Bradley Campbell of Faegre Drinker recently commented on the unusual strength of the language in the Fifth Circuit’s “Memorandum Opinion and Order” staying the DOL’s Retirement Security Rule.¹ Given distristrict court Chief Judge Lynn’s earlier well-reasoned analysis and opinion in connection with the DOL’s initial Fiduciary Rule,² as well as the fact that the Fifth Circuit’s Chief Judge cited the district court’s decision in his dissenting opinion in the 5th Circuit’s decision on the Rule,³ the Fifth’s Circuit’s statement that “[p]laintiffs are virtually certain to succeed on the merits,”⁴ arguably raises some legitimate questions, especially if, as expected, this case moves forward to SCOTUS..

As the court stated, in order to grant a stay or a preliminary injunction or stay, the movant must show  (1) a substantial likelihood of success on the merits; (2) a substantial threat of irreparable harm; (3) that the balance of hardships weights in the movant’s favor; and (4) that issuance of a preliminary injunction will not disserve the public interest.⁵

As to the likelihood of success, I would point to the Judge Lynn’s well-reasoned district court decision, one which was persuasive enough to convince the Chief Judge of the Fifth Circuit’s to dissent from the majority’s decision. The Fifth Circuit stated that the DOL’s Rule was “arbitrary and capricious.”¹⁰ The Court also stated that it had weighed the equities between the parties. And yet, I would respectfully submit that common sense and “humble arithmetic” suggest otherwise.

Annuity advocates often argue that the DOL’s proposed Rule is unnecessary, that the NAIC oversees the insurance industry to ensure that the public’s “best interests” are protected, that conflicts of interest are properly addressed. However, as the Retirement Security Rule points out

[The NAIC’s] definition of ‘material conflict of interest] expressly carves out ‘cash compensation or non-cash compensation’ from treatment as sources of conflicts of interests. The NAIC model Regulation also provids that it does not apply to transactions involving contracts used to fund an employee pension or welfare plan covered by ERISA.⁶

The NAIC expressly disclaimed that its standard creates fiduciary obligations, and the obligations differ in significant respects from those applicable to broker-dealers in the SEC’s Regulation Best Interest..[The NAIC’s model] does not expessly incorporate the obligation not to put the producer’s or insurer’s interests before the customer’s interests, even though compliance with their terms is treated as meeting the ‘best interest’ standard.⁷

Additionally, the obligation to comply with the ‘best interest’ standard is limited to the indivual producer, as opposed to the insurer repsonsible for supervising the producer.⁸

Judge Lynn then provides support for the need for the DOL’s Retirement Security Rule by pointing out that

Further, the SEC’s Regulation Best Interest and the NAIC Model Regulations are each limited in important ways in terms of application to advice provided to ERISA plan fiduciaries although this is not the case with the Advisers Act fiducirry obligations….The NAIC Model Regulation does not apply to transactions involving conracts used to fund an employee pension or welfare plan covered by ERISA. The Department [of Labor] believes that retirement investors and the regulated community are best served by an ERIAS fiducairy standard that applies uniformly to all invstments that retirement investors may make with respect to their retirement accounts.⁹

And yet, the Fifth Circuit ignored the DOL’s accurate and logical arguments and analysis, choosing to protect the annuity industry over protecting plans and plan participants by issuing a stay of the DOL Rule based upon the Court’s opinion that the industry is virtually certain to succeed on the merits. It could legitimately be argued that Judge Lynn’s opinion more accurately reflects the current situations and concerns that caused the DOL to create the Retirement Security Rule in the first place..

One of the key targets of the Rule was fixed indexed annuities (FIAs). FIAs were origianlly marketed as equity indexed annuities (EIAs). I was a compliance director at the time EIAs were introduced. My immediate response when the annuity wholesaler introduced then during a weekly sales meeting was “no way,” as the product was misleading in suggesting market returns. However, the various artificial restrictions on returns made it clear that the product was structured more to ensure that the annuity issuer benefitted at the annuity owner’s expense.

My opinion on FIAs/EIAs remains the same. And apparently others in the industry agreed with my assessment, since many of the larger insurance companies avoided the product due to potential liability concerns when the EIAs were first introduced.

A vice president at Northwestenn Mutual stated that

These products are so complicated that I think it’s a stretch to believe that the agents, much less the clients, understand what they’ve got. The commissions are extreme. The surrender eriods are too long. The complexity is way too high.¹¹

MassMutual Financial Group was so concerned that they prepared a study compaing how an FIA based on the S&P 500 would have performed over the 30-year period ending Dececmber 2003. The study concluded that the EIA would have delivered just 5.8% a year, compared to the 8.5% return on the S&P 500 (without dividends) and 12.2% return (with dividends reinvested). The study also found that investors in the EIA would have even done better invested in simple Treasury bills, which delivered 6.4% a year.¹²

In ” Can Annuities Offer Competitive Returns?,¹³“Dr. William Reichenstein, formerly a chaired professor of finance at Baylor University, came to the same conclusion about the imprudence of EIAs

By design, indexed annuities cannot add value. By design, (1) they do not attempt market timing, (2) they do not make sector/industry/style/size bets, and (3) they do not try to add value through security selection….So, I concluded that the risk-adjusted returns on indexed annities must trail the risk-adjusted returns available in marketable securities by the sum of their spread plus their transaction costs,¹⁴

Annuity issuers adamantly oppose disclosing the spreads that they assess against annuity owners. Spreads reduce the amount of interest credited to the annuity owner. Even when annuity disclose alleged spreads, they may not accurately reflect the actual impact in terms of reduced returns/loss incurred by an annuity owner. The graphic shown below shows how an alleged annual  2 percent spread (200 basis point) in connection with an FIA with a 10 percent cap effectively reduces an annuity owner’s annual return by 20 percent, not by the alleged 2 percent. And this does not even factor in the annual compounding effect of this excessive cost.

