The Northern District of Texas has ruled new Department of Labor (“DOL”) regulations that would require financial institutions to preserve an investor’s right to bring or participate in a class action do not violate the Federal Arbitration Act (“FAA”). In Chamber of Commerce of the United States of America, et al. v. U.S. Department of Labor, et al., No. 3:16-cv-01476 (N.D. Texas, February 8, 2017), a group of plaintiffs brought a lawsuit challenging new DOL regulations that are scheduled to become effective on April 10, 2017.
The new rules modify the regulation of conflicts of interest in the market for retirement investment advice, and consist of: 1) a new definition of “fiduciary” under ERISA and the Code; 2) an amendment to, and partial revocation of, PTE 84-24; and 3) the creation of the Best Interest Contract Exemption (“BICE”). The first rule revises the definition of “fiduciary” under ERISA and the Code, and eliminates the condition that investment advice must be provided “on a regular basis” to trigger fiduciary duties. The second rule amends PTE 84-24, which provides exemptive relief to fiduciaries who receive third party compensation for transactions involving an ERISA plan or individual retirement account (“IRA”). The DOL excluded those selling fixed indexed annuities (“FIAs”) as eligible for exemptions under amended PTE 84-24. The third rule, BICE, creates a new exemption for FIAs and variable annuities, and allows fiduciaries to receive commissions on the sale of such annuities only if they adhere to certain conditions, including signing a written contract with the consumer that contains enumerated provisions.
Exemptive relief under BICE is not available if the written contract includes: 1) “provisions disclaiming or otherwise limiting liability of the Adviser or Financial Institution for a violation of the contract’s terms,” 2) a provision that “waives or qualifies [the] right to bring or participate in a class action or other representative action,” or 3) a liquidated damages provision. The contract may, however, include provisions that reasonably agree to arbitrate individual claims, knowingly waive punitive damages, and waive the right to rescission of recommended transactions. Such provisions are permitted “to the extent such a waiver is permissible under applicable state or federal law.”
Although the plaintiffs unsuccessfully challenged the DOL regulations on numerous grounds, the federal court addressed their argument that the class waiver provisions violated the FAA near the end of its 81-page memorandum opinion. The Northern District of Texas stated:
The FAA provides that a written provision in any contract that “settle[s] by arbitration a controversy thereafter arising out of such contract…shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” BICE and PTE 84-24 require financial institutions receiving exemptions under them to preserve an investor’s right to bring or participate in a class action. Plaintiffs argue this provision violates the FAA because it conditions the enforceability of arbitration agreements on the particular terms and conditions of the contracts required by each exemption. Plaintiffs’ argument is without merit, as the exemptions’ contract requirements do not render arbitration agreements between a financial institution and investor invalid, revocable, or unenforceable. Institutions and advisers may invoke and enforce arbitration agreements, including terms that waive or qualify the right to bring a class action or any representative action; such contracts remain enforceable, but do not “meet the conditions for relief from the prohibited transaction provisions of ERISA and the Code.” The exemptions, therefore, do not violate the FAA’s primary purpose, which is to “ensure that private arbitration agreements are enforced according to their terms.” AT&T Mobility LLC v. Concepcion, 563 U.S. 333, 344 (2011). This conclusion is also supported by the FINRA Customer Code, which since 1992 has allowed individual arbitration but disallowed class action prohibitions.
The DOL determined the protections associated with class litigation “ensure adherence to the impartial conduct standards and other anti-conflict provisions of the exemptions,” finding the provisions satisfied the three exemption requirements under ERISA and the Code. The requirement fits within the DOL’s authority to grant “conditional or unconditional” exemptions, and do not violate the FAA.
Ultimately, the federal court issued an order granting summary judgment in favor of the DOL. Despite this, there will likely be future developments related to the new regulations. On the same day the Northern District of Texas issued its opinion, the United States Department of Justice filed a motion to stay the proceedings in response to a Presidential Memorandum on Fiduciary Duty Rule issued by the Trump administration on February 3rd.
Hat tip to Merril Hirsh for alerting us to this case!