June 10, 2016

Rules In Focus: FSR Joins Lawsuit to Overturn DOL Rule on Definition of Fiduciary

FSR, along with eight trade associations (Associations), filed a legal challenge on June 1 to the Department of Labor’s Final Fiduciary Rule (Rule) and related prohibited transaction exemptions (PTEs). In the lawsuit, the Associations allege the “Rule and PTEs overstep the Department’s authority, create unwarranted burdens and liabilities, would undermine the interests of retirement savers, and are contrary to law.”

Rules In Focus: FSR Joins Lawsuit to Overturn DOL Rule on Definition of Fiduciary
Share This

Rules In Focus

Rules in Focus is FSR’s regulatory newsletter featuring the latest insights from the Fed, CFPB, SEC and other major regulators that oversee the financial services industry and the implementation of the Dodd Frank law.

FSR Regulatory Updates

Investment Management

Lending & Leasing

Risk Management

Other News

FSR Joins Lawsuit to Overturn DOL Rule on Definition of Fiduciary

FSR, along with eight trade associations (Associations), filed a legal challenge on June 1 to the Department of Labor’s Final Fiduciary Rule (Rule) and related prohibited transaction exemptions (PTEs). In the lawsuit, the Associations allege the “Rule and PTEs overstep the Department’s authority, create unwarranted burdens and liabilities, would undermine the interests of retirement savers, and are contrary to law.”

The Associations also note in the lawsuit the industry’s commitment to serve the best interest of customers, and reaffirm their support and that of their members for the Securities and Exchange Commission to adopt a uniform “best interest” standard of care for broker-dealers and investment advisers in accordance with the authority granted to the SEC in section 913(g) of the Dodd-Frank Act (Act).

The lawsuit identifies several flaws in the Rule and the PTEs. First, the lawsuit notes that in establishing a new standard of care for broker-dealers, DoL “encroaches on responsibilities Congress gave to the SEC” to regulate broker-dealers under federal securities laws and the Act. For example, the Act specifically authorized the SEC to establish a fiduciary standard for broker-dealers and investment advisers that provide advice on securities to individuals. DoL’s treatment of commission-based compensation, proprietary products, and sales activity is inconsistent with these laws.

Second, DoL’s overly-broad definition of investment-advice “fiduciary” conflicts with ERISA, and encompasses “a wide range of activities that have never been understood to be fiduciary activities under the law of trusts, Investment Advisers Act of 1940, ERISA, or otherwise.” As the lawsuit notes, “sales activity” is distinct from fiduciary activity, which arises out of a “special relationship marked by trust and confidence between the parties.”

Third, DoL “misused its exemptive authority to create a private right of action and regulate IRAs and the broker-dealers who offer them.” DoL acknowledged that it created a private right of action in the Best Interest Contract Exemption and Principal Transaction Exemption to provide an enforcement “mechanism” for IRA owners because these investors do not have an independent statutory right to sue fiduciaries for violation of prohibited transaction rules. The lawsuit notes, however, that Congress did not confer authority on DOL to create the private right of action.

Fourth, DoL also unlawfully banned class action waivers in arbitration agreements. The lawsuit notes the strong federal policy in the Federal Arbitration Act that favors arbitration, and a recent Supreme Court decision holding that “conditioning the enforceability of an arbitration contract on the availability of class procedures . . . is prohibited by the FAA.”

Fifth, DoL regulated fixed-indexed annuities in a manner contrary to Congress’ intent in the Dodd-Frank Act. Under the Act, Congress excluded fixed-indexed annuities from regulation by the SEC if the products met certain state insurance regulatory requirements. DoL also failed to give adequate notice that it intended to amend PTE 84-24 to exclude fixed-indexed annuities and group variable annuities from coverage by the exemption, and provide firms an opportunity to explain why it would be impractical to offer these products under the Best Interest Contract Exemption.

