Hiltzik: Why crypto shouldn’t be part of your retirement plan

The federal government has some advice for workers considering adding Bitcoin or any other cryptocurrency to their retirement: Don’t do it.

The advice is not exactly new. The Department of Labor, which oversees employer-funded pension offerings like 401(k) plans, first warned plan sponsors in March to “use extreme diligence” before opening those plans to cryptocurrency investments.

“These investments pose significant risks and challenges to participants’ retirement accounts, including significant risks of fraud, theft and loss,” the agency said.

The industry is full of charismatic child prodigies, opportunistic scammers, and self-proclaimed investment advisors who promote financial products with little to no transparency.

— Democratic Sens. Elisabeth Warren, Dick Durbin and Tina Smith in a letter to Fidelity Investments

Since then, the dangers facing investors in the cryptocurrency markets have only become more apparent.

They were underscored by the collapse earlier this month of FTX, a leading crypto exchange whose founder Sam Bankman-Fried had become the fresh spokesman for the safety of these markets and their potential to generate investment gains.

FTX filed for bankruptcy protection on Nov. 11, amid allegations of financial misconduct and evidence of spectacularly lax and chaotic internal operations. It was the second major player to file for bankruptcy in four months, after Celsius Networks, which was also seen as a high-flying and safe player in the space.

Celsius filed for bankruptcy on July 13, an abrupt collapse that has financially devastated untold numbers of its 1.7 million customers.

It’s not clear if these debacles will cool investment promoters’ efforts to lure average working men and women to the crypto wild west.

Leading companies include Fidelity Investments, which manages retirement plans for approximately 35 million insured with approximately $1.4 trillion in assets. Fidelity announced earlier this year that it would allow plan sponsors to offer their employees the option to invest in Bitcoin.

Is that a wise policy? Democratic Sens. Elizabeth Warren of Massachusetts, Dick Durbin of Illinois, and Tina Smith of Minnesota don’t think so. In a Nov. 21 letter, they asked Fidelity to reconsider.

The launch of FTX “made it clear that the digital asset industry is in serious trouble,” they wrote. “The industry is full of charismatic child prodigies, opportunistic scammers and self-proclaimed investment advisors who promote financial products with little to no transparency.”

The lawmaker’s letter was a follow-up to a July 26 letter in which he called Fidelity’s decision “immensely disturbing”.

While the final decision on whether employees are allowed to invest in Bitcoin through their 401(k) plans rests with the employers who support their plans, they wrote, “It does not seem advisable that any of the leading names in the financial world should support the Use of such a volatile, illiquid and speculative asset in 401(k) plans – which are intended to be retirement vehicles defined by… steady returns over time.”

Fidelity seems unfazed by such observations; instead, it stands behind its own reputation for integrity.

“Recent events in the digital assets industry have further underscored the importance of standards and safeguards,” a Fidelity spokesperson told me via email. “As a company that has been serving clients in the financial markets for over 75 years, Fidelity has consistently prioritized operational excellence and client protection across all of its businesses.”

Still, crypto is a uniquely dangerous investment for families struggling to manage their retirement resources.

Defined contribution plans, such as 401(k) plans, have become the primary retirement offering for most employers over the past few decades, supplanting traditional defined benefit plans. The latter offer pension payments based on employees’ income and length of service.

Pension payments from defined contribution plans depend on the amounts workers set aside as investments plus the investment gains their funds generate over time.

Both systems have advantages and disadvantages. Defined benefit plans are best suited for employees who remain with an employer long-term. The risk of downturns in the investment market is borne by the employer, but is usually not transferable to new employers.

Defined contribution plans are portable – they can follow workers as they move from company to company. But workers bear the risks of market downturns.

401(k) plan owners have seen these risks materialize in real time. Average balances on those plans are down 23% year over year in the third quarter of this year, according to Fidelity. An analysis by Vanguard, which goes neck and neck with Fidelity as the manager of defined contribution plans, showed that the average plan was about $129,000 at the end of 2021.

This is misleading, however, because the average figure is inflated by disproportionately wasteful nest egg held by wealthier workers. The median inventory — the level that falls in the middle of all account holders’ assets — was only about $33,500.

