On March 15, the U.S. Court of Appeals for the Fifth Circuit issued a decision vacating the Department of Labor’s Fiduciary Rule, the controversial measure requiring brokers and other financial professionals to adopt a “best interest” standard for their clients with ERISA or IRA accounts.
The decision in Chamber of Commerce v. U.S. Department of Labor represents a major victory for industry participants who raised concerns that the rule had unintended collateral effects that would render investment and retirement services more costly and potentially inaccessible for certain individual investors. The Fifth Circuit’s decision further muddles the rule’s already uncertain future, while simultaneously providing an even greater impetus for the Securities and Exchange Commission to adopt its own rule, which is expected this summer.
The Fiduciary Rule, in actuality a package of seven interrelated rules, was promulgated by the Department of Labor in April 2016 and sought to redefine how brokers and registered investment advisers serve consumers with individual retirement accounts and Employee Retirement Income Security Act (ERISA) plans. By reinterpreting the term “investment advice fiduciary” within ERISA, the rule created a fiduciary duty for these financial professionals that requires them to act in the “best interest” of their clients. This “best interest” standard is a significant departure from the prior standard for brokers, which required them to recommend investments that were “suitable” for their clients.
The rule also created a “Best Interest Contract Exemption,” which allowed financial professionals to make transactions otherwise prohibited by the rule if they contractually affirmed their fiduciary status; however, the exemption is coupled with a significant number of conditions that make its ultimate efficacy difficult to determine. Although some consumer advocacy organizations praised the rule, major industry groups, including the Chamber of Commerce and the Securities Industry and Financial Markets Association (SIFMA), raised concerns that the rule would actually harm middle-class investors by raising the cost of retirement account services. Industry participants also raised concerns that the rule would create a patchwork regulatory regime, given that it did not come from the industry’s primary regulator, the SEC, and did not apply across all types of brokerage accounts. Although the rule was partially implemented in June 2017, full implementation and enforcement of the rule by DOL is being delayed until 2019 while the Trump administration seeks a renewed review of its economic effects.
In Chamber of Commerce, three separate industry groups brought legal challenges to the Fiduciary Rule. These actions, which were consolidated in the Northern District of Texas, raised a slew of legal issues but principally concerned whether the rule’s new definition of an investment advice fiduciary comports with ERISA, or — to the extent ERISA’s definition of “fiduciary” is ambiguous — is a “reasonable” interpretation under the Supreme Court’s decision in Chevron U.S.A. v. NRDC.
On appeal, a divided panel of the Fifth Circuit held that the expansion of the statutory term “fiduciary” was not authorized under ERISA. Judge Edith Jones, in a cutting opinion on behalf of the majority, held that the DOL’s reinterpretation of the term “fiduciary” conflicted with the statutory text of ERISA, which itself is founded upon the common-law understanding of fiduciaries. “When enacting ERISA, Congress was well aware of the distinction,” Judge Jones held, “between investment advisers, who were considered fiduciaries, and stockbrokers and insurance agents, who generally assumed no such status in selling products to their clients. The Fiduciary Rule improperly dispenses with this distinction.”
The Fifth Circuit also held that the DOL’s regulatory reinterpretation was not reasonable and therefore not entitled to Chevron deference, even assuming that ERISA’s definition of “fiduciary” is ambiguous. Identifying seven different problems that “highlight the unreasonableness of the Rule and its incompatibility with [Administrative Procedure Act] standards,” the court held that the Fiduciary Rule ignores important statutory distinctions and exemptions within ERISA. The court also noted that the rule “infring[es] on SEC turf.” While the “SEC has the expertise and authority to regulate brokers and dealers uniformly,” the DOL’s authority extends only to retirement accounts. The rule “effect[s] dramatic industry-wide changes because it is impractical to separate IRA transactions from non-IRA securities advice and brokerage.” The court therefore held that the promulgation of the Fiduciary Rule constituted an “arbitrary and capricious” exercise of administrative power that rendered it unlawful under the Administrative Procedures Act. In dissent, Chief Judge Carl Stewart described the rule as an “expansive-but-permissible shift in DOL policy,” reasoned that the DOL’s action was entitled to Chevron deference, and stated that he would have held that the DOL acted within its regulatory authority in promulgating the rule.
The Fifth Circuit’s decision marks a milestone in the Fiduciary Rule’s winding path. The decision creates at least a partial circuit split, as the Tenth Circuit previously held that the rule’s treatment of fixed-index annuities was not arbitrary and capricious. While the Department of Labor can either petition for rehearing en banc before a full panel of the Court of Appeals, or directly petition the Supreme Court for certiorari, the ultimate fate of the Fiduciary Rule is unclear. Even setting aside the Fifth Circuit’s decision, the rule remains only partially implemented and under renewed administrative review.
The current state of play is uncertain, as one state securities regulator — the Massachusetts Securities Division — has already brought a complaint alleging a violation of the partially implemented (and now vacated) rule. At the same time, the SEC appears to be moving forward in drafting its own proposed fiduciary standard. Industry participants have long urged the SEC to provide its own guidance, at least in part because a promulgated SEC rule would cover all types of brokerage accounts and be enacted by the industry’s principal regulator. Indeed, on the same day that the Fifth Circuit issued its decision, newly appointed SEC Commissioner Hester Pierce noted that the SEC’s own proposed fiduciary rule likely will clarify the definition of “fiduciary” and provide guidance on how advisers must act to comport with a “best interest” standard.