DOL Puts Fiduciary Rule’s Right to Sue Under Microscope

Will the fiduciary rule give way to frivolous class action claims brought under the Employee Retirement Income Security Act?

That question is at the forefront of the Labor Department’s new analysis of the rule, ordered by President Trump.

The answer is in the eye of the beholder. Opponents of the rule have long argued it will be a boon for the plaintiffs’ bar; proponents say the rule’s clear guardrails will protect against frivolous claims, so long as firms comply with the new best-interest standard.

The Presidential memorandum issued in February instructs the Labor Department to assess how the rule’s private right of action will impact retirement investors.

The Department has requested comments on whether an increase in litigation will impact the cost of retirement advice and investments. Regulators also want to know if class-action lawsuits against sponsors of defined contribution plans have been “particularly prone to abuse,” according to Labor’s solicitation for comments.

Stakeholders who want to see the rule amended or withdrawn can be expected to focus on those questions, says Rob Foregger, cofounder of NextCapital, a provider of automated investment platforms in the institutional and retail space.

“The rule is focused on forcing conflicted advice out of the industry,” said Foregger, an early supporter of the fiduciary rule. “One could argue that will create more litigation, or that it will create cleaner lines as to what best-interest practices are. It certainly is an area some want to see amended.”

According to Morningstar, $3 trillion in IRA assets will be affected by the fiduciary rule, which creates new relief for IRA investors who claim to be victims of conflicted investment advice.

The private right-of-action provision prohibits financial service firms and insurance companies from writing class-action exclusions into the rule’s Best Interest Contract Exemption, the binding agreement brokers and advisors must use when receiving compensation on individual investment recommendations.

By design, the threat of class-action claims serves as the rule’s primary enforcement mechanism. Without the plaintiffs’ bar patrolling for alleged breaches of the BIC Exemption, oversight of the trillions in IRAs would be left to individual arbitration claims, which proponents of the rule say are a weak deterrent to conflicted advice.

Phyllis Borzi, former head of Labor’s Employee Benefits Security Administration, was forthcoming about the agency’s enforcement limitations before she left her post. The EBSA’s 400 auditors are spread across 15 field offices, and already oversee trillions in employer-sponsored retirement plans. Expecting them to police millions of IRA transactions impacted by the rule is hardly realistic.

Whether or not litigation would increase under the rule is dependent on how industry reacts to it, says Foregger. “I think we’ve already seen that industry has done a good job adapting to the letter and spirit of the rule, and that puts industry in a strong position.”

Seth Rosenbloom, associate general counsel at Betterment for Business, expects commenters to bring attention to the past decade’s worth of 401(k) class-action litigation.

By and large, those cases have vastly improved the quality of retirement plans offered by employers, thinks Rosenbloom.

“When those cases first emerged, everyone was skeptical of the claims,” he said. “But ultimately what they did was bring some of the worst practices to light.” Betterment is also a supporter of the fiduciary rule in its current form.

“At a minimum, the deterrent value of the threat of litigation will help reduce the worst practices in the retail space,” says Rosenbloom. “Will there be frivolous litigation brought under the rule? No one really knows. But I don’t see how it will be appealing to file lawsuits without merit.”