James W. Watkins, III, J.D., CFP Emeritus^TM, AWMA®

Lori Chavez-DeFemer has been approved as the new Secretary of Labor. With time still remaining on the 60-day period that the Fifth Circuit granted the DOL to decide on whether the DOL would appeal the stays granted by two Texas district courts. some decisions will need to be made in order to protect the future of the Retirement Security Rule (Rule).

Fortunately, I believe Head Judge of the Northern District of Texas, Judge Barbara Lynn, and Head Judge of the Fifth Circuit, Judge Carl E. Stewart, have seemingly made the DOL’s decision a no-brainer as a result of the judges’ decisions. Both Judge Lynn and Judge Stewart have come out in support of the Rule. While it is doubtful that the Fifth Circuit will similarly rule in the DOL’s favor, that is to expected since the financial services and annuity industries always run to the Fifth Circuit for protection against proposed laws holding their industries to a higher standard of care and greater investor protection.

However, at this point, I believe that the DOL has to look at the bigger picture, the potential for having the courts, specifically SCOTUS, decide the case. The fact that two well-respected federal judge have submitted excellent, well-reasoned opinions supporting the DOL’s process in creating and submitting the Rule cannot be overlooked in projecting the potential outcome before SCOTUS.

Judge Lynn’s detailed analysis clearly indicated she knew that the Fifth Circuit would not look favorably upon her decision. As a result, she did a masterful job of addressing the possible arguments that the Fifth Circuit would raise relative to the Chevron decision. While the Fifth Circuit continues to refuse to rule on the actual merits of her decision, opting to simply issue a stay of her decision, they essentially said she exceeded her authority and that her decision was “arbitrary and capricious,” essentially with no legal basis and/or support. I have provided a link to Judge Lynn’s order at the end of this post so the reader can decide for themselves who has the better argument, Judge Lynn or the Fifth Circuit.

Some of they key points raised by Judge Lynn in her opinion include

The DOL described the complexity of FIAs (fixed indexed annuities) in its Regulatory Impact Analysis (“RIA”). The RIA explained that FIAs generally provide “crediting for interest based on changes in a market index,” but noted there are hundreds of indexed annuity products, thousands of index annuity strategies, and that “the selection of the crediting index or indices is an important and often complex decision.” Further, there are several methods for determining changes in the index, with different methods resulting in varying rates of return. Rates of return are also affected by “participation rates, cap rates, and the rules regarding interest compounding.” Because “insurers generally reserve rights to change participation rates, interest caps, and fees,” FIAs can “effectively transfer investment risks from insurers to investors.” The DOL found that FIAs may offer guaranteed living benefits, but such benefits “may come at an extra cost and, because of their variability and complexity, may not be fully understood by the consumer.” The DOL also cited the SEC, which recently stated, “[y]ou can lose money buying an indexed annuity … even with a specified minimum value from the insurance company, it can take several years for an investment in an indexed annuity to break even.¹ (emphasis added)

The DOL found the annuity market to be influenced by contingent commissions, which “align the insurance agent or broker’s incentive with the insurance company, not the consumer,” that existing protections do not “limit or mitigate potentially harmful adviser conflicts,” and that “notwithstanding existing [regulatory] protections, there is convincing evidence that advice conflicts are inflicting losses on IRA investors.” The DOL found the conflicts would cost investors “at least tens and probably hundreds of billions of dollars over the next 10 years … despite existing consumer protections,” and that “the material market changes in the marketplace since 1975 have rendered [prior regulation] obsolete and ineffective.”²

The extensive changes in the retirement plan landscape and the associated investment market in recent decades undermine the continued adequacy of the original approach in PTE 84–24. In the years since the exemption was originally granted in 1977, the growth of 401(k) plans and IRAs has increasingly placed responsibility for critical investment decisions on individual investors rather than professional plan asset managers. Moreover, at the same time as individual investors have increasingly become responsible for managing their own investments, the complexity of investment products and range of conflicted compensation structures have likewise increased. As a result, it is appropriate to revisit and revise the exemption to better reflect the realities of the current marketplace.³

Judeg Stewart left no doubt as to his opinion on both the propriety of the DOL’s proposal of the Rule and Judge Lynn decision. Judge Stewart apparently felt so strongly that he felt the need to call out his brethren for what he termed their “strained” decision..

