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Is The Dol Fiduciary Rule Dead Or Alive?

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  • Posted on: Mar 19 2018

Since the summer of 2016, this Blog has written about the Fiduciary Rule (the “Fiduciary Rule” or the “Rule”), which the Department of Labor (“DOL”) promulgated in April 2016. (See, e.g., here, here, here, here, here, here, here.) Readers of this Blog know that the implementation of the Rule has not gone smoothly. The Rule has been the subject of congressional and industry attacks and legal challenges. On March 15, 2018, one of the legal challenges succeeded – the Court of Appeals for the Fifth Circuit struck down the Rule in its entirety, finding that the DOL exceeded its authority in promulgating the Rule.

A Primer on The Fiduciary Rule

The Fiduciary Rule provides that an individual “renders investment advice for a fee” whenever s/he is compensated in connection with a “recommendation as to the advisability of” buying, selling, or managing “investment property.” 29 C.F.R. § 2510.3-21(a)(1) (2017). A fiduciary duty arises when the “investment advice” is directed “to a specific advice recipient . . . regarding the advisability of a particular investment or management decision with respect to” the recipient’s investment property. 29 C.F.R. § 2510.3-21(a)(2)(iii) (2017). The Rule encompasses virtually all financial and insurance professionals who do business with ERISA plans and IRA holders.

An important component of the Fiduciary Rule is the “Best Interest Contract Exemption” (“BIC Exemption” or “BICE”), which, if adopted by “investment advice fiduciaries,” allows them to avoid prohibited transaction penalties. The BICE and related exemptions were promulgated pursuant to the DOL’s authority to approve prohibited transaction exemptions (PTEs) for certain classes of fiduciaries or transactions. 29 U.S.C. § 1108(a), 26 U.S.C. § 4975(c)(2). To qualify for a BIC Exemption, providers of financial and insurance services must enter into contracts with clients that, inter alia, affirm their fiduciary status; incorporate “Impartial Conduct Standards” that include the duties of loyalty and prudence; “avoid[] misleading statements;” and charge no more than “reasonable compensation.” In addition, the contracts may not include exculpatory clauses such as a liquidated damages provision or a class action waiver.

Another significant component of the Fiduciary Rule is the amended Prohibited Transaction Exemption 84-24 (“PTE 84-24”). Since 1977, that exemption had covered transactions involving insurance and annuity contracts and permitted customary sales commissions where the terms were at least as favorable as those at arm’s-length, provided for “reasonable” compensation, and included certain disclosures. As amended in the Fiduciary Rule, PTE 84-24 subjects these transactions to the same Impartial Conduct Standards as in the BIC Exemption.

The Long and Winding Road of the Fiduciary Rule

Shortly after taking office in 2017, President Trump instructed the DOL to perform an “economic and legal analysis” of the potential impact of the Rule on retirement investors and the market before its effective date.

In late March 2017, following demands by industry participants, such as Vanguard and Blackrock, for a delay in the implementation of the Rule, and after a 15-day public comment period, the DOL decided to delay implementation of the Rule. The DOL sent its decision to the Office of Management and Budget (“OMB”) for review and approval.

After the review by the OMB, the DOL delayed implementation of the Rule by 60-days. In the announcement, the DOL explained that “it would be inappropriate to broadly delay application of the fiduciary definition and Impartial Conduct Standards for an extended period in disregard of its previous findings of ongoing injury to retirement investors.”

In late May 2017, Alexander Acosta, the newly-appointed Secretary of Labor, wrote in an opinion piece for the Wall Street Journal, that the Fiduciary Rule would not be delayed beyond June 9, 2017, though the DOL was still seeking “additional public input” about the Rule. On June 30, 2017, the DOL reopened the public comment period for another 30 days.

In early August 2017, the DOL decided to delay implementation of the Rule to 2019. In a court filing, the DOL proposed an 18-month delay in the implementation of the Rule, changing the final deadline for compliance from January 1, 2018, to July 1, 2019. The proposed delay was approved by the OMB in August 2017.

Court Rulings

Prior to and during the first year of the Trump presidency, trade groups, among others, challenged the legality of the Rule in court. For the most part, the DOL scored many victories. Some of those cases made it to the appellate courts. In one case, the Rule survived; in another, the Rule was struck down.

The Tenth Circuit Affirms The Rule

On March 13, 2018, the Court of Appeals for the Tenth Circuit ruled that the DOL did not “arbitrarily treat fixed indexed annuities differently from fixed annuities” under the Fiduciary Rule. The plaintiff, Kansas-based Market Synergy Group (“MSG”), argued that the DOL arbitrarily threw fixed indexed annuities (“FIA”) under the BICE without notice, and therefore without any opportunity for public comment. The Tenth Circuit was “unpersuaded” by the argument, noting that “[t]he [notice of public comment and review] clearly asks for comment on whether removing variable annuities from PTE 84- 24 but leaving FIAs and fixed rate annuities struck the appropriate balance.” Thus, the DOL’s decision to include FIAs under PTE 84-24 was “not arbitrary or capricious.”

