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What Should 401k Plan Sponsors Do Now That The Fiduciary Rule Has Been Stayed?
by Christopher Carosa July 30, 2024
That was fast. We just had two back-to-back court rulings that effectively nullified, at least temporarily, the Department of Labor’s latest attempt to install a new Fiduciary Rule. What in Sam Hill happened?
“On April 25, 2024, the US Labor Department published a rule that interprets which facts show a person renders investment advice to make one a fiduciary under the Employee Retirement Income Security Act of 1974 (ERISA) or the Internal Revenue Code, and changes to several exemptions that allow, under specified conditions, conflicted compensation,” says Peter Gulia, a Philadelphia lawyer and shareholder of Fiduciary Guidance Counsel. “Some lawsuits ask a court to set aside that rule and some changes in exemptions. These lawsuits ask not only for those ultimate decisions but also for temporary relief until a court’s ultimate decision is final. The challengers argue they shouldn’t have to change their business practices now to follow a rule, or exemption conditions, that later might be declared contrary to law. Combining two courts’ decisions on July 25 and 26, they stay the effective date of the rule and of the changes to exemptions. Strictly speaking, this is not a preliminary injunction; neither court orders the Labor Department to do (or not do) anything. Rather, the changes that would have become effective September 23, 2024, do not take effect.”
The relative quickness of this one-two shot from the District Courts suggests an obvious flaw in the new Rule.
“Both District Courts were totally unpersuaded by the Department of Labor’s efforts to distinguish the Retirement Security Rule from the 2016 fiduciary rules that were invalidated by the Court of Appeals for the Fifth Circuit in the Chamber of Commerce case in 2018, with both District Courts stating that in their view, the Department of Labor’s position was that the Chamber of Commerce case had been incorrectly decided,” says Marcia S. Wagner of the Wagner Law Group in Boston, Massachusetts. “Once a District Court concludes that a plaintiff is likely to prevail on the merits of the case, and the Department of Labor did not seriously contest that plaintiffs would suffer irreparable harm if the rule were enforced, it became clear that the District Courts would issue a stay, although both courts declined to grant plaintiff’s request for the technically more drastic remedy of a preliminary injunction.”
Let’s break it down case by case.
“In the U.S. District Court for the Northern District of Texas, the plaintiffs sought, under the Administrative Procedures Act, a preliminary injunction and stay of the effective date of the DOL’s April 25, 2024 Retirement Security Rule: Definition of an Investment Advice Fiduciary (the Rule) and of related amendments to applicable prohibited transaction exemptions,” says Michelle Capezza, Of Counsel at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. in New York City. “On July 25, 2024, the Eastern District of Texas issued a stay of the effective date of the Rule and amendments to Prohibited Transaction Exemption 84-24. In this latest decision, the court also stayed the effective date of the Rule during the pendency of this suit and any appeal. The court found that the 1975 regulations for determining an investment advice fiduciary, particularly requirements that investment advice be provided for a fee on a regular basis and pursuant to a mutual arrangement of trust and confidence, generally did not reach one-time sales recommendations, such as a recommendation by insurance agents and brokers to purchase an annuity for inclusion in an IRA. The court opined that the Rule conflicts with ERISA and the prior precedent set by The Fifth Circuit when it had vacated the DOL’s revisions to the 1975 regulations in 2016. Thus, the court noted that there is a distinction between investment advice and sales conduct.”
Specifically, the judge could not have been more forthright in his ruling.
“Judge Jeremy Kernodle of the U.S. District Court for the Eastern District of Texas criticized the DOL’s attempts to reconcile the new rule with the previous Fifth Circuit ruling, stating that these attempts were insufficient and failed to address the core issues identified explicitly by the court,” says Richard Bavetz, investment advisor at Carington Financial in Westlake Village, California. “He noted that the DOL contends the previous ruling unduly limits the agency’s authority, an argument that the DOL should make to higher courts like the Fifth Circuit en banc or the Supreme Court. Kernodle agreed with the plaintiffs, including the Federation of Americans for Consumer Choice Inc. and other independent insurance agents, who argued that the new fiduciary rule was not significantly different from the previous proposal struck down by the Fifth Circuit and they would likely succeed on the merits of their claim.”
What happens next shouldn’t surprise you.
