Blackboxes Within Blackboxes: Cryptocurrency In Your State Pension
The recent collapse of the global cryptocurrency markets has exposed many previously hidden dangers related to these blackbox investments. Growing secrecy at our nation’s public pensions has turned these retirement plans into blackboxes themselves. Public pension officials have agreed to be kept in the dark about how much they’re poised to lose in cryptocurrency investments and aren’t eager to acknowledge the losses resulting from their gambling in crypto. No one knows for certain just how much blackbox cryptocurrency blackbox public pensions own.
What do the bankrupt crypto companies Terra
Here in America, according to a 2022 study published by the CFA Institute, 94% of state and government-sponsored pension funds are invested in one or more cryptocurrencies despite the obvious risk. Due to an alarming lack of fiduciary oversight, most of these pensions have failed to monitor and have agreed to be kept in the dark as to their cryptocurrency holdings. Pension officals aren’t eager to publicly acknowledge losses resulting from their gambling in crypto.
Nevertheless, reports of cryptocurrency holdings at our nation’s public pensions are slowly surfacing. The Houston Firefighters Relief and Retirement Fund reportedly bought $25 million in cryptocurrencies, which was touted as the first announced direct purchase of digital assets by a U.S. pension plan. Two public pension funds for Fairfax County of Virginia reportedly indirectly invested over $120 million into funds that pursue opportunities in the crypto world, such as blockchain technology, digital tokens and cryptocurrency derivatives. A recent report shows the Minnesota State Board of Investment held small stakes in the crypto exchange Coinbase Global and bitcoin miners Riot Blockchain and Marathon Digital Holdings, as well as fixed-income securities from Coinbase. The State of Wisconsin Investment Board reportedly made purchases of Coinbase, Marathon and Riot Blockchain. New Jersey’s main state pension fund appears to have invested in some crypto-related stocks recently. Other public funds that have reportedly taken stakes in crypto firms include the Utah Retirement Systems and the Pennsylvania Public School Employees’ Retirement System.
Although the initial wave of public pension cryptocurrency disclosures involve relatively small sums—tens or hundreds of millions per pension, not billions—recent disclosures suggesting intentional fraud by FTX executives once again raise important questions about public pension investment decision-making and practices. For instance, how do government pensions perform due diligence on prospective investments, and can plan decision-makers be held accountable for reckless or negligent investments?
For U.S. private pensions subject to the comprehensive federal law, ERISA, the Department of Labor’s Release No. 2022-01 offers guidance about investing in cryptocurrencies. It cautions plan fiduciaries to exercise “extreme care” before deciding to offer cryptocurrencies because they present significant risks of fraud, theft, and loss to plan participants. As emphasized by the DOL in the Release, plan fiduciaries must act “… solely in the financial interests of plan participants and adhere to an exacting standard of professional care” that courts have commonly held as the highest obligations known to the law. Moreover, as detailed by the U.S. Supreme Court in Hughes v. Northwestern University (2022), ERISA-governed fiduciaries have a continuing duty to monitor investments, and to remove imprudent ones within a reasonable time. Any breach of these duties results in personal liability to the fiduciary for any losses to the plan, including for losses incurred as a result of investments in cryptocurrency.
To be sure, ERISA provides plan participants with a great deal of protection and avenues for recourse if fiduciaries violate their duties of care—protections government employees are not afforded in their retirement plans. Suing public pensions for failing to prudently vet or monitor investments in cryptocurrency (or anything else for that matter) is virtually impossible under state law.
For example, the State Retirement System of Ohio (STRS) lost over $5 billion last year, but for reasons that are difficult to fathom, still chose to pay $10 million in performance bonuses to staff. Would a $10 billion loss have resulted in $20 million in undeserved bonuses?
Staggering long-term mismanagement of investments previously resulted in elimination of contractually required cost of living adjustments to fund participants. When a Board member recently proposed clawing-back bonus payments to staff, the staff tried to implement a no-dissent policy to muzzle board members from publicly discussing policy decisions with which they disagreed. How did the STRS staff lose all that money? We’ll likely never know because for over two years the pension has steadfastly refused to provide prospectuses and other documents related to its investments in response to public records requests filed on behalf of participants, claiming trade secret protection. What we are learning from the FTX flop, however, indicates that these defenses may be on their last breath.
The collapse of the world’s second-largest crypto exchange FTX is unprecedented. “Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here,” wrote Jay Ray III, FTX’s newly appointed CEO in a document recently filed with the Delaware Bankruptcy Court. Per his investigation, he reports that “[t]he FTX Group did not keep appropriate books and records, or security controls, with respect to its digital assets,” and its quarterly financial statements were never audited. The resulting shockwaves throughout the FTX investor community has less to do with its disbelief that such a fraud could ever happen, but that it could happen in a company that employs blockchain. It never occurred to anyone that although FTX user transactions transpire on a blockchain, the company did not use the technology for its own corporate transactions. Because FTX Founder Sam Bankman-Fried spent so much time with U.S. federal regulators, it may have appeared to the public that FTX had been government-vetted and approved.
“There is no inherent requirement that a blockchain issue a cryptocurrency,” says Florida attorney Anessa Santos. “Fundamentally, blockchain is a network-styled data management system that can solve many problems endemic to central banking. For example, financial systems properly designed on blockchain can provide transaction records that are open, transparent, immutable, and secure in near real-time.”
Santos believes blockchain could be “a great solution to the transparency problem in public pension plans. If all of the investment funds and financial products were required to transact on the same blockchain network, and the activity of that network was made open and transparent, then each order and related information would be time-stamped, immutable, and available for viewing on demand. The technology to do this is over a decade old and proven beyond reproach. The only thing that’s missing is the political will and understanding to require its use.”
In short, the only obstacle to public pension transparency is the fact that no one—including Wall Street money managers hired by pensions, elected officials and union representatives serving on pension boards, state Attorneys General, state auditors, securities regulators and law enforcement—wants to expose what I refer to in my book Who Stole My Pension? as “gross malpractice generally practiced” at our nation’s government pensions to public scrutiny.
No one cares except pension stakeholders, including active government workers, retirees and taxpayers.