Judicial Recommendation Reins in ‘Rollover Rule’

A federal magistrate judge has recommended curtailment of a key rollover provision of the Labor Department’s investment advice regulation.

The recommendation of U.S. Magistrate Judge Rebecca Rutherford comes in a 75-page “findings, conclusions, and recommendations” in response to a suit filed last February by the Federation of Americans for Consumer Choice Inc. 

In that suit, they were joined by several advisors and advisory firms that sell annuities as part of their practice(s)—all of which are said to be licensed insurance agents in the State of Texas and members of the FACC—explaining that “the Agent Plaintiffs oftentimes make rollover recommendations for purchase of annuities to IRA owners and participants in employer-sponsored 401k and similar benefit plans, for which they receive commissions or other compensation from annuity issuers. The Agent Plaintiffs will thus be directly and adversely affected by the DOL’s New Interpretation suddenly categorizing their status as investment advice fiduciaries under ERISA or the Code, as applicable.”

Since then, of course, the Labor Department’s “new interpretation” of the so-called fiduciary rule (a.k.a. PTE 2020-02) has also been challenged in federal court in Florida—lost (at least with regard to one of the FAQs explaining the applicability of that prohibited transaction exemption (PTE) to rollovers)—declared its intention to appeal that loss—and then pulled back on that, with most industry watchers presuming DOL meant to address the issue with a new regulation.

The Analysis

After a brief introduction, Judge Rutherford’s analysis (Federation of Americans for Consumer Choice Inc. et al. v. United States Department of Labor et al., case number 3:22-cv-00243, in the U.S. District Court for the Northern District of Texas) began by acknowledging that, “While the Court may view the DOL’s new interpretation as part of the agency’s well-intentioned efforts to update its regulations to ensure that fiduciary advice providers adhere to stringent standards designed to ensure that investment recommendations by financial institutions and professionals reflect the best interests of plan and IRA investors, the Court must also recognize that other similar agency efforts have not held up well under judicial scrutiny.” 

Recalling that this action was filed in the Texas federal district court, she continued to write “Five years ago, the United States Court of Appeals for the Fifth Circuit vacated the DOL’s revised definition of an investment advice fiduciary to include all financial professionals who give advice to roll assets out of a plan to an IRA”—going on to reference the recent decision in the U.S. District Court for the Middle District of Florida “in which the court vacated the policy referenced in Frequently Asked Question (FAQ) 7 in the New Fiduciary Rule Advice Exemption FAQs which extended the five-part test to a recommendation to roll plan assets to an IRA, in the context of an ongoing advice relationship.”

That said, she quickly affirmed that the plaintiffs in the case—those filing suit—had standing (meaning they were impacted by the regulation) to bring suit—and dismissed the defendants’ (the Labor Department) argument that they did not.

She then quickly proceeded to comment that “…based on ERISA’s text and purpose, coupled with the common law understandings of fiduciary relationships, the Court should find the DOL’s new interpretation of the five-part test narrowly conflicts with ERISA and the DOL’s own regulations,” and that “in view of this conflict, the Court should conclude that the DOL exceeded its statutory authority in promulgating the new interpretation and that the new interpretation is an arbitrary and capricious interpretation of the five-part test,” more specifically she recommended that “the Court should VACATE the portions of PTE 2020-02 that permit consideration of actual or expected Title II investment advice relationships when determining Title I fiduciary status.”

The Background

Judge Rutherford then proceeded to discuss the “statutory framework & regulatory history,” culminating with not only the origins of the so-called “five part test[i]” (which she noted was “unchanged until 2016”), but also the analysis applied by the Fifth Circuit in its rejection of the Obama Administration’s Labor Department’s fiduciary regulation, and distinctions between that design and the one currently under consideration.   

