Compliance

DOL Responds to Fiduciary Rule Lawsuit

The agency defends its authority to issue a new rule and to extend provisions of the rule to IRAs.

By Rebecca Moore editors@strategic-i.com | July 19, 2016

In a reply to complaints brought against it by the National Association for Fixed Annuities (NAFA), the Department of Labor says it is entitled to summary judgment on all claims, and the court should deny NAFA’s motion for summary judgment and a preliminary injunction.

Among its many arguments, the DOL says that, in enacting the Employee Retirement Income Security Act (ERISA), Congress gave the agency broad administrative and interpretive power to “prescribe such regulations as ... necessary or appropriate to carry out the [relevant] provisions,” including to “define accounting, technical and trade terms used in” the Act.

In exercising that authority, the DOL says it promulgated a reasonable interpretation of “investment advice” in light of the text, legislative history, and purposes of ERISA. Where Congress did not specifically define “investment advice,” but entrusted DOL with broad discretion to interpret that language in light of its expertise and competing policy concerns, the DOL says its reasonable interpretation is entitled to deference. To back this up, the agency quoted the case of Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., in which the opinion says, “When Congress has entrusted the Secretary with broad discretion, we are especially reluctant to substitute our views of wise policy for his.”

The court document notes that while NAFA does not contest that the Chevron framework applies to the DOL’s conflict-of-interest rule, NAFA contends that the agency’s interpretation of “investment advice” fails at Chevron step one because “Congress intended ERISA fiduciary duties to apply only to those who participate in ongoing management of a plan or its assets.” The DOL contends NAFA’s interpretation runs afoul of the statutory text and case law regarding ERISA fiduciaries.

NEXT: Definition of fiduciary

The DOL cited the conference report accompanying ERISA, which says, “The substitute defines ‘fiduciary’ as any person who exercises any discretionary authority or control respecting management of a plan, exercises any authority or control respecting the management or disposition of its assets or has any discretionary authority or responsibility in the administration of the plan.... The term ‘fiduciary’ also includes any person who renders investment advice for a fee and includes persons to whom discretionary’ duties have been delegated by named fiduciaries.”

NAFA submits that the second prong of the fiduciary definition covers only fiduciaries “who participate in [the] ongoing management of a plan or its assets.” According to the court document, in support of its position, NAFA relies heavily on the five-part test in DOL’s previous regulation, arguing that test “precis[ely] … implement[ed] congressional intent,” by requiring, among other things, that investment advice be rendered “on a regular basis.” But, the DOL says NAFA confuses an interpretation that the statute permits with an interpretation that the statutory language requires. Nothing in the text of ERISA mandates such a requirement, and NAFA provides no evidence to necessitate reading one into it.

“NAFA’s insistence that fiduciary status is limited to persons involved in “’plan management and administration’ would essentially read the second prong out of the statute altogether and give it no significance at all, independent or otherwise,” the DOL says in its response.

NAFA defends its reading by positing that Congress adopted a definition of “investment advice” in ERISA “[s]imilar to” the definition of “investment adviser” in the Adviser’s Act, the latter of which distinguishes “between persons engaged in rendering investment advice for compensation and those persons ... merely ... selling products.” Given that Congress was aware of this distinction when it enacted ERISA in 1974, NAFA posits that Congress “incorporated those very concepts into ERISA,” such that fiduciary status would not apply to “salespersons compensated only for their sales.” But, the DOL says NAFA’s argument again misses the mark. To create the distinction that NAFA identifies, Congress in the Adviser’s Act “define[d] ‘investment adviser’ broadly and create[d] ... a precise exemption for broker-dealers.” Had Congress intended to adopt the same distinction in ERISA, presumably it would have done so expressly, as it did in the Advisers Act, by including a similar exemption. As there is no such exemption in ERISA, one can presume that Congress did not mean to limit investment advice under ERISA in the way NAFA suggests.

NEXT: The BIC exemption

The DOL points out that it was expressly given broad authority to grant “conditional or unconditional” administrative exemptions to the prohibited transaction provisions in the Code. Moreover, Congress expressly delegated to DOL the authority to grant exemptions only on its determination, in accordance with DOL’s expertise and competing policy concerns, that an exemption would be administratively feasible and in the interests of retirement investors and protective of their rights. 

