencies and related products. What about defined benefit plan investment funds? What about investments held by welfare benefit funds (VEBAs)? A number, albeit not all, of the five DOL concerns expressed in the Release apply similarly to these other types of plans; but the Release did not focus on those types of plans.

For now, plan sponsors and fiduciaries should keep an eye on new developments. If DOL does launch an investigatory program for cryptocurrency investments, it is possible that this guidance might take the form of audit questions for plan fiduciaries. Regardless, fiduciaries need to be ever vigilant in monitoring plan investments and making investment decisions.

Tags: 401(k) Plan, blockchain, brokerage window, Compliance Assistance Release No. 2022-01, cryptocurrency, defined benefit plan, defined contribution plan, Department of Labor, digital assets, DOL, Employee Benefits Security Administration, ERISA, fiduciary duty, investment funds, investments, plan fiduciary, SEC
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