The Fifth Circuit vacated the Department of Labor’s long-suffering conflict of interest rule (commonly referred to as the “fiduciary rule”), holding that the rule exceeds the scope of DOL’s regulatory authority. The decision means that the expanded definition of fiduciary, the elevated standards of conduct for certain investment advisors, and the accompanying prohibited transaction exemptions are not enforceable in the Fifth Circuit, at least for the time being.
At issue in U.S. Chamber of Commerce v. DOL, No. 17-10238 (5th Cir Mar. 15, 2018) was the fiduciary rule’s greatly expanded definition of “fiduciary,” which seeks to encompass a large number of transactions in which an investment advisor or advisory firm makes recommendations to an individual regarding the investment of retirement assets held in IRA or being rolled over into an IRA. Enacted in 2016, after years of work by the DOL, the expanded definition would cover a range of investment professionals and firms and subject them to standards of conduct not unlike those that have applied for many years to retirement plan investment fiduciaries under ERISA. Before the promulgation of the fiduciary rule, those individuals and firms operated free from the burdens of fiduciary status. Importantly, investment recommendations made by a “fiduciary” under the DOL rule for which the fiduciary receives compensation would be considered a prohibited transaction unless one of the new exemptions applied to the transaction.
The Fifth Circuit held that the fiduciary rule’s definition is inconsistent with ERISA’s definition of “fiduciary.” Central to the court’s decision is the common law requirement that fiduciary status must involve the existence of a relationship of trust and confidence between the fiduciary and the client. The court held that Congress is presumed to have used the term “fiduciary” consistently with that preexisting definition, and that there is nothing to suggest that Congress did not do so. Because the definition of “fiduciary” developed by the DOL could encompass even a single transaction in which a salesperson may recommend an investment product, the court held that this definition is inconsistent with the requirement that a fiduciary relationship involve trust and confidence between fiduciary and client.
The court went on to state that even if ERISA were ambiguous regarding the definition of “fiduciary,” the DOL’s chosen definition in the fiduciary rule is unreasonable. Notably, the court pointed to the existence of a “seller’s carve-out” for transactions with plans with more than $50 million in assets, and questioned why an interaction in this context is free from a relationship of trust and confidence while a sale to an individual or smaller plan is not.
The court also noted that the “best interest contract” (BIC) exemption does not cure the problems with the expansive definition of fiduciary, because qualification for that exemption requires the voluntary adoption of fiduciary responsibilities through a written agreement between the investment advisor and the individual receiving advice. The court further stated that the BIC exemption exceeds the powers of the executive branch by creating a private right of action where Congress has failed to do so.
Finally, the court stated that the fiduciary rule conflicts with provisions of the Dodd-Frank Act that empower the SEC to regulate investment advice to retail retirement plan customers, and provisions that leave regulation of fixed-index annuities to the states.
The Fifth Circuit’s decision contradicts the Tenth Circuit’s decision to uphold the fiduciary rule two days earlier. The Tenth Circuit’s decision in Mkt. Synergy Grp., Inc. v. United States Dep’t of Labor, No. 17-3038 (10th Cir. Mar. 13, 2018), was narrower in scope, focusing on the regulation of fixed-index annuities and the procedural steps DOL took in enacting the regulation. Nevertheless, the Fifth Circuit opinion will almost certainly not be the last word on the fiduciary rule. The parties in Chamber of Commerce v. DOL, could ask for rehearing by the Fifth Circuit, or seek an appeal to the United States Supreme Court. Courts in other circuits will likely have a chance to weigh in. The Fifth Circuit’s decision could also spark further efforts by DOL to delay or roll-back the rule.
Outside the Fifth Circuit, which comprises Texas, Mississippi, and Louisiana, the fiduciary rule remains in effect, and within the Fifth Circuit it is likely too soon to change compliance strategies. For now, those affected by the rule would be advised to continue to comply with rule as in effect (regardless of its weakened state), and await further developments.