Sixth, DoL inadequately evaluated the costs and benefits of the Rule. The lawsuit notes that DoL failed to assess the impact of the Rule on guaranteed lifetime income products—including the value and availability of these products to consumers or the impact on the insurance companies that provide these products. The lawsuit notes that the DoL admitted the Rule’s costs will fall disproportionately on U.S. small businesses. The lawsuit further notes that the benefits of the rule “might barely exceed costs,” based on DoL’s estimates. For example, over a 10-year period, the DoL’s estimated compliance costs of $31.5 billion and benefits on the low-end of $33 billion. Even with the flawed cost estimates, the “possible net benefit . . . is thus potentially only $1.5 billion, an amount that could easily be overwhelmed by the loss of even a small fraction of the potential broker benefits associated with portfolio rebalancing and discouragement of investor market disruption,” according to estimates in an Economists Incorporated study.

Seventh, the Rule, and the Best Interest Contract Exemption impermissibly burden truthful and Constitutionally-protected speech in violation of the First Amendment. The lawsuit notes that the regulation improperly abridges the right to engage in truthful, non-misleading speech by prohibiting this speech if it does not occur in “a fiduciary relationship subject to definitions, limitations, and burdens created by the [DoL].”

The lawsuit seeks, in part, an order and judgment (1) vacating the Rule and related PTEs under the Administrative Procedure Act and the First Amendment to the U.S. Constitution; (2) enjoining DoL’s implementation or enforcement of the Rule; (3) postponing the effective date of the Rule and PTEs; and (4) maintaining the status quo pending conclusion of this case.

In addition to FSR, the plaintiff Associations in the lawsuit are the Chamber of Commerce of the United States of America, Financial Services Institute, Greater Irving-Las Colinas Chamber of Commerce, Humble Area Chamber of Commerce DBA Lake Houston Area Chamber of Commerce, Insured Retirement Institute, Lubbock Chamber of Commerce, Securities Industry and Financial Markets Association, and Texas Association of Business.

A copy of the complaint filed with the U.S. District Court for the Northern District of Texas is here.

Plaintiffs representing the insurance industry subsequently filed legal challenges to the DoL’s fiduciary regulation: (1) National Association for Fixed Annuities, filed June 2 in the U.S. District Court for the District of Columbia, complaint and preliminary injunction motion; (2) Market Synergy Group, filed June 8 in the U.S. District Court for the District of Kansas, complaint; (3) American Council of Life Insurers, et al., filed June 8 in the U.S. District Court for the Northern District of Texas, complaint; and (4) Indexed Annuity Leadership Council, filed June 8 in the U.S. District Court for the Northern District of Texas, complaint.

For more information, please contact Felicia Smith,

Industry Suggests Changes to Federal Reserve Rules on Lending Limits

On June 3, FSR in cooperation with The Clearing House Association, as well as three other industry trade associations, filed a comment letter with the Board of Governors of the Federal Reserve System in response to the Board’s notice of proposed rulemaking implementing the single-counterparty credit limits (“SCCL”) for domestic and foreign bank holding companies with total consolidated assets of $50 billion or more. While the letter stresses that this proposed rulemaking is a substantial improvement over the Federal Reserve’s initial 2011 proposed rule, FSR, and the other associations hold that there are still significant flaws and weaknesses in the reproposal that should be addressed before any final adoption of an SCCL.

This reproposal seeks to implement Section 165(e) of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which requires the Federal Reserve to prescribe standards that limit “the risks that the failure of any individual company could pose” to a bank holding company with total consolidated assets of $50+ billion or to a systemically-important nonbank financial company. In the letter, the associations noted their support of improvements in the proposal that allow for more risk-sensitive measurements of derivatives and other transactions, and SCCL exemptions for exposures to certain sovereign issuers and qualifying central counterparties. However, the letter also notes that the reproposal would still establish a framework that is too operationally complex.

The associations recommended in the letter that the elements of the SCCL proposed rule should be evaluated on a cost-benefit basis. In particular, the comment letter stressed that the current reproposal overstated the credit risk associated with securities financing and other transactions and that it imposed more stringent restrictions on certain covered companies without a sound analytical basis. To remedy this, the associations suggested that the SCCL rules be more aligned with related regulatory regimes to avoid the creation of unnecessary gaps. The letter also suggested a number of changes intended to provide a more risk-sensitive and risk-based approach to identifying and measuring certain exposures subject to the SCCL.