These stats illustrate the dangers of bad investment decisions for your 401(k) plan. They explain why Fidelity’s initiative unsettled Labor Department regulators.

The agency did not issue a hard-and-fast rule governing defined contribution investing, in part because it would have required a long period of analysis and public comment before it could be issued. Instead, regulators issued a less formal recommendation to plan for trustees — the company directors responsible for employees’ retirement options.

Under federal law, according to the Department of Labor, “trustees must act solely in the financial interests of plan participants and adhere to a superior standard of professional diligence…. Trustees who breach these duties will be personally liable to the plan for any losses resulting from that breach.”

Regulators identified five potential pitfalls in crypto investing that would weigh whether offering the option is prudent. Crypto is “highly speculative” and its prices are exceptionally volatile, in part due to “the volume of reported fictitious trades, widespread incidents of theft and fraud, and other factors.” The market is complex and over-promoted as one with “unique potential for outsize gains”.

Record-keeping is often sloppy, account security patchy, regulators noted, and published cryptocurrency ratings unreliable. Finally, regulations and enforcement are still evolving, so it’s still unclear whether some crypto offerings are even legal.

All of these issues have arisen in relation to FTX.

In fact, the Department of Labor advised employers that their decisions to allow workers to invest in crypto would be scrutinized very carefully.

At least until the end of October – before the FTX collapse – crypto promoters vigorously defended themselves against the Labor Department’s warning.

The most direct attack came from ForUsAll, a Silicon Valley-based administrator of small business 401(k) plans with a relatively modest $1.7 billion in assets under management. The company offers 401(k) plans through which employers can allow their employees to invest limited amounts in cryptocurrencies.

ForUsAll sued the Department of Labor in June in federal court in Washington, D.C., alleging that the agency’s crypto advisory violated federal regulations that require such initiatives to be subject to public comment and other administrative procedures. But the main problem was that the agency was interfering with “the rights of American investors to choose how to invest money in their own retirement accounts.”

The agency, ForUsAll chief executive Jeff Schulte said in announcing the lawsuit, “plays several important roles serving American workers — but ‘financial advisor’ shouldn’t be one of them.” He accused the department of being “winners” among asset classes and select losers”.

The government asked the court in October to dismiss the case, arguing that the guidelines did not fall into the category of rulemaking subject to administrative regulation. ForUsAll then offered to drop the case if the government agreed never to block cryptocurrency investments in retirement plans, deeming it a breach of fiduciary standards, among other things. The government has rejected the company’s terms.

Another objection to the Labor Department’s recommendation is the Crypto Council for Innovation, an alliance of cryptocurrency promoters including venture investors, crypto exchanges and Fidelity.

In a letter to the ministry on June 14, the council complained that the recommendation “categorically barred 401(k) administrators from including crypto investment options in their plans, based on a factually and legally flawed analysis.”

The council claimed that the recommendation “only narrowly considers the risks of cryptocurrencies while ignoring their potential benefits, including growth and portfolio diversification.”

At least until the FTX collapse, crypto promoters still expected public interest in the asset class to be building, making it a promising area for business growth. There were many naysayers, to be sure. Among them is Jamie Dimon, CEO of giant bank JP Morgan Chase & Co., who has repeatedly mocked Bitcoin and other digital currencies. “These are decentralized Ponzi schemes,” Dimon said in a congressional hearing on 21/14. “And the idea that it’s good for everyone is incredible.”

It’s possible that the coverage of FTX’s collapse and the revelations of its internal chaos will cure Americans of their fascination with the asset class.

Skepticism seems to be growing; An online sportsbook, Bet Online, has started accepting bets on “the next crypto exchange to file for bankruptcy.” (The betting favorite in the run-up to Thanksgiving was Crypto.com, the exchange that paid to put its name on the former Staples Center, the Los Angeles home of the NBA Lakers and Clippers.)

Or it’s possible that the prospects of a get-rich-quick scheme outweigh the dangers of investing your precious retirement nest egg with investment firms that play by their own rules, or no rules at all. Nothing can stop ordinary Americans from investing in any product, no matter how much evidence of his sketches emerges. But no one can say they weren’t warned.

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