On July 8, the public got its first view into how the U.S. Department of Labor will defend its fiduciary rule when it filed a cross motion for summary judgment, asking the U.S. District Court for the District of Columbia to dismiss a law suit brought by the National Association for Fixed Annuities.
The first hearing in that case, NAFA v. Thomas Perez, et al., has been scheduled for Aug. 25. NAFA is seeking an injunction to stay Labor Department’s rule, which is slated for a first round of implementation in April 2017.
In its suit against the Labor Department, NAFA, a Washington, D.C.-based trade organization representing insurance carriers and independent insurance agents that account for 85 percent of fixed annuity sales, alleges the Labor Department rule is “impermissibly vague, and otherwise promulgated in violation of federal law,” according to language in its suit against Labor Department.
NAFA’s suit challenges the Labor Department rule on six counts, ranging from questions of the Labor Department’s statutory authority to redefine the term “fiduciary,” to the rule’s requirement that any advice to roll over 401(k) assets to an IRA rises to the level of a fiduciary recommendation, to the rule’s allegedly vague definition of reasonable compensation, and to the question of whether fixed indexed annuities can legally be regulated under the rule’s Best Interest Contract Exemption.
Private right of action
NAFA also alleges that the Labor Department rule creates a new private right of action in crafting the fiduciary rule.
So, too, does the lawsuit brought in U.S. District Court for the Northern District of Texas, on behalf of the U.S. Chamber of Commerce, the Securities Industry Financial Market Association, the Insured Retirement Institute, and several other insurance and financial industry trade groups. That suit has been consolidated with two others brought in the same court, which also allege the Labor Department created a new private right of action in its rule.
That question — whether the Labor Department rule creates a new private right of action — figures to factor significantly in how courts decide the cases, say attorneys expert in securities law and the Employee Retirement Income Security Act.
In laymen’s terms, a private right — or cause — of action is the right for people to sue, as individuals or as a class, under an existing law.
Only Congress can create that right. In a 2001 Supreme Court decision, Alexander v. Sandoval, the high court wrote: “like substantive federal law itself, private rights of action to enforce federal law must be created by Congress.” That case is cited in the lawsuits brought against the Labor Department.
DOL denies it created a ‘new’ private right of action
In its defense against NAFA’s lawsuit, the Labor Department denies that the rule “creates” a new private right of action.
Under the rule’s Best Interest Contract Exemption, advisors to 401(k) plans and IRAs are allowed to receive commission-based compensation that the rule otherwise prohibits, so long as the contractual terms of the Best Interest Contract Exemption are met — namely, that an advisor is operating as a fiduciary and selling products only in the best interest of investors.
A provision in the Best Interest Contract Exemption includes language articulating investors’ right to sue if they find an advisor is not acting in their best interest.
That right is vital for the Labor Department and the agency’s proponents hoping to see the rule fully implemented, and enforced.
At a recent gathering of fiduciary proponents in Philadelphia, Phyllis Borzi, assistant secretary of labor and head of the division charged with crafting, implementing and enforcing the at-issue rule, said the question of how the rule would be enforced was the “most difficult” challenge regulators faced.
That’s because the Employee Retirement Income Security Act does not give the Labor Department “direct enforcement authority” over IRAs, said Borzi in comments at the symposium.
To enforce a new fiduciary requirement on advisors to IRAs, regulators at the Labor Department are relying on the power of private legal action, she said.
“The consumer has to enforce the rules through state contract actions,” added Borzi.
In its brief calling for NAFA’s lawsuit to be dismissed, attorneys at the Labor Department and the U.S. Department of Justice argued that NAFA “mischaracterizes” the provision in the Best Interest Contract Exemption that makes insurance and financial services companies subject to lawsuits if the contract’s fiduciary requirements are breeched.
While the Best Interest Contract Exemption expands ERISA’s fiduciary requirements to advisors in the retail market, and creates new prohibited transactions, and exemptions to those transactions, the right to sue is not new, but exists “under the laws already in existence governing such contracts,” according to the brief filed by the Justice Department.
The brief continues: “Because the [Labor] Department has not, in fact, created any new private right of action, this claim fails.”
Dissenting expert opinions
The question of whether or not the Labor Department rule creates a new private right of action, or merely relies on existing rights to sue, is certainly not the only weighty legal question courts will have to parse in coming months.
But it is a substantial one, says James Fleckner, a partner and chair of the Employee Retirement Income Security Act litigation practice at Goodwin LLP, a Boston-based law firm.