Compliance August 8, 2019

New York Trial Court Endorses Fiduciary Standard for Insurance Sales

New York’s expanded “best interest” standard took effect on August 1st for annuity contracts and will take effect February 1, 2020, for life insurance policies. In a new decision, the New York Supreme Court calls the expansion “a rational and reasonable movement towards consumer protection.”

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A ruling issued by the New York State Supreme Court strongly sides with the state’s Department of Financial Services’ (DFS) effort to expand the state’s fiduciary rules to cover the sale and service of annuities and life insurance products.

Notably, the Supreme Court of the State of New York is the trial-level court of general jurisdiction in the New York State Unified Court System, rather than the state’s top court. 

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The ruling addresses two distinct applications for a declaratory judgement by the state’s high court, one submitted by the Independent Insurance Agents and Brokers of New York and the other by the National Association of Insurance and Financial Advisers – New York State. The applications ask the Supreme Court to halt the expansion of the fiduciary duty in New York such that it now applies to annuity sales and will soon apply to insurance brokerage business.

The text of the decision includes a substantial recounting of arguments made both for and against the fiduciary rule expansion. However, in drawing its conclusions, the New York Supreme Court unequivocally sides with the Department of Financial Services.

Neither Arbitrary Nor Capricious

“The Court finds that the Amendment is a proper exercise of the powers granted to the DFS Superintendent, that it is not an attempt by DFS to improperly legislate, and that is nether arbitrary or capricious,” the decision states.

By way of context, back in July 2018, New York’s Department of Financial Services approved an amendment to its insurance regulations to impose a “best interest” standard on the sale of life insurance and annuity contracts. The amendment took effect on August 1, 2019, for annuity contracts and will take effect February 1, 2020, for life insurance policies.

Financial services industry analysts and attorneys have called this development a “sea change,” at least for advisers and brokers operating in New York with some interest in selling or servicing insurance products. They note how the regulation not only heightens the standard of care owed by the sellers of life insurance products, but how it also vastly expanded the breadth of the products covered from annuities to all life insurance products, including term-life insurance.

Among other arguments, challengers to the fiduciary rule expansion suggested the approach taken by DFS violated the State Administrative Procedure Act (SAPA). On this point, the Supreme Court is skeptical and sides entirely with DFS.

“The record establishes that—albeit the petitioners attempt to argue otherwise—DFS has complied with SAPA in adopting the amendment,” the decision states. “The Amendment, initially proposed in December 2017, went through two rounds of changes before it was promulgated, and in response to all the same issues raised in the petitions. DFS issued a Regulatory Impact Statement (RIS), a Regulatory Flexibility Analysis (RFA) and a statement in lieu of a Job Impact Statement (JIS), receiving 36 comments.”

No SAPA Violation

Turning to the petitioners’ argument that SAPA was violated because DFS did not provide a valid cost analysis, the Court finds that the efforts of DFS in this regard “are amply sufficient.”

“The petitioners have provided no specifics to back up their own cost estimates, and most of the petitioners’ statements regarding the cost increases on insurers and the industry are vague and inconclusive,” the decision concludes. “DFS explains that the costs associated with the implementation of the Amendment are deminimus, because it is a principles-based approach allowing producer and insurer flexibility, and that this flexibility makes it impossible to estimate the costs of compliance.”

According to the New York Supreme Court, DFS asserts, and the record supports, that the Amendment does not impose any particular system, forms, or procedures for meeting the requirements of the Amendment. It further provides that compliance procedures can be minimal, and may be as simple as briefly documenting why a recommendation is being made.

“Costs that consumers incur when they are sold products that do not fit their needs—wasted premiums, loss of needed benefits—far outweigh any costs to the insurer,” the decision states. “Revenues lost from recommending products which are not in the consumer’s best interests is not a viable insurer ‘cost’ for the purposes of a reasonable SAPA analysis.”

The Supreme Court turns next to the petitioners’ arguments that the Amendment is “arbitrary, capricious, irrational, and an abuse of discretion on the part of the respondents.”

“The Amendment, which is directed at providing guidelines for trustworthy and competent producer practices, and preventing self-dealing by producers at the consumer’s expenses, falls squarely within the provisions of Financial Services Law and the Insurance Law,” the decision concludes. “Against a backdrop of legitimate concerns for consumers, the burgeoning market of increasingly complex insurance and annuity products, and the rather remarkable lapse rate the market is experiencing, the Amendment is interstitial—consistent with underlying statutory purposes—and reflects a rational and reasonable movement towards consumer protection.”

Read the full text of the decision here.

*Editor’s note: This article was updated after publication to reflect the fact that the Supreme Court of the State of New York is in fact the trial-level court of general jurisdiction in the New York State Unified Court System, rather than the state’s top court. 

Compliance August 7, 2019

Court Denies Dismissal of Kaleida Health Excessive Fee Suit

Among other things, a federal court judge found the director of benefits at Kaleida Health and the retirement plan committee of its 403(b) and 401(k) plans were fiduciaries.

