On March 15, 2018, in a 2-1 decision, a 3-judge panel of the Fifth Circuit Court of Appeals ruled for plaintiffs in Chamber Of Commerce of the United States of America, et al. v. United States Department of Labor, vacating in toto the Department of Labor’s Fiduciary Rule. In this article we briefly review the decision and consider its implications.
After considerable controversy, in April 2016 DOL finalized (quoting the court) “an overhaul of the investment advice fiduciary definition, together with amendments to six existing exemptions and two new exemptions to the prohibited transaction provision in both ERISA and the [Tax] Code.” The regulation “package” implementing this overhaul is generally called the “Fiduciary Rule.”
On February 3, 2017, President Trump issued an executive memorandum instructing DOL to “examine the Fiduciary Duty Rule to determine whether it may adversely affect the ability of Americans to gain access to retirement information and financial advice.” DOL was instructed to consider whether the rule: (i) “has harmed or is likely to harm investors due to a reduction of Americans’ access to certain retirement savings offerings;” (ii) “has resulted in dislocations or disruptions within the retirement services industry;” and (iii) “is likely to cause an increase in litigation, and an increase in the prices that investors and retirees must pay.”
On April 7, 2017, DOL delayed the rule’s applicability date until June 9, 2017. DOL also delayed compliance with certain requirements of the Best Interest Contract Exemption (BICE) (and other exemptions) that were part of its “regulation package” until January 1, 2018 (the “limited applicability period”). Until that date, “fiduciaries relying on these exemptions for covered transactions [are required to] adhere only to the Impartial Conduct Standards (including the “best interest” standard), as conditions of the exemptions.” Thus, generally, the exemptions’ written contract, disclosure and pay policy requirements do not apply during the limited applicability period. On November 27, 2017, DOL finalized a regulation extending the limited applicability period another 18 months, to July 1, 2019.
In 2016, the U.S. Chamber of Commerce, the American Council of Life Insurers, and the Indexed Annuity Leadership Council filed a lawsuit in the United States District Court for the Northern District of Texas (Dallas Division) challenging the Fiduciary Rule on a number of grounds. On February 8, 2017, the district court ruled in favor of DOL. The Fifth Circuit’s decision reverses that lower court decision.
The Fifth Circuit decision
The Fifth Circuit held that the Fiduciary Rule (1) conflicts with the “plain text” of ERISA and (2) fails the “reasonableness” test applicable when courts are asked to defer to agency statutory interpretations.
No statutory authority
The court found that, as a general matter, ERISA is to be interpreted based on “the well-settled meaning of the common-law terms it uses” and that at common law “[f]iduciary status turns on the existence of a relationship of trust and confidence between the fiduciary and client.”
Thus, ERISA’s identification of an advice fiduciary as someone who renders investment advice for a fee “comports with common law and the structure of the financial services industry” which distinguishes “between investment advisers, who were considered fiduciaries, and stockbrokers and insurance agents, who generally assumed no such status in selling products to their clients.”
This understanding – which the Fiduciary Rule, in effect, overturns – is, as noted, reflected in the statute. It is also reflected in DOL’s original (1975) rule, which only applied where advice was given on a “regular basis” and served as the “primary basis” for investment decisions. And it “harmonizes” with the other two prongs of the fiduciary definition, which require the exercise of “authority or control.”
Thus, the court concluded:
The Fiduciary Rule conflicts with the plain text of the “investment advice fiduciary” provision as interpreted in light of contemporary understandings, and it is inconsistent with the entirety of ERISA’s “fiduciary” definition. DOL therefore lacked statutory authority to promulgate the Rule with its overreaching definition of “investment advice fiduciary.”
While the foregoing holding would in itself be sufficient to vacate the rule, the court went on to consider whether DOL’s interpretation of ERISA was entitled to deference under the Chevron doctrine. It rejected that argument, finding DOL’s interpretation unreasonable.
In addition to its finding that the rule “conflicts with the statutory text,” the court found that the fact “that it took DOL forty years to ‘discover’ its novel interpretation further highlights the Rule’s unreasonableness.”
The court itemized the following objections to the rule’s reasonableness:
1. It ignores the distinction in ERISA between DOL’s authority over ERISA plans and IRAs.
2. The new definition of fiduciary is so broad that “it comprises nearly any broker or insurance salesperson who deals with IRA clients.”
3. The creation of an overbroad rule and then narrowing it by exemptions, including the BICE, is an impermissible regulatory “tactic.”
4. The Fiduciary Rule (via the BICE) grafts “novel and extensive duties and liabilities on parties otherwise subject only to the prohibited transactions penalties.”
5. The BICE impermissibly creates a private right of action – the ability to sue under state law based on the required contract.
6. The rule “outflank[s] two Congressional initiatives [under Dodd-Frank] to secure further oversight of broker/dealers handling IRA investments and the sale of fixed-indexed annuities.”
7. And, finally, “the Supreme Court has been skeptical of federal regulations crafted from long-extant statutes that exert novel and extensive power over the American economy.”
Based on the foregoing, and its finding that “this comprehensive regulatory package is plainly not amenable to severance,” the court vacated the Fiduciary Rule in toto (that is, in its entirety).
What does this decision mean?
As a legal matter, the Fifth Circuit’s decision means that the pre-April 2016 five-part rule for determining when a person becomes an ERISA advice fiduciary “snaps back” into effect. The critical question the Fifth Circuit’s decision raises is: what will be DOL’s response? It can ask for a re-hearing of the case by the full Fifth Circuit, appeal the decision to the Supreme Court or do nothing.
Even if DOL decides to acquiesce in the court’s decision, it’s conceivable that a third party may attempt to get a further review of it, either in the Fifth Circuit or in another court.
There is an ongoing project at the Securities and Exchange Commission on broker-dealer conduct.
And, finally, there are, at the state level, emerging legislative initiatives to regulate investment advice.
Bottom line: at this point it is too early to tell what will happen next.