Biden Rolls Legal Dice by Proposing Fourth Fiduciary 401(k) Rule

The Biden administration’s latest attempt at regulating more retirement plan investment advice is vulnerable to the same kinds of legal challenges that undermined a failed Obama-era bid at fiduciary rulemaking.

A set of new US Labor Department proposals (88 Fed. Reg. 75890–76045) President Joe Biden announced Oct. 31 would subject more financial professionals to the strictest fiduciary standards of conduct under trust law and federal benefits statutes.

The regulatory package paints diverse investment advisory services in broad strokes, a key oversimplification the US Court of Appeals for the Fifth Circuit latched onto when it vacated the prior rule in 2018, benefits litigators told Bloomberg Law.

Fiduciary status threatens the commissions many Wall Street broker-dealers and insurance agents make when they sell IRAs and annuities to 401(k) participants rolling their savings out of an employer-sponsored plan. Regulators claim those financial incentives supplant the interests of workers and retirees, but insurance companies and banks say they keep financial advice affordable. That debate appears poised to play out in the courts once again.

A critical component of the Fifth Circuit’s review was a distinction the court said DOL failed to make between investment advice for a fee and sales activity. The department’s latest proposal “does the same thing with essentially the same scope,” said Brad Campbell, the former head of DOL’s employee benefits regulator under President George W. Bush. “They’ve just repackaged how they express it, and I think they have the same legal problem as a result.”

“At it’s heart, it’s a direct challenge to the Fifth Circuit,” said Campbell, now a partner at Faegre Drinker Biddle & Reath LLP. “DOL and the administration are willing to roll the dice on litigation because they think that a different court or a different panel of judges might achieve a different result.”

Junk Power

The financial services lobby came out swinging after last week’s fiduciary rule announcement, which they say wrongly labeled some IRA and annuities sales “junk fees,” a target of Biden’s 2024 campaign messaging.

Congress anticipated a clear difference between financial professionals who hold themselves out as investment advice fiduciaries and those whose recommendations are part of a sales pitch, according to Tom Roberts, a principal attorney at Groom Law Group Chartered. That was and remains settled law, and it’s how the Fifth Circuit “told us to do it,” he said.

“DOL may not like how Congress delegated authority over investment advisers, but that does not give it the power to change the law and usurp other agencies’ authority,” said Chantel Sheaks, vice president of retirement policy at the US Chamber of Commerce, a lead plaintiff in the Obama-era fiduciary rule challenge.

The 2016 rule “fatally conflicts with the statutory text” of the Employee Retirement Income Security Act of 1974 (Pub. L. No. 93-406), which set the department’s regulatory purview, and common law establishing a fiduciary duty of trust and confidence, the court ruled in Chamber of Commerce of the USA v. U.S. Dept. of Lab.

The prior rule threatened to “infringe on SEC turf,” the court added. The US Securities and Exchange Commission and more than two-thirds of state regulators have also since upped their own standards of conduct for IRA and annuities sales.

DOL’s latest proposal attempted to augment other regulators’ authority by taking what one department official called a more “narrowly tailored” approach, but it did a better job undoing what imperiled a later, third version of the fiduciary rule that was partially struck down by a Florida district court earlier this year, said Jason Levy, of counsel at Covington & Burling LLP.

“The regulation, as expected, is clearly intended to capture almost all rollover transactions,” he said. “I think it might be a long time before we really know what the full implications of that are, because the regulation will almost certainly be subject to challenges and litigation.”

Reasonable Standard

In its latest fiduciary rulemaking attempt, DOL’s Employee Benefits Security Administration stripped away much of the complexity underpinning its prior rule and focused instead on revamping the original 1975 test defining an investment advice fiduciary.

One part of that test that focused on “regular basis” advice was a central tenet in the Florida district court challenge. Now, the department wants fiduciary investment advice to revolve around a facts-and-circumstances analysis that hinges on prudence, loyalty, honesty, and trustworthiness.

In simple terms, the proposal states that, “in order to be a fiduciary with respect to advice, you need to be holding yourself out in such a way that really a reasonable investor looking at the objective circumstances here would think you are,” Deputy Assistant Secretary for EBSA Program Operations Tim Hauser said at a Nov. 3 conference hosted by the American Law Institute.

The fact-dependent test may be the department’s best shot at surviving legal scrutiny, but it introduces new types of doubt such as whether competitive bidding processes for investment managers might inadvertently trigger fiduciary status, said Josh Lichtenstein, a partner at Ropes & Gray LLP. Prior exceptions would have carved out special status for sophisticated independent fiduciaries.

“This seems to be their response to the Fifth Circuit decision,” Lichtenstein said. “But by eliminating those exemptions, they’ve created uncertainty about where the fiduciary line is drawn in all of these interactions.”

The prior rule also tried to apply new exemptions to IRA advisers that focused on mirroring the two types of fiduciary status under ERISA. It would have required IRA advisers to contract with their clients, giving those workers and retirees the same type of private-right-of-action employer-sponsored plans have. Those two are gone under the new proposed standard.

“It is literally the case under the five-part test that you could hold yourself out as a fiduciary; you could say, ‘I am a fiduciary. I care about nothing other than your individual interests. I would rather experience all kinds of horrors than anything happen other than I put you in the best possible retirement,’” Hauser said. “You can do all of that, and yet, if you don’t give that advice on more than a one-time basis, if you have a disclaimer elsewhere, you’re out. It really doesn’t honor the Fifth Circuit’s test of trust and confidence.”