Senior Vice President, Financial Advisor
Investor Protection: DOL Fiduciary Rule Nixed – SEC Proposes New Regulation
On March 15, the U.S. Court of Appeals for the Fifth Circuit vacated the Department of Labor’s (DOL) fiduciary rule and related prohibited transaction exemptions. Ruling in Chamber of Commerce of the United States of America v. DOL (5th Cir. 2018), the court struck down a lower court decision, finding that the DOL exceeded its authority in issuing the fiduciary regulation and related exemptions.
The decision will become effective when the Court of Appeals issues the mandate in the case, which has not yet happened. The DOL has until June 13 to appeal the decision to the Supreme Court, although it appears unlikely to do so. The Court of Appeals may be waiting for passage of the time to appeal before issuing the mandate to avoid further confusion if the case were to be successfully appealed.
If the DOL does not appeal—or is unsuccessful—it will be as if the rule never existed. It is our understanding this would apply nationwide. The DOL has said that it will not enforce the rule pending review of the 5th Circuit decision. On May 7, 2018, the DOL issued Field Assistance Bulletin 2018-02 which provides that the “Department will not pursue prohibited transactions claims against investment advice fiduciaries who are working diligently and in good faith to comply with the impartial conduct standards for transactions that would be been exempted…” The DOL also foreshadowed their issuance of additional guidance to help un-wind prior reliance on the rule.
The DOL’s earlier ambivalence about implementing the fiduciary rule led some states to adopt their own rules requiring fiduciary standards for the sale of securities in their states. (We reported on the expansive rule in Nevada in a prior edition of the fiduciary update.) Absence of the DOL’s rule may propel additional states to adopt their own, similar rules.
From a plan fiduciary perspective, if the fiduciary rule is vacated, it will be important to understand what changes plan recordkeepers will be making and identify any action that may be appropriate.
Independent of the DOL’s rule, on April 18, the Securities and Exchange Commission issued more than 1,000 pages of proposed regulations and interpretations designed to “enhance the quality and transparency” of investors’ relationships with brokers and investment
advisors. It is noteworthy that the SEC proposal does not seek to redefine who is (and is not) a fiduciary. Rather, it focuses on mandating a “best interest” standard of care along with increased and simplified disclosure. The proposed regulation for brokers is significantly less stringent than the (now apparently vacated) DOL rule in terms of investor protection. Broker disclosures and facts-and-circumstances determinations take the place of clear conflict-of-interest prohibitions. Among other things, the proposed regulation would prevent brokers from referring to themselves as “advisers” or “advisors.”
The SEC proposal was issued on a four-to-one vote, with three of the commissioners who voted for it expressing misgivings about some portion. In the coming months and years, discussions, debates, and suggested revisions of the proposed regulation will undoubtedly follow. The likely form of a final SEC regulation cannot be predicted.
Because qualified retirement plan fiduciaries are under the umbrella of ERISA and the DOL’s regulation and enforcement, the SEC’s proposed regulation would likely have little, if any, direct impact on fiduciary committee responsibility or operations.
DOL Confirms Constraints on Using Economically Targeted Investments
In the waning days of the Obama administration, the DOL issued Interpretive Bulletin (IB) 2016-01 on plan fiduciaries’ responsibilities for shareholder activism and proxy voting. Just a year earlier, the DOL had issued IB 2015-01 to address fiduciary standards in considering economically targeted investments. Both Interpretive Bulletins seemed to embrace a broader use of social activism in connection with retirement plan assets. Most specifically related to IB 2015-01, plan fiduciaries wishing to prudently offer such investment options to their participants were left wanting more clarity.
Clarifying the limited circumstances in which economically targeted investments may be used in retirement plans, on April 23, the DOL issued Field Assistance Bulletin (FAB) 2018-01. The DOL reiterated that “fiduciaries are not permitted to sacrifice investment return or take on additional investment risk as a means of using plan investments to promote collateral social policy goals. . . . Fiduciaries must not too readily treat [socially responsible objectives] as economically relevant. . . . Rather, ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits.”
The DOL also recognized that there may be instances when “otherwise collateral Environmental, Social or Governance (ESG) issues present material business risk or opportunities . . .” such that “these ordinarily collateral issues are themselves appropriate economic considerations, and thus should be considered by a prudent fiduciary along with other relevant economic factors . . .” While still not perfectly clear, the new FAB is another installment in a series of bits of guidance on this evolving investment issue that is growing in popularity among some investors.
The new FAB also notes that proxy and other shareholder activities are appropriate only when there is a reasonable expectation that they will enhance the economic value of the plan’s investments, net of any costs.
Service Provider Not a Fiduciary in Negotiating Fees
Service providers are subject to ERISA’s fiduciary rules only in their fiduciary roles. When negotiating their fees, service providers are not in a fiduciary role. Fiduciary responsibility for the reasonableness of fees rests with the fiduciaries who hire service providers.
