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In this update on the Department of Labor’s fiduciary rule, we discuss in detail DOL’s proposed 18-month extension of the “full applicability date” for exemptions that were part of the fiduciary rule package and briefly review the substance of oral argument in the Fifth Circuit in litigation challenging the rule.
On April 7, 2017, DOL finalized a regulation delaying the applicability date of its 2016 Fiduciary Rule for 60 days, until June 9, 2017. At the same time, it delayed the “full application” of the requirements of the exemptions that were part of its regulation package (including, e.g., the Best Interest Contract exemption (BIC)) until January 1, 2018. 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.”
Critically, the regulation delayed until January 1, 2018, the application of the BIC requirements of a written contract, (robust) fee and conflicts disclosure and adoption of conflict-mitigation pay policies. The latter (among other things) prohibited reliance on “quotas, appraisals, performance or personnel actions, bonuses, contests, special awards, differential compensation, or other actions or incentives that are intended or would reasonably be expected to cause advisers to make recommendations that are not in the best interest of the retirement investor.”
On August 28, 2017, DOL proposed a further 18-month delay in full application of the exemption requirements, to July 1, 2019. DOL identified three reasons for the delay:
1. DOL has not yet completed its review of the fiduciary rule and related exemptions, as directed by President Trump. (For a discussion of President Trump’s memorandum requiring this review, see our article Administration issues executive order calling for review of DOL’s Conflict of Interest rule.) According to DOL “[m]ore time is needed to carefully and thoughtfully review the substantial commentary received in response to the March 2, 2017 solicitation for comments and to honor the President’s directive to take a hard look at any potential undue burden.” On the other hand, in the preamble to the April 17, 2017 regulation, which provided for a June 9, 2017 effective date for the fiduciary rule, DOL stated: “the Fiduciary Rule and the Impartial Conduct Standards are among the least controversial aspects of the rulemaking project.”
Whether there will be changes, either to the fiduciary rule or the exemptions, and what those changes will be, will depend in part on this ongoing review.
2. DOL “anticipates it will propose in the near future a new and more streamlined class exemption built in large part on recent innovations in the financial services industry.” The reference here is to (among other things) the development by some providers of “clean shares.” As DOL describes it: “Clean shares would have no commission attached. Instead, distributing brokers would set their own commission levels, and generally would set the levels uniformly across different funds they recommend, thereby mitigating potential conflicts from variation in commission levels.” The development by providers of clean shares “recently became more viable, owing to new SEC staff guidance clarifying its permissibility under applicable law.”
Clearly, DOL is enthusiastic about developing an exemption specifically tailored to clean shares. All of this – development of a clean shares product in response to Securities and Exchange Commission guidance and development of an exemption in response to the development of the product – will take time.
3. The need to provide more time for coordination with the SEC. In this regard, DOL cited the Chairman of the SEC’s recent Request for Information seeking input on the “standards of conduct for investment advisers and broker dealers,” (discussed in our August, 2017, fiduciary rule update).
All of the foregoing means that DOL may want to make significant changes to the exemptions and (even) the fiduciary rule itself over a period lasting beyond January 1, 2018. Asking providers and sponsors to implement, by that date, current rules could thus result in a significant waste of resources.
As noted, DOL is proposing a delay in the full application of the exemptions to July 1, 2019. But it is also requesting comments on two alternatives: (1) A delay for a specified period after action by DOL, e.g., 12 months after DOL concludes its review of the fiduciary regulation and related exemptions. Or (2) a “tiered approach” – a delay to “the earlier or the later of (a) a date certain [e.g., July 1, 2019] or (b) the end of a period following the occurrence of a defined event [e.g., conclusion of its review].”
On July 31, 2017, a three-judge panel of the Fifth Circuit Court of Appeals heard oral arguments in the litigation (Chamber Of Commerce Of The United States Of America, et al. v. United States Department Of Labor) challenging, among other things, the constitutionality of the fiduciary rule. The three judges on the panel are Chief Judge Carl E. Stewart (a Clinton appointee), Judge Edith H. Jones (a Reagan appointee) and Judge Edith Brown Clement (a George W. Bush appointee).
Judge Jones questioned the lawyer for DOL intensely, focusing on (as she seemed to view it) the characterization of sales activity as fiduciary conduct. In this regard, she requested further briefing on statutory language in ERISA and and the Internal Revenue Code, as to whetherthe prohibited transaction exemptions make a distinction between sales activity and advice.
Judge Clement appeared to agree (at least to some extent) with Judge Jones, stating that “along with Judge Jones, I’m sort of befuddled by why this whole hornets’ nest was created.” Judge Stewart, on the other hand, suggested that there might be a distinction between a “straight sale” (with no advice) and a sale-plus-advice transaction.
Judge Jones also seemed to view as problematic the creation, under the BIC Exemption, of a private right of action via state contract law. She questioned DOL’s lawyer about the possible application of the fiduciary rule to casual advice given to a participant by a sponsor HR employee. And she expressed doubt as to DOL’s authority to regulate IRAs and its expertise with respect to “the market for individual investment advice.”
While predicting results based on oral argument is notoriously risky, some believe that – in view of how this oral argument went – there is a significant possibility that the Fifth Circuit will rule against the government.
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We will continue to follow this issue.