[A copy of Market Synergy Group, Inc. v. United States Department of Labor, et al., No. 17-3038 (10th Cir. Mar. 13, 2018), can be found here.]

Micah Hauptman, financial services counsel for the Consumer Federation of America, said the decision “is yet another [one] concluding that the DOL acted properly in promulgating the rule. The DOL’s careful analysis in promulgating the rule stands in stark contrast to the agency’s more recent arbitrary and capricious actions in delaying the rule’s full implementation.”

The Fifth Circuit Strikes Down The Rule

On March 15, 2018, the Court of Appeals for the Fifth Circuit vacated the Rule in a 2-1 decision, overturning a Dallas district court opinion that rejected the attacks on the Rule and the DOL’s authority to promulgate it.

The case was brought by several industry groups, including the U.S. Chamber of Commerce, the Securities Industry and Financial Markets Association and the Financial Services Institute. Chief Judge Barbara M.G. Lynn of the United States District Court for the Northern District of Texas, granted summary judgment to the DOL in 2017. Chamber of Commerce of the United States of America, et al. v. Hugler, et al., 231 F. Supp. 3d 152 (N.D. Tex. Feb. 8, 2017). (Here.) In doing so, the court rejected each of the arguments advanced by the plaintiffs; namely, that the DOL did not exceed its authority, did not create a private right of action for clients and did not violate rulemaking authority. In fact, Chief Judge Lynn endorsed the DOL’s analysis of how the Rule would affect investors and financial firms, finding that “the DOL adequately weighed the monetary and non-monetary costs on the industry of complying with the rules, against the benefits to consumers.” “In doing so,” said the court, “the DOL conducted a reasonable cost-benefit analysis.” That finding struck at the heart of President Trump’s directive to the DOL to perform an analysis to determine whether the Fiduciary Rule harms investors and/or the market.

The plaintiffs appealed.

The Fifth Circuit ruled that the DOL exceeded its authority in extending the reach of the Fiduciary Rule to IRAs. In so holding, the Court found that the DOL improperly attempted “to rewrite the law that is the sole source of its authority.” “This it cannot do,” said the Court.

The Court observed that the “DOL’s principal policy concern about the lack of fiduciary safeguards in Title II” was one that should be addressed by Congress, not by “de facto statutory amendments” or rule:

That times have changed, the financial market has become more complex, and IRA accounts have assumed enormous importance are arguments for Congress to make adjustments in the law, or for other appropriate federal or state regulators to act within their authority. A perceived “need” does not empower DOL to craft de facto statutory amendments or to act beyond its expressly defined authority.

On the merits, the Court found that the Rule’s definition of an “investment advice fiduciary” did not comport with ERISA Titles I and II, was not “reasonable” under Chevron U.S.A., Inc. v. NRDC, Inc., 467 U.S. 837 (1984), and was violative of the Administrative Procedures Act (“APA”), 5 U.S.C. § 706(2)(A) (2016).

In holding that the Rule is unreasonable and violative of the APA, the Court found that the DOL ignored the distinction between its authority over employer-sponsored plans and IRAs:

By statute, ERISA plan fiduciaries must adhere to the traditional common law duties of loyalty and prudence in fulfilling their functions, and it is up to DOL to craft regulations enforcing that provision. 29 U.S.C. §§ 1001(b), 1104. IRA plan “fiduciaries,” though defined statutorily in the same way as ERISA plan fiduciaries, are not saddled with these duties, and DOL is given no direct statutory authority to regulate them. As to IRA plans, DOL is limited to defining technical and accounting terms, 11 U.S.C. § 1135, and it may grant exemptions from the prohibited transactions provisions. 26 U.S.C. § 4975(c)(2), 29 U.S.C. § 1108(a). Hornbook canons of statutory construction require that every word in a statute be interpreted to have meaning, and Congress’s use and withholding of terms within a statute is taken to be intentional. It follows that these ERISA provisions must have different ranges; they cannot mean that DOL may comparably regulate fiduciaries to ERISA plans and IRAs. Loughrin v. United States, 134 S. Ct. 2384, 2390 (2014). Despite the differences between ERISA Title I and II, DOL is treating IRA financial services providers in tandem with ERISA employer-sponsored plan fiduciaries. The Fiduciary Rule impermissibly conflates the basic division drawn by ERISA.

The Court also found that the Fiduciary Rule’s definition of “investment advice fiduciary” was overbroad, illogical and otherwise internally inconsistent, characteristics of “arbitrary and unreasonable agency action.”

