DOL Prevails In First Challenge to the Conflict of Interest Rule and Related Exemptions

by Proskauer - Employee Benefits & Executive Compensation Blog

On November 4, 2016, Judge Moss in the U.S. District Court for the District of Columbia granted the U.S. Department of Labor’s motion for summary judgment and dismissed claims brought by the National Association for Fixed Annuities (“NAFA”) challenging the Department’s conflict of interest rule and related exemptions. Nat’l Ass’n for Fixed Annuities v. Perez, No. CV 16-1035 (RDM), 2016 WL 6573480 (D.D.C. Nov. 4, 2016).  The decision is the first to be issued among the four pending cases asserting similar challenges. (Our earlier blog posts on the cases are available here.)

NAFA asserted claims under the Administrative Procedures Act, the Regulatory Flexibility Act and the Due Process Clause of the Fifth Amendment, challenging: (i) the Department’s decision to replace the five-part test set forth in the 1975 regulation and, in particular, its decision to eliminate the requirement that advice be offered “on a regular basis;” (ii) the Department’s decision to apply the rules to IRAs and other plans that are not subject to Title I of ERISA; (iii) the written contract requirement contained in the Best Interest Contract (“BIC”) Exemption on the ground that it impermissibly creates a private right of action; (iv) the BIC Exemption on the ground that the “reasonable compensation” condition is vague; (v) the Department’s decision to move fixed indexed annuities (“FIAs”) from PTE 84-24 to the BIC Exemption; and (vi) the effectiveness of the rule for want of a regulatory impact analysis.

First, the court rejected NAFA’s argument that the Department exceeded its statutory authority by abandoning its decades-old five-part test under which an individual was an investment advice “fiduciary” only if they rendered investment advice for a fee “on a regular basis.”  The new rule establishes a broader definition of “investment advice,” which includes advice even if not given “on a regular basis.” In ruling against NAFA, the court held that the Department was entitled to Chevron deference in its interpretation of the term “investment advice,” and that nothing in the statutory text foreclosed the Department’s new interpretation.  In fact, the court concluded that the Department’s new interpretation better comports with the text and purpose of ERISA than the old rule.

Second, the court rejected NAFA’s argument that the Department exceeded its statutory authority by extending fiduciary duties found only in Title I of ERISA to individuals who advise IRAs and other non-Title I plans.  The court determined that the Department had the authority to condition prohibited transactions exemptions on compliance with ERISA’s duties of loyalty and prudence.

Third, the court rejected NAFA’s argument that the new rules impermissibly created a private right of action for violations of the BIC Exemption.  The court concluded that the Department was extending rights that already existed under state law and that any action brought to enforce the terms of the written contract would be brought under state law.

Fourth, the court rejected NAFA’s argument that the “reasonable compensation” requirement of the BIC Exemption was void for vagueness because the concept of “reasonable compensation” is a common one that appears throughout the U.S. Code, including in ERISA.  The court determined that “a reasonably prudent person, familiar with the conditions the BIC Exemption is meant to address and the objectives the exemption and conditions are meant to achieve, would have fair warning of what the regulations require.”

Fifth, the court rejected NAFA’s argument that the Department failed to give fair warning or an opportunity to comment on the Department’s decision to make FIAs ineligible for PTE 84-24.  Although the decision to subject FIAs to the more onerous BIC Exemption is different than the proposed rule, the court held that the Department had satisfied the notice requirements because the final rule was a “logical outgrowth of the notice.”

Lastly, the court rejected NAFA’s argument that the Department failed to accompany the final rule with a “final regulatory flexibility analysis.” According to the court, the final regulatory flexibility analysis is only a procedural requirement, and it is not for the court to analyze whether the agency’s analysis was correct.  Rather, the only question for the court was whether the Department put forth a reasonable good-faith effort to comply with the procedural steps laid out in the statute.  The court concluded that the Department’s 382-page final analysis satisfied the requirement.

Proskauer’s Perspective

Although the Department scored an early victory in the NAFA litigation, it will certainly not be the last word on the Department’s conflict of interest rule and related exemptions.  NAFA already has filed an appeal to the D.C. Circuit and that appeal, along with the three other cases, remain to be decided.

In the lawsuit filed by Market Synergy Group, the U.S. District Court in Kansas heard oral argument on September 21, 2016. In the consolidated case led by the U.S. Chamber of Commerce, the U.S. District Court for the Northern District of Texas heard oral argument on November 17, 2016.  In the case filed by Thrivent Financial, the U.S. District Court in Minnesota is scheduled to hear oral argument on March 3, 2017.  Unlike the cases filed by Market Synergy and the Chamber, Thrivent Financial challenges the rule on the ground that it impermissibly requires the resolution of disputes in federal court rather than allowing for alternative dispute resolution methods.

It also remains to be seen what action, if any, the Trump administration will take. President-elect Trump has expressed a desire to reduce regulation and the Republican-controlled Congress previously passed legislation that would have undone the regulation (but was vetoed by President Obama).  Although nothing is certain – and there has been no announcement – the April 10, 2017 applicability date very well may be delayed.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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