In a significant blow to the Department of Labor’s controversial regulation re-defining what constitutes an investment-advice fiduciary, a split three-judge panel of the Fifth Circuit Court of Appeals ruled on March 15 that the DOL exceeded its authority when creating the rule. The 2-1 decision of the appellate court strikes down the regulation and its associated prohibited transaction exemptions in their entirety. (Chamber of Commerce v. U.S. Dept. of Labor (5th Cir. March 15, 2018)). In its wake, the court’s decision leaves even more of the confusion that has plagued the DOL’s 2016 rulemaking.
As we explained in our whitepaper describing the new regulation and its associated complex of prohibited transaction exemptions (together, the “Fiduciary Rule”), a primary objective of the Fiduciary Rule was to expand the DOL’s enforcement authority over investment advisors. The Fifth Circuit’s ruling rejects the regulation that redefines investment-advice fiduciaries and the associated prohibited transaction exemptions. It was through those exemptions that the DOL attempted to regulate investment advice to non-ERISA entities, such as IRA owners. The court found that the DOL did not have the regulatory authority to adopt the new fiduciary advice definition, and that it acted arbitrarily and capriciously in creating the Rule.
The Fifth Circuit’s decision comes just two days after a panel of the Tenth Circuit Court of Appeals (whose jurisdiction includes Kansas, Colorado, Oklahoma, Wyoming, Utah, and New Mexico) upheld key parts of the Fiduciary Rule. The Tenth Circuit ruling upholding portions of the Fiduciary Rule was more limited in its scope, but at least implicitly affirmed the authority of the DOL to enact it. Indeed, the Rule had survived every other judicial challenge, though an appellate court in the District of Columbia had put its consideration of the Rule on hold pending the outcome of the Fifth Circuit case.
What happens next is unclear. If the Chamber of Commerce decision is left intact, the regulatory definition of investment-advice fiduciary adopted in 1975 will once again become the law of the land – at least in the Fifth Circuit (which includes Texas, Louisiana, and Mississippi). The differences between that definition and the one adopted in the Fiduciary Rule are described in our 2016 whitepaper.
The Trump administration has been less than supportive of the Fiduciary Rule. It is therefore possible that the Department of Labor will leave the Fifth Circuit’s ruling intact, without filing an appeal. But the Fifth Circuit’s decision striking down the Rule is at odds with the Tenth Circuit’s opinion upholding it. The prospect that investment advisors in Texas will be held to a different standard than those in Oklahoma makes an appeal to resolve the Circuit split more likely.
It is possible that the DOL – or parties that support the Fiduciary Rule – will ask the full court of the Fifth Circuit to rehear the case. The deadline for doing so is May 6, 2018. Given the 2-1 decision, and the fact that the dissenting judge in the Chamber of Commerce case was the chief judge of the Fifth Circuit, it is likely that such a request would be granted. It is also possible that the DOL or Rule proponents will appeal the decision directly to the Supreme Court. In the case of either a rehearing en banc to the full Fifth Circuit or an appeal to the Supreme Court, the Fifth Circuit panel’s decision striking down the Fiduciary Rule would likely be stayed.
In the meantime, the DOL announced on March 19 that it will not enforce the Fiduciary Rule “pending further review.” This announcement has only limited significance, however, because the DOL had previously announced a non-enforcement policy while the Rule is being reevaluated under an order issued by the Trump administration.
Considerations For Employers And Advisors
The recent judicial rulings will not have a direct effect on plan sponsors. Neither the Fifth Circuit’s decision in the Chamber of Commerce case nor the DOL’s non-enforcement announcement will insulate employers from the obligation to monitor their plans’ investment advisors. Plan fiduciaries should continue to evaluate whether advisors and consultants are operating under a conflict of interest, and whether their advice is in the best interest of the plan and its participants.
The effect on plan service providers also is unclear. Many broker-dealers and registered investment advisors have already altered their service offerings, fee structures, and internal compensation models in order to comply with the Fiduciary Rule. The sunk costs incurred to make those modifications, as well as market pressure to comply with the “best interest” standard when rendering advice, may make it difficult to walk those changes back.
Service providers in the three states that comprise the Fifth Circuit may have a reprieve from the Fiduciary Rule, but only until the future of the Chamber of Commerce decision is clear. That future could include a rehearing by the entire Fifth Circuit, an appeal to the Supreme Court, or both. In the meantime, the SEC is continuing to pursue its own regulatory efforts to articulate a fiduciary standard for investment advice, the DOL is continuing to reevaluate its Fiduciary Rule, and state securities regulators are bringing their own enforcement actions based on the principles articulated in the Fiduciary Rule.