DOL Fiduciary Rule Gets Another Successful Defense in Appeals Court

The 10th U.S. Circuit Court of Appeals has ruled against Market Synergy Group, which recently lost two lawsuits in the U.S. District Court for the District of Kansas aiming to halt the implementation of the Department of Labor (DOL) fiduciary rule expansion.

In the original complaint underlying this appeal, plaintiffs argued unsuccessfully that they would never be able to make the Best Interest Contract Exemption workable given the commission-based distribution arrangements traditionally used for fixed-index annuities. They wanted the DOL to be forced by the court to allow annuity providers to work under the separate “84-24 Exemption,” rather than the new and stricter general Best Interest Contract Exemption. Originally, their claims were stated under the Administrative Procedure Act and Regulatory Flexibility Act.

Plaintiffs’ arguments failed outright, with the District Court judge rehashing the same conclusions reached in a previous denial of a motion for preliminary injunction filed by Market Synergy. That initial decision led many to predict (successfully) the second lawsuit would ultimately fail, as it has now done again on appeal.

The latest action by the 10th Circuit represents yet another setback for Market Synergy Group (MSG), although the ultimate future of the DOL fiduciary rule remains quite murky. Notably, MSG itself does not directly sell fixed-indexed annuities but instead conducts market research and provides training and products for independent marketing organization (IMO) member networks and the independent insurance agents that IMOs recruit. Market Synergy and its 11 IMO network members had $15 billion in fixed-indexed annuity sales in 2015 and substantially all of Market Synergy’s revenues involve developing, marketing, and distributing these annuities. MSG alleges that it would lose 80% of its revenue if the new regulation were to be enforced.

In this latest decision, the appellate panel takes time to spell out why this case is a vexing one: “A fixed-indexed annuity [FIA] falls somewhere in-between a fixed rate and variable annuity. Like a fixed rate annuity, principal and prior credited interest are protected from market downturns. Like a variable annuity, however, the amount of interest actually credited varies based on a market index the FIA is tied to, such as the S&P 500 index. Unlike a variable annuity though, FIAs are not actually invested in the market; rather, the market index’s performance is used simply as a reference to determine the amount of interest credited. The crediting rate for an FIA is never less than zero. FIAs, like fixed rate annuities, generally are governed by state insurance law and are exempt from federal securities law.”

The appellate court further observes that, when an investor speaks with an insurance agent about buying an annuity, that insurance agent will often give advice and receive a commission for selling the annuity. This conduct is governed under Title II of the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code, which broadly defines a fiduciary as someone who “renders investment advice for a fee.” These insurance agents selling annuities would generally be classified as fiduciaries and therefore be barred from receiving commissions; however, they had been exempt from that prohibition under Prohibited Transaction Exemption (PTE) 84-24.

This was the case before the 2016 publication of the final DOL fiduciary rule expansion. As the appellate court lays out, the final rule contained two changes important to this case. First, it created a new exemption, with added regulatory requirements, entitled the Best Interest Contract Exemption (BICE). Much like PTE 84-24, the BICE allows certain investment advice fiduciaries to receive compensation that would otherwise violate ERISA’s prohibitions. The BICE, however, also imposes a more stringent set of requirements on prohibited transactions than those required under PTE 84-24.

Second and more important here, the DOL specifically removed FIAs (as well as variable annuities) from the PTE 84- 24 exemption and placed them in the newly created BICE. Fixed rate annuities, however, were kept within the PTE 84-24 exemption. The DOL’s stated reason for this change was because FIAs require the customer to shoulder significant investment risk, “do not offer the same predictability of payments as Fixed Rate Annuity Contracts,” are “often quite complex,” and are “subject to significant conflicts of interest at the point of sale.” Thus, those engaged in selling FIAs would now have to satisfy the conditions set forth in the BICE to be granted an exemption.

Details from the new decision

With that background spelled out, the appellate court points out that only the Administrative Procedure Act (APA) claim is at issue on appeal. MSG claimed that the DOL violated the APA in three ways: “(1) it failed to provide adequate notice of its intention to exclude transactions involving FIAs from PTE 84-24; (2) it arbitrarily treated FIAs differently from other fixed annuities by excluding FIAs from PTE 84-24; and (3) it did not adequately consider the detrimental economic impact of its exclusion of FIAs from PTE 84-24.”

While the district court’s grant of summary judgment on these matters is reviewed de novo, essentially the same results are reached by the appellate panel.

On the first matter, the appellate court states that, while the agency must give notice of the rule it proposes to implement, “it is a well settled and sound rule which permits administrative agencies to make changes in the proposed rule after the comment period without a new round of hearings. The final rule must, however, be a ‘logical outgrowth’ of the proposed rule. A final rule qualifies as a logical outgrowth ‘if interested parties should have anticipated that the change was possible, and thus reasonably should have filed their comments on the subject during the notice-and-comment period.’”

According to the appeals court, “MSG acknowledges, as it must, that the DOL asked for comment, but argues it was unclear on what specific topic comment was sought.” According to MSG, the DOL simply did not give notice that it might exclude FIAs from PTE 84-24 and therefore did not give adequate notice of the final rule.

“We are unpersuaded,” the appellate court concludes. “And while MSG may not have anticipated the final rule, other commenters read the [request for comment] as asking for comment on whether to keep FIAs and fixed rate annuities within PTE 84-24. Some commentators (including one of the IMOs in MSG’s own network) suggested that FIAs be kept within PTE 84-24 while others advocated for their removal. While comments in and of themselves do not resolve the notice issue, they do suggest that various parties anticipated that the final rule might include an option to remove FIAs from PTE 84-24. We conclude that the [request for comment] gave sufficient notice and that the final rule was a logical outgrowth of the proposed rule.”

MSG next argues that the DOL’s action of retaining the PTE 84-24 exemption for fixed rate annuities, but moving FIAs to the BICE, was arbitrary and capricious for two reasons. First, it argues that FIAs are virtually indistinguishable from fixed rate annuities; therefore, separating them into different exemptions was arbitrary. Second, MSG argues that the DOL did not adequately take into account state regulation already in place.

The appellate court notes that, in applying the arbitrary-and-capricious standard of review, it must “ascertain whether the agency examined the relevant data and articulated a rational connection between the facts found and the decision made.”

“The administrative record shows the DOL met this standard,” the court concludes, before also concluding that FIAs and fixed rate annuities differ sufficiently in terms of their complexity, risk profiles and potential for conflicts of interest. “The DOL considered both sides of this issue and ultimately decided to treat FIAs differently than fixed rate annuities because of their risk, complexity, and conflicts of interests. It did so with evidentiary support in the record.”

MSG also claims that the DOL unreasonably infringed on an area of State concern, thereby missing an “important aspect of the problem.” But the DOL did consider this aspect of the problem, the appellate court ruled: “It noted that there was not a uniform standard adopted by all the states and this was particularly concerning for complex and risky products such as FIAs. It surveyed the state regulations and sought to ensure that the requirements of this exemption work cohesively with the requirements currently in place.”

Finally, the appellate court turns to MSG’s contention that the DOL violated the APA by failing to consider how the regulation would affect the FIA industry. Simply put, the appellate court ruled that the “DOL predicted that new markets would open, the regulation would promote innovation, and it would save investors millions of dollars by reducing or curtailing conflicted advice from fiduciaries. Relying on the record before it, the DOL could reasonably conclude that the benefits to investors outweighed the costs of compliance.”

The full text of the appellate decision is available here.