Tuesday, November 15, 2016

No. 188: The U.S. Department of Labor Wins One of the Lawsuits Challenging Its New Fiduciary Rule

On April 8, 2016, the U.S. Department of Labor (DOL) promulgated its long-awaited "fiduciary rule" addressing conflicts of interest in the marketing of commission-driven retirement advice given to consumers. In the months that followed, the industry's opposition to the rule took the form of several lawsuits seeking to prevent or at least delay implementation of the rule. The rule is to go into effect on April 10, 2017, with full implementation of certain aspects of the rule on January 1, 2018.

The NAFA Lawsuit
On June 2, 2016, the National Association for Fixed Annuities (NAFA) filed a complaint seeking to delay implementation of the new DOL rule, a motion for a preliminary injunction, and a memorandum in support of the motion. The defendants are the DOL and Secretary of Labor Thomas E. Perez. The case was assigned to U.S. District Judge Randolph D. Moss. President Obama nominated him in April 2014, and the Senate confirmed him in November 2014. (See NAFA v. DOL and Perez, U.S. District Court, District of Columbia, Case No. 1:16-cv-1035.)

On June 7 Judge Moss said NAFA's motion will be treated as a motion for a preliminary injunction and for summary judgment. On July 8 the defendants filed an opposition to NAFA's motion and a cross-motion for summary judgment. On August 30 Judge Moss held a hearing on NAFA's motion and the defendants' cross-motion.

The Opinion
On November 4 Judge Moss issued a 92-page opinion and a one-page order. They constitute a win for the defendants. Here, without citations, are the first and last paragraphs of the five-page introductory section of the opinion:
  • Plaintiff the National Association for Fixed Annuities ("NAFA") brings this action under the Administrative Procedure Act and the Regulatory Flexibility Act, challenging three final rules promulgated by the Department of Labor on April 8, 2016. Taken together, the three rules substantially modify the regulation of conflicts of interest in the market for retirement investment advice under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. NAFA focuses its challenge on how the new rules will affect the market for the fixed annuities its members sell.
  • Based on these arguments, and its further contention that the new rules will have catastrophic consequences for the fixed indexed annuities industry, NAFA seeks both a preliminary injunction and summary judgment. The Department opposes both motions and has cross-moved for summary judgment. For the reasons explained below, the Court will deny NAFA's motions for a preliminary injunction and summary judgment and will grant the Department's cross-motion for summary judgment.
The Outline
Below is an outline of the opinion. In parentheses is the page number on which the discussion of each item begins. "ERISA" is "Employee Retirement Income Security Act of 1974," "PTE" is "Prohibited Transaction Exemption," and "BIC" is "Best Interest Contract."

Memorandum Opinion (1)
I. Background (5)
A. Annuities (5)
B. Statutory and Regulatory Background (7)
1. ERISA (7)
a. Title I of ERISA (8)
b. Title II of ERISA (10)
2. The 1975 Definition of "Fiduciary" and PTE 84-24 (11)
3. The Current Rulemaking (14)
a. The 2010 Proposed Rule (14)
b. The 2015 Proposed Rules (15)
c. The Final Rule (21)
C. Procedural Background (27)
II. Analysis (29)
A. Revised Definition of "Rendering Investment Advice" (30)
1. Chevron Step One (30)
2. Chevron Step Two (40)
B. Imposition of Fiduciary Duties as Condition of PTE 84-24 and the BIC Exemption (45)
C. Written Contract Requirement of the BIC Exemption (55)
D. Reasonable Compensation Requirement and Due Process (61)
E. Placement of Fixed Indexed Annuities in the BIC Exemption (71) 
1. Treatment of Fixed Income [sic] Annuities as "Securities" (72)
2. Notice and Opportunity to Comment (73)
3. Reasoned Explanation (76)
4. Workability and Rationality (79)
5. Cost/Benefit Analysis (85)
F. Regulatory Flexibility Act (88)
Conclusion (92)

