The Department of Labor’s recent Proposed Rule, which defines the term "fiduciary" as it applies to persons who provide "investment advice" to ERISA plans and IRAs, will impact the likelihood and severity of fiduciary litigation against life insurers and their agents. This article summarizes that potential impact, and will be supplemented periodically with updates focused on particular elements of the Proposed Rule not covered here.

As promulgated, the Proposed Rule would make significant changes to the two key fiduciary features of ERISA legislation: (1) fiduciary status; and, (2) fiduciary standards. The Proposed Rule creates a new and complex construct for the continued sale of variable and fixed annuities and mutual funds, among other products, particularly in the IRA plan market. If enacted, it will require a costly "compliance" structure imposing new duties on insurance agents, brokers, and the insurers they represent. From a litigation analysis perspective, it is most relevant that insurers face a serious potential increase in litigation or arbitration as a result of the Proposed Rule’s new definition of "investment advice" coupled with a corresponding expansion of the definition of a "fiduciary," and a proposal, with respect to variable products (and potentially fixed as well) to effectively legislate a new cause of action for ERISA and IRA plans, participants, and owners.

The Proposed Rule

The Proposed Rule would sweep into the definition of an investment advisory fiduciary any person who, "in exchange for a fee," provides any of the four specified categories of advice:

  1. Advisability of acquiring, holding, disposing of, or exchanging securities or other property, including a recommendation to take distribution or to take a rollover from the plan to an IRA or a recommendation regarding investments to be made with rollover monies;
  2. Recommendations as to management of plan assets, including assets to be rolled over into an IRA;
  3. Appraisals, fairness opinions or similar, if provided in connection with specific transactions involving plan or IRA assets; and,
  4. Recommending someone else, for a fee, to provide any of the types of advice described in 1 or 2, above.

The Proposed Rule focuses largely, although not exclusively, on the advice and sales practices of parties in the IRA marketplace. The Proposed Rule defines "recommendation" as "a communication that, based on its content, context, and presentation would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action."

Since it is clear that annuities or life insurance used to fund an IRA or other benefit plan will be treated as "other property" for purposes of the definition of "investment advice," we can therefore safely assume that many of what today are normal sales transactions between a plan or IRA owner, participant or trustee and an insurance agent, where neither likely would view the insurance agent as a fiduciary, will likely meet the definition of a transaction involving an "investment advisory fiduciary."

The Proposed Rule also contains an exemption, the "Best Interest Contract Exemption," pursuant to which agents and brokers will be permitted to receive compensation as a fiduciary. However, the contract itself will expand on the duties imposed on such agents and the "firms" they represent by creating certain contract obligations on persons who sell variable annuities or mutual funds they would not otherwise have.

The "Best Interest Contract Exemption" Under the Proposal

To meet the "principles" underlying the Best Interest Contract Exemption, the DOL requires a series of actions by the investment advisory fiduciary and the firm being represented by that fiduciary, including that they (1) contractually acknowledge fiduciary status, (2) commit to basic standards of impartial conduct, (3) warrant compliance with state and federal laws, and (4) provide disclosure and "mitigate" conflicts of interest. The DOL intends that this "contract" will enable IRA investors to "hold their fiduciary advisers accountable if they violate basic obligations of prudence and loyalty."

The Change in Fiduciary Status

Under current case law applying either ERISA or the common law, the sale of an annuity to a prospective IRA purchaser or ERISA plan will not, absent unusual circumstances, constitute providing investment advice for a fee. Since adoption of the 1975 Rule, courts have held that fiduciary liability does not apply to insurance agents or the companies they represent merely when the conduct involves exclusively or primarily the sale of an insurance or annuity contract. Such results have been premised both on grounds of a failure to demonstrate that the salesperson had the requisite statutory discretion to be a fiduciary and also on the basis that the sales agent was not rendering "investment advice." As the Fifth Circuit Court of Appeals said in 1988:

Simply urging the purchase of its products does not make an insurance company an ERISA fiduciary with respect to those products.

From a litigation perspective, this change to a fiduciary status for the sales agent is substantial and in many cases will afford litigants unhappy with investment results, or the ultimate characteristics of a particular form of annuity, the opportunity to second guess the original decision applying a significant range of issues. One potential saving grace, depending on one’s view of the desirability of "arbitration," is that it is permissible to limit disputes under the contract to arbitration.

Assuming that the "firm" referenced in the "contract" required under the exemption signed with the IRA purchaser or ERISA plan is an insurer, then to comply with the terms of the exemption, the insurer will be required to meet the obligations set forth therein. This includes acknowledging fiduciary status, committing to basic standards of impartial conduct, warranting compliance with federal and state law, adopting policies and procedures reasonably designed to mitigate any harmful impact of conflicts of interest, and disclosing basic information on conflicts and costs of the advice.

Future Impact

Clearly the Proposed Rule will have a significant impact on the marketing of annuities and other investment products into ERISA plans and IRAs and the consequential potential litigation under fiduciary and other standards that will apply in those circumstances that qualify as rendering "investment advice." In addition, the development of a separate cause of action, both for fiduciary breaches and potential breach of contract claims, raises numerous unanswered questions.