Recent actions by both state and federal regulators impose “best interest” standards for sales of annuities and securities.
Insurance and annuity sales “best interest” standards are reflected in the NAIC’s Model Regulation, while the sale of securities by brokers are subject to comparable “best interest” standards imposed by the SEC’s Regulation Best Interest.
These standards also reflect an appreciation of the distinctions between “fiduciary” and “non-fiduciary” conduct.
The Department of Labor recently issued notice of a proposed class exemption (proposed exemption) for investment advice fiduciaries. That proposal imposes “best interest” standards as well.
The preamble to the DOL’s proposed rule acknowledges that the SEC and the NAIC have propounded a unique set of suitability regulations for the purpose of imposing “best interest” standards,” and asserts that its standards are “aligned with [these] other regulators.”
Unfortunately, this clearly isn’t the case. While the proposed class exemption is based on the SEC’s Regulation Best Interest, it does not “align” with the NAIC standard due to material differences in insurance regulation. Further, and even more troubling, the DOL’s new guidance reinterpreting the definition of a “fiduciary” under the traditional five-part test as discussed below, results in the application of ERISA fiduciary status and standards to rollover recommendations not previously considered fiduciary advice. The combination of these two would subject some insurance sales transactions to fiduciary status Congress never intended, and to an exemption process that simply does not fit.
DOL Overturns 2005 Advisory Opinion
State and federal courts have routinely held that the common law surrounding fiduciaries was developed for continuing relationships in which one party entrusts decision-making authority to another.
The DOL’s long standing five-part test provides that a fiduciary relationship only exists if the “adviser’s” services are individualized, furnished on a “regular basis,” provided subject to a mutual understanding, for a fee, and that the information provided is “aprimary basis” for the client’s decisions. As the U.S. Court of Appeals for the Fifth Circuit Court wrote in vacating the 2016 DOL regulation that sought to replace this test, Congress never intended recommendations associated with the sale of a product to rise to the level of fiduciary investment advice.
In the life insurance space, virtually all of the sales of annuities to an IRA in a rollover transaction by a life insurance sales agent should not require the application of any exemption under ERISA. That is because the sales transaction will normally not meet the definition of a “fiduciary” either under the DOL’s “five-part test” or under any other rational application of a traditional fiduciary standard.
In fact, a DOL opinion in 2005 specifically held that, generally, a party having no prior fiduciary relationship to an ERISA plan would not become a fiduciary solely because of a recommendation to roll over the participant’s account balance into an IRA.
Although formally confirming and reinstating the five-part test, DOL is attempting to nonetheless change its meaning by rescinding the 2005 opinion, and finding instead that “rollover advice” may constitute “investment advice” for purposes of the five-part test.
Their comments suggest that a “fiduciary” label may be imposed on transactions in which an insurance agent suggests or confirms a customer’s decision to use assets in an existing pension plan to purchase a fixed annuity, and the agent receives compensation, not for that “advice,” but for the sale of the annuity.
Imposing such a standard does not “align” the DOL with existing state regulation. It applies a “fiduciary” label and standard to a transaction which lacks the essential characteristics to a fiduciary relationship.
The DOL’s interpretation leads to a re-creation of the very problems and costs associated with the failed 2016 fiduciary rule. As was pointed out during the litigation over that rule, imposing a fiduciary status on the traditional sale of a fixed annuity into a pension plan would effectively destroy the opportunity for such products for a vast segment of the population, given that over 50% of fixed annuities are sold by independent agents with no intention or reasonable expectation of becoming investment advice fiduciaries.
According to one study, during the period that the 2016 rule was presumed to become the regulatory standard, and before it was overturned by the Fifth Circuit, “95% of surveyed institutions reduced access to products offered to retirement savers, including annuities.”
The Fifth Circuit’s opinion vacating the 2016 rule recognized the rule’s inconsistency with traditional fiduciary standards and emphasized the importance of “control and authority” by the sales person, which “necessarily implies a special relationship beyond that of an ordinary buyer and seller” (885 F.3d 360, 377 (5th Cir. 2018)).
“Alignment” would more likely arise if the DOL acknowledged that the vast majority of annuity sales in a rollover transaction do not involve the rendering of “investment advice” and recognized that annuity purchasers are already protected under current requirements consistent with the standards being imposed by the DOL under the proposed exemption.
Revising the Proposal
Pursuing a harmonized fiduciary rule that is consistent with the objectives of current regulators, the SEC for securities and the NAIC for insurance, is a worthy objective. A rational set of rules which protect customers and at the same time permits the marketplace to continue to provide access to both annuities and securities serves to both protect and benefit the public.
True alignment requires the DOL to clarify that fiduciary duties do not automatically confer upon insurance agents who are compensated solely to sell annuities in an IRA rollover transaction.
At a minimum, the DOL should revise the proposed exemption standards for annuity transactions to be consistent with the standards for best interest found under the NAIC’s promulgations, not the standards developed for the securities industry under Reg BI.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
James F. Jorden is a litigation partner with Faegre Drinker Biddle & Reath LLP in Washington, D.C. He represents large institutions in securities, corporate, and pension cases, and has served as lead counsel in more than 100 class actions involving insurance, RICO, and securities claims.