Over the last forty years, the retirement-investment market has experienced a dramatic shift toward individually controlled retirement plans and accounts. Whereas retirement assets were previously held primarily in pension plans controlled by large employers and professional money managers, today, individual retirement accounts (“IRAs”) and participant-directed plans, such as 401(k)s, have supplemented pensions as the retirement vehicles of choice, resulting in individual investors having greater responsibility for their own retirement savings. This sea change within the retirement-investment market also created monetary incentives for investment advisers to offer conflicted advice, a potentiality the controlling regulatory framework was not enacted to address. In response to these changes, and pursuant to its statutory mandate to establish nationwide “standards . . . assuring the equitable character” and “financial soundness” of retirement-benefit plans, 29 U.S.C. § 1001, the Department of Labor (“DOL”) recalibrated and replaced its previous regulatory framework. To better regulate conflicted transactions as concerns IRAs and participant-directed retirement plans, the DOL promulgated a broader, more inclusive regulatory definition of investment-advice fiduciary under the Employee Retirement Income Security Act of 1974 (“ERISA”) and the Internal Revenue Code (“the Code”). Despite the relevant context of time and evolving marketplace events, Appellants and the panel majority skew valid agency action that demonstrates an expansive-but-permissible shift in DOL policy as falling outside the statutory bounds of regulatory authority set by Congress in ERISA and the Code. Notwithstanding their qualms with these regulatory changes and the effect the DOL’s exercise of its regulatory authority might have on certain sectors of the financial services industry, the DOL’s exercise was nonetheless lawful and consistent with the Congressional directive to “prescribe such regulations as [the DOL] finds necessary or appropriate to carry out [ERISA’s provisions].”⁴

In the decades following the passage of ERISA, the use of participant directed IRA plans has mushroomed as a vehicle for retirement savings. Additionally, as members of the baby-boom generation retire, their ERISA plan accounts will roll over into IRAs. Yet individual investors, according to DOL, lack the sophistication and understanding of the financial marketplace possessed by investment professionals who manage ERISA employersponsored plans. Further, individuals may be persuaded to engage in transactions not in their best interests because advisers like brokers and dealers and insurance professionals, who sell products to them, have “conflicts of interest.” DOL concluded that the regulation of those providing investment options and services to IRA holders is insufficient.⁵

The panel’s majority conclusion that the DOL exceeded its regulatory authority by implementing the regulatory package that included a new definition of investment-advice fiduciary and both modified and created new exemptions to prohibited transactions is based on an erroneous interpretation of the grant of authority given by Congress under ERISA and the Code.⁶

Despite the relevant context of time and evolving marketplace events, Appellants and the panel majority skew valid agency action that demonstrates an expansive-but-permissible shift in DOL policy as falling outside the statutory bounds of regulatory authority set by Congress in ERISA and the Code. Notwithstanding their qualms with these regulatory changes and the effect the DOL’s exercise of its regulatory authority might have on certain sectors of the financial services industry, the DOL’s exercise was nonetheless lawful and consistent with the Congressional directive to ‘prescribe suchregulations as [the DOL] finds necessary or appropriate to carry out [ERISA’sprovisions.⁷

For 41 years, the DOL employed a five-part test to determine whether a person is an investment-advice fiduciary under ERISA and the Code, and that test limited the reach of the statutes’ prohibited transaction rules to those who rendered advice “on a regular basis,” and to instances where such advice “serve[d] as a primary basis for investment decisions with respect to plan assets.” See 29 C.F.R. § 2510.3–21(c)(1) (2015). This regulation “was adopted prior to the existence of participant-directed 401(k) plans, the widespread use of IRAs, and the now commonplace rollover of plan assets” from Title I plans to IRAs, thus leaving out of ERISA’s regulatory reach many investment professionals, consultants, and advisers who play a critical role in guiding plans and IRA investments. Fiduciary Rule, 81 Fed. Reg. 20,946.⁸

In 1975, DOL promulgated a five-part conjunctive test for determining
who is a fiduciary under the investment-advice subsection. Under that test, an investment-advice fiduciary is a person who (1) “renders advice…or makes recommendation[s] as to the advisability of investing in, purchasing, or selling securities or other property;” (2) “on a regular basis;” (3) “pursuant to a mutual agreement…between such person and the plan;” and the advice (4) “serve[s] as a primary basis for investment decisions with respect to plan assets;” and (5) is “individualized . . . based on the particular needs of the plan.”⁹

The rule challenged on appeal addresses these and other changes in the retirement investment advice market by, inter alia, abandoning the five-part test in favor of a definition of fiduciary that includes “recommendation[s] as to the advisability of acquiring . . . investment property that is rendered pursuant to [an] . . . understanding that the advice is based on the particular investment needs of the advice recipient.¹⁰

The DOL’s interpretation of “renders investment advice” is reasonably
and thoroughly explained. The new interpretation fits comfortably with thepurpose of ERISA, which was enacted with “broadly protective purposes” and which “commodiously imposed fiduciary standards on persons whose actionsaffect the amount of benefits retirement plan participants will receive”. In light of changes in the retirementinvestment advice market since 1975, mentioned above, the DOL reasonably concluded that limiting fiduciary status to those who render investment advice to a plan or IRA “on a regular basis” risked leaving retirement investors inadequately protected. This is especially so given that “one-time transactions like rollovers will involve trillions of dollars over the next five years and can be among the most significant financial decisions investors will ever make.”¹¹

Notwithstanding the DOL’s reasoned explanation for the new regulations, the panel majority maintains that the DOL acted unreasonably and arbitrarily when it promulgated the new fiduciary rule and, in a strained attempt to justify this conclusion, the panel majority disregards the requirement of showing judicial deference under Chevron by highlighting purported issues with other provisions of the regulation. Each of the panel majority’s positions fails.¹²(emphasis added)