It is hard to believe that any court could/would try to ignore or justify such an inequitable practice, one which reduces an investor’s annual return by an outrageous 20 percent or more a year. Despite the Fifth Circuit’s “arbitrary and capricious “ allegation, these are facts based on ‘humble arithmetic,” not self-serving, speculative projections and “declarations”.  

Yet, in staying the effectiveness of the DOL’s Rule, that is exactly what the Fifth Circuit has effectively done by virtue of issuing a stay of the Rule and allowing the annuity industry to continue to market these anti-consumer best interest products for who knows how long, with serious consequences for workers trying the prepare for “retirement readiness,” workers who may not have the time to make up for unnecessary losses resulting from the stay.

The Fifth Circuit also tried to justify the stay based on the annuity industry’s allegations of irreparable harm. The first words that came to mind when I read this was the “squandering plaintiff” ruse that the annuity industry used to try to convince the courts to require that structured settlements be required in actions involving significant damages. The annuity advocates claimed that the annuity industry had data and studies showing that 90 percent of injured plaintiffs receiving lump sum settlements instead of structured settlements and annuities dissipated such settlements within five years. And yet, when called on to produce such data studies, the annuity industry failed to do so.¹⁵

Jeremy Babener, a settlement expert, wrote several informative articles on this issue. Eventually, he cited an annuity advocate and industry in-house legal counsel who suggested that no such studies or findings ever existed, that they were simply made up/imaginary.¹⁶

So, against that backdrop of the annuity industry’s willingness and propensity to exaggerate and misrepresent the truth when it serves their purpose, I have to wonder to what extent the Fifth Circuit properly weighed the industry’s alleged irreparable claims, especially given the Court’s note that the alleged injury must also be complete, that “speculative injury is not sufficient.”¹⁷

Among the industry’s claims, based on personal self-serving “declarations”

• (1) the Rule will cause more than half a billion dollars in compliance costs, and another $2.5 billion in costs over the next decade. Compliance costs are always in flux as new products are introduced. And yet, by their very nature, such forward looking projections are self-serving and speculative, and, thus, should not be a factor in any decision since they would be inadmissable under the federal rules of evidence;¹⁸
• (2) 87% of independent insurance agents “estimate” that the Rule will increase their staffing and operational costs,¹⁹
• (3) 93% of these independent agents anticipate rising professional liability insurance premiums,²⁰
• (4) Some agents fear they will be forced out of business, forced to restructure their business, or to retire. (speculative and hyperbole).²¹

Compliance costs are always a cost in both the securities and insurance industries. However, I remain sceptical of such claims given my compliance background. If one accepts these claims at face value, I would argue that it is tantamount to an admission against interest, an admission that an insurance/annuity company is selling these products without proper compliance programs and safeguards. These “woe is me” claims are reminiscent of the Aesop’s famous saying _ “A tyrant always has a pretext for his tyranny.”

These self-serving “declarations” should have absolutely no weight in whether to protect workers against imprudent investment products. Instead, the evidence suggests that once again the legal system is once again drinking the annuity industry’s self-serving misrepresentation Kool-aid without verification of same, just as with the industry’s “squandering plaintiff” ruse in connection with structured settlements and significant injuries, all to once again benefit the annuity industry at the public’s expense.

The insurance/annuity industry created and market these complex and misleading products to ensure that they profit at the public’s expense. They should now be tasked with cleaning up their own mess to ensure that their products are actually in the best interest of consumers, especially those saving for retirement.

I think that most people agree that this case will, and should, be heard by SCOTUS to ensure an equitable and consistent interpretation and enforcement of the rights and guarantees promised under ERISA. As for now, the courts need to “call” the annuity industry’s bluff in order to properly weight the equities and to preserve, protect and promote ERISA’s stated purpose and goals. The DOL should also petition for a reconsideration of the stay by the Fifth Circuit, en banc, and then petition SCOTUS, if necessary.

For more information on the inherent fiduciary liability issues with FIAs, variable annuities, and annuities in general, see my earlier post, “A Fiduciary’s Guide to Annuities: Why Go There?

Notes
1. American Council of Life Insurers v. United States Department of Labor, “Memorandum Opinion and Order,” Civil Action No. $:24-cv-00482-O 7-26-2024. (Memorandum)
2. Chamber of Commerce of the United States of America v. United States Department of Labor, 231 F. Supp.3d 152 (N.D. Tex 2017). (District Court)
3. Memorandum, 7.
4. Memorandum, 7..
5. Memorandum, 7.
6. 29 CFR Part 2510.B.5 (Retirement Security Rule), State Legislative and Regulatory Developments
7. Retirement Security Rule, 100.
8. Retirement Security Rule, 101.
9. Retirement Security Rule, 101.
10. Memorandum, 7.
11. “Why Big Insurers Are Staying Away From This Year’s Hot Investment Product,” Wall Street Journal, D-12, December 14, 2005. (Staying Away)
12. Staying Away, D-1.
13. William Reichenstein, “Can Annuties Offer Competitive Returns?” Journal of Financial Planning, (August 2011), 36; William Reichenstein, “Financial Analysis of Equity-Indexed Annities,” Financial Services Review 18, 291-311.
14. Reichenstein, 36
15. Jeremy Babener, “Justifying the Structured Settlement Tax Subsidy: The Use of Lump Sum Settlement Monies,” NYU Journal of Law and Business Vol 6 (Fall 2009), 129. (Babener)
16. Babener. 129.
17. Memorandum, 10.
18. Memorandum, 11.
19. Memorandum, 11-12
20.. Memorandum, 11-12.
21. Memorandum, 12.