She noted that the Fifth Circuit observed that “[t]he stated purpose of the new rules [was] to regulate in an entirely new way hundreds of thousands of financial service providers and insurance companies in the trillion-dollar markets for ERISA plans and [IRAs].” However, she noted that “the Fifth Circuit found that the 2016 Fiduciary Rule was inconsistent with the ‘touchstone of common law fiduciary status—the parties’ underlying relationship of trust and confidence’ that is incorporated in ERISA’s text”—and thus vacated the rule in its entirety.

Judge Rutherford then noted that, “notwithstanding the Fifth Circuit’s decision, the DOL again sought to regulate the ever-growing rollover market,” citing the issuance of PTE 2020-02 alongside what she termed “technical amendments which implemented the vacatur of the 2016 Fiduciary Rule and re-implemented the five-part test.” That was then followed by a consideration of comments and a final prohibited transaction exemption (PTE) with what she called a “New Interpretation of the now-reinstated five-part test on December 18, 2020, which took effect on February 16, 2021.”

Judge Rutherford commented that this “New Interpretation” (she put that in caps, btw) made “several changes to existing standards by way of its preamble and exemption.” Notably, it “withdrew the Deseret Letter and reversed the DOL’s position that rollovers do not constitute fiduciary investment advice.” She then said that the DOL’s NEW (our emphasis) position is that “a recommendation to roll assets out of a Title I Plan is advice with respect to moneys or other property of the plan” and that “[a]n investment advice fiduciary making a rollover recommendation would be required to avoid prohibited transactions under Title I and the Code unless an exemption, including this one, applies.”     

Ultimately, Judge Rutherford seemed to believe that the Labor Department was well within its authority to promulgate not only the new PTE 2020-02 and the ensuing FAQs, except to the extent that in doing so the Labor Department sought to link Title I advice (that to an ERISA plan) and Title II advice (to an IRA).  More specifically, she commented that the “New Interpretation” “exceeded the DOL’s authority under ERISA and constitute arbitrary and capricious interpretations of the five-part test. There is no realistic possibility that the DOL would be able to substantiate this unlawful action if the Court remanded without vacatur. As noted, Congress carefully delineated between the two types of ‘plans,’ and the DOL may not use both Title I and Title II relationships to determine Title I fiduciary status.”

After acknowledging the limits on judicial review of challenges under the APA (Administrative Procedures Act), Judge Rutherford found no reason not to consider the claims made in the suit. She further commented that the plaintiffs had argued that the New Interpretation “must be vacated because it ‘perpetuates the original sin of the 2016 Fiduciary Rule by completely ignoring the historically recognized distinction between fiduciary investment advisers and financial salespeople’ and neglects incorporating the ‘special relationship of trust and confidence’ into the determination of whether financial professionals are acting as investment advice fiduciaries.” They further noted that this “blurred” the distinction between trusted adviser and ordinary salespeople and produced an “expanded definition of fiduciary that exceeds the statutory grant of authority under ERISA.”

The Five-Part ‘Tested’

Judge Rutherford noted that “while the New Interpretation is a complete reversal from the position represented by the Deseret Letter, the withdrawal of the Deseret Letter itself does not modify or change the five-part test; rather, it reinterprets the contexts where the five-part test will apply,” and that “the DOL may adopt or withdraw advisory opinions in order to effectuate ERISA’s mandate to the Secretary of Labor to promulgate exemptions—and, here, the DOL has provided a lengthy and reasoned opinion for doing so.”

That said, Judge Rutherford noted that, while the five-part test requires a “regular basis,” ERISA itself does not. She noted that the “New Interpretation” keeps the regular basis requirement of the five-part test, but it “now also covers rollover transactions if there is a reasonable expectation of ongoing advice from financial professionals to retirement investors, and other portions of the five-part test are met. Accordingly, the New Interpretation appears consistent with ERISA insofar as it covers rollover relationships of trust and confidence.”

That said, she also noted that the New Interpretation “allows for the consideration of fiduciary relationships with both Title I and Title II plans, which is contrary to the text and ERISA’s legal precedents. Accordingly, the New Interpretation conflicts with ERISA, and the portions of the New Interpretation that allow for consideration of relationships that span more than one ERISA plan should be vacated.”

