Compliance January 10, 2024

Can You Permit Crypto in a Brokerage Window?

Probably not worth the risk, but there is no ban on it.

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The Securities and Exchange Commission on Wednesday approved applications for a “number of spot bitcoin exchange-traded product (ETP) shares.” An SEC order confirmed that a total of eleven ETFs were approved.

The SEC had denied an application from Grayscale Investments to create a bitcoin exchange-traded fund. The U.S. Court of Appeals for the District of Columbia Circuit overturned the decision in August 2023 for being arbitrary and capricious.

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Now that the ETFs have been approved, what does this mean for sponsors? Michael Kreps, a principal in Groom Law Group, says that guidance issued by the Department of Labor in March 2022 cautioning sponsors against using cryptocurrency in plans governed by the Employee Retirement Income Security Act is “still good agency guidance.”

The guidance says that “the Department has serious concerns about the prudence of a fiduciary’s decision to expose a 401(k) plan’s participants to direct investments in cryptocurrencies.” It refers to them as “speculative and volatile” and noted valuation and regulatory concerns.

Addressing participants’ ability to access crypto assets through a plan’s brokerage window, the guidance adds that “plan fiduciaries responsible for overseeing such investment options or allowing such investments through brokerage windows should expect to be questioned about how they can square their actions with their duties of prudence and loyalty in light of the risks described above.”

Kreps says that the DOL has not elaborated on this, but if the “federal government is telling people, firing a warning shot, that if you invest in crypto, we will investigate you, it is hard to see that as not having any sort of chilling effect.”

The 2022 guidance suggests that sponsors should be monitoring what is offered through brokerage windows, though that is not a common practice in the industry, Kreps says.

According to Kreps, very few plans offer crypto assets in their lineups or brokerage windows. A sponsor does have a fiduciary duty to select a prudent brokerage window provider, and that provider is not a fiduciary itself. However, if either party “vets the investments that are offered in that window, or over-curates the window, you could at some point become a fiduciary.”

The eleven applications were approved together, according to Teresa Goody Guillén, a partner in Baker Hostetler, to prevent giving any one applicant a “first mover advantage.” Only the ETF created by Ark Invest and 21 Shares had a deadline for Wednesday.

SEC Chairman Gary Gensler, in his statement about the approval of spot bitcoin ETPs, said, “Commission staff is separately completing the review of registration statements for 10 spot bitcoin ETPs simultaneously, which will help create a level playing field for issuers and promote fairness and competition, benefiting investors and the broader market.”

Guillén explains that the ETF model will “open up the investment to smaller investors.” This possibility has led to some “market movement” in the bitcoin currency, which is “indicative of how interested the market is in this.” Other applicants include Fidelity Investments and Grayscale Investments, according to Guillén.

Applications were initially denied because of the risk of market manipulation. Since that reason was struck down, the SEC must either approve them or find another reason to deny them, Guillén says.

Gensler posted on social media platform X on Tuesday that crypto assets “may not be complying w/ applicable law” and that “crypto assets also can be exceptionally risky and are often volatile.” He added that “Fraudsters continue to exploit the rising popularity of crypto assets to lure retail investors into scams.”

The SEC’s release stated that the approval “should in no way signal the Commission’s willingness to approve listing standards for crypto asset securities. Nor does the approval signal anything about the Commission’s views as to the status of other crypto assets under the federal securities laws or about the current state of non-compliance of certain crypto asset market participants with the federal securities laws.”

Gensler added: “While we approved the listing and trading of certain spot bitcoin ETP shares today, we did not approve or endorse bitcoin. Investors should remain cautious about the myriad risks associated with bitcoin and products whose value is tied to crypto.”

Compliance January 10, 2024

House Committee Hears Expert Testimony on Fiduciary Proposal

Members of Congress and their invited experts discussed the pros and cons of the Department of Labor’s retirement security proposal.

