Cohen & Buckmann, P.C.
Cohen & Buckmann, P.C.



Fiduciary Rule Survives First Court Challenge - Will Other Courts Follow?

Fiduciary Rule Survives First Court Challenge - Will Other Courts Follow?

by Carol Buckmann

A district court in Washington D.C. has just handed the Department of Labor a significant victory in its efforts to derail legal challenges to the fiduciary rule.  The decision itself is 92 well-reasoned pages, and contains a clear refutation of the arguments put forth by NAFA,  a group of whose members sell fixed annuities, challenging the rule.  The court not only refused to enjoin the regulations on an interim basis, but made a final ruling on summary judgement.

The Big Picture.

Prior to the effective date of the fiduciary rule,  a broad class exemption generally permits the receipt of commissions in connection with annuity sales, and due to the rule that recommendations do not result in fiduciary status unless advice is given on a “regular basis”, a one-time sale would not currently trigger fiduciary responsibilities.  In addition to objecting to the new fiduciary definition, plaintiffs specifically objected to the new structure that will impose  Impartial Conduct Standards (including prudence, loyalty and avoidance of misleading statements) in order to receive commissions on annuity sales under the  Best Interest Contract (BIC) Exemption.

Courts are usually reluctant to substitute their judgment for that of the agency with authority to interpret a statute, and this decision is no exception.  The court rejected arguments that the Department of Labor exceeded its authority in issuing the fiduciary rule and was not sympathetic to claims that sellers of annuities would not be able to operate under the new rules, even noting that a commission-based compensation system was not the only option.

What Was Decided. 

The decisions made by the court can be boiled down to the following:

1. The Department of Labor has statutory authority to interpret Title 1 of ERISA and to determine the conditions of any prohibited transaction exemptions it issues, and did not exceed that authority in issuing the fiduciary rule or imposing Impartial Conduct Standards on certain annuity sales under the Best Interest Contract (BIC) Exemption. 

In response to arguments that the fiduciary rule was an improper interpretation of the statute, the court stated that: “Nothing in the statutory text forecloses the Department’s current interpretation.”  Judge Moss went on to explain why the prior regulation (the “five part test”) was not the only permissible interpretation of the law:

“… there is a vast difference between accepting an existing interpretation of a statute and treating that interpretation as the only permissible one. NAFA’s efforts to support the latter approach prove too much: If taken to its logical extreme, it would suggest that every pre-1986 Treasury Department regulation interpreting the Internal Revenue Code was forever frozen in place when Congress reenacted the Code in 1986. That is not the law.”

2. The Department of Labor did not exceed its authority in regulating IRAs under the fiduciary rule.  Even though IRAs are not subject to Title I of ERISA, the Department of Labor may impose requirements of Title I of ERISA, such as the duties of prudence and loyalty, on those using exemptions for transactions involving IRAs.

3.  The Department of Labor’s requirement under the BIC Exemption that compensation be “reasonable” was not unconstitutionally vague because it is a commonly understood term. The court pointed out that other prohibited transaction exemptions and many IRS rules also use the term “reasonable compensation.”

4.  The Department of Labor was within its authority and not acting in an “arbitrary and capricious” manner in requiring that the BIC Exemption be used for fixed index annuity sales.

5.  The Department of Labor was not impermissibly creating a private right of action when it established requirements for the written contracts to be used for sales to IRAs under the BIC Exemption.  State laws, rather than ERISA, would govern the contract’s enforceability.

6.  The Department of Labor didn’t fail to do a sufficient regulatory analysis of the impact of the fiduciary rule on small business.

Where Do We Go From Here? 

There are other challenges to the fiduciary rule waiting for decision in other courts, and judges in other jurisdictions may come out differently. This decision is expected to be appealed, so it is certainly not the last word on whether all or parts of the fiduciary rule are valid. However, the reasoning in this decision may provide a blueprint for the other courts issuing their decisions.

Since these cases were filed, some financial firms such as Merrill Lynch and Morgan Stanley have  announced how they plan to comply with the new rules, which undercuts the arguments put forward by plaintiffs in these cases that they will be unable to operate under the fiduciary rule.  And at least this one court appears to be saying that the fact that you don’t want things to change from the way you have always done them is not grounds for invalidating a regulation.

Of course, the election may well make all of this legal maneuvering moot, given Republican opposition to the rule.   However, even if the fiduciary rule is withdrawn or overturned by Congress,  it may not be possible to turn back the clock to a time when plans were unaware that many of the people who give them advice and sell them products were not doing so as fiduciaries.  There may be long-term changes in their hiring and supervisory practices.