In regards to existing regulatory regimes, the comment letter noted that in the last several years there have been a number of micro and macroprudential rules enacted by the Federal Reserve that already address many of the underlying concerns in the reproposal. Specifically, the G-SIB capital surcharge, Dodd-Frank Title II Orderly Liquidation Authority, resolution planning, the ISDA resolution stay protocol, Total Loss Absorbing Capacity (TLAC) requirements, and other rules and regulations have helped to reduce interconnectedness among financial institutions. These rules and regulations have also aided the reproposal’s goal of substantially reducing the probability and potential systemic impact of the failure of a systemically important financial institution.

The comment letter specifically recommended that any final SCCL rule craft a clear and consistent risk-based framework that is not so complex as to make it difficult for covered companies to provide economically beneficial products and services to customers. It also recommended that the Federal Reserve refrain from creating any new limitations on exposures that are critical to the proper functioning of banking and financial markets through the final rule, while also encouraging risk management practices that enhance the safety and soundness of covered companies.

For more information, please contact Robert Hatch,

FSR Letter Highlights Possible Impact of Federal Reserve Counterparty Rules on Insurance Companies

In addition to the above reference join-trade comment letter on single-counterparty credit limits (“SCCL”) FSR also filed a letter focused specifically on the potential impact of the rule on non-bank systemically important financial institutions (“SIFIs”) in the insurance industry.

While the current reproposal would not generally apply to insurance companies designated as SIFIs, the Federal Reserve has indicated that it intends to apply “similar” SCCL requirements to non-banks financial companies designed as SIFIs in a future rulemaking or order. In the comment letter, FSR highlights a number of issues that the Federal Reserve should consider in adapting and applying an SCCL requirement to Insurance SIFIs, including both general concerns shared with banking organizations as well as concerns independent to the insurance industry.

The comment letter lists a number of specific insurance company issues that the Federal Reserve should consider as part of a future SCCL rulemaking. First, FSR stresses that any future SCCL applicable to Insurance SIFIs should exclude foreign sovereign exposures as these holdings are required under the laws of many foreign jurisdictions. Second, the comment letter notes that short-dated exposures, including cash management exposures, resulting from payment, clearing and settlement activities should also be excluded from SCCL requirements.

Additionally, the comment letter identifies how the determination of an Insurance SIFIs’ capital base eligibility would be problematic under the current SCCL rules. It also highlights the lack of clarity in how separate accounts of insurance companies would be treated for SCCL purposes. The letter also discusses how the current SCCL proposal does not take into account reinsurance exposures, as well as if an Insurance SIFI can, in fact, be deemed a major counterparty of a global systemically important bank.

For more information, please contact Robert Hatch,

FSR Urges OCC to Take Steps to Allow Innovation

On May 31 FSR and BITS filed a comment letter in response to the Office of Comptroller of the Currency’s (“OCC”) white paper, “Supporting Responsible Innovation in the Federal Banking System.” In the letter, FSR applauds the OCC’s efforts to address technological change in the financial services industry, yet urges the agency to allow experimentation, develop clear and consistent regulations, and work with other agencies and trade groups to facilitate innovation.

FSR comments note that in the face of rapidly evolving technologies, the financial services industry must continually innovate to meet evolving consumer expectations. As such, FSR’s comment letter outlines areas where the OCC and other regulators can improve its approach to financial technology innovations.

First, the letter urges the OCC and other federal oversight agencies to work together to provide clear administrative guidelines. FSR supports OCC’s plan to update and clarify guidance on how the agency would assess certain technological innovations in light of Community Reinvestment Act requirements. This guidance would be especially beneficial to smaller banks. Furthermore, the OCC should work with other agencies to promote consistent regulatory interpretations and applications. In doing so, financial institutions can then pursue innovation without encountering disparate rules. The OCC should clarify and regulate in a conservative manner, first focusing on removing “overt regulatory gaps.”

Second, the OCC should facilitate responsible innovation by supporting financial service providers’ experimentation with new technology. FSR suggests that in order for the industry to develop new technology – lasting beyond the next fad or trend – the industry must experiment with new strategies and tools. FSR and BITS specifically urge the OCC to adjust its outlook to allow some uncertainty, a natural product of innovation, in order to facilitate beneficial change.

Third, the letter urges the OCC to establish advisory committees across agencies to monitor and assess innovations and engage in dialogue about technology-related matters.