The Parties' Statements
After Judge Moss's ruling, Secretary Perez issued a brief statement. NAFA sent its members a relatively lengthy statement entitled "NAFA to Appeal Court Decision on DOL Fiduciary Rule" and subtitled "NAFA Will Seek Expedited Review." Here are the statements:
Perez: The conflicts of interest rule was developed after substantial input from a variety of stakeholders, including the industry, and it will make sure that retirement savers receive advice that puts their interests first. I'm pleased that the court recognized the comprehensive and thoughtful process we used in crafting this rule—this ruling is a win for working Americans who simply want a secure retirement.
NAFA: The National Association for Fixed Annuities ("NAFA") announced today, following a federal district court decision upholding the Department of Labor's fiduciary rule, that it will appeal to the D.C. Circuit Court of Appeals. "We are obviously disappointed by the court's decision, but we have always assumed this case would get decided by a higher court and we are pleased the issues will get de novo review by the Circuit Court," said Chip Anderson, Executive Director of NAFA. De novo review means the appellate court will consider the case without being bound or influenced by the lower court's decision. NAFA filed its lawsuit last June seeking a preliminary injunction to stay implementation of the rule, which is scheduled to go into effect in April 2017. Judge Randall [sic] Moss denied the preliminary injunction and at the same time ruled in favor of the DOL on the merits upholding the rule. NAFA's lawsuit, one of four lawsuits against the rule, challenges the DOL's authority to issue the rule, asserts the rule creates an impermissible private right of action, contends the rule contains unconstitutionally vague requirements that compensation be reasonable, and alleges the manner of adoption of the rule by DOL was arbitrary and capricious. Anderson stressed that NAFA would move quickly to get the case up to the appellate court and would continue to seek a preliminary injunction. Anderson said NAFA remains optimistic that the courts will ultimately find the rule to be an overreach by the Department of Labor that is inconsistent with existing tax and financial services laws. "NAFA believes the fiduciary rule will disrupt the distribution and availability of fixed annuities and have a particularly adverse impact on the low and middle income consumers who have come to rely on these valuable retirement savings products," said Anderson. Fixed annuities provide consumers with a guaranty of principal and minimum accumulation and provide a guaranteed lifetime income stream consumers cannot outlive. NAFA consists of insurance companies, agencies, and agents and affiliated persons who provide fixed annuities.
Other Lawsuits
As mentioned in NAFA's statement, several lawsuits have been filed seeking to delay implementation of the DOL rule. Some of the lawsuits have been consolidated. It is beyond the scope of this post to discuss the status of the other cases. However, to appreciate the significance of the DOL rule, it is instructive to identify some (but by no means all) of the parties involved as plaintiffs, as filers of amicus curiae (friend of the court) briefs, and as participants in other capacities, on both sides of the cases.

Some of those opposing the DOL, in addition to NAFA, are American Council of Life Insurers, American Equity Investment Life Insurance Company, Chamber of Commerce of the U.S., Life Insurance Company of the Southwest, Midland National Life Insurance Company, National Association of Insurance and Financial Advisors, North American Company for Life and Health Insurance, and Thrivent Financial for Lutherans. Some of those supporting the DOL are AARP, Americans for Financial Reform, Better Markets, Inc., Consumer Federation of America, and Public Citizen, Inc.

General Observations
Judge Moss's opinion is an extraordinary document. The five-page introductory section is an excellent summary of the DOL rule and the arguments for and against its implementation.

The terminology is interesting. In the first paragraph of the introductory section of the opinion, the expression "fixed annuities" appears. In the fifth paragraph, the expression "fixed index annuities" appears. Including NAFA's name, the statement to its members contains four references to "fixed annuities" and no mention of "fixed index annuities." It is my understanding that "fixed annuities" have no special upside potential based on a stock index, and that they are deemed to be insurance products. "Index annuities," on the other hand, have some upside potential based on a stock index, and therefore should be deemed securities. However, those arguing against their being deemed securities changed the name in a confusing and even contradictory manner to "fixed index annuities" in an effort to strengthen their argument.

Although many readers have asked me to write in detail about index annuities or fixed index annuities, I have not done so. The reason is that I do not understand the instruments well enough to feel comfortable writing about them. Some promoters have said I am too stupid to know a good thing when I see it, but I think the instruments are being sold by agents who do not understand them to buyers who do not understand them.

I have long believed that those selling insurance instruments, whether or not the instruments are deemed securities, should be required to operate under the fiduciary standard of care rather than the much weaker suitability standard of care. I think the new DOL rule, provided it survives the efforts of the industry to delay its implementation, will be an important step in that direction. In the long run, I think such a result would benefit not only insurance consumers but also the insurance industry.

Blogger's Note
In view of the results of the November 8 election, it is likely that the Trump-appointed Secretary of Labor—whoever he or she may be—will withdraw the DOL rule in view of the campaign promises that have been made to cut back on government regulations. Thus the efforts of all the parties—including the industry and the Department of Labor—in developing the rule and preparing for its implementation, as well as all the efforts of the parties and the courts in fighting over the rule, are likely to have been wasted.

More importantly, withdrawal of the rule will have a severe, adverse effect on retirement savers and other consumers. They will continue to be victimized by purchasing so-called fixed index annuities that benefit primarily commission-driven agents and others who sell them.

Available Material
I am offering a complimentary 92-page PDF containing the opinion Judge Moss issued on November 4, 2016. Email jmbelth@gmail.com and ask for the Moss ruling in the NAFA/DOL case.