A message for firms struggling to prepare for the Labor Department’s updated fiduciary duty rule: good luck, you may need it.
The rule, controversial since its conception, is taking a convoluted path to adoption and execution. In the span of just seven days, there was a Presidential Memorandum punting the rule back to the Labor Department for further review, a court decision that decisively upheld its legality and constitutionality, and an awaited Trump Administration response that has yet to materialize.
In April 2016, the Labor Department finalized a new rule that creates a fiduciary duty for brokers and registered investment advisers who offer retirement advice. The rule—scheduled to be phased in between April 10, 2017 and Jan. 1, 2018—expands the “investment advice fiduciary” definition under the Employee Retirement Income Security Act.
The rule provides exemptions that, if applied for and granted, would allow covered advisers to maintain fee-based arrangements. Unless fiduciaries qualify for an exemption, they are prohibited from receiving commissions, which are considered to present a conflict of interest. Prior to the new rules, fiduciaries could qualify for an exemption known as the Prohibited Transaction Exemption, which, if they qualified, allowed them to receive commissions on all annuity sales as long as the sale was as favorable to the consumer as an arms-length transaction and the adviser received no more than reasonable compensation. The new rule creates a new exemption called BICE (Best Interest Contract Exemption), for fixed index annuities and variable annuities, and allows fiduciaries to receive commissions only if they adhere to certain conditions, including signing a written contract with the consumer that contains enumerated provisions intended to protect their interests.
Soon after, critics mustered their forces. The U.S. Chamber of Commerce, Financial Services Institute, Financial Services Roundtable, Insured Retirement Institute, and Securities Industry and Financial Markets Association developed a legal challenge and, in the interest of venue shopping, aligned with co-plaintiffs—among them the Greater Irving-Las Colinas' Chamber of Commerce, Lake Houston Area Chamber of Commerce, Lubbock Chamber of Commerce, and Texas Association of Business—to bring the case to the U.S. District Court for the Northern District of Texas.
The plaintiffs described the Labor Department’s rule as “over-reaching,” with an end result that “will restrict hardworking Americans' access to retirement advice and planning services."
“Although the industry will likely respond in different ways to BICE, [it] does not appear to be a ‘Hobson’s choice,' and the exemption’s conditions have been deemed workable by many in the industry.”
Chief Judge Barbara Lynn
Among the numerous arguments made in the lawsuit the Labor Department: did not conduct an adequate cost-benefit analysis; ignored the public’s comments and those of an SEC commissioner; enacted an “impermissible departure” from the historical understanding of a fiduciary; overstepped its bounds by regulating certain insurance products (including fixed-indexed annuities) that the Dodd-Frank Act expressly left to oversight by state regulators; and unlawfully created a private right of action.
The Department’s promulgation of the rule was arbitrary, capricious, and otherwise not in accordance with law, they concluded. “Financial institutions and financial professionals have a First Amendment right to engage in truthful, non-misleading speech related to their products and services, including in their communications with customers and potential customers,” they added. “The rule improperly abridges this speech by prohibiting it unless it occurs in the confines of a fiduciary relationship subject to definitions, limitations, and burdens created by the Department.”
Very little of those arguments proved persuasive for Chief Judge Barbara Lynn. In an 81-page ruling made public on Feb. 8, she decisively sided with the Labor Department.
The ruling tosses yet another spanner in the works for the Trump Administration, complicating what has already been a shifting strategy for dealing with the rule.
Leaked copies of a Feb. 3 memorandum to the Labor Department, for example, called for a 180–day moratorium on the rule and retreating from the government’s defense of lawsuits challenging it. The final document took a more measured approach for dealing with requirements.
The Labor Department was ordered to review the rule “to determine whether it may adversely affect the ability of Americans to gain access to retirement information and financial advice.” As part of this examination, it was directed to prepare an updated economic and legal analysis. If the Labor Department concludes that the rule is “inconsistent” with Administration priorities, it was instructed to “publish for notice and comment a proposed rule rescinding or revising the rule, as appropriate and as consistent with law.”
The memo prompted the Department of Justice to request that the Texas court delay its decision until at least March 10, time needed to better assess the White House’s directive, including the possibility that the rulemaking could be “revised or rescinded.”