“In light of the changes in the marketplace for retirement advice since ERISA was enacted in 1974, the Rule’s revisions ensure that the fiduciary definition extends to those who are now largely responsible for providing investment advice to retirement investors. Instead of relying on ERISA-covered defined benefit plans, ‘where their employer has both the incentive and fiduciary duty to facilitate sound investment choices,’ most investors are now covered by individual account-based plans for which individuals make their own choices and rely on advisers in a market where ‘both good and bad investment choices are myriad and [conflicted] advice ... is commonplace,’” the DOL says in its response. Thus, contrary to NAFA’s contention that the rule improperly expands the universe of fiduciaries, the DOL says the rule instead aligns the definition of investment advice with today’s marketplace realties and ensures, consistent with congressional intent, that fiduciary status applies to “persons whose actions affect the amount of benefits retirement plan participants will receive.” 

In the preamble to the Rule, the Department—which has the relevant authority and expertise to account for these considerations—explains in detail how the “regular basis” requirement in the 1975 regulation, in particular, no longer aligns with congressional intent in light of today’s market realities. 

As DOL explained in the preamble to the Best Interest Contract (BIC) Exemption, the impartial conduct standards constitute “baseline standards of fundamental fair dealing that must be present when fiduciaries make conflicted investment recommendations to Retirement Investors” because the standards “are necessary to ensure that Advisers’ recommendations reflect the best interest of their Retirement Investor customers, rather than the conflicting financial interests of the Advisers and their Financial Institutions.” The DOL argues that given Congress’s broad delegation of authority to DOL, as well as the requirement that any exemptions serve the interests, and protect the rights, of retirement investors, DOL’s determination to condition use of the BIC Exemption on compliance with “baseline standards of fundamental fair dealing,” id., is entirely reasonable and “entitled to great deference.”

NEXT: Extending the rule to IRAs

NAFA nonetheless argues that DOL exceeded its authority by “impos[ing] ERISA fiduciary obligations on parties to transactions involving IRAs.” The DOL says NAFA’s first contention—that “ERISA does not permit the Department to impose ERISA fiduciary obligations on any fiduciaries involved in IRA transactions,”—is a red herring. The DOL responds that in revising the definition of fiduciary investment advice and granting the BIC Exemption, it did not “impose ERISA fiduciary obligations” on fiduciaries to IRAs, as NAFA contends. As was the case prior to promulgation of the rule, those who qualify as fiduciaries with respect to employer-based plans are required under ERISA to adhere to fiduciary duties and to refrain from specified prohibited transactions, absent an applicable exemption, whereas, those who qualify as fiduciaries with respect to IRAs are not subject to fiduciary duties under ERISA but are subject only to the parallel prohibited transaction provisions in the Code.

In arguing to the contrary, NAFA emphasizes that while ERISA requires fiduciaries to adhere to fiduciary obligations, the Code contains no parallel provisions for fiduciaries to IRAs. The DOL responds that, while that may be the case, all that can be inferred is that Congress did not intend to mandate such obligations for fiduciaries to IRAs. But nothing in the Code or ERISA suggests that, in exercising its discretion to fashion appropriate exemptions, DOL could not, as it did, condition an exemption on adherence to the impartial conduct standards, including fiduciary standards of prudence and loyalty. To the contrary, when considered in context, the Code connotes just the opposite. Notably, under the prohibited transaction provisions, the default is that transactions must be free from conflicted advice, or else the transaction cannot proceed at all. In other words, the DOL says, Congress deemed such transactions so fraught with conflict and the potential for abuse that it prohibited them altogether in both ERISA and the Code.

The DOL says Congress permitted such transactions by way of exemptions only if the Secretary determined that protections could be put in place, such that, despite the conflicts, the transaction would be in the interest of, and protect the rights of, the retirement investor. By giving DOL discretion to craft exemptions as needed to protect participants and beneficiaries, Congress intended to delegate to DOL the authority to determine what obligations should apply to fiduciaries to IRAs.

The DOL’s response is here.