Chamber of Commerce of the U.S. v. Hugler

• Decision Date: 08 February 2017
• Docket Number: C/w : 3:16–cv–1530–C, 3:16–cv–1537–N,Civil Action No. 3:16–cv–1476–M
• Parties: CHAMBER OF COMMERCE OF THE UNITED STATES OF AMERICA, et al., Plaintiffs, v. Edward HUGLER, Acting Secretary of Labor, and United States Department of Labor, Defendants.
• Court: U.S. District Court — Northern District of Texas

231 F.Supp.3d 152

CHAMBER OF COMMERCE OF THE UNITED STATES OF AMERICA, et al., Plaintiffs,

v.Edward HUGLER, Acting Secretary of Labor, and United States Department of Labor, Defendants.

Civil Action No. 3:16–cv–1476–M

C/w : 3:16–cv–1530–C, 3:16–cv–1537–N

United States District Court, N.D. Texas, Dallas Division.

Signed February 8, 2017

James C. Ho, Russell H. Falconer, Gibson Dunn & Crutcher LLP, Dallas, TX, Eugene Scalia, Jason J. Mendro, Paul Blankenstein, Rachel E. Mondl, Gibson Dunn & Crutcher LLP, Steven P. Lehotsky, U.S. Chamber Litigation Center, David T. Bellaire, Robin Traxler, Financial Services Institute Inc., J. Lee Covington, II, Insured Retirement Institute, Felicia Smith, Kevin R. Foster, Financial Services Roundtable, Ira D. Hammerman, Kevin Carroll, Securities Industry and Financial Markets Association, Washington, DC, for Plaintiffs.

Galen N. Thorp, Emily Sue Newton, U.S. Department of Justice, Washington, DC, for Defendants.

MEMORANDUM OPINION AND ORDER

BARBARA M. G. LYNN, CHIEF JUDGE

Before the Court are the parties' Cross–Motions for Summary Judgment (ECF Nos. 48, 51, 54, 67). On November 17, 2016, the Court held oral argument on the Motions. For the reasons stated below, Plaintiffs' Motions for Summary Judgment are DENIED and Defendants' Motion for Summary Judgment is GRANTED.

I. Introduction

Plaintiffs U.S. Chamber of Commerce ("COC"), the Indexed Annuity Leadership Council ("IALC") and the American Council of Life Insurers ("ACLI") (collectively, "Plaintiffs") bring this lawsuit to challenge three rules published by the Department of Labor ("DOL") on April 8, 2016, which were to become effective on April 10, 2017.¹ Shortly after the final rules were published, COC filed this action. On June 21, 2016, the Court consolidated that case with cases filed by IALC and ACLI. On July 18, 2016, the Plaintiffs filed their Motions for Summary Judgment, asking the Court to vacate the new rules in their entirety.²

Prior to the new rules, a financial professional who did not give advice to a consumer on a regular basis was not a "fiduciary," and therefore was not subject to fiduciary standards under the Employee Retirement Income Security Act ("ERISA") and the Internal Revenue Code (the "Code"). Unless fiduciaries qualify for an exemption, they are prohibited by ERISA and the Code from receiving commissions, which are considered to present a conflict of interest. Prior to the new rules, fiduciaries could qualify for an exemption known as the Prohibited Transaction Exemption 84–24 ("PTE 84–24"), which, if they qualified, allowed them to receive commissions on all annuity sales as long as the sale was as favorable to the consumer as an arms-length transaction and the adviser received no more than reasonable compensation.

The new rules modify the regulation of conflicts of interest in the market for retirement investment advice, and consist of: 1) a new definition of "fiduciary" under ERISA and the Code; 2) an amendment to, and partial revocation of, PTE 84–24; and 3) the creation of the Best Interest Contract Exemption ("BICE"). The first rule revises the definition of "fiduciary" under ERISA and the Code, and eliminates the condition that investment advice must be provided "on a regular basis" to trigger fiduciary duties.³ The second rule amends PTE 84–24, which provides exemptive relief to fiduciaries who receive third party compensation for transactions involving an ERISA plan or individual retirement account ("IRA").⁴ The DOL excluded those selling fixed indexed annuities ("FIAs") as eligible for exemptions under amended PTE 84–24. The third rule, BICE, creates a new exemption for FIAs and variable annuities, and allows fiduciaries to receive commissions on the sale of such annuities only if they adhere to certain conditions, including signing a written contract with the consumer that contains enumerated provisions.⁵

Plaintiffs complain that financial professionals are improperly being treated as fiduciaries and should not be required to comply with heightened fiduciary standards for one-time transactions. Plaintiffs also complain that the conditions to qualify for an exemption under BICE are so burdensome that financial professionals will be unable to advise the IRA market and sell most annuities to ERISA plans and IRAs. They challenge the new rules and rulemaking procedure, and ask the Court to vacate them in their entirety.