“A judicial decision on a rulemaking as complex as this while the Department is undertaking the examination and potential promulgation of a proposal pursuant to the Presidential Memorandum can be expected to cause confusion with the affected public, whether parties to this litigation or not,” the justice Department wrote.
The plaintiffs, for their part demanded that there be no such delay in issuing a ruling. Judge Lynn, for her part, denied the government’s motion and promised that her decision would be released by Feb. 10, a deadline she beat by two days.
The plaintiff’s argument that the fiduciary rule exceeds the coverage of ERISA because it imposes fiduciary status on those who earn a commission merely for selling a product, regardless of whether advice is given, failed to gain traction. The rule “plainly does not make one a fiduciary form selling a product without a recommendation,” Lynn said, quoting the relevant language.
WHAT'S WITH THE DELAY?
The Trump administration is working on a proposal to delay the start date of a rule that governs the way retirement advisors interact with clients, government filings show, despite a court decision this week that upheld the regulation.
The administration sent its draft proposal to the Office of Management and Budget on Thursday, according to the records. The "fiduciary rule," as it known, is currently slated to go into effect April 10.
The proposal also seeks to redefine the term "fiduciary," which generally requires advisers to put their clients' best interest first, according to public records.
The rule was one of the Labor Department's signature achievements under former President Barack Obama. It was intended to force retirement advisers to disclose conflicts of interest and eliminate hidden fees. But the measure was opposed by industry groups that argue it unfairly exposes them to litigation and limits consumers' choices.
The White House issued a presidential memo last week ordering the DOL to review the regulation, and public records show a status update was slated for March 10.
But on Wednesday, a Texas court upheld the rule and rejected a lawsuit filed by business groups that challenged the regulation. That could make it difficult for the Trump administration to make substantive changes to the rule down the road.
Debate over the rule is sowing confusion over a regulation estimated to cost the financial services industry as much as $20 billion.
The Obama administration had argued that the rule would save retirement investors about $17 billion a year in fees and lost earning potential. However, industry groups such as the Financial Services Roundtable and the Securities Industry and Financial Markets Association say the regulation effectively forces brokers to put clients in the lowest-fee products, even if a higher-cost product might be more beneficial in the long run.
A senior administration official also argued that investors are already protected under the Securities and Exchange Commission so the rule creates unnecessary and burdensome paperwork for financial advisers.
Plaintiffs also argued that the Labor Department’s exemptive authority is limited to reducing regulatory burdens and, because financial professionals have no choice but to comply with BICE requirements, it is a mandate that exceeds its authority rather than an exemption. “Any exemption the DOL grants from the prohibited transaction rules reduces the industry’s regulatory burden,” Lynn countered. “Although BICE imposes different obligations than did previous exemptions, it does not follow that the new exemptions exceed the Labor Department’s authority.”
As for whether BICE requirements were “arbitrary and capricious” and a violation of the Administrative Procedures Act, Lynn pointed to an amicus brief filed by the Financial Planning Coalition. It noted that its nearly 80,000 members have, since 2008, successfully operated under a regime similar to that in BICE, including a fiduciary standard; a written contract; disclosure of certain fees, costs, and conflicts of interest; and policies to mitigate conflicts. At oral argument, the DOL represented that Mass Mutual and Lincoln National, which sell variable annuities, “fully intend to use” BICE, and that broker-dealers such as Morgan Stanley, Ameriprise, and Raymond James have expressed their intent to do the same.
“Although the industry will likely respond in different ways to BICE, [it] does not appear to be a ‘Hobson’s choice,' and the exemption’s conditions have been deemed workable by many in the industry,” Lynn wrote. As for the BICE condition requiring that the written contract with the retirement investor may not waive or qualify the investor’s ability to participate in a class action, the Court does not find it to be unreasonable, especially when variable annuities have been subject to similar conditions under the Financial Industry Regulatory Authority’s Customer Code since 1992.
Lynn dismissed claims that the rule’s required cost-benefit analysis was either inadequate or unreasonable. “The Labor Department adequately weighed the monetary and non-monetary costs on the industry of complying with the rules, against the benefits to consumers,” she wrote. “In doing so, the [it] conducted a reasonable cost-benefit analysis.”
