The viability of the DOL’s Fiduciary Rule and related exemptions was put in some doubt yesterday by a Court of Appeals decision that “vacate[s] the Fiduciary Rule in toto.” The U.S. Court of Appeals for the Fifth Circuit, in U.S. Chamber of Commerce v. United States Department of Labor, upheld a comprehensive challenge brought by the U.S. Chamber of Commerce, SIFMA, the American Council of Life Insurers and other trade groups against the Fiduciary Rule and the DOL’s authority to issue the rule. Although the district court and other courts around the country have held that the DOL followed appropriate procedure in issuing the Fiduciary Rule, the Fifth Circuit’s decision makes it increasingly likely that the Supreme Court will decide the issue. In the wake of the Fifth Circuit’s decision, the DOL announced that it will not enforce the Fiduciary Rule pending further review.
(The DOL finalized the Fiduciary Rule in 2016 after a long and exhaustive administrative process. The “Fiduciary Rule”, as the phrase is used by the Court (and others) consists of a revision of a 1975 regulation that defined the term “investment advice” for purposes ERISA, and specifically for identifying fiduciaries of plans, two new prohibited transaction exemptions (the Best Interest Contract Exemption – BICE – and the Principal Transaction Exemption), and revisions to several other prohibited transaction exemptions.)
The Decision Vacating The Fiduciary Rule
A two-judge majority of the Fifth Circuit Court of Appeals found the Fiduciary Rule defective in two key ways. First, the Court held that the Fiduciary Rule conflicts with the language of ERISA and the common law understanding of the term fiduciary, which the Court said was incorporated in ERISA. The Court argued that ERISA, other federal law, the common law, and the DOL’s 1975 regulation make a distinction between sales activities, particularly sales activities of brokers, and fiduciary activities. In the Court’s view, the text of ERISA provides that mere sales activity cannot, by definition, be fiduciary activity. Moreover, the common law understanding of fiduciary, which was at least partially incorporated by ERISA, presumes a preexisting relationship of trust. The Fiduciary Rule, according to the Court, ignores the common law and other federal laws dealing with fiduciaries.
Second, the Court held that the Fiduciary Rule was not a reasonable interpretation of existing law and thus failed to comply with the Administrative Procedures Act and controlling Supreme Court precedent. In particular, the Court found that the DOL’s insistence (in the BICE) that people providing services to IRAs sign a contract in which they admit that they are fiduciaries and can be sued as such to be an improper expansion of DOL authority over IRAs. Although IRAs and IRA fiduciaries are subject to prohibited transaction rules just as ERISA plans are, they are not, under ERISA or the Internal Revenue Code, subject to the same fiduciary standards or litigation risk. The Fifth Circuit found that the DOL’s attempts to create these rights of contract and lawsuit to be improper, arbitrary and capricious. Additionally, the Court found the DOL to have acted unreasonably because the Fiduciary Rule ignores or conflicts with the 2010 Dodd-Frank Act. That Act empowers the SEC to develop standards regulating brokers who provide personalized advice to retail customers and forbids the SEC from eliminating commissions or other standard broker compensation. Moreover, the Dodd-Frank Act provides that states would regulate fixed indexed annuities. In contrast, the Fiduciary Rule greatly restricts the use of fixed indexed annuities for retirement accounts.
In short, the Fifth Circuit found that the DOL had overstepped its statutory and regulatory authority in promulgating the Fiduciary Rule. However, the Chief Judge of the Fifth Circuit dissented. That Judge found that both the Court and the trade groups had improperly construed “valid agency action that demonstrates an expansive-but-permissible shift in DOL policy as falling outside the statutory bounds of regulatory authority.” The dissenting Judge also found that the majority had accepted the trade group’s erroneous characterizations of the Fiduciary Rule. The dissenting judge found that the DOL acted within its authority in finalizing the Fiduciary Rule.
