Fiduciary debate rises from dead, irking some

The debate around one of the Department of Labor's most contentious rule-making topics — fiduciary investment advice — is alive and well as the department works on crafting a new rule proposal and faces legal challenges on an investment-advice exemption and subsequent guidance.

There's a lot of "frustration with what appears to be the department trying to have a second bite at the apple," said Jennifer Eller, a Washington-based principal at Groom Law Group and co-chairwoman of the firm's retirement services practice group and fiduciary practice.

Stakeholders who have followed this issue over the past three presidencies understand Ms. Eller's "second bite at the apple," referring to a 2016 regulation known as the fiduciary rule.

That rule, finalized under the Obama administration, broadened the definition of a person or entity taking on fiduciary responsibilities; it replaced a five-part test used to determine whether an investment professional or financial institution serves as a fiduciary.

But in 2018, a three-judge panel at the Fifth U.S. Circuit Court of Appeals in New Orleans vacated the rule in a 2-1 decision, saying the department exceeded its legal authority.

The Trump administration then decided not to appeal the decision and the fiduciary rule died.

However, much like the murderous Michael Myers in the Halloween movie franchise, the rule wasn't truly dead, at least in the opinion of some observers.

In mid-2020, the Labor Department under the Trump administration announced a final rule reinstating the five-part test. Then later that year, the DOL finalized a prohibited transaction exemption that permitted investment-advice fiduciaries to receive compensation for more types of guidance, including advice to roll over assets from a retirement plan to an individual retirement account.

The Biden administration in early 2021 allowed the exemption to take effect, but signaled its work on the issue would continue.

While the exemption now has proponents and opponents, its lengthy preamble garnered the most attention, particularly with respect to rollovers.

"The facts and circumstances analysis required by the five-part test applies to rollover recommendations," the exemption stated.

The language in the preamble led the Federation of Americans for Consumer Choice, which represents annuity and life insurance firms, along with several advisory firms and advisers for annuities, to file a lawsuit seeking to vacate the exemption.

The lawsuit, filed in February in District Court in Dallas, alleges the Labor Department "sought to resurrect and repackage the substance of its vacated fiduciary rule through adoption of a new prohibited transaction exemption."

Kim O'Brien, CEO of the Dallas-based FACC, said her group needed to challenge the exemption.

"We felt the DOL is really unnecessarily meddling in our industry," she said.

"They're trying to turn all insurance salespeople into fiduciaries and they're creating a really onerous supervisory and regulatory environment for our world that really doesn't fit in the way insurance is sold and annuities and fixed guaranteed annuities are sold to consumers."

Their lawsuit refers to the preamble language around rollovers as a "new interpretation" of who is categorized as an investment-advice fiduciary.

"It seemed fairly straightforward that they were just blatantly disregarding the Fifth Circuit's ruling on what the five-part test meant and what Congress originally intended in the statute," Don Colleluori, Dallas-based partner at Figari & Davenport LLP, who's representing the FACC in the case, said of the new interpretation.

A Labor Department spokesman did not respond to a request for comment, but on Sept. 7 the department filed a motion to dismiss the case, saying the plaintiffs have not established that they are "directly and adversely affected by the DOL's new interpretation."

The Labor Department also noted that following the Fifth Circuit's ruling, another prohibited transaction exemption, PTE 84-24, was reinstated and could apply to insurance sales, like variable, fixed-indexed and fixed-rate annuities, which could likely be used by the FACC's members.

Mr. Colleluori said the FACC will file another motion of its own by Nov. 7 and the Labor Department will have the opportunity to file a final reply due Dec. 9.

A hearing date is slated for Jan. 24, 2023, Mr. Colleluori added.

The American Council of Life Insurers and the Hispanic Leadership Fund, a Washington-based public policy not-for-profit, have each filed amicus briefs in support of the FACC's case.

Kent Mason, a Washington-based partner with law firm Davis & Harman LLP who filed the brief on behalf of the Hispanic Leadership Fund, said the Labor Department "essentially resurrected" its 2016 rule in the exemption's preamble.

