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This article should be helpful to fiduciaries seeking an understanding of how the markets related to virtual currency function in the context of retirement planning. Virtual currency is being embraced by more institutional investors, some of whom work with retirement plans subject to the Employee Retirement Income Security Act of 1974 (ERISA).
Virtual currency or cryptocurrency (crypto) is a digital asset that can be exchanged freely without a central monetary authority such as a financial institution or governmental entity. Instead, cryptocurrencies are made using cryptography methods so that traders can make trades 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 keep the private keys (passwords) that give 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 a “named fiduciary” (typically an employer) responsible for the plan. The named fiduciary must prudently assign a certified “investment manager” (e.g., 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 advantages and disadvantages of virtual currency as an investment asset in retirement planning. Here are some of the key takeaways of these risks specific to crypto.
Plans under ERISA must have all U.S.-based assets. Though there are certain exceptions for foreign currencies, there is no such exception for cryptocurrency at this time. To comply with this ERISA rule, named fiduciaries and investment managers should diligently review the crypto exchange platform (wallet) they wish to use and confirm that neither the trading platform nor the currency itself are based outside the United States.
Virtual currency’s most attractive trait — its nonregulation — is also a trait that gives it heightened risk as an investment asset. At present, it is not apparent which governmental agencies are primarily charged with protecting the public in virtual currency exchange.
The Securities and Exchange Commission (SEC) appears to be leading the charge as a regulator. There have been some interventions by the SEC in crypto trading, including allegations of wire fraud against certain platforms. However, only an unclear number of virtual currency exchanges have been identified by the SEC as needing to be registered under federal securities laws. The SEC maintains a list of its enforcement actions involving digital assets on its website.
While there are no clear guidelines for investors in assessing the legitimacy of a crypto type or trading platform, it is wise for investors to confirm the veracity of the trading platform’s statements and/or engage legal counsel to determine, for instance, whether an initial coin offering would be subject to federal securities laws.
The crypto market is vulnerable to unpredictable, complex security attacks. There have been concerning reports of data breaches resulting in millions in losses for exchanges and their customers, and some victims still have not been compensated.
ERISA plan investors engaged in virtual currency should understand that at any time (due to hacking, for example), assets could become inaccessible, trading could be suspended and the exchange may not offer to reimburse investors for any losses. Investors should therefore exercise diligence in selecting the crypto exchange they wish to use.
As mentioned above, assessing U.S.-based investment is required for ERISA compliance purposes. However, doing so could also ensure that the exchange will be subject to U.S. laws addressing money laundering (AML) and customer due diligence (KYC).
Michael Pollock is an associate attorney with Wright Lindsey Jennings who advises and represents companies and individuals in tax and business matters. The opinions expressed are those of the author.
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