Fourth, while FSR supports the OCC’s establishment of a centralized office of innovation, FSR warns that in order for the office to be efficient, it must be funded and staffed appropriately. The staff should be up-to-date on private sector technological innovations, and the office should make the licensing and supervisory processes easier, not add additional red tape.

Fifth, FSR recommends that the OCC create a website that is a “one-stop-shop” for guidance on the agency’s expectations regarding innovation. Additionally, the OCC should partner with other agencies to educate private companies and the general public on safeguard requirements.

Sixth, the OCC should encourage innovation by sharing information through sector and innovator conferences and forums, including events sponsored by BITS and FSR. The OCC should also consider outreach to engineering universities and other conferences.

For more information, please contact Josh Magri,

Federal Reserve Releases Proposed Capital Regulations for Insurance Companies

On June 3, the Federal Reserve Board voted to approve two regulatory releases that provide information on how the Board will seek to exercise its regulatory authority over the insurance firms that it supervises.

One document is an advanced notice of proposed rulemaking (ANPR) on capital levels for insurance companies that own a thrift affiliate (Insurance SLHCs) or companies that have been designated as “systemically import” by the Financial Stability Oversight Council (Insurance SIFIs).

The ANPR contemplates using a “Building Block Approach” (BBA) for the capital requirements of Insurance SLHCs. The BBA aggregates the capital resources and capital requirements of the different legal entities that exist within an Insurance SLHC. As a result, the core of the BBA will derive from state level capital requirements and as necessary any foreign insurance supervisors. Any non-insurance or non-regulated legal entities within the group would be subject to the Federal Reserve’s current capital rules for banking entities. Because different capital regimes entail differing requirements, the ANPR asks for public comments on scalars that could be used to standardize capital inputs from different jurisdictions.

The ANPR notes several advantages to the proposal, including the fact that it can be implemented relatively quickly and that it is sensitive to the needs of different insurance business lines.

The ANPR contemplates using a “Consolidated Approach” (CA) for Insurance SIFIs. The CA would categorize insurance liabilities and assets into specific risk segments and determine what equity instruments will qualify as acceptable capital. Different risk segments would generally track the difference segments that are common in the insurance industry. A different risk factor would be applied to each segment to create consolidated risk-weighted insurance amount.

Many key features of the CA approach are left undefined. The Federal Reserve specifically asks for comments on the appropriate definition of qualifying capital, how exposures should be segmented, applicable requirements for off-balance sheet exposures, the risk factor that should apply to each segment, and the actual ratio amount that will make an insurance SIFI adequately capitalized.

The Federal Reserve Board also released an NPR that would establish certain enhanced prudential standards for non-bank insurance SIFIs. Unlike the capital standards ANPR, this second proposal sets forth actual qualitative management standards that insurance SIFIs will be required to integrate into their risk management and capital management control systems.

Standards in the NPR include the requirement that covered institutions create an independent risk committee, name a Chief Risk Officer and Chief Actuary, administer a consolidated risk management framework, and implement a variety of liquidity risk management controls. The proposed liquidity controls include creating comprehensive cash flow projections, contingency funding plans, and liquidity risk limits. The proposal also includes requirements on collateral risk monitoring and liquidity stress testing, though the elements of those stress tests are different then the requirements that are applied to banking institutions.

Public comments will be accepted on both of these proposals until August 2.

For more information, please contact Robert Hatch,

FSR, Other Associations, Ask for More Time to Respond to Proposed Rule on Executive Compensation

FSR, in cooperation with the American Bankers Association, Center for Executive Compensation, Securities Industry and Financial Markets Association, and U.S Chamber Commerce have expressed concern over a truncated timeline to respond to a wide ranging regulatory proposal that would limit the employee bonuses of certain financial services employees. Versions of the proposal are being considered by six different regulatory agencies. All are requested comments to be filed by July 22.

In a June 1 letter to the agencies on this issue, the industry associations noted that although a deadline had been set for comments, the proposal had been yet to be published in the Federal Register. As the official version of the proposal has yet to have been released, institutions that are covered under the rules are still not in a strong position to provide their response on the full scope of the rule. To remedy this problem, the letter asks that the public have at least 150 days to comment on the rule after it has been released. The letter notes that the requested comment period would be in keeping with past comment periods on important regulatory proposals.

