The Fifth Circuit Court of Appeals has vacated the Department of Labor's new fiduciary rule in its entirety, including the prohibited transaction exemptions that were issued or amended at the same time. This has set up a split between circuits as to the effectiveness of the fiduciary rule and great confusion as to how to apply the rule until the uncertainty is resolved.

The fiduciary rule, as written, has two key components: (1) it broadens the definition of "investment advice fiduciary," thus subjecting to fiduciary regulation service providers such as broker-dealers who have not been deemed to be offering investment advice since ERISA was enacted, and (2) it extends fiduciary protection to plans such as individual retirement accounts and KEOGH plans that are not subject to ERISA but are subject to the prohibited transaction provisions of Section 4975 of the Internal Revenue Code of 1986. Under the fiduciary rule, fiduciaries would be responsible for acting in the "best interest" of their plan clients. Prior to the issuance of the rule, broker-dealers only had to offer clients "suitable" investment options; that is still the standard with respect to all other investors.

According to the Fifth Circuit's March 15 ruling, the DOL, for over 40 years, "considered the hallmarks of an 'investment advice' fiduciary's business to be its 'regular' work on behalf of a client and the client's reliance on that advice as the "primary basis" for her investment decisions." The court compared the fiduciary rule with the ERISA statutory definition of fiduciary and examined the meaning of fiduciary under common law. It held that the new definition of fiduciary went beyond Congressional intent when it passed ERISA, thus leading to fatal "conflict[s] with the statutory text." The court further held that the DOL exceeded its authority under the US Administrative Procedures Act because it failed to meet that act's requirements.

In contrast to the Fifth Circuit's opinion, the Tenth Circuit Court of Appeals, in Market Synergy Group, Inc. v. the DOL, a decision issued two days before the Fifth Circuit's opinion, upheld the fiduciary rule. It ruled that the fiduciary rule met the requirements of the Administrative Procedure Act (the only issue on appeal). Unlike the Fifth Circuit's decision, which completely vacated the fiduciary rule, the Tenth Circuit's opinion left the entire fiduciary rule in effect.

These conflicting opinions have set up a quandary for firms that provide any investment-related information to plans as they ponder whether to continue complying with the fiduciary rule or whether to proceed under the former regulations. The future of the fiduciary rule will depend on whether the DOL decides to appeal the ruling. If it chooses not to do so, the likely result is that the fiduciary rule will be completely invalidated and the former regulation will once again be used to determine fiduciary responsibility in the context of providing investment advice.

To make matters more confusing, the Securities and Exchange Commission has announced that it will hold a public meeting on April 18 to discuss three matters related to its expected fiduciary regulation proposal.

The agenda will focus on whether to propose:

  1. new and amended rules and forms to require registered investment advisers and registered broker-dealers to provide a brief relationship summary to retail investors
  2. a rule to establish a standard of conduct for broker-dealers when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer and
  3. an SEC interpretation of the standard of conduct for investment advisers.

Takeaways

We believe that, for the moment, it may be prudent for firms that have already made changes to their procedures to comply with and to continue operating under the fiduciary rule, understanding that there is a strong likelihood that it may not survive in its current form.

In addition to the cost involved with changing practices to revert to the earlier definition of investment advice fiduciary, such firms would have to consider the effect on their business of informing clients, particularly IRA clients, that they will no longer comply with the ERISA fiduciary standard.

It is widely expected that the SEC will adopt new, more uniform standards of conduct for broker-dealers and investment advisers. Accordingly, regardless as to which actions the DOL may take with respect to its own regulation, the DOL may very well have to revisit the applicability of its current and proposed prohibited transaction exemptions in light of the applicable DOL rule as well as the new SEC position.

For background on the DOL fiduciary rule, see this alert.