Annuities Industry Fiduciary Challenge Dwelt Blow In Federal Court

A U.S. District Court has handed down a DOL-friendly ruling in one piece of anti-fiduciary rule litigation that is seeking more leniency for fixed-index annuity providers. 

A U.S. District Court judge has denied a motion for preliminary injunction filed by annuity firm Market Synergy in a case focused on whether fixed-index annuity providers will be able to use the so-called “84-24 prohibited transaction exemption [PTE],” rather than the “best-interest contract exemption [BIC],” when bringing sales and compliance procedures into alignment with the new Department of Labor (DOL) fiduciary rule.

Several attorneys had suggested to PLANADVISER that the litigation filed by Market Synergy would likely be among the first of a sizable handful of anti-fiduciary rule lawsuits to receive a ruling—given its narrow focus on fixed-index annuity sales conditions and the request for preliminary injunction made by the plaintiff. Turns out they were correct.

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In short, plaintiffs in the case feel they will never be able to make the BIC workable given the commission-heavy distribution arrangements traditionally used for fixed-index annuities, and so they want the DOL to be forced to allow annuity providers to work under the 84-24 exemption, as had been initially proposed by DOL but subsequently dialed back in the final version of the rulemaking. While their case can still proceed without receiving an order for preliminary injunction, it is clear that the court believes the plaintiff is not likely to succeed on the merits of their claim. Thus the “extraordinary relief of preliminary injunction” was not granted, and the future of the case remains uncertain. 

Specifically, the plaintiffs had sought a court-ordered injunction on the implementation of the portions of the DOL rulemaking that may directly impact the sale and service of fixed-annuities—especially PTE 84-24 and the BIC. Plaintiffs suggest business revenues could fall by almost 80% under the amended version of PTE 84-24 because the rule change prohibits plaintiff and others affiliated with it from receiving third-party compensation for fixed-index annuity (FIA) sales. The plaintiff also anticipates that the independent market organizations (IMOs) and insurance agents that it works with to distribute FIAs will experience significant revenue losses. And, the plaintiff forecasts that more than 20,000 independent insurance agents could exit the marketplace if the rule change takes effect.

NEXT: On the court’s decisionmaking 

According to the text of the ruling, PTE 84-24 simply provides regulatory relief to insurance agents and others who, according to the DOL’s new regulatory definition, are “fiduciaries” and who receive compensation from third parties in connection with transactions involving an Employee Retirement Income Security Act (ERISA) plan or individual retirement account (IRA).

“Unless an exemption like PTE 84-24 applies, ERISA and the IRS Code prohibit fiduciaries from receiving third-party compensation,” the ruling states. “With the new rule, the DOL revoked PTE 84-24’s exemption of annuity contracts that do not satisfy the DOL’s newly created definition of a ‘Fixed Rate Annuity Contract.’ In doing so, the DOL specifically excluded fixed-index annuities from the PTE 84-24 exemption.”

Plaintiffs suggest these actions stand in violation of the Administrative Procedure Act and Regulatory Flexibility Act, among other issues, but the DOL argues that the rule changes are natural to its function and necessary to protect consumers. The DOL asserts that FIAs are “complex transactions that involve significant conflicts of interest at the point of sale.” Because of these characteristics, the DOL contends that FIA sales require more stringent rules governing the payment of third-party compensation, and thus should not enjoy exemption under PTE 84-24.

To reach the decision announced this week, the court suggests it “needed not decide whether the DOL’s amendment to PTE 84-24 is appropriate given the DOL’s consumer protection concerns. It also need not question whether the DOL’s amendment is improper because it imposes significant challenges to plaintiff’s business model … Instead, because the lawsuit challenges the DOL’s action under the Administrative Procedure Act and (APA) Regulatory Flexibility Act (RFA) of 1980, the court must determine whether plaintiff is likely to succeed on the merits of its claim that the DOL failed to follow the appropriate procedures in exacting the rule changes.”

To make the case, Market Synergy asserts that the DOL violated the APA and RFA in four ways: (1) the DOL failed to provide notice that it would remove FIAs from the scope of the exemption in PTE 84-24; (2) the DOL arbitrarily treated FIAs differently from all other fixed annuities; (3) the DOL failed to consider the detrimental effects of its actions on independent insurance agent distribution channels; and (4) the DOL exceeded its statutory authority by seeking to manipulate the financial product market instead of regulating fiduciary conduct.

The text of the decision shows none of these arguments was particularly persuasive to the court—at least not persuasive enough to warrant preliminary injunction. Additional details on the decision are presented in the text of the decision

Finding Investment Managers With the Best Culture for Performance

New research suggests that an investment manager organization with a culture of purpose and passion has better long-term outcomes than those that don't.

