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RULE PROTECTING RETIREMENT INVESTMENTS SURVIVES COURT CHALLENGES

Wednesday, February 15th, 2017 | Mary Gallagher
retirement

Just days after Donald Trump took steps to derail a rule meant to protect retirement investments, a federal court decision has bolstered hopes for its survival.

The regulation, known as the fiduciary rule, was adopted by the Department of Labor (DOL) last April and took effect in June 2016. Compliance was to start on April 10 of this year, with some aspects of the rule not set to kick in until 2018.

The rule requires financial advisers to act in the best interest of the clients who pay them for their professional advice and prohibits them from recommending or selling inferior or more costly investments that will garner them higher commissions.

If you are like me, you were probably surprised to learn that financial advisers were allowed to put their own interests above those of their clients so long as they did not recommend “unsuitable” investments or strategies.  So long as it was suitable, it was okay, even if there was an alternative that was cheaper or a better fit for the client.  The client did not even have to be informed of the better option.

As an attorney—albeit a retired one—I am very uncomfortable with the idea of such a conflict of interest, one that would not be allowed in the legal profession, where .lawyers have a clearly recognized fiduciary duty to their clients. There seems no good reason to apply a lower standard where people are trying to arrange a secure financial future for their old age, a situation in which there is at least as much at stake as in many types of legal services.

Previously, the fiduciary standard was triggered only when retirement investment advice was provided to a consumer on a regular basis and it prohibited advisers from receiving commissions from insurance companies that sold annuities to their clients. They could, however, qualify for an exemption from that prohibition if the sale was as favorable to the consumer as an arm’s-length transaction and the adviser received no more than “reasonable” compensation.

The new rule, however, applies to even one-time advice.

As the DOL explained, the way people plan for retirement has changed since the creation of the fiduciary standard decades ago, when pensions dominated. Today, people have self-directed 401k plans and IRA accounts. Most significantly, it has become common to roll over retirement assets from fiduciary-protected plans into IRAs, a one-time event that did not qualify for fiduciary protection under the old rule even though, as the DOL put it, rollover investments are often “the most important financial decisions that many consumers make in their lifetime.”

Retirement rollovers are expected to affect more than $2 trillion in assets over the next 5 years.

The new rule also replaces the old exemption with a more stringent one, known as BICE—the best interest contract exemption—which allows investment advice fiduciaries, including broker-dealers and insurance agents, to receive commissions and other compensation from third parties that would otherwise be prohibited.

BICE requires a written contract with the retirement investor, agreeing to comply with standards of impartial conduct, act in the customer’s “best interest,” receive no more than “reasonable compensation,” and disclose basic information about conflicts of interest and the cost of advice

Even before Trump’s action, the fate of the fiduciary rule was in doubt, with his chief economic adviser, former Goldman Sachs executive Gary Cohn, saying he wanted to get rid of it.

Then, in a Feb. 3 memo, Trump directed the DOL to review the fiduciary rule because it “may significantly alter the manner in which Americans can receive financial advice, and may not be consistent with the policies of my Administration.” Specifically, he directed it to look at whether the rule could hurt those trying to plan for their retirement by reducing the scope of information or options available to them, by disrupting the industry or spurring an increase in litigation that would drive up the price of retirement services.

If any of those or other problems are found, the DOL is supposed to scrap or at least revise the rule.

The memo did not specifically ask for a delay in implementation but on Feb. 9, the DOL filed a notice to do so with the Office of Management and Budget (OMB).

Just one day earlier, however, the U.S. District Court for the Northern District of Texas rejected a challenge to the rule brought by a group of plaintiffs including the U.S. Chamber of Commerce, the Indexed Annuity Leadership Council, the American Council of Life Insurers and other entities acting on behalf of the financial industry.

Their chosen venue, in Dallas, is part of the Fifth Circuit, which is viewed as less friendly to Obama administration rulemaking. For instance, last November, a judge in that district issued a nationwide injunction blocking a DOL rule expanding eligibility for overtime pay. A year before that, a Fifth Circuit panel blocked a series Obama executive orders on immigration.

