Ask people in our industry the single most surprising aspect of the Department of Labor’s fiduciary rule and you’ll probably get a variety of answers.
Many will point to the stunning late addition of fixed indexed annuities to the Best Interest Contract Exemption. Some will say it’s the very idea the DOL would set a fiduciary standard in defiance of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which called on the SEC to develop fiduciary standards.
Still others are no doubt wondering why the DOL is even attempting to regulate financial advisors in the first place. To some, the Employee Retirement Income Security Act of 1974 is vague on whether DOL has standing to issue such rules.
These arguments (and many others) are found within the five lawsuits that have been filed against the DOL and Secretary of Labor Thomas Perez. The $20 billion question is whether a judge will agree.
A Goldman Sachs report pegs annual compliance costs at about $13 billion in upfront costs and more than $7 billion annually.
The lawsuits all seek a key ruling: an injunction that essentially calls time out so the issues can be parsed and properly ruled upon. In this scenario, the ultimate ruling isn’t the focus. Just gaining the injunction will delay the rule until President Barack Obama is out of office.
That gives opponents — and a new administration — time to better influence a final fiduciary rule. And there’s a decent chance they could succeed, said Kim O’Brien, vice chairwoman and CEO of Americans for Annuity Protection.
“If they don’t get the injunction, then any decision they get in court is going to be moot, because the industry is going to be moving on and getting ready for life under the rule,” she added.
An Injunction Here, an Injunction There
Experts note that judges are loath to grant injunctions. But DOL opponents need only to look at several recent legal setbacks dealt to Environmental Protection Agency rules to realize that victory is possible.
Last summer, a federal judge in Wyoming granted an injunction to halt Obama administration regulations for fracking on public lands. Likewise, a North Dakota district court ruled against the EPA on a rule that clarified which bodies of water were covered by the Clean Water Act.
“Irreparable harm” is the oft-cited standard that must be proved in order to gain an injunction and plaintiffs in the DOL lawsuits say they can meet that standard. Most glaringly with the decision to move FIAs out of the 84-24 Prohibited Transaction Exemption to the BIC.
Fixed indexed annuity sales in the first quarter were up nearly 33 percent when compared with the same period last year, marking the best first quarter in the products’ history, according to Moore Market Intelligence.
The decision to require a BIC exemption to sell FIAs is going to devastate those numbers, researchers with the LIMRA Secure Retirement Institute said. Selling under the BIC means onerous and costly disclosures as well as a best interest contract with clients.
The majority of the fiduciary rule goes into effect in April 2017, with some aspects delayed until Jan. 1, 2018. LIMRA sees total annuity sales going down 15 to 20 percent next year, with variable annuities plummeting 25 to 30 percent, and fixed annuities slipping 5 to 10 percent.
And that prediction was made before the final rule took FIAs out of PTE 84-24 and put them into the BIC exemption.
“The FIA industry was blindsided by this last-minute switch, and the impact will be highly detrimental to the FIA industry and its clientele,” according to the National Association for Fixed Annuities lawsuit. “Insurance carriers will need to restructure their distribution models, because they will not be able to guarantee in a BIC that independent agents selling insurance products from different carriers have acted in the best interest of purchasers.”
Worse still, the DOL moved FIAs into the stricter standard long after its economic analysis was completed, and months after public comment wrapped up on the fiduciary rule. Opponents see a legal strategy for victory in this event timeline.
“The department failed to consider the economic impact of its decision to take fixed indexed annuities out of the 84-24,” said Brian P. Perryman, shareholder with Carlton Fields Jorden Burt, a Washington, D.C., law firm.
The Rule 151A Playbook
The opponents most confident of beating the DOL in court are those industry activists around long enough to remember a similar fight against the SEC over its ill-fated Rule 151A.
Rule 151A was introduced by the SEC in June 2008 and adopted by the agency in December of that year. A month later, a coalition of insurance companies and marketing organizations filed American Equity Investment Life Insurance Company, et al., v. Securities and Exchange Commission.
Seven months later, the U.S. Court of Appeals ruled that the SEC failed to rigorously analyze the impact of Rule 151A. The judge told the SEC that it needed to prove Rule 151A would improve competition, capital formation and efficiency.
“We thought the odds were against us,” O’Brien recalled. “The securities people hated these indexed annuities. This was back in 2009 when they were even more vilified and hated than they are today.”
The lawsuits are also universally focused on the fiduciary rule giving clients a private cause of action for breach of contract. Only Congress has the power to create a private cause of action, the lawsuits state.
“The Department bootstrapped its way into regulating matters outside its jurisdiction by first defining the term ‘fiduciary’ in an impermissibly broad manner, and then exploiting its exemptive authority to obligate financial services professionals to accept special duties and liabilities that have no basis in ERISA and the Code,” reads the U.S. Chamber of Commerce lawsuit.
The DOL knows it cannot create a private cause of action, which led to the overly complicated 1,024-page rule and use of exemptions to achieve its goals, Perryman said.
“The challenge here will be establishing that what the Department of Labor cannot do through the front door, it can also not do through the back door,” he added.
While plaintiffs from the five lawsuits have their days in court, the rest of the industry must carry on. And that means working on twin tracks to comply with the fiduciary rule even as the legal fight is carried out.
Disclosures, procedures and websites are all areas an eager attorney will search out for potential claims if the rule takes effect. And when investments inevitably don’t pan out as expected, some clients will be in a lawsuit mood, said Phillip Stano, a partner at Sutherland, Asbill & Brennan, a Washington, D.C., law firm.
The industry has a golden opportunity to shape the landscape, he said.
“It’s going to depend mostly on you to a large extent,” Stano said. “Are you setting yourself up for failure or for success? You will be well prepared to face the suit that’s about to come. And they will come.”