In light of changes in the retirement investment advice market since 1975,…, the DOL reasonably concluded that limiting fiduciary status to those who render investment advice to a plan or an IRA “on a regualr basis” risked leaving retirement investors inadequately protected. This is especailly so given that “one-time transactions like rollovers will involve trillions of dollars over the next five years and can be among the most significant financial decisions investors will ever make.¹³

The panel majority’s conclusion that the DOL exceeded its regulatory authority by implementing the regulatory package that included a new definition of investment-advice fiduciary and both modified and created new exemptions to prohibited transactions is premised on an erroneous interpretation of the grant of authority given by Congress under ERISA and the Code. I would hold that the DOL acted well within its regulatory authority—as outlined by ERISA and the Code—in expanding the regulatory definition of investment-advice fiduciary to the limits contemplated by the statute, and would uphold the DOL’s implementation of the new rules.¹⁴

Congress was concerned to protect all retail inbvestment clients, and there is no evidence that Congress expected DOL to more restrictively regulate a trillion dollar portion of the market when it delegated the general question to the SEC (for broker-dealers and registered investment advisers) and conditionallly deferred to state insurance practices.¹⁵

Armed with these two excellent opinions from two highly respected federal judges, one could argue that a decision by the DOL not to pursue the appeals, as well as pursue this case all the way to SCOTUS, if necessary, would constitute a betrayal of both American workers and the spirit of ERISA.

Non-attorneys might consider that an extreme statement. But I believe that trial attorneys would back me up, given the strength of having two well-respected federal judges unconditionally supporting the propriety of and need for the DOL’s proposed Retirement Security Rule.

The DOL Knew that the Rule would face serious obstacles, including the fact that the financial services and annuity industries would run to seek the Fifth Circuit’s protection. But when Judge Lynn issued a spot on and masterful opinion upholding the Rule, the Fifth Circuit’s “strained ” opinion attempting to “dismiss” Judge Lynn by calling her opinion “arbitrary and capricious”, Judge Stewart seemingly felt compelled to call his brethern on Fifth Circuit out and set the record straight.

Both Judge Lynn and Judge Stewart displayed an incredible amount of courage for stepping forward and issuing opinions that they no doubt knew would draw criticism from the financial services and annuity industries. They should be commended for doing the right thing and trying to protect American workers and preserving the spirit of ERISA.

Whenever I see someone display such courage and conviction, I am reminded of three quotes that I pften used in my closing argument to challenge jurors:

Facts are stubborn things; and whatever may be our inclinations , or the distates of our passions, they cannot alter the state of facts and evidence. – John Adams

The truth is we always know the right thing to do. The hard part is doing it. – General Norman Schwartzkopf

Knowing the right thing to do, and not doing it, is the worst kind of cowardice. – Confucius

Hopefully, the DOL will decide to take advantage of the situation it has been dealt with Judge Lynn and Judge Stewart’s support. While I believe it may require the help of SCOTUS to resolve this case, I like the DOL’s chances before SCOTUS.

One final thought. ERISA attorney Bonnie Treichel, arguably offered the best observation on this whole case: “Arguably the most impacted perties then are the investors these individuals serve that aren’t provided service as an ERISA fiduciary¹⁶

For fellow legal nerds, Judge Lynn’s opinion and Judge Stewart’s dissenting opinion can be found at the following links:

Judge Lynn: Chamber of Commerce of the United States, et. al. v Hugler, 231 F. Supp. 3d 152 (N.D. Tex. 2017) (Lynn decision)

Judge Stewart: Chamber of Commerce of the United States of America v. United States Department of Labor, 885 F.3d 360 (5th Circuit 2018) (Stewart’s dissent is at end of decision)

Notes
1. Chamber of Commerce of the United States, et. al. v Hugler, 231 F. Supp. 3d 152 (N.D. Tex. 2017) (Lynn decision), 187
2. Lynn decision, 189-190;
3. Lynn decision, 190.
4.. American Council of Life Insurers, et. al. v Department of Labor, et. al. , In the United States Court of Appeals For The Fifth Circuit, Case No. 17-10238 (3/15/2018), (5th Circuit decision), 388.
5. 5th Circuit, 365.
6. 5th Circuit decision, 398.
7. 5th Circuit decision, 388.
8.5th Circuit decision, 389.
9. 5th Circuit decision, 364-365; 29 C.F.R.§ 2510.3-21(c)(1) (2015).
10. 5th Circuit decision, 389.
11. 5th Circuit decision, 394-395; 29 CFR Section 2510.3-21(c)(1) (2015).
12. 5th Circuit decision, 397-398.
13. 5th Circuit, 394-395.
14. 5th Circuit, 397-398.
15. 5th Circuit, 386.
16. https://401kspecialistmag.com/erisa-attorneys-outline-next-steps-actions-item-after-dol-fiduciary-rule-stay