Late last week, news emerged that the United States Court of Appeals for the Fifth Circuit had ruled, by a two-to-one majority, to vacate the Department of Labor (DOL) Fiduciary rule, based on arguments put forward by the U.S Chamber of Commerce and the Securities Industries and Financial Markets Association.
Judging by the wide range of industry commentary already shared with PLANADVISER, the retirement plan and brokerage industries are viewing this latest appellate decision as a real milestone in the decade-long battle to craft and implement a stricter fiduciary standard under the Employee Retirement Income Security Act (ERISA).
Readers will likely not have to be reminded that the controversial rulemaking represents a signature Obama-era effort to tamp down on conflicts of interest that many say are prevalent in the retirement plan and retail investing industries. The rulemaking was finalized and implemented during the very last days of the Obama administration, with many provisions left to Obama’s predecessor to effectuate, and as a result the rule’s long-term viability has consistently been questioned and challenged by the oppositely minded Trump administration—which came into office promising to dramatically cut business regulations.
Against that background, the fact that two U.S. Circuit Courts of Appeals, the Fifth and the Tenth, have issued conflicting rulings about the propriety of the DOL’s process in creating and implementing a stricter fiduciary standard, leaves the investing industry with a number of challenging questions. In one sense, it seems unlikely that the Trump administration’s DOL would appeal the Fifth Circuit decision to the Supreme Court, given that the president has publicly spoken out against the fiduciary rule expansion. Yet there is also the pressing consideration that investment services providers will now have to operate under potentially two different standards, depending on their geographic region. And the DOL, even under Republican leadership, may feel compelled to appeal the decision simply to defend its ability to create rulemaking on its own terms in the future.
Something else to point out is that the Tenth Circuit decision was far more narrowly constructed than the Fifth Circuit decision, focusing on certain specific issues involving annuity sales and what exemptions annuity sellers can rely on when collective commissions. This has led some commentators to suggest that there is not actually a strong conflict at this stage between the circuits; thus it is far from clear that the Supreme Court would even agree to hear an appeal by DOL of the Fifth Circuit decision.
Speaking to this uncertainty, attorneys with Wagner Law Group suggest it is in fact “increasingly likely that the Supreme Court will decide the issue.” As the attorneys lay out, the 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 original 1975 regulation make a distinction between sales activities, particularly sales activities of brokers, and fiduciary activities,” the attorneys note. “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 Wagner attorneys explain, the Fifth Circuit 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 best interest contract exemption) that people providing services to individual retirement accounts (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.
The Fifth Circuit’s reasoning is that, 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. On the Wagner Law Group’s interpretation, 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 Fifth Circuit 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,” the attorneys explain. “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.”
Preliminary interpretation from Wagner Law Group
Important to note, the Wagner Law Group attorneys suggest it is still too soon to draw any far-reaching conclusions in this matter, as follows: “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.”
The one thing that is certain at this stage, the attorneys conclude, is that there will be further legal challenges: “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.”
According to the Wagner attorneys, it is actually “more interesting at this stage” to think about what the DOL and the wider Trump administration might do. Notably, the DOL has announced that it would not enforce the fiduciary rule pending further review of these latest developments.
“This may mean very little,” the attorneys warn. “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.”
The Wagner attorneys conclude that, 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,” they suggest. “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.”
On balance, the Wagner attorneys predict it is “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.” They further conclude that, 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 best interest contract exemption 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.”