Securities Litigation

The U.S. Department of Labor ("DOL") recently heard public comment[1] to its proposed regulatory changes implementing a fiduciary duty on any individual receiving compensation for advice tailored to a plan sponsor, participant or individual retirement account owner if that advice seeks to assist the recipient in retirement planning decisions.[2] Currently, a customer does not have a specific private right of action for a breach of contract or a breach of fiduciary duty toward the investment selections within an ERISA plan or an individual retirement account. Put another way, the insurance agent or broker selling mutual funds, annuities or other investment products inside of an IRA was only exposed to liability for the selection of those products under a suitability standard. Under the proposed regulation, a higher fiduciary standard will require heightened scrutiny from financial institutions for the sale of investment securities or contracts unless those investments qualify for certain exemptions to the proposed rule changes.[3] Chief among those exemptions, is the Best Interest Contract Exemption ("BICE"). Unless financial institutions or broker-dealer firms and insurance companies meet the necessary exemption requirements, the compensation received for the sale of the investment contracts or securities within a retirement plan must be level and not authorize additional revenue sharing or other forms of soft dollar compensation. By shifting from the "sole interest" standard under ERISA to the "best interest" standard, it appears the DOL seeks to broaden the exemption; however, in doing so the DOL may be creating even more potential conflicts of interest under the fiduciary duty standard. For instance, what type of contractual language must a financial institution include to meet the potential BICE standards for the sale of a variable annuity or an equity indexed annuity to a consumer? Would up front commissions on the sale of this type of product (typically between 5-9%) still be considered reasonable? What does this do to the separate classes for mutual fund shares under 12B-1 fees? Because additional compensation may be received only if a "prohibited transaction exemption" exists within the ERISA based plan (defined contribution plans such as 401k or 403b plans) or within any type of IRA, how does the financial institution assist in making a determination of what is in the "best interest" as it is defined by the proposed promulgated rules?[4] The proposed definition requires the advisor and firm "under the prevailing circumstances" to act "with the care, skill, prudence and diligence that a prudent person would exercise based on the investment objectives, risk tolerance, financial circumstances, and the needs of the Retirement Investor." Applying this reasonable person standard to financial institutions for the investment selection process in retirement accounts may broaden exposure unless a company provides complete disclosure of all revenue generation arrangements to the investor. Financial institutions will be required to include summary charts and other documented forms of point of sale disclosures to the individual consumer for a recommended investment. Arguably, point of sale disclosures will apply to insurance and annuity contracts regardless of whether they are considered securities under federal securities law. This change may negate defense arguments regarding the applicability of securities laws to certain investment products. Otherwise, a new private right of action for breach of a fiduciary duty because of a conflict of interest regarding undisclosed soft dollar commissions or other related revenue sharing agreements may be available to plaintiff's counsel under the new regulation. [1] Ron A. Rhoades, My Testimony Before the U.S. Dept. of Labor re: Conflicts of Interest Proposed Rule (August 11, 2015) http://scholarfp.blogspot.com/. [2] William H. Byrnes and Robert Bloink, Exemptions Provide Key to Unlocking DOL Fiduciary Rules (May 18, 2015), http://www.thinkadvisor.com/2015/05/18/exemptions-provide-key-to-unlocking-dol-fiduciary. [3] Daniel Solin, The Hidden Provision in the Department of Labor's Proposed Fiduciary Rule (May 8, 2015), http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2015/05/08/the-hidden-provision-in-the-department-of-labors-proposed-fiduciary-rule. [4] Ron A. Rhoades, DOL Fiduciary Rule Proposal: Questions for Readers (May 17, 2015) http://scholarfp.blogspot.com/2015/05/dol-fiduciary-rule-proposal-questions.html.