By Pamela Wolf, J.D.
Secretary of Labor Thomas Perez and the Department of Labor are going to have to defend the controversial final rule defining “fiduciary” for ERISA purposes against a lawsuit filed on June 1 by the U.S. Chamber of Commerce and other industry associations that challenges the rule under the First Amendment and the Administrative Procedure Act. Finalized in April, the rule has sparked sharp controversy.
The “fiduciary” catch.
Substantial controversy arose over, among other things, the “best interest contract exemption” in the final rule
, which would let fiduciary advisers and their firms collect fees not typically permitted to them under existing laws—but only if they acknowledged their fiduciary status. The plaintiffs contend that the rule “makes it impossible to sell most individual retirement investment products without being deemed a fiduciary” and “bars non-fiduciaries from engaging in a range of ordinary and customary communications with clients, including communications that explain their products and services.”
Stepping into SEC territory?
points out that the Securities and Exchange Commission has 80-plus years of experience regulating financial markets and services, including the provision of investment advice. Moreover Congress has charged the SEC with studying the propriety of adopting a uniform fiduciary standard. In contrast, the DOL’s authority is narrower and generally restricted to employee benefit plans. “It possesses neither the expertise nor the authority to regulate financial services in a manner that properly balances the needs of retirement savers and small businesses,” the plaintiffs contend.
Since it lacks the affirmative
authority to regulate financial services outside the context of employee benefit plans, the Labor Department tried to promulgate “this new regulatory regime” through its exemptive
authority under ERISA, according to the complaint. Specifically, the DOL tries “to convert its authority to lift
regulatory burdens into a means to impose
them, resulting in the most sweeping change in retirement planning since the adoption of ERISA itself,” the plaintiffs allege. The DOL, in doing so, “has disregarded the regulatory framework established by Congress, exceeded its authority, and assumed for itself regulatory power that is vested in the SEC in ways that will harm retirement savers,” the plaintiffs contend.
Labor Department’s two-step move.
The complaint asserts that the Labor Department has pursued an improper expansion of its authority in two steps. The first move was to redefine “fiduciary” to expand the term’s coverage “in a manner that is inconsistent with the statutory text and the ordinary and historical understanding of what constitutes a fiduciary relationship.” Along the way, the DOL has banned common, long-accepted types of compensation for financial services and insurance professionals—commissions and sales loads (a mutual fund sales charge), for example. This “broad redefinition” nets this effect because fiduciaries under ERISA and the Internal Revenue Code are prohibited from receiving compensation that varies based on the investment “advice” provided or the transaction engaged in, according to the complaint. The DOL knows full well that these methods of compensation are necessary for firms and professionals to continue to offer many of the services and products they provide, the plaintiffs allege.
In its second move, the DOL offered an exemption from “this far-reaching prohibition,” the Best Interest Contract Exemption (BIC exemption). The catch, though, is that the exemption is “conditioned on financial services firms and insurance institutions agreeing to subject themselves to fiduciary standards of conduct in contracts that they must enter into with their customers, as well as a range of other restrictions and requirements,” the complaint observes.
What activities fall under the definition that historically did not?
The new definition of “fiduciary” standing alone, the complaint alleges, would preclude a range of activities that “have long been routine in the financial services sector and were not considered fiduciary activity” historically, including the following:
- General sales activity, such as a sales presentation in which the financial professional identifies investment options that she can provide;
- Client referrals or solicitations to other investment professionals;
- Communications in which a financial professional makes comparisons between products offered by the professional’s firm;
- A one-time discussion between an individual and a financial professional regarding whether to “rollover” that individual’s assets from an employer plan to an IRA; and
- Responding to a request for proposal for retirement plan services by providing a sample 401(k) investment option menu, unless the sample menu is based only on the existing menu or on the plan’s size, and the response includes, among other things, a written notification to the plan fiduciary that the responder is not providing fiduciary advice.
The eight-count complaint contends that the Labor Department’s fiduciary rule, the BIC exemption, and the other related prohibited transactions in the rule are arbitrary, capricious, and violate the APA and First Amendment, and should be vacated. The DOL should also be enjoined from implementing or enforcing them.
“Our organizations have a long, well-documented record of support for the creation of a uniform best interest—or fiduciary—standard of customer care for financial professionals providing personalized investment advice to retail investors,” the plaintiffs’ CEOs said in a joint statement
. “The Department of Labor’s new, 1,023-page rule, however, creates sweeping changes to existing regulations that will make saving for retirement more difficult for the very same hardworking American families and individuals it claims to protect. It specifically hinders many of our member firms’ ability to continue providing the level of holistic financial advice and suitable investment options their clients are accustomed to.”
Labor Secretary reacts.
The Secretary of Labor quickly issued a statement
in response to the lawsuit. “People saving for retirement have a legal right and a compelling economic need to receive retirement investment advice that is in their best interest. Today, a handful of industry groups and lobbyists are suing for the right to put their own financial self-interests ahead of the best interests of their customers,” he said.
“Conflicted advice is eroding the savings of working Americans to the tune of $17 billion each year,” he continued. “The Conflict of Interest rule aims to address that problem by requiring retirement advisors to look out for the best interests of their clients. Many financial services professionals, from small town advisers to some of the nation’s largest firms, engaged constructively with the department throughout the rulemaking process and, after publication of the final rule, noted that they do put the interests of their clients first and are well positioned to comply. They recognize that putting their customers first is good for business.”
Perez called the rulemaking “one of the most deliberate, open regulatory processes in recent memory.” He said the rule “is built upon solid statutory and legal foundations” and vowed to defend it vigorously.
Companies: U.S. Chamber of Commerce; Financial Services Institute; Financial Services Roundtable; Greater Irving-Las Colinas Chamber of Commerce; Insured Retirement Institute; Lake Houston Area Chamber of Commerce; Lubbock Chamber of Commerce; Securities Industry; Financial Markets Association; Texas Association of Business.