If the Department of Labor’s final fiduciary rule were an infrastructure project, perhaps the best analogy would be to a catastrophically leaky dam.
Like their peers in the civil engineering world, insurance and financial services experts assessing the legal foundations of the DOL’s hole-ridden edifice — a 1,000-plus-page document that stretches definitions, makes new jurisdictional claims and defies historical precedent — have to ask themselves this question: When (not if) will the department’s paper dam break?
That’s the conclusion to be drawn if a growing number of critics are right in their assertion that the department badly overstepped its authority in promulgating its “conflict of interest final rule” last April. Those critics are now fighting back in the courts, and it’s a fair bet that the rule will meet its demise there, potentially this month.
On August 25, a U.S. District Court judge for D.C. overseeing one of several lawsuits against the department, The National Association for Fixed Annuities v. [DOL Secretary] Thomas E. Perez et al., will hear motions for preliminary injunction and summary judgment. A ruling in favor of the plaintiffs will, absent a successful appeal, spare the industry a lengthy and expensive trial, plus months of regulatory uncertainty.
Should the DOL’s attorneys prevail in the NAFA case, they’ll have to brace themselves for counteroffensives on two other fronts: (1) a suit filed by the Market Synergy Group in Kansas; and (2) a 9-party complaint filed in a U.S. District Court for the Northern Texas.
The latter may be the key case to watch, for it consolidates three lawsuits: one a complaint filed by 9 trade organizations and Texas business associations led by the U.S. Chamber of Commerce; a second by American Council of Life Insurers (ACLI) and the National Association of Insurance and Financial Advisors (NAIFA); and a four-party suit of insurers filing under the banner of the Indexed Annuity Leadership Council (IALC).
A litany of grievances
The three lawsuits differ on some counts, notably in respect to alleged constitutional violations: NAFA contends the DOL’s rule’s definition of reasonable compensation is “unduly vague” and infringes on the 5th’s amendment’s due process cause; the 9-party Texas suit argues the rule’s best interest contract exemption (BICE) runs afoul of the first amendment’s right of free speech (i.e., by prohibiting “truthful, non-misleading” communications with clients and prospects outside the confines of a fiduciary relationship).
But the lawsuits also have much in common. Chief among the shared charges: that the DOL overstepped its authority in crafting the conflict of interest rule, starting with its expanded definition of fiduciary. The Texas suit (to which the Insured Retirement Institute, Financial Services Roundtable, and Securities Industry and Financial Markets Association (SIFMA), among others, are also parties) is detailed on this count.
The 9-party complaint claims the DOL’s expanded interpretation of “fiduciary” encompasses activities that have “long been understood to be sales-related” (i.e., not those of a fiduciary).
The long-held definition of fiduciary — as established under the law of trusts, the Investment Advisers Act of 1940 and ERISA law (the DOL’s province) — makes clear that these duties are consistent with “ongoing and continuous investment discretion” of financial professionals charged with managing clients’ assets. These responsibilities, the suit alleges, were never interpreted to apply to one-time product sales transacted by brokers who provide only “incidental investment advice,” and who don’t have a client relationship built on “heightened trust and confidence.”
Hence the long-established distinction between the fiduciary standard of care that registered investment advisors owe under the Security and Exchange Commission’s Investment Advisers Act of 1940; and the (non-fiduciary) product suitability standard that brokers-dealers and their registered reps are bound by. On this key point, the Texas complaint pulls no punches.
“[The DOL] referred disparagingly to the ‘fine legal distinction’ —a distinction created by Congress — between broker-dealers and registered investment advisers…and it forthrightly proclaimed its “reject[ion] of the purported dichotomy between a mere ‘sales’ recommendation . . . and advice . . . in the context of the retail market for investment products,” the complaint states. “This ‘dichotomy’ is not ‘purported’ — it is established by Congress as a matter of federal law.”
During a June 2nd media conference call presented by chiefs of 5 of the 9 organizations represented in the Texas suit, an attorney of the plaintiffs’ law firm emphasized the point.
“The DOL has given ‘fiduciary’ a meaning that’s unrecognizable — one different from how Congress and the securities laws intended,” said Eugene Scalia, the attorney and a partner at Eugene Dunn. “So we start out [in the complaint] by pointing out the legal error of the DOL in formulating an overbroad definition of fiduciary.”
The DOL’s “arbitrary” and “capricious” missteps mount form there. And many of them — from the department’s BIC exemption requirements to its folding of non-ERISA IRAs and fixed indexed annuities into the rule — amount to an “impermissible departure” from the industry’s historical understanding of fiduciary, the Texas suit contends. Add to this a larger perceived transgression: the DOL’s fundamental misreading as to what falls under its purview.
Take the myriad compliance requirements — disclosure of (among other things) costs, fees and compensation relating to a recommended product — that the DOL mandates for brokers receiving a sales commission under the BICE.
By “exploiting its exemptive authority to obligate financial services professionals to accept special duties and liabilities” absent from ERISA law and the Internal Revenue Code, the complaint asserts, the DOL improperly extended its authority to an area that Congress vested in the SEC. This has been a longstanding sore point of the DOL’s critics. They’ve argued since Congress’ passage of the Dodd-Frank Act of 2010 (which assigned exclusively to the SEC a review of standards of care for broker-dealers and investment advisors) that the DOL had no business crafting its fiduciary rule.
Tug of war over FIAs
But craft it did — and in the process felled jurisdictional walls once thought to be set in stone. Among the Texas complaint’s allegations: that ERISA granted the DOL regulatory authority over qualified employee benefits, but not to non-ERISA, tax-favored plans like IRAs; and that the DOL exceeded its mandate (and violated Congress’ intent under Dodd-Frank) in extending the fiduciary rule to sales of fixed indexed annuities.
The latter move was a particular shock to FIA players, and not only because the DOL left the products out of earlier versions the rule.
Industry veterans will recall the bruising battle over the SEC’s proposed Rule 151A, which sought to regulate FIAs as securities, rather than insurance products. Thanks to a 2010 decision of the U.S. Court of Appeal in D.C., that rule was vacated; a subsequent amendment to the Dodd-Frank Act sought to ensure that regulation of indexed annuities remained with the states.
So more than a few state insurance commissioners (not to mention the insurers, agents and brokers they oversee) were surprised to learn that FIAs, like other products now subject to the DOL rule, will fall under federal jurisdiction after all.
The Texas plaintiffs aren’t the only ones crying foul over the DOL’s perceived power grab. The NAFA lawsuit takes direct aim at the department’s inclusion of FIAs under the BIC exemption. One bone of contention: that ERISA plan fiduciaries (insurance agents and brokers, among others) will no longer be able receive a commission under ERISA’s prohibited transaction exemption (PTE) 84-24.
Participants in a July 26 roundtable hosted by LifeHealthPro and National Underwriter concurred that the DOL had overreached in engineering the PTE 84-24-to-BICE swap; and in upending “settled law” that exempts fixed-indexed annuities from federal securities regulations.