II. Definitional Issues

A. Annuities

Annuities are insurance contracts where the purchaser invests money and receives payments at set intervals or over the lifetime of the individual. They are generally used as retirement vehicles. Annuity payments may be immediate or deferred. Deferred annuities have two phases: in the first phase, they accumulate value through premium payments and interest; in the second phase, they pay out based on an application of a predetermined formula. The three most common types of deferred annuities are fixed rate annuities, variable annuities, and FIAs (fixed indexed annuities).

Fixed rate annuities guarantee the purchaser will earn a minimum rate of interest during the accumulation phase. Insurance companies bear the market risk on fixed rate annuities because the annuity is guaranteed to earn at least the declared interest rate for the time period specified in the contract. When the purchaser begins to receive payments, income payments are either based on the original guaranteed rate or the insurer's current rate, whichever is higher. Fixed rate annuities are subject to state insurance regulations and are not regulated by federal securities laws. Fixed rate annuities are usually sold by banks and insurance agents.

Variable annuities do not guarantee future income. Instead, returns on such annuities depend on the success of the underlying investment strategy. Premiums are invested, and the consumer bears the investment risk for both principal and interest. There is opportunity for greater return, but it comes with a higher risk. Variable annuities are regulated under federal securities laws and are usually sold by broker-dealers.

FIAs share features of fixed rate and variable annuities. FIAs earn interest based on a market index, such as the Dow Jones Industrial Average, or the S&P 500. Depending on the performance of the market index chosen by the consumer, returns on FIAs can be higher or lower than the guaranteed rate of a fixed rate annuity. At the same time, the rate of return cannot be less than zero, even if the index is negative for the relevant time period. Principal, therefore, is shielded from poor market performance. FIAs give the purchaser more risk but more potential return than fixed rate annuities, but less risk and less potential return than variable annuities. FIAs are not regulated under federal securities laws and are usually sold by insurance agents. They, like fixed rate annuities, are regulated by state insurance regulators.

B. Investment Advisers and the Distribution Model for Sale of FIAs

Three groups of professionals generally provide investment advice to retirees: registered investment advisers, broker-dealers, and insurance agents. Registered investment advisers must register with the Securities and Exchange Commission ("SEC"). Broker-dealers are not required to register with the SEC as investment advisers if their advice is "solely incidental" to the conduct of their business and they receive no "special compensation" for advisory services.⁶ Broker-dealers are generally subject to a suitability standard, which requires they have a reasonable basis to believe that a recommended transaction or investment strategy involving securities is suitable for the consumer based on the consumer's investment profile.⁷

Financial professionals generally charge for their services in one of two ways. In a transaction-based compensation model, the professional receives a commission, mark-up, or sales load on a per transaction basis. In a fee-based compensation model, the investor pays based on either the amount of assets in the account, or pays a flat, hourly, or annual fee.

FIAs are most often sold by independent insurance agents. Independent marketing organizations ("IMOs") serve as intermediaries between independent agents and insurance companies, and provide product education, marketing, and distribution services to agents.⁸

C. Title I of ERISA: Employee Benefit Plans

To protect employee benefit plan beneficiaries, Title I of ERISA, 29 U.S.C §§ 1021 et seq. , imposes obligations on persons who engage in activities related to employee benefit plans as fiduciaries. Under Title I, a person "is a fiduciary with respect to a plan" if:

i) [h]e exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets,

ii) [h]e renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or

iii) [h]e has any discretionary authority or discretionary responsibility in the administration of such plan.⁹

Under Title I, a fiduciary must adhere to the duties of loyalty and prudence, which requires the fiduciary to:

[d]ischarge his duties with respect to a plan solely in the interest of the participants and the beneficiaries and for the exclusive purpose of providing benefits to participants and their beneficiaries, and defraying reasonable expenses of plan administration; and act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.¹⁰

Title I also protects plan beneficiaries from a broad range of transactions deemed to present a conflict of interest for fiduciaries.¹¹ The prohibited transaction rule prevents a fiduciary from participating in a...