Wednesday, December 14, 2016

No. 192: The U.S. Department of Labor Wins A Pyrrhic Victory in Another Lawsuit Challenging Its New Fiduciary Rule

In No. 188 (posted November 15, 2016), I discussed a lawsuit filed by the National Association of Fixed Annuities (NAFA) challenging the new fiduciary rule promulgated in April 2016 by the U.S. Department of Labor (DOL). I characterized the lawsuit as a win for DOL, because the judge denied the plaintiff's motion for a preliminary injunction and for summary judgment, and granted DOL's cross-motion for summary judgment.

Now we have a second win for DOL, in a lawsuit filed by Market Synergy Group, Inc. (MSG). The judge denied MSG's motion for a preliminary injunction to prevent implementation of the rule.

The MSG Lawsuit
On June 8, 2016, MSG filed a complaint against DOL, and on June 17 filed a motion for a preliminary injunction. The case was assigned to U.S. District Judge Daniel D. Crabtree. President Obama nominated him in August 2013, and the Senate confirmed him in April 2014.

On July 22, DOL opposed the motion for a preliminary injunction. On August 5, MSG responded. On September 28, DOL commented further.

The Court Ruling
On November 28, Judge Crabtree filed a memorandum and order. He concluded that MSG is not likely to succeed on the merits of its claim, and that MSG therefore is not entitled to injunctive relief. Consequently he denied MSG's motion for a preliminary injunction. (See MSG v. DOL, U.S. District Court, District of Kansas, Case No. 5:16-cv-4083.)

The Plaintiff
To understand this case, it is helpful to know about MSG, the plaintiff. Here is how Judge Crabtree describes MSG in his order:
Plaintiff is a Kansas Corporation and a licensed insurance agency based in Topeka, Kansas. Plaintiff works with insurance companies to develop specialized, proprietary FIAs [fixed index annuities] and other insurance products for exclusive distribution. It partners with IMOs [independent marketing organizations] to distribute these products. About 3,000 agents and other financial professionals sell proprietary products developed through plaintiff's relationships with insurance companies.
Plaintiff also conducts market research and provides training and product support for IMO network members and the independent insurance agents who IMOs recruit. Plaintiff describes its business as dependent upon the viability of the IMO/independent insurance agent distribution channel for sales of FIAs and other fixed insurance products.
Plaintiff distributes FIAs and other insurance products through 11 IMO network members. These IMO network members are independently owned insurance wholesalers that assist independent agents and financial advisers who aspire to increase their life insurance and annuity business. About 20,000 individual agents work with the 11 IMOs in plaintiff's network. In 2015, plaintiff and its network members collectively generated about $15 billion of FIA sales, measured by premiums paid. Nationwide, about 80,000 independent insurance agents are engaged in the sale of FIAs.
The Parties' Contentions
Judge Crabtree describes the contrasting views of MSG and DOL in his order. Here are his two paragraphs about MSG's views and one paragraph about DOL's views:
Plaintiff asserts that the rule change will have grave consequences for its business. Plaintiff describes its business model as one depending heavily on its ability to receive compensation generated from FIA sales. Plaintiff estimates that its revenue will decline by almost 80% under the amended version of PTE [prohibited transaction exemption] 84-24 because the rule change prohibits plaintiff and others affiliated with it from receiving third-party compensation for FIA sales. Plaintiff also anticipates that the IMOs and insurance agents that it works with to distribute FIAs will experience significant revenue losses. And, plaintiff forecasts that more than 20,000 independent insurance agents will exit the marketplace if the rule change takes effect.
Plaintiff also complains that the DOL lacked a sufficient basis to remove FIAs from the exemption in PTE 84-24 when it allowed other types of fixed annuities to remain under the exemption. Plaintiff contends that other types of transactions that still enjoy exemption under the amended version of PTE 84-24 are indistinguishable from FIAs and present no different risks of conflicts of interest compared to FIAs.
The DOL responds that the rule change is necessary to protect consumers. The DOL asserts that FIAs are complex transactions that involve significant conflicts of interest at the point of sale. Because of these characteristics, the DOL contends that FIA sales require more stringent rules governing the payment of third-party compensation, and thus should not enjoy exemption under PTE 84-24.
General Observations
The NAFA and MSG cases are Pyrrhic victories for DOL because the expense associated with the lawsuits may be wasted. Although the DOL rule is scheduled to go into effect in April 2017, it is likely that President-elect Donald Trump's incoming Secretary of Labor will withdraw the rule.

Available Material
I am offering a complimentary 63-page PDF containing Judge Crabtree's memorandum and order. Email and ask for the November 2016 Crabtree order in the MSG/DOL case.