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The U.S. House Committee on Financial Services’ Subcommittee on Capital Markets hosted a hearing on Wednesday about the Department of Labor’s retirement security proposal, sometimes called the fiduciary proposal. The hearing proceeded largely along partisan lines, with Republicans pointing out flaws and Democrats noting merits.

The proposal, whose comment period closed January 2, would extend fiduciary status under the Employee Retirement Income Security Act to one-time transactions that are not currently fiduciary acts. These include investment menu design, annuity sales and rollovers to individual retirement accounts.

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During the hearing, Subcommittee Chair Ann Wagner, R-Missouri, explained that this is the “fourth attempt” the DOL has made to regulate in this space, a reference to past rulemakings, one of which was struck down by the U.S. 5th Circuit Court of Appeals in 2018. Wagner argued that the proposal will only lead to the “disrupting of the client-adviser relationship” and severely restrict access to annuities and rollovers for lower-income retirement savers.

Wagner added that Regulation Best Interest, enforced by the Securities and Exchange Commission, and the current five-part fiduciary test enforced by the DOL “fully protect consumers seeking financial advice.”

Arguments for …

Representative Brad Sherman, D-California, said the proposal needs some improvements, but “we need a regulation in this space.” He urged the DOL, as many commenters did, to more clearly exclude educational materials and “hire me” conversations in which an adviser pitches their services to an ERISA plan.

Sherman also entered into the subcommittee’s record a letter written by national retiree advocacy group AARP. The lobby group’s statement supports the proposal, arguing that “when Americans seek out financial advice for their retirement savings, they expect the advice they get will be in their best interest, not in the best interest of their financial adviser. This is very simply what the Retirement Security Rule does.”

The letter also states that “regulatory loopholes allow some financial advisers to recommend that their clients invest their retirement savings in products simply because the adviser will get higher fees and commissions for doing so” and that the proposal “closes a glaring loophole that allows some advisers to offer very bad advice to their clients, as long as they only do it once.”

A representative of AARP did not testify at the hearing.

Kamila Elliott, the CEO and founder of Collective Wealth Partners, testified at the hearing representing the Certified Financial Planner Board in support of the proposal.

She argued that under current law, “financial professionals can be paid handsomely for advice that is not in the investor’s best interest.” She added that “financial professionals should not be allowed to make recommendations that compensate them well but burden the client with excessively high fees, unnecessary risk or harmful illiquidity.”

Elliott noted that CFPB certificants abide by a fiduciary standard, even with one-time recommendations, and are still able to service smaller accounts.

The CFPB has been a supporter of the proposal.

… and Against

Jason Berkowitz, the chief legal and regulatory affairs officer at the Insured Retirement Institute, who testified at the hearing, sided with Subcommittee Chair Wagner in arguing that the proposal would hurt low-income savers.

Many professionals, he argued, would not be able to work with smaller balances because the costs associated with regulatory compliance and risk would make these smaller accounts no longer worth servicing. He added that “this proposal is not fixable.”

The IRI has been an opponent of the proposal throughout its rollout.

Brad Campbell, a partner in the Faegre Drinker law firm and a former assistant secretary of labor, testified that the DOL was going beyond its authority by regulating IRAs.

“The reason we are here today is that the proposals go well beyond DOL’s limited authority,” Campbell noted in written testimony. “In fact, the proposals would make DOL the primary financial regulator of $26 trillion, approximately half of which is held by individuals in individual retirement accounts and annuities (“IRAs”) rather than employer-provided plans.”

He argued in his remarks that individuals receiving financial assistance from insurance, securities and bank professionals are subject to other state and federal securities and banking regulation.

“If the proposals were finalized,” he testified, “and those individual accounts were subjected to the department’s authority in a manner similar to employer-provided plans, those insurance, securities and bank professionals serving them would now have to comply with a new, highly detailed, and very proscriptive federal regulatory regime led by the Labor Department that would simultaneously apply with—and in many cases, materially conflict with—the requirements of their ‘normal’ state insurance regulation, state and federal securities regulation, or state and federal banking regulation.”

The DOL has not yet announced a timetable for finalizing the proposal.

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