401(k) Advice Rule Compliance Abandoned as Key Deadline Arrives

Many firms gearing up to comply with the Labor Department’s embattled 401(k) investment advice rule have opted to change course on compliance since two federal courts paused the regulation that was originally scheduled to begin taking effect Monday.

Both of the Texas judges temporarily stayed the implementation of the fiduciary rule and accompanying prohibited transaction exemptions in July, pending the outcome of two challenges to the rule by industry groups who say it exceeds the DOL’s regulatory authority.

The about-face that suspended the rule was not entirely unexpected among retirement and life insurance industry professionals, who had anticipated potential Administrative Procedure Act challenges to the rule and sought to avoid unnecessary expenditures on complying with it, benefits lawyers say.

“Once the court decisions came down, they basically put pencils down and they didn’t go forward because it’s going be a while before anything actually happens,” said Lori Basilico, a partner at Locke Lord LLP. “I don’t necessarily think it’s going to be months, I think it will be years, so my clients just didn’t want to continue going down that road until and unless they had to.”

The DOL filed notices of appeal in both cases on Sept. 20, having previously requested more time to decide whether it would be appropriate. The underlying cases challenging the fiduciary rule will proceed during an appeal and its implementation will remain on hold until the US Court of Appeals for the Fifth Circuit has weighed in on the lower courts’ decision to pause the effective date.

Past agency attempts to expand fiduciary duties under the Employee Retirement Income Security Act to cover 401(k) rollover advice provided by the life insurance industry, among others, have been blocked by court order. But the Texas district court decisions to put the new rulemaking package temporarily on hold arrived sooner than in past administrative challenges, months before the Sept. 23 initial effective date for staggered implementation.

Changing Course

The halting of the rule, which was finalized by the Biden administration in April, leaves 401(k) service providers relying on a set of older standards, including a five-part test for fiduciary advice dating back to 1975 and older iterations of prohibited transaction exemptions.

“All of my clients stopped their work on complying with the new regulation and exemptions when the courts stayed the effective dates,” said Fred Reish, partner at Faegre Drinker Biddle & Reath LLP. “In some ways, the SEC rules for broker-dealers and investment advisers are similar to the DOL’s rules, so there are compliance issues there as well.”

Annuities industry players vocally opposed the rulemaking and filed both Texas legal challenges, which were led by the American Council of Life Insurers and the Federation of Americans for Consumer Choice, respectively. While the industry waits to see if the courts will ultimately vacate the rule, firms and sales agents are pivoting their compliance plans to focus on National Association of Insurance Commissioners Model Rule 275, which has been adopted by 47 states.

Those state-level rules set requirements for rollover recommendations that are far less demanding than their Labor Department or Securities and Exchange Commission counterparts, making insurance professionals the “primary beneficiary of the stays,” Reish said.

The NAIC regulations, which require those making annuity recommendations to act in consumers’ best interest, are less threatening to insurance business models and more permissive when it comes to commission-based sales practices, opponents of the DOL rule have argued.

ACLI and other industry groups have said that the Labor Department’s new standards would undermine altogether their business model of selling insurance products like annuities to retirement savers considering rollovers.

An Oxford Economics survey commissioned by the Financial Services Institute found that the rule, in its proposed form, would create $2.5 billion in compliance costs for extra time spent on client interactions, as well as document costs for additional disclosures.

Expense was one factor that made many in the industry hesitant to gear up for full compliance with a rulemaking package that had faced vocal opposition from Wall Street, as well as the threat of legal challenges even before it was finalized.

Implementation Deferred

The Fifth Circuit, where the decisions to stay the rule have been challenged, has developed a reputation for striking down Biden administration regulations., The court in 2018 vacated a previous Obama-era fiduciary rule.

Texas federal judges Jeremy Kernodle and Reed O’Connor appeared largely unconvinced by the DOL’s arguments that the transactions newly covered in the final fiduciary rule qualify as relationships of “trust and confidence” under ERISA. The Labor Department focused on that aspect of the 2018 Fifth Circuit ruling that undermined the Obama-era rule when drafting the 2024 investment advice standard, maintaining that the new rule is narrower than its predecessor.

“When you read the proposed rule and final rule, it was definitely written to fix what the Fifth Circuit didn’t like, but trying to do it and having a court actually agree with you are two different things,” said Craig Spenner, a partner at Armstrong Teasdale LLP. “People had begun gearing up to put the groundwork into place and think about how they were going to do this, but I think they were cautious about how much they were going to do because of previous experience gearing up just to have a rule vacated in 2018.”

Any decision that vacates the rule and accompanying exemptions entirely would also likely draw a separate appeal down the line, according to benefits lawyers.

Meanwhile, lawmakers’ effort to undermine the rule through a Congressional Review Act resolution is still pending in Congress, where it received a majority vote from the House Committee on Education and the Workforce in July. That resolution would ultimately be subject to review by President Joe Biden, who used his first-ever veto in 2023 to kill a CRA bid to overturn the DOL’s sustainable 401(k) investing rule.

“The general consensus, at least from what I’m seeing, is that people are going to honor the stay,” Spenner said. “They put a pause as to compliance until this shakes out, but understanding we are in an election year, we don’t really know how it’s going to shake out.”

The cases are ACLI v. DOL, N.D. Tex., No. 4:24-cv-00482 and FACC v. DOL, E.D. Tex., No. 3:22-cv-00243.