Under the new interpretation, when a representative of a broker-dealer makes a cold call to a prospective customer suggesting that the individual roll their retirement assets into an IRA serviced by the broker-dealer, then that broker-dealer would be acting as a fiduciary, despite this being a cold sales call with no relationship of trust and confidence, Mr. Mason said in an argument summary.

"By saying that later events make a cold call part of a series of recommendations made on a regular basis" — one of the prongs of the five-part test— "means that a cold call is part of a relationship of trust and confidence, which does not make any sense," Mr. Mason said in an interview.

Micah Hauptman, Washington-based director of investor protection at the Consumer Federation of America, also doesn't like the exemption — but because it doesn't go far enough. He also doesn't support the plaintiff's claims in this case.

"I think the argument that they're making, that DOL essentially reinstated the (2016) rule is ludicrous," he said. "If it did, we would've supported it. We're still in the (original) 1975 rule and there are still loopholes that need to be addressed."

A separate lawsuit was filed by the American Securities Administration, a trade group representing financial services firms, in February in U.S. District Court in Tampa, Fla. The suit alleged the Labor Department violated federal law by issuing guidance related to the exemption without seeking public comment.

The DOL asked the court to dismiss that case in August.

Whether the legal challenges are successful remains to be seen. But the facts surrounding the debate have changed since the Fifth Circuit's ruling in 2018, said Fred Reish, a Los Angeles-based partner at Faegre Drinker Biddle & Reath LLP.

He pointed to 2019 guidance from the Securities and Exchange Commission that applies a best-interest standard to broker-dealers and investment advisers for a single recommendation. Also, in March, the SEC published a staff bulletin that said when making a rollover recommendation, broker-dealers and investment advisers "must have a reasonable basis to believe both that the rollover itself and that the account being recommended are in the retail investor's best interest."

The staff bulletin, Mr. Reish said, aligns with the Labor Department's new interpretation on rollovers.

"The SEC saying that a single recommendation of a rollover, for example, by an investment adviser invokes a fiduciary standard, (and) by a broker-dealer invokes a best-interest standard, which is based on fiduciary-like principles, didn't exist when the Fifth Circuit made its decision," Mr. Reish said. "The Fifth Circuit decision said, 'Gee, not a whole lot has changed in the financial services industry since the 1970s,' and this has changed things."

Mr. Reish added, "It would be more difficult today to say that there haven't been significant changes over the last 40-some-odd years as the Fifth Circuit said in its (2018) decision," Mr. Reish said, due to the SEC guidance.

The Labor Department continues working on its rule-making initiative that could broaden who's considered a fiduciary under ERISA by amending the regulatory definition of the term fiduciary.

In its spring regulatory agenda, released in June, the Labor Department's Employee Benefits Security Administration said the rule-making "would amend the regulatory definition of the term fiduciary … to more appropriately define when persons who render investment advice for a fee to employee benefit plans and IRAs are fiduciaries."

Moreover, the broadening of fiduciaries would "take into account practices of investment advisers, and the expectations of plan officials and participants, and IRA owners who receive investment advice."

Mr. Reish thinks the department's desire is to have a rule that parallels the SEC's rules for investment advisers and broker-dealers, "which is that a single recommendation can be a fiduciary recommendation (and) does not require that advice be provided on a regular basis, but that any material recommendation could impact a plan or a participant would be fiduciary advice."

When asked what she'd like to see in a proposed rule on this subject, the FACC's Ms. O'Brien said "nothing."

She added, "People are seeking the guarantees and the insurance elements of fixed annuities and what the DOL is trying to do is just making it difficult for people to access a professional's experience and expertise on insurance and on annuities by playing in our sandbox. We would like to see the DOL just stop and abide by the Fifth Circuit decision."

The Labor Department's agenda indicates it will propose the rule in December, but industry sources expect it to come out sometime in 2023.