Bitcoin and Brokerage Windows: A Risk for Fiduciaries?

The Securities and Exchange Commission on Wednesday approved applications for a “number of spot bitcoin exchange-traded product (ETP) shares.”

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.

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.”

There are now 10 outstanding applications for bitcoin ETFs, and the SEC is expected to approve all of them soon, according to Teresa Guillen, a partner in Baker Hostetler, to prevent giving any one applicant a “first mover advantage.” The SEC’s release did not state if all had been approved, and 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.”

Guillen 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 Guillen.

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, Guillen 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.”


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