On Thursday, March 15, 2018, the Fifth Circuit vacated the DOL Fiduciary Duty Rule in its entirety, including the Best Interest Contract Exemption (BICE) and the amendments to Prohibited Transaction Exemption (PTE) 84-24, in Chamber of Commerce et al. v. United States Department of Labor, et al., No. 17-10238. The Fifth Circuit’s Opinion, which reversed the decision of the Northern District of Texas, is here.

Only two days earlier, on Tuesday, March 13, 2018, the Tenth Circuit upheld the DOL’s exclusion of indexed annuities from PTE 84-24, in Market Synergy Group, Inc. v. United States Department of Labor, et al., No. 17-3038. The Tenth Circuit’s decision, which affirmed the judgment of the Kansas federal district court, is here.

The Fifth Circuit’s decision is much broader and more comprehensive than the Tenth Circuit’s decision, as the Fifth Circuit struck down not just amended PTE 84-24, but the expanded Fiduciary Duty Rule itself, the BICE, and the whole “comprehensive regulatory package.” Decision at p. 46.

The question now is: will the Supreme Court have to weigh in?

It is unfortunate indeed that the rulemaking process was flawed and the legal review has been so lengthy, leaving financial institutions with years of great costs and uncertainty.

In Chamber of Commerce, the Fifth Circuit held that the DOL had exceeded its authority by expanding the definition of “fiduciary” beyond the statutory confines of ERISA. The Court held that, “[w]hen enacting ERISA, Congress was well aware of the distinction… 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.” Decision at p. 19.

The Fifth Circuit reasoned that, “[h]ad Congress intended to abrogate both the cornerstone of fiduciary status – the relationship of trust and confidence – and the widely shared understanding that financial salespeople are not fiduciaries absent that special relationship, one would reasonably expect Congress to say so.” Decision at pp. 25-26. And then, the death blow:

The Fiduciary Rule conflicts with the plain text of the “investment advice fiduciary” provision…and it is inconsistent with the entirety of ERISA’s “fiduciary” definition. DOL therefore lacked statutory authority to promulgate the Rule with its overreaching definition of “investment advice fiduciary.”

Decision at p. 31.

The BICE received a similar fate: “The BIC Exemption is integral to retaining the Rule. Because it is independently indefensible, this alone dooms the entire Rule.” Decision at p. 38.

Amended PTE 84-24, which excludes indexed and variable annuities from the exemption, didn’t escape either: “in failing to grant certain annuities the long-established protection of PTE 84-24, the Rule competitively disadvantages their market because DOL believes these annuities are unsuitable for IRA investors.” Decision at p. 32.

The Fifth Circuit went on to hold that the DOL had abused its power by attempting to regulate IRAs like employer-sponsored ERISA plans, when Congress had withheld that authority from the DOL under ERISA. Decision at p. 39. (“Together the Fiduciary Rule and the BIC Exemption circumvent Congress’s withholding from DOL of regulatory authority over IRA plans”).

Finally, the Fifth Circuit held that the BICE’s requirement that retirement investors be permitted to sue under the Best Interest Contract was invalid, because only Congress may create privately enforceable rights: “DOL’s assumption of non-existent authority to create private rights of action was unreasonable and arbitrary and capricious.” Decision at p. 40.

In short, the Fifth Circuit rejected the entire “comprehensive regulatory package.” Decision at p. 46. The Opinion vacates the “Fiduciary Rule in toto.” Id.

What are the next steps after the Chamber of Commerce decision? As it was a 2-1 Opinion, with the Chief Judge writing a lengthy, vigorous dissent, a petition for rehearing en banc is not out of the question. But, if the government seeks review, a petition for certiorari seems more likely, especially in light of the Tenth Circuit’s contrary view about PTE 84-24, at least. Petitions for certiorari must be filed 90 days after the circuit court decision, so we may not see how the parties intend to resolve this until mid-June.

Two days before the Fifth Circuit’s Chamber of Commerce decision, the Tenth Circuit had upheld the DOL’s amendment to PTE 84-24 in Market Synergy Group.

PTE 84-24 acts as an exemption that permits fiduciaries to receive compensation that varies based upon the advice given, so long as certain requirements are met. Prior to the DOL Fiduciary Duty Rule, PTE 84-24 applied to all annuity transactions. Under the full implementation of the DOL Fiduciary Duty Rule (currently scheduled for July 1, 2019), PTE 84-24 will apply only to fixed annuities; fiduciaries who sell variable annuities or indexed annuities will need to operate under the more rigorous requirements of BICE. (During the currently extended transition period to July 1, 2019, however, firms and advisers may continue to rely on PTE 84-24 for all annuity contracts, except that they must also comply with the Impartial Conduct Standards.)

Market Synergy Group had claimed that, in excluding indexed annuities from PTE 84-24, the DOL violated the Administrative Procedure Act (APA) in three ways: (i) it failed to provide adequate notice of its intention to exclude transactions involving indexed annuities from PTE 84-24; (ii) it arbitrarily treated indexed annuities as different from fixed annuities (as the Fifth Circuit just held); and (iii) it did not adequately consider the detrimental economic impact of exclusion of indexed annuities from PTE 84-24.

The Tenth Circuit disagreed. It held that the DOL gave sufficient notice of the possibility that indexed annuities would be excluded and that the final rule was a logical outgrowth of the proposed rule. Decision at p. 10.  The Tenth Circuit held that the DOL’s decision to treat indexed annuities differently than fixed annuities due to their risk, complexity, and potential for conflicts of interest was supported by record evidence and therefore was not arbitrary and capricious, and that the DOL had adequately considered existing state regulation in its analysis. Decision at p. 14. Finally, the Tenth Circuit held that the DOL had addressed the effect that implementation would have on the insurance market and could reasonably conclude that the benefits to investors outweighed the costs of compliance. Decision at p. 16.

So, the Tenth Circuit upholds PTE 84-24 and, two days later, the Fifth Circuit strikes down that exemption, along with the BICE, and the whole DOL Fiduciary Duty Rule itself.

What now?

Firms and advisers who followed the DOL’s direction last year that it “expects financial institutions to adopt such policies and procedures as they reasonably conclude are necessary to ensure that advisers comply with the Impartial Conduct Standards,” should be wary of undoing that work based upon a Fifth Circuit decision that could end up before the Supreme Court. Better, in our view, to stay the course for now.