Compliance February 12, 2020

Rockwell Automation Must Face ERISA Challenge

Allegations in the lawsuit, which has now cleared Rockwell’s dismissal motion, echo those filed in other lawsuits challenging the actuarial assumptions used by pension plan sponsors to value alternative forms of benefits other than the default.

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A new decision issued by the U.S. District Court for the Eastern District of Wisconsin denies dismissal of a would-be class action complaint, rejecting Rockwell Automation’s allegation that a retired pension plan participant failed to adequately state a claim.

The plaintiff in the lawsuit alleged Rockwell has harmed participants, in violation of the Employee Retirement Income Security Act (ERISA), by incorporating outdated actuarial assumptions that resulted in certain alternative pension payments being less than the actuarial equivalent of the normal default pension benefit.

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As is essentially standard procedure in such cases, Rockwell moved to have the complaint dismissed for failing to state a claim, but the District Court has now sided with participants and has agreed to at least allow the case to move forward to the discovery phase.

Background in case documents shows the Rockwell pension plan allows participants to choose from a variety of annuity types once they claim their pension benefit. One such optional annuity is a “certain and life” annuity, under which payments are made for the life of the participant or for at least a specified number of years. If the participant dies before receiving payments for the specified period, the remaining payments are made to the participant’s beneficiary.

According to case documents, when the lead plaintiff in this case, referred to as “Smith,” retired some years ago, he elected to receive his pension in the form of a 10-year certain-and-life annuity, with his son as the beneficiary.

Case documents show the Rockwell plan’s governing documents specify that, to calculate actuarial equivalence for the annuity that Smith elected to receive, the plan must use a specific mortality table, known as the 1971 Group Annuity Mortality (GAM) Table for Males. The governing documents further detail that the applicable discount interest rate is 7%.

According to the complaint, the 1971 GAM is nearly 50 years old and reflects life expectancies of retirees in 1970. In 1970, a 65-year-old had a life expectancy of 15.2 years, the plaintiffs suggest. However, in 2010, a 65-year-old had a life expectancy of 19.1 years, a 26% increase.

“Thus, in 2010, the average retiree receiving a single life annuity would have expected to receive more payments than a retiree in 1970,” the complaint states. “By using the 1971 GAM to calculate actuarial equivalence, the plan’s optional annuities assume that the annuitant will die sooner than average and thus receive fewer payments than is likely. This, in turn, causes the value of the optional annuity to be less than the actuarial equivalent of a single life annuity, in violation of ERISA.”

In its motion to dismiss, Rockwell contended that a plan pays actuarially equivalent benefits so long as it calculates actuarial equivalence using actuarial assumptions that were reasonable at the time they were written into the plan. “The conclusion that the defendants would like me to draw from these provisions is that Congress could not have intended to require that plans periodically review their actuarial assumptions to ensure that they are reasonable at the time benefit calculations are made,” U.S. District Judge Lynn Adelman wrote in his opinion. He decided that nothing in the provisions of law the company pointed to suggests that the term “actuarial equivalent” means “actuarial equivalent as of the date the plan adopted its actuarial assumptions.”

For example, Adelman pointed out that Section 401(a)(25) does not prohibit employers from amending a plan’s actuarial assumptions to bring them up to date. It places no constraint whatsoever on an employer’s discretion to amend the plan for any reason. “And it is easy to draft an amendment that incorporates updated actuarial assumptions but does not also grant the employer discretion to manipulate those assumptions,” he wrote.

Adelman suggested that “the plan could adopt a variable standard that is self-updating, such as one of the variable standards identified in Revenue Ruling 79-90.”

Adelman also noted that plans can minimize conflict between the actuarial-equivalence requirement and ERISA’s anti-cutback rule by adopting variable actuarial assumptions that self-adjust to reflect changes in mortality and interest rates. Under Revenue Ruling 81-12, “in the case of a variable standard, any variation in accordance with the plan standard is not subject to” the anti-cutback rule. He agreed with the defendants’ contention that nothing in ERISA requires plans to use a variable standard. However, he said the point is that a plan that is concerned about having to “continually increase benefits” has the option of adopting a variable standard. Once the variable standard is adopted, the plan will not have to continually increase benefits to comply with the anti-cutback rule—only those employees who accrued benefits under the old, fixed standard would potentially be entitled to increased benefits.

The defendants also contended that, to accept the plaintiff’s interpretation of “actuarial equivalent,” the court “would have to legislate a detailed set of rules … specifying when a plan must change the actuarial assumptions it used to determine its contractually promised annuity benefits, how a plan should decide which mortality tables and interest rates to use and for which plan participants.” But Adelman disagreed, saying ERISA already contains the relevant rule: Plans must ensure that any optional annuity forms are actuarially equivalent to a single life annuity.

“This means that plans must use the kind of actuarial assumptions that a reasonable actuary would use at the time of the benefit determination. A court does not have to specify further details to enable plans to comply with the rule. They may comply by periodically consulting with professional actuaries who will review the plan’s actuarial assumptions for reasonableness and recommend whether changes to mortality tables or interest rates are needed,” Adelman wrote.

In rejecting the motion to dismiss, he found that the Rockwell plan’s actuarial assumptions do not provide actuarial equivalence and that the complaint adequately alleges that the plan did not provide Smith with an actuarially equivalent annuity.