Transamerica offered a 401(k) product in which it preselected investments that were then held for multiple clients in a separate account structure. The share classes used were not always the least expensive, and additional fees were charged in connection with creating and maintaining the separate account structure. Fees for the arrangement were fully disclosed. Plan participants sued, alleging fiduciary breaches by Transamerica for, among other things:
- not using the least expensive share classes of investments,
- adding an investment management fee to the underlying fund investment fees, and
- receiving revenue sharing from the underlying investments.
The district court refused Transamerica’s motion to dismiss, believing that the company owed a fiduciary duty in the negotiation of its fees. Transamerica appealed. Consistent with other courts that have considered this issue, the U.S. Court of Appeals for the Ninth Circuit found that Transamerica was not a fiduciary to its 401(k) client plans in setting its fees. Santomenno v. Transamerica Life Insurance Company (9th Cir. 2018)
Participants argued that Transamerica was a fiduciary because it exercised discretion over plan assets by selecting the investments and because it had the authority to change those investments from time to time. Although Transamerica acted as a fiduciary for some aspects of its work, it was not in the setting of its fees. The court noted that plan fiduciaries who agree to an unreasonable fee would themselves be responsible for breaching their fiduciary duty.
Plan Documents and Processes Control—No Exceptions
In early 2012, Ford Motor Company announced that it would offer lump sum distributions to a number of retirees in pay status. Because a large number of pensioners would be involved, Ford established a series of election periods during late 2012 and 2013, noting that they would be randomly assigned and could not be altered. One participant who would receive the opportunity to convert from monthly payments to a lump sum had retired in 2007. Unfortunately, he was diagnosed with terminal cancer at the end of July 2012.
Although the retiree and his wife contacted Ford and let them know of his illness, they were not permitted to change from their assigned election period between December 14, 2012, and March 13, 2013. The retiree died on November 18, 2012. The surviving spouse was later able to claim a lump sum distribution of her survivor benefit under the pension plan. However, it was $465,000 less than the lump sum she and her husband were eligible for before his death. She sued for the shortfall.
The district court found that plan fiduciaries reasonably interpreted the plan and applied the lump sum distribution process in providing only a survivor benefit. The appellate court acknowledged the very difficult facts of the situation. Nonetheless, noting that plan documents and established processes were properly followed, it upheld awarding the lower benefit to the surviving spouse. Strang v. Ford Motor Company General Retirement Plan (6th Cir. 2017)
Employer Life Insurance: Practical Issues with Aging Participants and Additional Coverage
Two recent cases highlight practical fiduciary issues that can arise with employer-provided life insurance:
- Frye v. Metropolitan Life Insurance Company (ED Ark. 2018). An employee’s dependent was covered under optional life insurance coverage. At the time of enrollment, the dependent’s birth date was provided, and, under the terms of the plan, dependent coverage was to end upon reaching age 23. When the dependent reached age 23, the employee was not alerted to termination of the dependent’s coverage, and payroll deductions for the dependent’s coverage continued without interruption. Eighteen months after the dependent reached age 23, he died in a car accident. Following the dependent’s death, the employee filed a claim for life insurance benefits. The claim was denied because the dependent had aged out of coverage. The employer refunded to the employee premiums paid while the dependent was too old to be covered.
The employee sued for the death benefit that would have been due had the insurance been in force. The court found that the employer and the insurance company breached their fiduciary duties by having flawed procedures that harmed the employee: they allowed the employee to pay for coverage on an ineligible dependent. MetLife elected to determine eligibility when claims were made, rather than when coverage was paid for, and the employer did not screen for age. The court noted that, under the plan, the employee had a duty to alert the employer or insurance company about changes in the dependent’s status. However, the predictability of a dependent aging and the employer and insurance company having age information “in hand, or at least handy” outweighed the employee’s responsibility. The employee was awarded an amount equal to the insurance coverage had it been in force. Both the insurance company and the employer were liable.
- Silvia v. MetLife Group (D Neb. 2017). When he first became eligible, an employee elected optional life insurance of two and a half times his annual compensation. Withdrawal of premiums from the employee’s pay began immediately. The plan document required proof of good health before the optional insurance would be effective. However, the plan and summary plan description did not adequately indicate what was required to prove good health. After the employee died, his wife claimed benefits under the optional insurance coverage. The employer and insurance company could not locate proof of good health and denied the claim. The surviving wife sued.
The court found a fiduciary breach by both the employer and MetLife in failing to adequately inform the employee what was required to qualify for the optional life insurance. The court also found that the employer and MetLife were liable for the amount of the optional insurance because they had misled the employee and his wife by withholding and processing the premiums as if coverage was in place. Believing the coverage was in place, the employee and his wife did not get other coverage. This reliance on the reasonable belief that the optional insurance was in place carried the day for the surviving wife.