New research by the Center for Applied Research, the independent think-tank of State Street, and CFA Institute, argues that to succeed, the investment industry and its professionals need to move from a performance-driven culture to one that is purpose-driven to better ensure clients’ long-term goals are met.

The research, titled “Discovering Phi: Motivation as the Hidden Variable of Performance,” has identified “phi”, a factor that has a positive impact on organizational performance, client satisfaction, and employee engagement. Phi is the alignment of purpose, habit and incentives at the intersection of the goals and values of the individual, the organization, and the client. The research asked three questions based on motivation theory (self-determination theory) to diagnose phi: What motivates you to perform generally and in your current role? What is the reason that you are still working in the investment management industry? Would you describe your work as a job, a career, or a calling?

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The research found that phi has a statistically significant and positive link to broad performance measures, including client satisfaction and employee engagement, that can sustain the industry and drive client satisfaction for decades to come. A one point increase in phi is associated with 28% greater odds of excellent organizational performance, 55% greater odds of excellent client satisfaction and 57% greater odds of excellent employee engagement.

Rebecca Fender, CFA, head of CFA Institute’s Future of Finance initiative, who is based in Charlottesville, Virginia, and is a co-contributor to the report, tells PLANSPONSOR, the analysis did not get into the specifics of how phi in an organization affects performance of investments offered to clients because of how complicated that would be. “But, long-term organizational performance [of investment managers] client satisfaction and employee engagement are important,” she says. “The latter item is important because of turnover of investment management employees who make important judgements. It is important to have consistency, and CFA interviews with investors found consistency in investment management organizations is important to them.”

NEXT: Recognizing ‘phi’ in investment managers

The research report says the findings clearly point to the existence of phi as a previously uncovered variable that, in addition to motivation, might have an outsized impact on investment performance, as in quantum mechanics, where a “hidden variable” is an element missing from a model that leaves the system incomplete. The research argues that the same is true for the investment management industry: without the alignment of purpose and passion, the industry model is flawed.

So, how can plan sponsors and advisers determine if an investment manager organization has this culture of purpose and passion?

Fender notes that plan sponsors have a long-term time horizon for investing, but for many investment managers, professionals’ incentives are the opposite. She says the research found 39% of investment professionals would be in favor of extending their bonus cycle to two to five years instead off one year, which, Fender adds, would be helpful for the entire system.

In addition, those organizations with high phi are driven by working in the service, and similarly, they have a belief they can reach organizational and client end goals, and they focus on end goals. “Doing due diligence and having conversations can get a sense of an investment professional’s calling,” Fender adds.

Mirtha Kastrapeli, senior research analyst at the Center for Applied Research at State Street, who is based in Boston and is a co-author of the report, tells PLANSPONSOR State Street has a diagnostic test:

  • Identify managers that have the ability to close the gap between what they say they have and what they do have - Do leaders spend time talking about values and belief, do they create and opportunity for investment professionals to see what matters in clients lives?
  • Habits - How is that manager creating a habit of learning how to learn—providing effective feedback, quickly recognizing and addressing mistakes without fear and making sure they are aligning with clients’ goals?
  • Incentive structure - A short-time contingency award is a red flag. Are incentive structures aligned with clients’ and the investment manager organization’s long-term goals?

“We are working on a diagnostic tool, a quantitative measure of something that is hard to measure,” Kastrapeli says. “We are designing a potential survey or questionnaire to assist plan sponsors and advisers with recognizing managers with phi. We are looking toward rolling that out next year.”

NEXT: Benefits to clients

According to Kastrapeli, researchers also looked at phi for individual investors using a different methodology—looking at psychological personalities and sensitivities to the environment around them, among other things. On one hand, motivational investors are focused on goal setting and attaining, they trust investment managers, have knowledge of fees and use advisers. On the other hand are investors driven by fear and negative consequences; they fail to engage and they buy and sell at the wrong times.

Fender adds that investment managers with higher phi are more engaged with retirement planning. “The more we know about plan participant investors’ motivations, the more we can customize education and advice. Motivation is the engine that drives behavior,” she says.

In addition, Fender notes, phi is something investment managers can control during market volatility. It can create a better relationship with clients and alignment with client interests.

Fender says a worrying finding of the research is that 54% of individual investors said investment managers are looking out for the firm’s best interest rather than clients’ best interests. In addition, 62% of employees at investment manager firms said the same. “The paper is a call to action for investment manager leaders,” she says. “A lot of a firm’s culture goes back to leadership; 44% of investment professionals think their leaders are articulating a specific vision.”

Fender concludes: “There’s a big opportunity for the investment management industry. The research shows only 17% have high phi, and more than 50% have low or no phi. Better cultures lead to better long-term performance.”

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