The Labor Department also assessed plaintiffs’ concerns that the rules would decrease access to investment advice, Lynn said. For example, it utilized data from the United Kingdom’s more aggressive regulatory regime, which banned all commissions on retail investment products. “Because evidence showed the UK’s comprehensive changes did not result in advisers abandoning consumers, the DOL reasonably found its less burdensome rulemaking would not cause a material number of advisers to leave the market or negatively impact access to investment advice,” she wrote.
Does the rule suppress First Amendment Protections? Lynn was unconvinced. To start with, the plaintiffs did not raise any First Amendment issues during the rulemaking process. Only later did they claim that the rule would directly regulate speech by insurance agents, broker-dealers, and others, prohibiting recommendations unless BICE is satisfied, and effectively banning commercial sales speech, as “salespersons now may speak as a fiduciary, or not at all.”
“At worst, the only speech the rules even arguably regulate is misleading advice,” Lynn wrote. “Plaintiffs and their members may speak freely, so long as they recommend products that are in a consumer’s best interest. If an investment adviser recommends a product merely because the product makes the most money for the adviser or financial institution, despite the product not being in the investor’s best interest, such advice is not appropriate for the investor and would be misleading.”
For commercial speech to warrant First Amendment protection, the speech must “not be misleading,” because the government may regulate communication that is “more likely to deceive the public than to inform it,” she added.
In a joint statement following the ruling, the plaintiffs said they “continue to believe that the Labor Department exceeded its authority” and they will “pursue all of our available options to see that this rule is rescinded.”
“The President's recent directive to the Department, reflecting well-founded, ongoing and significant concerns about the rule, is a welcome development,” they added.
Proponents of the rule, as expected, celebrated the decision. “Three courts have now carefully considered the full range of industry attacks on the DOL’s best interest fiduciary rule, and they have firmly rejected all of them,’ says Stephen Hall, legal director of Better Markets, a consumer advocacy organization that supports financial reforms. “The decision is definitive and sends a message that ought to put a stake through the heart of industry’s efforts to destroy this common-sense rule.
There was a lot of unusual maneuvering in the past several days, notes Erin Sweeney of the law firm Miller & Chevalier. Various parties appear to have been strategizing in response to the others’ actions. The backdrop is even more complicated because the Trump Administration’s nominee to lead the Labor Department, Andrew Puzder, is held up in contentious Senate confirmation hearings.
“It is wildly unusual for a judge to say they are going to drop a decision on a given date, she says of Lynn, speculating that she had written her decision, had it in hand, and was waiting to see if the Labor Department published notice in Federal Register that would either extend the applicability date or reopen a notice and comment period. The reason why the Trump Administration issued the Presidential Memorandum when they did, may have been to signal its position (at least at the time).
“I’m sure it would have happened eventually, but that the reason it came out the day that it did was probably because the administration wanted to telegraph to the judge that it intends to take a deeper dive into the regulation,” Sweeney says. “Meanwhile, Judge Lynn was waiting to see what the Labor Department was going to do.”
Why did plaintiffs oppose the government’s request for a stay? Sweeney posed that question directly to representatives of the Chamber of Commerce during a panel discussion that, coincidently, was the same day the ruling was issued. “Our members are imminently harmed and we need to move full speed ahead,” was the answer. “We don’t want any more delays.”
“The plaintiffs saw this fast train coming around the corner and needed to do something,” she adds.
Don’t expect that the Texas decision alters the likelihood that the Labor Department will eventually reopen the rule. Sweeney points out that two of the three matters the Presidential Memorandum demanded be reviewed have now been similarly evaluated by Judge Lynn in her ruling.
“I still believe the Labor Department is going to reopen the rule, as the administration has suggested, but it is now a harder path and a harder battle,” she said, referring to the 0-for-three legal record for challenges. “It is tough sledding for the Department on this one, but I think they are still going to do it. We are likely going to still be looking at all this for about another year.”
The governments challenge, she added, that any effort to just delay the rule beyond 180-days would mean it is no longer in “a legal comfort zone with case law to back it up.” Withdrawing the current rule and issuing a new proposal would, at the very least, stop the clock.