For more information, please contact Robert Hatch,

Industry Files Comment on Basel Proposal on Operational Risk

The Financial Services Roundtable, the Clearing House Association L.L.C., and the Securities Industry and Financial Markets Association, on June 3, sent a comment letter to the Basel Committee on Banking Supervision in response to the committee’s March 2016 consultative document, “Standardised Measurement Approach to operational risk”. In the letter, the associations expressed support for the Committee’s withdrawal of the Advanced Measurement Approaches for operational risk and its replacement with a Standardized Measurement Approach (“SMA”) that would provide a more stable and less complex standardized measure of operational risk that would promote greater comparability and be appropriately risk-sensitive.

The associations note that the SMA has room for improvement. In order to prevent it from being empirically ungrounded and/or insufficiently risk-sensitive, the associations suggested in the comment letter that the Committee focus on two key objectives. The first objective is that any standardized measure of operational risk should be meaningfully calibrated and supported by robust empirical data. The second is that any firm specific adjustments should reflect the existing operational risk environment of individual banking organizations, and not merely historical risk experiences.

The comment letter identifies two weaknesses that would result in the SMA effectively requiring banking organizations to hold capital based on size and historical experience, rather than against operational risk as it is designed to do. The first weakness is that the currently proposed SMA would use a Loss Component that is backward-looking and therefore does not reflect the current risk environment, but instead reflects historical loss experiences which may or may not be relevant to current operational risks. The second weakness is that the SMA would rely on the Business Indicator component, a simplistic financial statement-based measure of operational risk that would ignore meaningful differences in operational risk between financial institutions and instead focus on bank size.

To address these shortcomings, the comment letter suggests that the Committee adopt a range of small but effective changes that would make the SMA meaningfully risk-sensitive and better reflect the current operational risk profile of financial institutions subject to it. These include changes to how the Loss Component and Business Indicator components are calculated, as well as full disclosure from the Committee on how the SMA is calibrated and what data was used for that calibration. The associations conclude that these steps would ensure that the promising conceptual framework of the SMA is implemented in a way that is empirically tethered, appropriately risk-sensitive and transparently calibrated.

For more information, please contact Robert Hatch,

House Financial Services Chairman Outlines Plan to Replace Dodd-Frank

Congressman Jeb Hensarling (R-TX), Chairman of the House Committee on Financial Services, delivered a speech on June 7 unveiling the Financial CHOICE Act, the Republican plan to replace the Dodd-Frank Act. In his speech to the Economic Club of New York, Chairman Hensarling outlined the key points of the proposal, the full legislative text of which will be available in the next few weeks.

The Chairman began his speech by stating that Dodd-Frank has been a failure, has increased the concentration of big banks, and has helped cripple the economic recovery through burdensome regulations. The Chairman also claimed that Dodd-Frank has codified bailouts and made them more likely by explicitly or implicitly guaranteeing financial sector liabilities.

The Financial CHOICE Act seeks to replace Dodd-Frank with a number of House and Committee passed bills as well as other proposals that aim to accomplish seven key objectives. The proposal would repeal the Financial Stability Oversight Council’s SIFI designation process and replace it with a new chapter of Bankruptcy Code. Other objectives contained in the Financial CHOICE Act include the ability for banks to opt out of Dodd-Frank and Basel III regulations if they meet stringent capital levels as well as reforms aimed at replacing the CFPB’s single director with a bi-partisan commission.

Chairman Hensarling also detailed plans to demand accountability by subjecting financial regulators to enhanced Congressional and Judicial oversight. The bill would also demand accountability from financial firms by increasing penalties for fraud and deception. In addition, the Financial CHOICE Act would incorporate more than two dozen House or Committee-passed bills that would encourage capital formation in order to increase economic growth. Lastly, the bill would provide regulatory relief for small businesses and community banks by exempting them from supposedly unneeded regulations.
The Chairman concluded his speech by stating that the Financial CHOICE Act would increase economic growth in this country, beginning by repealing Dodd-Frank. Chairman Hensarling emphasized that increased capital formation and more streamlined regulatory procedures are needed in order to increase economic growth. In a question and answer session following his speech, Chairman Hensarling acknowledged that while this proposal may not be passed in this legislative year, it was a clear example of a serious legislative idea that House Republicans have for encouraging and improving economic growth in the U.S. today.

For more information, please contact Rich Foster,