The full text of the ruling is available here.
Compliance February 12, 2020

FINRA Wants to Help You With Reg BI Compliance

As the enforcement date approaches for the sweeping Regulation Best Interest rulemaking package, FINRA is working hand-in-hand with the SEC to ensure effective coordination—and to support advisers working on associated compliance challenges.

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One of the biggest regulatory stories of 2019 was the finalization of the U.S. Securities and Exchange Commission’s (SEC) Regulation Best Interest (Reg BI) rulemaking package.

As the name suggests, Reg BI establishes a “best interest” standard of conduct for broker/dealers and associated personnel when they make a recommendation to a retail customer (i.e., an individual person) of any securities transaction or investment strategy involving securities, including recommendations of types of accounts. Tied into the broad rulemaking package is a related clarification and restatement of the SEC’s understanding of the fiduciary duty applying to investment advisers under the Investment Advisers Act.

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Reg BI has both supporters and detractors, but all parties agree its implementation is of critical importance for advisers and broker/dealers in 2020. Indeed, firms on both the advisory and brokerage side of the aisle must be in compliance with the Reg BI package by June 30. Almost without exception, such compliance will require material changes in processes and procedures for firms operating under the SEC’s expansive jurisdiction—even those that believe they already only provide best-interest service.

Due to the complex nature of the 1,000-plus page rulemaking package, which mandates best-interest treatment of brokerage and advisory clients without actually defining what “best interest” definitively means, the Financial Industry Regulatory Authority (FINRA) has made it a priority this year to help its member firms understand and ultimately comply with Reg BI. To this end, FINRA has published Reg BI checklists, podcasts and other helpful materials, such as a compliance guide designed specifically for smaller firms.

From ‘Suitability’ to ‘Best Interest’

Addressing FINRA’s plans to collaborate with the SEC on Reg BI’s implementation, Robert Colby, FINRA chief legal officer, says his “self-regulatory organization” will be able to draw on its experience enforcing its own “suitability” standard, which he says was clearly part of the inspiration for the specific approach to conflicts of interest taken by Reg BI.

“The big question we are hearing is, how is Reg BI different from how brokers currently deal with customers?” Colby says. “This makes sense, because probably every broker would say that they already put their customers’ interest first and that their own incentives are, by design, aligned with how well their customers do.”

Colby says it is critically important to point out that Reg BI requires much more than a broker simply believing he is providing best-interest service to all clients. Reg BI is meant to be a heightened standard of conduct for brokers, going above and beyond any previous rulemaking.

“Under Reg BI, there can be no ambiguity about recommendations being in the customers’ best interest, and perhaps most importantly, firms must put in place specific and reasonable processes and procedures to ensure they are complying with Reg BI,” Colby observes.

Another major part of Reg BI is that firms on both the advisory side and on the brokerage side will have to provide a “Customer Relationship Summary Form,” or “Form CRS,” to all retail clients. Colby notes that there has been some confusion about how firms or representatives that are registered to operate in both an advisory and a brokerage capacity should structure their Form CRS—an issue that will require careful consideration among dual-registered firms.

Stepping back, Colby notes, Reg BI will in many ways supersede FINRA’s existing regulatory requirements, and thus FINRA itself also has some soul-searching to do in 2020 and beyond.

“The new standards being implemented by the SEC build on FINRA concepts that have been developed in the suitability effort,” Colby says. “We will be preserving our rules, but we don’t want to see conflict or confusion between SEC and FINRA expectations. One possible approach is to say that, with respect to retail investors, compliance with Reg BI will constitute compliance with our suitability rule. Something else to mention is the sales contest prohibition in Reg BI. At FINRA, we have a set of rules that limits sales contests but does not entirely ban them. My reading of Reg BI is that sales contests are deemed to be an inherent conflict of interest. So we are going to have to revisit our sales contest rules, for example.”

According to Colby, FINRA is emphasizing that staff training is going to be an important part of Reg BI compliance.

“Once your compliance policies and procedures are developed, everyone must understand them and know what is required,” he explains. “This training is very likely going to be firm-specific, because it’s meant to be training based on the firm’s specific policies and procedures. General education about Reg BI won’t be enough.”

No Time to Wait

Firms should be well on their way toward Reg BI compliance at this stage, but for those that have been dragging their feet, FINRA suggests tackling the following questions. Any “no” answers will have to be addressed by June 30—the compliance date for Reg BI. 

  • Does your firm have procedures and training in place to assess recommendations using a best-interest standard?
  • Do your firm and your associated personnel apply a best-interest standard to recommendations of types of accounts?
  • If your firm and your associated personnel agree to provide account monitoring, do you apply the best-interest standard to both explicit and implicit hold recommendations?
  • Do your firm and your associated personnel consider the express new elements of care, skill and costs when making recommendations to retail customers?
  • Do your firm and your associated personnel consider reasonably available alternatives to the recommendation?
  • Do your firm and your registered representatives guard against excessive trading, irrespective of whether the broker-dealer or associated personnel “controls” the account?
  • Does your firm have policies and procedures to provide the disclosures required by Reg BI?
  • Does your firm have policies and procedures to identify and address conflicts of interest?
  • Does your firm have policies and procedures in place regarding the filing, updating and delivery of Form CRS?

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