Three separate suits challenging the fiduciary rule that were filed there were consolidated and decided by Chief Judge Barbara Lynn in her Feb. 8 opinion. Lynn was appointed to the bench in 1999 by President Bill Clinton  and is the first female judge to lead the district.

Lynn too denied a preliminary injunction and summary judgment for the plaintiffs, while granting the DOL’s cross motion for summary judgment.

Her 81-page opinion addresses questions raised in the Trump memo, which will make it harder for the DOL to base rescission or weakening of the rule on findings that contravene hers.

She held, among other things, that the DOL did not overstep its authority in adopting the rule nor did it violate federal rulemaking procedures by failing to conduct an adequate cost-benefit analysis to help justify the regulation.

“The court finds the DOL adequately weighed the monetary and non-monetary costs on the industry of complying with the rules, against the benefits to consumers,” wrote Lynn.

The DOL decided, based on the relevant evidence, that fewer conflicts of interest, more transparency, and a more efficient market would “increase the availability of quality, affordable advisory services for small plans and IRA investors,” and that it would not have “unintended negative effects on the availability or affordability of advice,” wrote Lynn. The agency relied in part on data from the United Kingdom, whose more aggressive regulatory approach of banning outright all commissions on retail investment products did not cause advisers to leave the market or negatively impact access to investment advice. Thus, it was reasonable for the DOL to conclude that the less burdensome fiduciary rule would not have that effect.

Lynn also found that the duties of loyalty and prudence imposed by the rule are reasonable given the DOL’s findings on the harm to retirement investors from receiving conflicted advice and its estimate that the new standards could save those investors up to $36 billion over the next ten years, and $76 billion over the next twenty years. That compares with the estimated $10 billion to $31.5 billion cost of compliance over the next ten years.

She rejected the contention that the rule will expose advisers to excessive litigation and liability. To the contrary, the DOL considered those issues and determined that potential litigation would incentive compliance. On top of that, BICE allows mandatory arbitration of individual claims, as well as waivers of the right to seek punitive damages or to rescind for violation of the contract. BICE, however, does not allow waiver or limitation of the investor’s right to take part in a class action.

The Chamber of Commerce and other plaintiffs in the Texas suit released a statement reacting to Lynn’s decision, saying they ccontinue to believe that the DOL exceeded its authority, and they will pursue all of their available options to see that the rule is rescinded. The statement referred to Trump’s Feb. 3 memo as a “welcome development” that reflected“well-founded, ongoing and significant concerns about the rule.”

Better Markets, a group that advocates for Wall Street reform, on the other hand, hailed Lynn’s decision as “a huge win for the American people,” and the best interest fiduciary rule as “a carefully considered and well-crafted rule that helps and protects Americans saving for a safe and secure retirement.”

Lynn is the third federal district judge to turn aside a challenge to the rule.

Judges Randolph Moss of the District of Columbia and Daniel Crabtree in Kansas denied preliminary injunctions that would have blocked the rule in The National Association for Fixed Annuities v. Perez, on Nov. 4, and Market Synergy Group v. U.S. Dept. of Labor, on Nov. 28, respectively.

The plaintiffs in the D.C. case have appealed. Their emergency motion for an injunction pending appeal was denied on Dec. 15.

Another lawsuit challenging the rule, Thrivent Financial for Lutherans v. Perez, was filed in September in federal district court in Minnesota. ‘It targets the requirement that best interest contracts include a provision permitting judicial class actions on the ground that this would interfere with Thrivent’s one-on-one alternative dispute resolution program, described as a “core component” of the governance and member-relations model of the tax-exempt membership-owned and member-governed fraternal benefit society.

UPDATE: Since this article was posted, District Judge Crabtree in the Kansas case followed the lead of Judge Lynn on Feb. 17, granting summary judgment for the Department of Labor and denying a cross motion by  plaintiff Market Synergy Group, which sought to block the rule.

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