America’s young workers are clamoring for 401(k) plans that allow them to invest in cryptocurrencies. And in today’s supertight labor market, companies are feeling heavy pressure to provide that option. But employers that now typically offer low-risk, plain-vanilla portfolios dominated by index funds are extremely fearful of putting the riskiest of risk assets on their menus. If they do open their defined contribution retirement offerings for the coins that, according to Fidelity, some 80 million Americans have already purchased as an investment, they’ll likely face a deluge of lawsuits in cycles when the digital holdings in those nest eggs crater—and the U.S. Department of Labor, which oversees 401(k)s, warns that a crypto disaster is likely.
Yet prospective employers that don’t offer Bitcoin and Ether choices could well lose great job candidates to rivals that make those new age picks available. “Companies are damned if they do and damned if they don’t,” one of the most prominent attorneys representing employers in suits over 401(k) plans told Fortune. “401(k) plans are already one of the most litigious areas in the business world. If cryptocurrencies become common in those plans, the cost to employers will be heavy litigation. The plaintiffs bar is looking over the next hill to see where the money is, and they’re thinking it’s all about winning class action settlements when employees take losses on, say, the Bitcoin in their 401(k).”
We’re about to witness a tense tug-of-war between what companies think they can safely proffer in their retirement plans, and what workers want.
Crypto 401(k) plans
On April 26, Fidelity Investments unveiled the first program ever advanced to offer cryptocurrency in 401(k)s. The announcement received heavy press coverage, and raised jubilation in the crypto community. The nation’s largest administrator of retirement accounts, serving 23,000 companies, introduced its Fidelity workplace Digital Assets Account (DAA) that allows employees to place 20% of their 401(k) savings in Bitcoin, at annual fees in the 1% range. The coins would sit in safe, regulated custody accounts. In the press release, Fidelity executives noted that the new product is a response to heavy demand from both companies and employees. Dave Gray, Fidelity’s head of workplace retirement platforms—who expressed being “thrilled” at the launch—cited “growing interest from sponsors [employers offering 401(k)s] and individuals with an appetite to incorporate cryptocurrencies into their long-term investment strategies,” while Chris Call, EVP of retirement services added, “Increasingly, we’re seeing interest from leading employers to add digital assets to their 401(k) plan.” Included in the release was news that MicroStrategy, the cloud and business intelligence platform run by Bitcoin-enthusiast Michael Saylor, will be Fidelity’s maiden customer, and the first company to offer a digital currency in retirement accounts. The Fidelity product is scheduled to roll out in midyear.
The U.S. Department of Labor apparently saw the Fidelity gambit coming, and seven weeks earlier, issued a note warning employers that they’d be courting grave danger by opening their 401(k)s to this new category of high-fliers. “The Department cautions plan fiduciaries to exercise extreme care before they consider adding a cryptocurrency option to a 401(k) plan’s investment option,” the March 10 report stated. It went on to point out that embracing crypto would mark a radical shift in the world of retirement savings. “Cryptocurrencies are very different from typical retirement plan investments, and it can be extraordinarily difficult, even for expert investors, to evaluate these assets and separate the facts from the hype,” the note stated, adding that crypto is anything but a “prudent” choice that can “lead investors astray and cause losses.” The regulator reminded the sponsors and fiduciaries that under the law, they’re the ones who are liable if they make questionable, high-risk choices available to their workers, and those volatile vehicles take a dive. “Fiduciaries may not shift responsibility to plan participants to identify and avoid imprudent investment options, but rather must evaluate…the alternatives and ensure they are prudent. A failure to remove imprudent investment options is a breach of duty,” the department cautioned.
The message to corporate America was stark: Adopting plans like Fidelity’s that offer crypto in your 401(k)s is a reckless practice that will invite a rash of lawsuits. Don’t do it.
Big litigation shaped the modern plain-vanilla 401(k)
To understand the trends that have made traditional 401(k) investments so bland and safe, and how that’s raised young investors’ thirst for more adventurous choices, it’s important to follow the trajectory of litigation in the field. Last year, the top 10 settlements paid by companies for violations of ERISA, the federal law under which the Department of Labor regulates private retirement plans, amounted to $837 million. That’s double the number in 2020, and a fraction of total damages from sundry suits. Insurer John Hancock and retailer Lowe’s paid $10 million and $12.5 million, respectively, to settle 401(k) class action cases last year.
The attorney who defends employers in these suits explains that the plaintiffs’ charges have shifted sharply in the past two decades, and are poised to veer again. “In [the] aughts, many companies allowed employees to invest in their own stock, and workers would frequently put a big part of those shares in their 401(k)s,” the lawyer says. “Then the company would have a bad quarter, the stock price would drop, and employees would suffer large losses.” The plaintiffs’ lawyers would then argue that the employer was irresponsible in letting workers park so much of their savings in a single stock. Those cases garnered big class action settlements. “Offering the company’s stock as an investment wasn’t outlawed,” notes the litigator, “but most companies stopped offering their own stock in 401(k)s, or imposed strict limits on the percentage it could constitute of an employee’s portfolio.”
The past 10 years witnessed a second wave of litigation. “These suits centered on the fees charged by actively managed funds,” observes the lawyer. “The suits targeted companies that provided menus of funds that were costly. That caused a war on expenses.” The upshot was a big shift to the cheapest choice: index funds. “It wasn’t about lowering risk,” says the litigator. “It was all about lowering the fees and expenses charged to the workers’ accounts.” As a result, companies switched en masse from actively managed mutual funds to index funds. “So menus became increasingly vanilla,” says the attorney. “Now, most companies offer menus through their service providers that primarily consist of low-cost, passively managed investments.”