“Both of these cases will be appealed by the Department of Labor to the Fifth Circuit,” says Wagner. “But, for the Department of Labor ultimately to prevail in this case, that would be more likely to occur, if it were to occur at all, in an en banc decision of the Fifth Circuit or a decision by the Supreme Court, rather than a decision by a three-judge panel.”
Some are quite certain of the ultimate outcome.
“It will be appealed, the process will likely take years, potentially making it all the way to the Supreme Court, before being ultimately vacated,” says Michelle Gordon, founder of MRG Advisors LLC in New York City. “How quickly/at what court level it’s vacated is dependent on election outcomes, but the current composition of the Supreme Court and the likelihood it remains similarly situated for a long period suggests high likelihood this Rule is vacated.”
Still, others think the result of the next election may make the point moot.
“The challengers and the United States continue to litigate whether the rule is and whether the changes to the exemptions are, contrary to law,” says Gulia. “That seems likely at least until the new President of the United States is in office. If the next President’s Labor and Justice departments’ officials have views that differ from those in President Biden’s administration, one can imagine a reevaluation of the government’s position. Even if a court sets aside the rule, a court independently interpreting ERISA or the Internal Revenue Code to find whether a particular case’s facts show a person rendered investment advice may be persuaded by any interpretation, including an interpretation expressed in a vacated rule.”
In the meantime, 401k plan sponsors might be wondering what to do.
“In light of the recent preliminary injunction issued by a Texas court, 401k plan sponsors should exercise skepticism regarding implementing the Department of Labor’s (DOL) new Fiduciary Rule,” says Bavetz. “The court’s decision highlights several vulnerabilities that plaintiffs and courts may exploit, which could lead to ongoing legal and compliance challenges.”
ERISA attorneys have a variety of opinions on what to do right now. Some say to stand by.
“We are advising clients to place their compliance efforts on hold for right now, to see how this litigation plays out,” says Wagner. “Most clients simply want to comply with the rules of the road, even if they personally disagree with those rules, and it is difficult operating in an environment when the operative rules on an important ERISA fiduciary rule are uncertain. Attorneys have the option of making arguments in the alternative, but retirement plan fiduciaries cannot administer 401k plans in that manner.”
Others say to remain in the review mode.
“Despite the Texas District Court stays of the effective date of the DOL’s Retirement Security Rule: Definition of an Investment Advice Fiduciary,” says Capezza, “plan sponsors should continue to review their plan service provider and plan investment advisor relationships to ensure that the scope of services vis a vis the plan and the participants are clear, to confirm which service providers or advisors have acknowledged fiduciary status, to evaluate whether certain services appear to be fiduciary in nature and should be revisited with the service provider or advisor from a documentary and operational standpoint, and to determine appropriate communications to participants regarding these services.
Still others advocate a more proactive “outside the box” approach.
“Instead of relying on public law alone, a retirement plan’s fiduciary (typically, the employer or some office of it) may use the plan’s bargaining power to negotiate extra responsibility to the plan and extra protections for the plan’s participants and beneficiaries,” says Gulia. “For example, a plan’s fiduciary might negotiate a contract by which an adviser confirms its responsibility as the plan’s fiduciary and commits to specified protections no less than those that would be provided by the delayed exemption conditions.”
When it comes to assessing plan changes relevant to the DOL’s now stayed Rule, advisers offer fairly blunt advice to 401k plan sponsors.
“They should not make any changes,” says Lawrence (Larry) Starr of Cornerstone Retirement/QPC in West Springfield, Massachusetts, and Senior Advisor to the Government Affairs Committee of the American Retirement Association. “Should they still make any relevant changes Not a very good recommendation.”
And if you think Starr can’t be more blunt, he says, “This whole thing is blown out of proportion by the nannies in the DOL. The five-factor rule has worked well for 50 years. The change is unnecessary. The issue rightly belongs to the SEC and not the DOL. And the reality is that this will never be litigated for the small plans of the universe; it will be a target for those big law firms to bring class actions against big insurance companies.”
One thing is for sure, no matter what happens, this appears to be a never-ending story.
Christopher Carosa is an award-winning online news producer and journalist. A dynamic speaker, he’s the author of 401(k) Fiduciary Solutions, Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort, From Cradle to Retirement: The Child IRA, and several other books on innovative retirement solutions.