‘Regular Prongs’

As to the “regular basis” prong of the five-part test, Judge Rutherford noted that “the 1975 regulation requires that a person ‘renders any advice . . . on a regular basis to the plan.’ 29 C.F.R. § 2510.3–21(c)(ii)(B). The unambiguous text provides that advice must be provided on a regular basis to the plan, with ‘plan’ being defined by the respective Titles.”

“The precise contours of what constitutes a ‘regular basis to the plan’ need not be defined here,” she wrote, “but the text and structure of the five-part test must mean advice given more than once to a specific Title I or Title II plan,” concluding that “the DOL’s interpretation of its own regulation is in conflict with its own regulation.”

“The DOL cannot read a prospective consideration of future advice spanning different plans when the text of the 1975 five-part test requires a relationship of trust and confidence between financial professionals and an ERISA plan.”

That said, she concluded that the New Interpretation “can stand alone without these provisions—covering those financial professionals who work regularly with a specific Title I plan and also give rollover recommendations to that same Title I plan in a fiduciary manner (or working regularly with a Title II plan and giving advice to that same Title II plan).” She basically recommended removing the “bridge” between advice provided to a Title I plan and subsequent advice that might be rendered to a Title II plan (say, an IRA). “While this might limit the New Interpretation’s impact, courts must decide the cases on the best and narrowest grounds possible,” she wrote. She also concluded that this “crafted relief” was aligned with the recent decision in the Middle District of Florida in the ASA case (“…the Florida court found that policies included in an FAQ that allowed for the regular basis prong to be satisfied through a review of combined Title I and Title II plan relationships were arbitrary and capricious”).  

She further concluded that there was no need to accede to the request for an injunction on the effect of PTE 2020-02, once the “unlawful provisions” are removed. “While Plaintiffs have demonstrated success on the merits, the failure to grant an injunction will not result in irreparable injury. Vacatur of the unlawful portions of the New Interpretation is a sufficient, tailored remedy for Plaintiffs as the vacatur will negate any threat of injurious actions by the DOL,” she wrote.

The Recommendation

“The Court should vacate the portions of PTE 2020-02’s text and preamble that allow consideration of Title II investment advice relationships when determining Title I fiduciary status, including the New Interpretation’s:

(i) allowance of review that a single rollover ‘can be the beginning of an ongoing advice relationship” to Title II plans,’

(ii) inclusion of potential ‘future, ongoing relationships’ to Title II plans, and

(iii) conclusion that ‘an ongoing advisory relationship spanning both the Title I Plan and the IRA satisfies the regular basis prong.’”

“[T]hese provisions exceed the DOL’s authority under ERISA and constitute arbitrary and capricious interpretations of the five-part test to determine whether financial professionals are acting as ‘investment advice fiduciaries.’”

What This Means

This is basically a recommendation, albeit from a federal magistrate, and it’s likely to be given thoughtful consideration by the judge that will actually rule on the suit. It’s not beyond the realm of possibility that that judge might make their own determinations here—but it seems more likely than not that the recommendations here will be adopted. 

In large part, the court backed the Labor Department’s actions in both promulgating the new prohibited transaction exemption (PTE 2020-02), and the follow-up efforts to clarify the import and impact of that regulation, including the decision to discard the interpretation of the Deseret letter.[ii] At least to the point that all of that applied to advice provided to Title I ERISA plans. However, the notion—described in FAQ-07 (that was also challenged in the Florida suit) that said a rollover recommendation could be viewed as the first in a series of transactions that could constitute a “regular basis”—was seen as being beyond the Labor Department’s authority.  

And THAT means that this would be a second federal court holding that the long-standing assessment of what constitutes a “regular basis” would be reinstated—and that while advice to the participant in the plan would continue to carry a fiduciary relationship to a rollover recommendation, a separate rollover recommendation by an advisor without that prior relationship would be a separate matter. 

At least for now.