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In a case alleging fiduciaries of Kaleida Health’s 403(b) and 401(k) plans failed to take advantage of the plans’ bargaining power by only offering actively managed retail mutual funds as investment options instead of identical investor class mutual funds with lower operating expenses, a federal court judge has denied motions to dismiss.

According to the decision by U.S. District Judge Elizabeth A. Wolford of the U.S. District Court for the Western District of New York, the defendants’ first motion to dismiss is denied as moot. After the defendants filed the motion, the plaintiffs filed an amended complaint, which alleges significantly more facts than the initial complaint. Woldford cited case law in saying, “Where plaintiffs have substantially bolstered their factual allegations through amendments to the complaint, it makes little sense for the Court to assess those claims based on briefing that does not consider the additions.”

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Secondly, the defendants contend that neither Susan Vallance, the director of Employee Benefits at Kaleida, nor the plans’ retirement committee are fiduciaries with respect to the alleged conduct at issue. The plaintiffs allege that Vallance has numerous responsibilities with respect to the plans, including to “[r]esearch, design, develop, negotiate, communicate and implement new or enhanced benefit programs, including retirement and pension plans.” Wolford said someone who had the responsibility of negotiating the plans could very well have played a role in deciding which share class to invest in. Plaintiffs also allege that Vallance signed the plans’ Form 5500s from 2014 to 2017 on the line labeled “signature of plan administrator.” Wolford found that these are statements about Vallance’s job description that sufficiently allege Vallance exercises “discretionary authority or discretionary control respecting management” and/or administration of the plans.

The defendants argue that the plans do not explicitly identify Vallance as an administrator or a fiduciary for the plans. But, Wolford cited Mertens v. Hewitt Assocs., which states “ERISA, however, defines ‘fiduciary’ not in terms of formal trusteeship, but in functional terms of control and authority over the plan, thus expanding the universe of persons subject to fiduciary duties.” Wolford concluded that the amended complaint sufficiently alleges that Vallance has functional control and/or authority over the plans so as to fall within the scope of an Employee Retirement Income Security Act (ERISA) fiduciary.

Additionally, Wolford found the plaintiffs’ allegations regarding the retirement committee’s status as a fiduciary are also sufficient at this stage of the proceedings. The amended complaint alleges that the retirement committee “has discretionary authority … to fix omissions, to resolve ambiguities regarding the plans and to construe terms of the plans,” as well as “to approve or disapprove funding vehicles under the plans.”

The defendants argue the retirement committee should not be considered a fiduciary because the Charter of the Kaleida Health Retirement Plan Committee “carved out responsibility” for the plans’ funding and oversight of the plans’ investments from being delegated to the retirement committee. “Defendants’ arguments do not persuade the Court; if anything, they create an issue of material fact that would be inappropriate to resolve in a ruling on a motion to dismiss,” Wolford wrote in her decision.

In addition, Wolford noted that Section 1.03 of the Charter states; “The purpose of the [Retirement] Committee is to serve as the plan administrator of the plans and, as a named fiduciary, to exercise authority and control over the management of the plans, excluding responsibilities for funding and investment of plan assets that have been delegated to the [Investment Committee.]”

Wolford wrote, “It is not clear at this point in the litigation that a failure to properly minimize administrative fees falls exclusively within the scope of funding and oversight responsibilities of the plans that the Charter delegated to the Investment Committee, or that such a claim is not within the scope of the Retirement Committee’s other administrative and managerial responsibilities.” However, she noted that Department of Labor (DOL) regulations provide that the performance of trustees and other fiduciaries should be reviewed regularly to “ensure that their performance has been in compliance with the terms of the plan and statutory standards, and satisfies the needs of the plan.”

In other words, Wolford explained, even though the Charter does delegate the responsibilities of funding the plans and oversight of plan investments from the Retirement Committee to the Investment Committee, it does not relieve the retirement committee of its fiduciary duty to monitor the investment committee. “Therefore, the Court will not dismiss Vallance or the Retirement Committee at this stage of the litigation,” she wrote.

The defendants argue the amended complaint fails to state a breach of fiduciary duty claim because the retail funds at issue are part of a wide range of options, and the fees associated with those retail funds fall within ranges permitted by the courts. Wolford said courts in her court’s circuit have found allegations that the “defendants breached their fiduciary duties by selecting specific retail funds over lower-cost, but otherwise identical, institutional funds … are sufficient to survive the motions to dismiss.”

Wolford also noted the 2nd U.S. Circuit Court of Appeals has found that “ERISA plaintiffs generally lack the inside information necessary to make out their claims in detail unless and until discovery commences,” and accordingly an omission in the complaint of the fiduciary’s “knowledge, methods, or investigations at the relevant times … is not fatal to a claim alleging a breach of fiduciary duty.” Instead, “a claim for a breach of fiduciary duty under ERISA may survive a motion to dismiss … if the complaint alleges facts that, if proved, would show that an adequate investigation would have revealed to a reasonable fiduciary that the investment at issue was improvident.”

She denied the defendants motion to strike without prejudice.

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