The Impact of The Fifth Circuit Decision – Law
Although the Fifth Circuit’s decision is important and potentially game-changing, it is difficult to predict immediate or short-term responses. Currently, we understand that there is a 14-day stay in effect. The Fifth Circuit could extend the stay, particularly if the DOL appeals to the Fifth Circuit en banc and the Fifth Circuit agrees to hear an appeal en banc. If the Fifth Circuit does not extend the stay, then the Fiduciary Rule is vacated in the Fifth Circuit, which includes Texas, Louisiana, and Mississippi.
One thing that is certain: there will be further legal challenges as other courts have rejected challenges to the Fiduciary Rule. Notably, two days before the Fifth Circuit decision, the Tenth Circuit (covering Kansas, Oklahoma, Colorado, Wyoming, Utah, and New Mexico) issued an opinion upholding the Fiduciary Rule in a challenge involving fixed indexed annuities, ruling that the DOL acted well within its authority. In effect, the Fiduciary Rule is vacated (or soon to be vacated) in three states, but remains in effect in the rest of the country. This make it more likely that the Supreme Court will hear the case (either because the DOL appeals the Fifth Circuit ruling to the Supreme Court or others challenge the Tenth Circuit or other decisions in light of the Fifth Circuit decision).
The Impact of The Fifth Circuit Decision – DOL and Policy Issues
It is more interesting what the DOL and the Trump Administration might do. A day after the decision the DOL announced that it would not enforce the Fiduciary Rule “pending further review.” This may mean very little. The DOL has not been enforcing the Fiduciary Rule and was not expected to begin significant enforcement activity until it had completed the review of the Fiduciary Rule mandated by President Trump in early 2017. Moreover, the DOL’s decision to suspend enforcement is not binding on states (Massachusetts has already taken enforcement action based on the Fiduciary Rule) or private parties.
In any other administration, an appeal of the Fifth Circuit’s decision would be certain if only to preserve the agency’s ability to issue regulations on its own terms. The DOL staff, which believes in the Fiduciary Rule and has worked on it for years, will certainly want to appeal. But the Trump Administration is very different than past administrations – regardless of political party – and it is at least possible that the DOL will not appeal. Not appealing would mean starting from scratch on a new definition of investment advice, perhaps working together with the SEC. We think it more likely that the DOL will appeal the Fifth Circuit ruling (either directly to the Supreme Court or to the Fifth Circuit en banc) and proceed with its review and revision of the Fiduciary Rule, the BICE and other exemptions.
We do think that the Fifth Circuit’s decision will encourage Secretary Acosta and others in the Trump Administration to speed up the DOL’s review of the Fiduciary Rule. The DOL has suggested that the review would produce new and alternative exemptions to the BICE. The Fifth Circuit decision offers Secretary Acosta and Trump Administration policymakers the chance to comprehensively change both the Fiduciary Rule and the role of the DOL with respect to IRAs if they wish to do so.
Takeaways for Service Providers and Plan Sponsors
A troublesome question now is what should service providers, plan sponsors, and others do. At the moment, any service provider that is a fiduciary under the Fiduciary Rule should proceed as if the Fiduciary Rule were in full effect nationwide. To the extent such fiduciaries need the BICE or another exemption packaged with the Fiduciary Rule, compliance with the Impartial Conduct Standards is important. Unless and until the legal picture is clarified, failure to comply with those standards creates a great degree of risk, particularly outside of Texas, Louisiana, and Mississippi.
Under the circumstances, we think that the prudent and best course of action for the moment is to maintain existent efforts to satisfy the Impartial Conduct Standards when relying on the BICE or other exemptions and to characterize advisers as a fiduciary (or not) pursuant to the terms of the Fiduciary Rule and its exceptions and exclusions. We do not think service providers and plan sponsors should make any assumptions about the outcome of future court decisions. This means both continuing to satisfy the Impartial Conduct Standards but also being cautious about designing or implementing new or enhanced compliance systems. The legal and policy landscape is very uncertain and is likely to remain so for the near future.