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IMO makes targeted claim against DOL rulemaking procedures

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Oral arguments were heard last week in U.S. District Court for the District of Kansas on behalf of Market Synergy Group, a Topeka, Kansas-based consortium of 11 independent marketing organizations that accounted $15 billion worth of fixed indexed annuity sales in 2015 through more than 3,000 independent insurance agents.

In Market Synergy Group, Inc. v. United States Department of Labor, the independent marketing organization is not asking the Kansas court to block the Labor Department’s entire fiduciary rule — just the provision that affects the regulation of fixed indexed annuities.

That targeted approach makes Market Synergies’ claim distinct from other lawsuits brought against the Labor Department, and could enhance its chances of success, say two legal experts.

“The narrowness of the claim is in its favor,” said Leland Beck, a Washington, D.C.-based administrative law expert that spent much of the past three decades consulting on regulatory matters at the U.S. Department of Homeland Security and the U.S. Department of Justice.

“It is much easier for a judge to grant a narrow remedy than a broader one — particularly if there is a substantial benefit in the rest of the rule,” added Beck, who is in private practice now.

A central argument in Market Synergy’s streamlined strategy is the allegation that the Labor Department failed to give “adequate notice” of its treatment of fixed indexed annuities required under the Administrative Procedure Act, the federal law enacted in 1946 that sets guidelines for agency rulemaking.

When the proposed version of the rule was released in 2015, fixed indexed annuities were to be regulated under Prohibited Transaction Exemption 84-24, a provision of the Employee Retirement Income Security Act that allows for commissions on the sale of fixed indexed annuities.

Two comment periods and a public open forum ensued. In April of 2016, when the final rule was released, the regulation of fixed indexed annuities had been moved to the Best Interest Contract Exemption, a new prohibited transaction exemption considered to be more restrictive to commission-based products by many stakeholders.

The problem with that, says Market Synergy and others suing the Labor Department, is that fixed indexed annuity providers, and the independent marketing organizations that market fixed indexed annuities, had no idea the Labor Department was considering such a move, and were not given the opportunity — or adequate notice — to comment on the effect moving fixed indexed annuities to the Best Interest Contract Exemption would have on industry.

Was the move to BIC a harmless error?

The APA requires federal agencies to provide public notice of proposed regulations, and give affected industries the opportunity to comment on the rules.

According to a brief on the APA published by the American Bar Association, any “agency change from the original proposal will require additional notice and comment unless the change is a ‘logical outgrowth’ of the proposal.”

The same brief describes a provision of the APA that instructs courts to consider the “harmless error” principle if a regulation is challenged on the grounds that stakeholders were not given fair notice to comment on a change in the final rule from the proposal.

The Bar Association’s brief says agencies often argue that their failure to follow required comment procedures was harmless, “typically because they would have reached the same result anyway.”

In the oral arguments heard in Kansas last week, lawyers from the Justice Department and Labor Department raised the harmless error principle before U.S. Judge Daniel Crabtree.

Effectively, government attorneys were asking the court to consider the harmlessness of moving fixed indexed annuities to the Best Interest Contract Exemption, if indeed the court found stakeholders did not have adequate opportunity to comment on the move, according to Erin Sweeney, an ERISA attorney with Miller and Chevalier.

“The fact that DOL raised it was significant,” said Sweeney in an interview. “To take up their limited time telegraphs that the DOL is concerned it is a big enough problem that they want the judge to be clear: if the notice on FIAs was not adequate, he has to consider if there ultimately is harm in that.”

Sweeney thinks the fact that the Labor Department raised the specter of the harmless error principle “came right to the edge” of an admission on the part of the government that regulators did not do a good enough job communicating the fate of fixed indexed annuities in the final rule.

“That speaks loudly to me,” added Sweeney. “It says to me the DOL thinks they are on shaky ground.”

Leland Beck said that in raising the harmless error principle, attorneys for the government were arguing that the Labor Department would have made the same decision on fixed indexed annuities no matter what comments were provided, had industry had the chance to offer them.

“That is arrogant at best,” said Beck. “Failure to give notice (to comment) is not a harmless error. The plaintiffs have been deprived of their right to comment on a proposed rule.”

For that reason, plaintiffs have a good argument that the provision of the rule impacting fixed indexed annuities should be vacated, according to Beck.

Market Synergy asked DOL to prove adequate notice to comment

During the hearing, attorneys for Market Synergy asked the Labor Department to provide proof that annuity providers and independent marketing organizations were given adequate notice to comment on the provision moving the regulation of fixed indexed annuities to the Best Interest Contract Exemption.

Attorneys for the government produced 20 comment letters from industry, stakeholders and three attorneys, according to Sweeney, who attended the hearing.

Nine of those comment letters were focused on the treatment of variable annuities under the proposed rule, not on fixed indexed annuities. Another five comment letters were in support of the proposed rule’s treatment of fixed indexed annuities under PTE 84-24.

Only one comment letter, from Mercer Bullard, a securities expert, former assistant chief counsel at the Security and Exchange Commission, and a strong supporter of a uniform, industrywide fiduciary standard, suggested the Labor Department should change the proposed rule, and regulate fixed indexed annuities under the Best Interest Contract exemption.

Sweeney says the absence of comment letters from independent marketing organizations was conspicuous, and evidence that the Labor Department did not give adequate notice for industry to comment on treatment of fixed indexed annuities in the final rule.

“The FIA market has a lot of big guns,” said Sweeney. “There are about 200 IMOs in the country. Had they seen this coming they each would have submitted a comment letter. But the record is silent because no one saw this coming — if industry had expected this they would have hammered their position home in comment letters.”

Handicapping Market Synergy’s chances

In National Association for Fixed Annuity Providers v. Thomas E. Perez, recently argued in U.S. District Court for the District of Columbia, the plaintiffs raised similar claims to Market Synergy’s, but are seeking an injunction against the entire rule, a much more substantial outcome than would be an injunction against one provision of the rule.

In Chamber of Commerce of USA, et al. v Thomas E. Perez et al., which is scheduled for a November hearing in the Northern District of Texas, a collection of industry trade associations is also seeking to have the entire rule thrown out. That lawsuit makes eight allegations under several laws, including a First Amendment claim. It also raises the question of the treatment of fixed indexed annuities under the final rule, and whether regulators failed the requirements of the APA.

Over his long career in administrative law, Beck has seen the harmless error principle invoked countless times.

Still, the long body of decisions offers little indication of how Crabtree, a 2014 Obama administration appointee, will rule.

“The evaluation is always fact specific,” said Beck. Some courts have found significant violations of APA to be harmless, and others have found minimal harm enough to stay some rulemaking, he said.

Beck says the burden the government carries in the three lawsuits against the Labor Department rule is considerable.

“An order to vacate the provision under the APA would be a nationwide order,” noted Beck. “Industry only needs to win in one court — the government needs to win in every court. That is the cross the government bears.”

See also:

NAFA plots course in DOL rule fight

Fiduciary rule causes insurers to pull back on financial products

DOL 101: The fiduciary rule’s impact on insurance-only agents

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