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News March 26, 2018 Issue

DOL Fiduciary Rule Tossed Out by Appellate Court

Things are beginning to look pretty gloomy for the Department of Labor’s Fiduciary Rule. A U.S. Court of Appeals for the 5th Circuit three-judge panel this month struck down the entire Rule, describing it as "backdoor regulation." With the SEC now working on its own fiduciary regulations that may prove dominant in this area, the DOL is now faced with the question of whether the appellate court ruling is worth appealing.

In a 46-page ruling, the appellate panel decided, 2 to 1, to vacate the long-contentious DOL Fiduciary Rule, which went into effect in June 2017, but important parts of which the Department has chosen not to enforce until July 2019. The Rule extends fiduciary obligations to broker-dealers and other financial institutions that work with clients on ERISA-based retirement plans.

In its March 15 ruling, the 5th Circuit panel said that the DOL found "in a long-extant statute an unheralded power to regulate a significant portion of the American economy," and that "although lacking direct regulatory authority over IRA ‘fiduciaries,’ DOL impermissibly bootstrapped what should have been safe harbor criteria into ‘backdoor regulation.’"

"The stakes were high in the 5th Circuit decision because many felt that was the decision most likely to strike the rule down, and it did," said Stradley Ronon partner George Michael Gerstein. "The opinion was sharply worded and held that the DOL exceeded its authority when it promulgated the 2016 Fiduciary Rule. The appellate court thinks the SEC is the federal agency with appropriate jurisdiction to govern broker-dealer activities and when those activities go beyond traditional broker-dealer functions. The court also accused the DOL of effectively re-writing ERISA, when that is Congress’ prerogative."

The Department now has three options:

  1. Request that the full 5th Circuit Court of Appeals conduct an en banc review of the ruling by its panel;
  2. Appeal the panel ruling directly to the Supreme Court, which might take up the case since another appellate circuit has ruled in favor of the DOL Rule, although on narrower grounds; or
  3. Accept the 5th Circuit panel ruling.

The last option is not an unlikely as it may sound at first. Secretary of Labor Alexander Acosta and SEC chairman Jay Clayton have reportedly been in communication about a fiduciary rule, stating that they want the SEC and the DOL to cooperate in resolving the situation (ACA Insight, 10/2/17).

In addition, noted Georgetown University School of Law professor Donald Langevoort, "Obviously, the [Trump] Administration is not enthusiastic about the Fiduciary Rule, and can choose not to seek review of the ruling." University of North Carolina School of Law professor Thomas Lee Hazen suggested that, since the Department is not currently enforcing the Rule, "it is possible the rule will be rescinded by the DOL, making the issue moot."

"The big wildcard is whether the 5th Circuit decision will galvanize some states that have so far taken a wait-and-see approach with respect to imposing their own investment advice rules, as already happened over the past year in Nevada, New York, Connecticut, New Jersey, and, potentially, Maryland and Illinois," said Gerstein.

What should advisory firms and broker-dealers do in the wake of the ruling? "It’s too soon to make any drastic changes to address the DOL Fiduciary Rule at this point," Gerstein said. The wisest course, he said, might be for firms to continue with the practices already in place, while waiting to see both how any DOL appeals play out and, perhaps more importantly, what the SEC does.

The appeal and the ruling

The 5th Circuit panel ruled on an appeal brought by a wide variety of organizations, including the U.S. Chamber of Commerce, the Securities Industry and Financial Markets Association, the Financial Services Institute and several insurance organizations. They originally challenged the DOL Fiduciary Rule in U.S. District Court for the Northern District of Texas in April 2016 on multiple grounds, including that the Rule was inconsistent with the governing statutes, and that the DOL was going beyond its authority in its effort to regulate services and providers. The district court rejected all of their challenges.

In its ruling on appeal, however, the 5th Circuit panel said it found "merit in several of these objections," noting that the Rule "fundamentally transforms over 50 years of settled and hitherto legal practices in a large swath of the financial services and insurance industries."

"The principal question," the panel said, "is whether the new definition of an investment advice fiduciary comports with ERISA Titles I and II." Alternatively, it said, the new definition would need to be deemed as "reasonable" under a 1984 ruling in Chevron U.S.A., Inc. v. NRDC, and not be in violation of the Administrative Procedures Act (APA).

Beyond that, the appellate panel said, are the questions of whether the Rule’s Business Interest Contract Exemption, including its impact on fixed indexed annuities, "asserts affirmative regulatory power inconsistent with the bifurcated structure of Titles I and II and is invalid under the APA."

"DOL has made no secret of its intent to transform the trillion-dollar market for IRA investments, annuities and insurance products, and to regulate in a new way the thousands of people and organizations working in that market," the appellate panel said. "Large portions of the financial services and insurance industries have been ‘woke’ by the Fiduciary Rule and BIC Exemption."

"Expanding the scope of DOL regulation in vast and novel ways is valid only if it is authorized by ERISA Titles I and II," the panel continued. "A regulator’s authority is constrained by the authority that Congress delegated it by statute. Where the text and structure of a statute unambiguously foreclose an agency’s statutory interpretation, the intent of Congress is clear, and ‘that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed content of Congress,’" it said, quoting from the Chevron decision.