Moreover, the Court found that the BIC Exemption is overbroad and “inconsistent” with an exemption specifically provided by ERISA:

Another such marker is the overbreadth of the BIC Exemption when compared with an exception that Congress enacted to the prohibited transactions provisions. 26 U.S.C. § 4975(d)(17) exempts from “prohibition” transactions involving certain “eligible investment advice arrangements” for individually directed accounts. 26 U.S.C. § 4975(e)(3)(B); 26 U.S.C. § 4975(f)(8)(A), (B). Moreover, in describing the transactions not prohibited by Section 4975(d)(17), Congress distinguished two activities: “the provision of investment advice” and “the . . . sale of a security . . . .” 26 U.S.C. § 4975(d)(17)(A)(i), (ii). Congress further distinguished the “direct or indirect receipt of fees” “in connection with the . . . advice” from fees “in connection with the . . . sale of a security . . . .” 20 U.S.C. § 4975(d)(17)(A)(iii). That Congress distinguished sales from the provision of investment advice is consistent with this opinion’s interpretation of the statutory term, “render[ing] investment advice for a fee,” 29 U.S.C. § 1002(21)(A)(ii), and inconsistent with DOL’s conflating sales pitches and investment advice.

Perhaps “[e]ven more remarkable,” said the Court, the “DOL had to exclude Congress’s nuanced § 4975(d)(17) exemption from the BICE exemption’s onerous provisions.” This was critical because “[b]ut for this exclusion, the BIC Exemption would have brazenly overruled Congress’s careful striking of a balance in the regulation of ‘prohibited transactions’ concerning certain self-directed IRA plans.” The Court concluded: “When Congress has acted with a scalpel, it is not for the agency to wield a cudgel.”

Most significantly, the Court found that the BIC Exemption exploited the “DOL’s narrow exemptive power in order to ‘cure’ the Rule’s overbroad interpretation of the ‘investment advice fiduciary’ provision.” The Court noted that the “DOL admitted that without the BIC Exemptions, the Rule’s overbreadth could have “serious adverse unintended consequences.” “That a cure was needed,” said the Court, “should have alerted [the DOL] that it had taken a wrong interpretive turn.” (Citation omitted.) The Court concluded that “[b]ecause [the BICE] is independently indefensible, this alone dooms the entire Rule.”

In dissent, Chief Judge Carl Stewart concluded that “the DOL acted well within the confines set by Congress in implementing the challenged regulatory package, and said package should be maintained so long as the agency’s interpretation is reasonable.”

“DOL has acted within its delegated authority to regulate financial service providers in the retirement investment industry — which it has done since ERISA was enacted — and has utilized its broad exemption authority to create conditional exemptions on new investment-advice fiduciaries,” Stewart wrote. “That the DOL has extended its regulatory reach to cover more investment-advice fiduciaries and to impose additional conditions on conflicted transactions neither requires nor lends to the panel majority’s conclusion that it has acted contrary to Congress’ directive.”

Micah Hauptman said that the “case was wrongly decided. The industry opponents went forum shopping and finally found a court that was willing to buy into their bogus arguments. This is a sad day for retirement savers.”

The opinion, Hauptman added, “is extreme by any measure. It strikes at the essence of the DOL’s authority to protect retirement savers under ERISA. It’s not only an attack on the rule, it’s an attack on the agency.”

A spokesman for the DOL said, “Pending further review [of the Fifth Circuit’s decision], the department will not be enforcing the fiduciary rule.”

[A copy of Chamber of Commerce of the United States of America, et al. v. United States Department of Labor, et al., No. 17-10238 (5th Cir. Mar. 15, 2018), can be found here.]

What’s Next?

The Fiduciary Rule may not be dead . . . at least as of now. The DOL can seek an en banc review or it can seek certiorari from the United States Supreme Court. As noted, the Tenth Circuit upheld the Rule, although on a much narrower question than the broader one resolved by the Fifth Circuit.  Also, the Court of Appeals for the D.C. Circuit is slated to hear an appeal involving the Rule. That court is not bound by either circuit court ruling. With a split among the circuits, the Supreme Court may grant a petition for certiorari.

Supreme Court review may also occur because the Fifth Circuit decision materially curtails the ability of the DOL to regulate through its rulemaking authority. Letting the Fifth Circuit’s decision stand could impact the DOL’s ability to promulgate rules going forward. Review by the high court will clarify the scope of the DOL’s ERISA rule-making authority.

Additionally, the Securities and Exchange Commission (“SEC”) has been considering and working on its own fiduciary rule, which the SEC may release over the next 12 months. Many experts believe that the SEC rule would likely supersede the Fiduciary Rule in some areas and achieve many of the same outcomes that were envisioned by the DOL when it created the Rule.

Further, Congress may wait to legislate the end of the Rule now that the Fifth Circuit has acted. In the proposed Choice Act 2.0, House Republicans have sought to end the Fiduciary Rule.  (For a discussion of congressional action, see here.)

Finally, there is activity on the state level that is likely to continue. Over the past few years, the states have been proposing their own fiduciary rules for financial advisors. This trend could continue and even be accelerated now that the federal rule has been vacated in toto.

Stay tuned for more updates on the Rule as they develop.

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