Oral arguments were heard last week in U.S. District Court forthe District of Kansas on behalf of Market Synergies Group, aTopeka, Kansas-based consortium of 11 independent marketingorganizations that accounted $15 billion worth of fixed indexedannuity sales in 2015 through more than 3,000 independent insuranceagents.

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Related: The good news for FIAs (after the fiduciaryrule)

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In Market Synergies Group, Inc. v. United States Departmentof Labor, the independent marketing organization is not askingthe Kansas court to block the Labor Department’s entire fiduciaryrule — just the provision that affects the regulation of fixed indexed annuities.

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That targeted approach makes Market Synergies’ claim distinctfrom other lawsuits brought against the Labor Department, and couldenhance its chances of success, say two legal experts.

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“The narrowness of the claim is in its favor,” said Leland Beck,a Washington, D.C.-based administrative law expert that spent muchof the past three decades consulting on regulatory matters at theU.S. Department of Homeland Security and the U.S. Department ofJustice.

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“It is much easier for a judge to grant a narrow remedy than abroader one — particularly if there is a substantial benefit in therest of the rule,” added Beck, who is in private practice now.

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A central argument in Market Synergies’ streamlined strategy isthe allegation that the Labor Department failed to give “adequatenotice” of its treatment of fixed indexed annuities required underthe Administrative Procedure Act, the federal law enacted in 1946that sets guidelines for agency rulemaking.

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When the proposed version of the rule was released in 2015,fixed indexed annuities were to be regulated under ProhibitedTransaction Exemption 84-24, a provision of the Employee RetirementIncome Security Act that allows for commissions on the sale offixed indexed annuities.

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Two comment periods and a public open forum ensued. In April of2016, when the final rule was released, the regulation of fixedindexed annuities had been moved to the Best Interest ContractExemption, a new prohibited transaction exemption considered to bemore restrictive to commission-based products by manystakeholders.

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The problem with that, says Market Synergies and others suingthe Labor Department, is that fixed indexed annuity providers, andthe independent marketing organizations that market fixed indexedannuities, had no idea the Labor Department was considering such amove, and were not given the opportunity — or adequate notice— to comment on the effect moving fixed indexedannuities to the Best Interest Contract Exemption would haveon industry.

Was the move to BIC a harmless error?

The APA requires federal agencies to provide public notice ofproposed regulations, and give affected industries the opportunityto comment on the rules.

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According to a brief on the APA published by the American BarAssociation, any “agency change from the original proposal willrequire additional notice and comment unless the change is a‘logical outgrowth’ of the proposal.”

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The same brief describes a provision of the APA that instructscourts to consider the “harmless error” principle if a regulationis challenged on the grounds that stakeholders were not given fairnotice to comment on a change in the final rule from theproposal.

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The Bar Association’s brief says agencies often argue that theirfailure to follow required comment procedures was harmless,“typically because they would have reached the same resultanyway.”

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In the oral arguments heard in Kansas last week, lawyers fromthe Justice Department and Labor Department raised the harmlesserror principle before U.S. Judge Daniel Crabtree.

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Effectively, government attorneys were asking the court toconsider the harmlessness of moving fixed indexed annuities tothe Best Interest Contract Exemption, if indeed the court foundstakeholders did not have adequate opportunity to comment on themove, according to Erin Sweeney, an ERISA attorney with Miller andChevalier.

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“The fact that DOL raised it was significant,” said Sweeney inan interview. “To take up their limited time telegraphs that theDOL is concerned it is a big enough problem that they want thejudge to be clear: if the notice on FIAs was not adequate, he hasto consider if there ultimately is harm in that.”

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Sweeney thinks the fact that the Labor Department raised thespecter of the harmless error principle “came right to the edge” ofan admission on the part of the government that regulators did notdo a good enough job communicating the fate of fixed indexedannuities in the final rule.

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“That speaks loudly to me,” added Sweeney. “It says to me theDOL thinks they are on shaky ground.”

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Leland Beck said that in raising the harmless error principle,attorneys for the government were arguing that the Labor Departmentwould have made the same decision on fixed indexedannuities no matter what comments were provided, had industryhad the chance to offer them.

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“That is arrogant at best,” said Beck. “Failure to give notice(to comment) is not a harmless error. The plaintiffs have beendeprived of their right to comment on a proposed rule.”

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For that reason, plaintiffs have a good argument that theprovision of the rule impacting fixed indexed annuities shouldbe vacated, according to Beck.

Market Synergies asked DOL to prove adequate notice tocomment

During the hearing, attorneys for Market Synergies asked theLabor Department to provide proof that annuity providers andindependent marketing organizations were given adequate notice tocomment on the provision moving the regulation of fixed indexedannuities to the Best Interest Contract Exemption.

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Attorneys for the government produced 20 comment letters fromindustry, stakeholders and three attorneys, according to Sweeney,who attended the hearing.

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Nine of those comment letters were focused on the treatment ofvariable annuities under the proposed rule, not on fixed indexedannuities. Another five comment letters were in support of theproposed rule’s treatment of fixed indexed annuities under PTE84-24.

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Only one comment letter, from Mercer Bullard, a securitiesexpert, former assistant chief counsel at the Security and ExchangeCommission, and a strong supporter of a uniform, industry-widefiduciary standard, suggested the Labor Department should changethe proposed rule, and regulate fixed indexed annuities underthe Best Interest Contract exemption.

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Sweeney says the absence of comment letters from independentmarketing organizations was conspicuous, and evidence that theLabor Department did not give adequate notice for industry tocomment on treatment of fixed indexed annuities in the finalrule.

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“The FIA market has a lot of big guns,” said Sweeney. “There areabout 200 IMOs in the country. Had they seen this coming they eachwould have submitted a comment letter. But the record is silentbecause no one saw this coming — if industry had expected thisthey would have hammered their position home in commentletters.”

Handicapping Market Synergies' chances

In National Association for Fixed AnnuityProviders v. Thomas E. Perez, recently argued inU.S. District Court for the District of Columbia, the plaintiffsraised similar claims to Market Strategies’, but are seeking aninjunction against the entire rule, a much more substantial outcomethan would be an injunction against one provision of the rule.

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In Chamber of Commerce of USA, et al. v Thomas E. Perez etal., which is scheduled for a November hearing in the NorthernDistrict of Texas, a collection of industry trade associations isalso seeking to have the entire rule thrown out. That lawsuit makeseight allegations under several laws, including a First Amendmentclaim. It also raises the question of the treatment of fixedindexed annuities under the final rule, and whether regulatorsfailed the requirements of the APA.

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Over his long career in administrative law, Beck has seen theharmless error principle invoked countless times.

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Still, the long body of decisions offers little indication ofhow Crabtree, a 2014 Obama administration appointee, will rule.

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“The evaluation is always fact specific,” said Beck. Some courtshave found significant violations of APA to be harmless, and othershave found minimal harm enough to stay some rulemaking, hesaid.

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Beck says the burden the government carries in the threelawsuits against the Labor Department rule is considerable.

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“An order to vacate the provision under the APA would be anation-wide order,” noted Beck. “Industry only needs to win in onecourt — the government needs to win in every court. Thatis the cross the government bears.”

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Nick Thornton

Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.