But the market-tracking safety of a 401(k) plan heavy on index funds doesn’t appeal to millions of Gen Xers and Gen Zers. “The new generations are bridling at getting stuck with their father’s-style 401(k) plan, with the cheap passive plans that are mainly being offered,” says the lawyer. “They all know a Bitcoin millionaire. So the prospect of putting cryptocurrencies into their 401(k)s is getting a lot of attention.”
Crypto 401(k) options
The big service providers such as Fidelity, Charles Schwab, and T. Rowe Price do all the record keeping for 401(k) plans, and provide the company with a broad range of funds to choose from—lists that now lean massively passive. So far Fidelity is the only player that’s offering a crypto option. In fact, it appears that most if not all of its big rivals are heeding the Department of Labor and choosing not to follow what they consider a dangerous path. In an email to Fortune, a spokesperson for T. Rowe Price wrote, “The mandates we manage for clients today are not well suited to investing directly in digital assets, and we are cognizant of the high level of speculation and lack of regulatory clarity in the space.”
Vanguard, another big 401(k) provider, also has no plans to offer crypto. In a blog post last year, Vanguard called the category “highly speculative,” and dismissed its prospects as a long-term investment as “weak,” adding that “our investment philosophy encourages staying the course and tuning out the noise.” So far, Schwab, another powerhouse in the space, hasn’t shown any signs it will launch a product to challenge Fidelity’s.
So if other than Fidelity, most service providers shun the high risks of a new crypto product, how will young employees find a way to park the crypto coins in their 401(k)s? And how will their employers make that option available, if not through a Vanguard or T. Rowe Price? Here’s a possible answer, and it’s one the Department of Labor dreads. About half of all 401(k) plans include, along with the providers’ choices approved by the fiduciaries appointed by the employer, a “brokerage window.” Under those regimes, workers can put a certain share of their portfolio in individual stocks, actively managed mutual funds, ETFs, and over-the-counter trust products. Those brokerage choices do not fall under ERISA, and in the past, weren’t regulated by the Department of Labor. “Those brokerage windows were seen as different from the investment menus selected by plan fiduciaries,” says the lawyer, and weren’t subject to the same legal requirements.” They’re not vetted by the fiduciaries. Holders of 401(k) accounts that lose money on those investments didn’t sue their employer for high fees charged by the funds, say, or for losses they take on high-risk bets that the fiduciaries would never allow in the investments they pick from menus provided by the plans.
Companies can restrict the share of 401(k) savings that an employee can put in the brokerage account. Employers can also ban extremely high-risk investments. Although good statistics aren’t available, it appears that few companies now allow folks to purchase Bitcoin or Ether through a 401(k) brokerage account. About 60% of the plans Schwab services provide a “brokerage window.” Besides offering the basic plan, Schwab also acts as the broker. In an email to Fortune, a spokesperson stated that assets in cryptocurrency products equaled less than 1% of total brokerage window assets at Schwab as of Dec. 31, 2021. Even that small number consists of investments tied to crypto, not actual coins. An example would be holdings in Bitcoin mining stocks such as Riot and Bitfarms that hold lots of the coins on their balance sheets. These numbers imply that most brokerage windows don’t allow workers to, say, buy Bitcoin on the Coinbase exchange, and park it in their 401(k) as they would in their digital wallet.
Employers may open the brokerage window to crypto—and the Department of Labor is plenty worried
The attorney predicts that if indeed employees push hard to make “physical” Bitcoin or Ether available in 401(k)s, the most likely venue will be brokerage windows. “So it won’t happen through the investment options selected by the plan fiduciaries, but through the brokerage windows,” says the litigator. “So far, that’s between the employees and the brokers. It hasn’t been the business of the fiduciaries, the company, or officially, the Department of Labor. It’s not now the subject of lawsuits.”
In its groundbreaking March 10 note, however, the Department of Labor saw this shift coming, and issued an alert that cheered the plaintiffs’ bar and greatly concerns employers. “Remarkably, it came as the last sentence in that long report,” says the attorney. It read: “The plan fiduciaries responsible for overseeing…such investments through brokerage windows should expect to be questioned about how they can square their actions with their duties of prudence and loyalty.” According to the attorney, the Department of Labor hasn’t so far moved to adopt new rules targeting brokerage windows. But its language gives plaintiffs’ attorneys a big opening to claim that by allowing workers to buy Bitcoin via a 401(k) brokerage account, the fiduciaries are violating their responsibilities to allow only prudent options.
“We’ll have litigation in the near future where the plaintiffs argue that brokerage windows aren’t any different from the standard plan menu. Labor’s new statement will hasten that day,” predicts the lawyer. Then we could see a series of decisions in favor of the plaintiffs that indeed make investments through the brokerage window the company’s responsibility. When employees lose money on Bitcoin, plaintiffs could notch big settlements on the grounds they were allowed to buy assets so excessively risky that the companies should have barred them from their 401(k)s.
In the view of the attorney who lives in the world of 401(k) litigation, the pressure on companies is so intense that they could buckle to the demands of young workers, and allow crypto purchases via the brokerage windows. Employers think providing that carrot for workers outweighs the looming costs from a big new wave of lawsuits. We’ll soon see if those costs cause companies to reverse course and close the window to digital coins, a move that risks riling legions of young workers. Or, a collapse in crypto could slam the window for them.