Week of July 8, 2022

Good morning and thank you for subscribing. This week, we review financial conflict of interest rules for federal government employees and a recent CRS report on crypto in 401(k) retirement plans.

Top Points

The U.S. Office of Government Ethics published a Legal Advisory finding executive branch staffers holding crypto are precluded from working on regulatory matters if they know that the matter could have a "direct and predictable effect" on the value of their crypto.
The nonpartisan Congressional Research Service published a report on "Cryptocurrency in 401(k) Retirement Plans."

Office of Government Ethics ("OGE") Issues Legal Advisory to Agency Ethics Officials

18 U.S.C. § 208, the primary criminal conflict of interest statute, prohibits an executive branch employee from participating personally and substantially in a particular government matter that will affect his own financial interests.
On Tuesday, July 5, OGE published a Legal Advisory opinion examining whether certain regulatory exemptions from 18 U.S.C. § 208 applied to crypto.
According to the Legal Advisory, executive branch employees holding a financial interest in crypto assets may "not participate in a particular matter if the employee knows that particular matter could have a direct and predictable effect on the value of their crypto."
Under certain mutual fund exemptions, employees may still work on crypto related matters if their crypto financial interest arises from holdings in:
- (1) a diversified mutual fund or
- (2) a sector mutual fund, so long as the aggregate value of all sector funds held by the employee in the same sector is less than $50,000 (categories explained further below).
The Legal Advisory applies to all executive branch employees, including White House staffers and federal agency employees--not members of Congress or their staff.

Deeper Dive

1. A regulatory exemption for de minimis holdings of publicly traded securities does not apply to crypto holdings.

According to the Legal Advisory, crypto and stablecoins are not "publicly traded securities" for purposes of OGE's regulations. Thus crypto does not qualify for the exemptions under 5 C.F.R. § 2640.202, which generally exempt de minimis holdings of publicly traded securities from 18 U.S.C § 208.

Thus, "an employee who holds any amount of a cryptocurrency or stablecoin may not participate in a particular matter if the employee knows that particular matter could have a direct and predictable effect on the value of their cryptocurrency or stablecoins." (emphasis added).

2. Mutual Fund Exemptions: Diversified Mutual Funds and Sector Mutual Funds (5 C.F.R. § 2640.201).

The extent to which an executive branch employee may invest in a mutual fund and still participate in a matter that might affect a financial interest in that fund, depends on whether the fund is a diversified mutual fund or a sector mutual fund.

First, if an employee holds a financial interest in a diversified mutual fund, that employee is not precluded from working on a matter affecting one or more holdings of that diversified mutual fund. See 5 C.F.R. § 201(a); See Legal Advisory at 3.

A mutual fund with a stated purpose of investing broadly in companies that would benefit from or use blockchain technology is considered a diversified mutual fund. Legal Advisory at 3.
Legal Advisory at 4, Example 4:
- "Employee owns the Blockchain and Innovative Technology Transformation fund. The fund’s prospectus states that it invests in companies in the natural resources, transportation, and energy sectors that will benefit from blockchain and distributed ledger technology. The fund is diversified."

Second, an employee may work on a particular matter affecting one or more holdings of a sector mutual fund, as long as the aggregate value of sector funds held by the employee in that same sector is less than $50,000. See 5 C.F.R. § 201(b); See Legal Advisory at 3.

A mutual fund with a "stated purpose of concentrating investments in cryptocurrencies, stablecoins, cryptocurrency or stablecoin derivatives, or cryptocurrency or stablecoin services" is considered a sector mutual fund, in the financial services sector. Legal Advisory at 3.
Mutual funds with a stated focus of investing in computer hardware used in crypto, such as ASIC hardware, is considered a computer hardware sector mutual fund. Legal Advisory at 5.
See Legal Advisory, Example 6:
- Employee owns $45,000 in the FutureSight PoW Mining fund and $20,000 in the J.S. Select Financial Sector Fund. Employee is asked to work on a regulation establishing mandatory Know Your Customer (KYC) requirements that will affect entities that accept cryptocurrency and companies that validate cryptocurrency. Employee must aggregate both funds for purposes of determining the sector fund threshold, as both funds are in the financial services sector and both funds have underlying holdings that may be affected by the regulation.

So What?

Ethics rules are intended to prevent financial conflict of interests to help ensure policy decisions are free from personal bias. However, the Legal Advisory may ultimately preclude staffers most interested and experienced in crypto from working on crypto regs. Agencies may also struggle to recruit top talent in the crypto space, as such talent is likely to own crypto.

What about Congress?

Conflict of interest rules for Congress are largely governed by the Ethics in Government Act of 1978 ("EIGA") and the Stop Trading On Congressional Knowledge ("STOCK") Act (signed into law in 2012). The rules are primarily disclosure based, requiring members and certain senior staff to file periodic reports disclosing generally the nature and extent of their financial interests. Neither Act specifically mentions crypto.

On May 20th, Reps. Elissa Slotkin (D-MI) and Dusty Johnson (R-SD) introduced the "Cryptocurrency Accountability Act."

The bill would amend the Ethics in Government Act by specifically requiring members to disclose any purchase, sale, or exchange of crypto which exceeds $1,000.
Full text here.

Further, in 2018, the House Ethics Committee issued a memorandum determining that crypto ownership must be disclosed under the EIGA because it qualified as "other forms of securities" for purposes of the EIGA. See Memo at 3.

According to Decrypt, nine members of Congress have reported trading crypto assets since 2020, though several more have crypto exposure through stocks like Coinbase and Block.

Several bills aimed at curbing conflicts interests and insider trading broadly, whether in crypto, stocks, bonds, or another asset, have been introduced in the 117th Congress.

Here is a CRS report outlining the various proposals and how they would amend current law.

Congressional Research Service ("CRS") Report on Cryptocurrencies in 401(k) Retirement Plans

On Friday, July 1, CRS published a report on 401(k) retirement plans, providing helpful background on the issue and highlighting recent policy actions from both sides of the aisle.

For example, on March 10, 2022, the Department of Labor released a "Compliance Assistance Release," expressing “serious concerns” about plan fiduciaries’ decisions to allow defined contribution plan participants to invest in crypto. (Link here).

Concerns raised in the guidance included:

the potentially speculative nature of cryptocurrency investments,
the difficulties individuals might have in evaluating whether to—or how much to— include in their investment portfolios,
recordkeeping challenges,
valuation concerns, and
the evolving regulatory environment.

Response to DOL's Guidance in the 117th Congress

Senator Tommy Tuberville (R-AL) in the Senate (S.4147) and Rep. Byron Donalds (R-FL) in the House (H.R. 7860) introduced the Financial Freedom Act of 2022.
- The Financial Freedom Act of 2022 would prohibit regulations that would constrain or prohibit the type of investments that could be offered through a brokerage window in a defined contribution plan.
Senators Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY) included a provision in S. 4356, the Responsible Financial Innovation Act ("RFIA") that would require the Government Accountability Office (GAO) to examine the use of crypto in retirement plans. RFIA §207.
Rep. Richard Neal (D-MA)(Chair of Ways and Means Committee) asked GAO to examine the use of cryptocurrency in retirement plans in a June 15, 2022 letter.
Further, Senators Elizabeth Warren (D-MA) and Tina Smith (D-MN) asked Fidelity to respond to several questions regarding its decision to add bitcoin to its 401(k) investment menu in a May 4, 2022 letter.

Here is the full CRS report.

Look Ahead

On Wednesday, July 13, 2022, House Small Business Subcommittee on Oversight, Investigations, and Regulations will host a hearing on Fintech and Transparency in Small Business Lending.