On March 15, 2018, the U.S. Court of Appeals for the Fifth Circuit, in a 2-1 decision,1 vacated the U.S. Department of Labor's (DOL) Fiduciary Rule. The Fifth Circuit found that the DOL overstepped its authority and acted unreasonably by enacting the Fiduciary Rule.
The Fiduciary Rule
The Fiduciary Rule, enacted by the DOL, reinterpreted the "investment advice fiduciary" definition and the exemptions to provisions for a fiduciary in the Employee Retirement Income Security Act of 1974 (ERISA).2 The new rule was controversial because, among other reasons, it required broker-dealers and other financial professionals to adopt the "best interest" standard, which replaced the DOL's five-part test (and over forty years of precedent) to determine whether one acted as a fiduciary. In addition, the Fiduciary Rule established the "Best Interest Contract Exemption," which provides a series of requirements to qualify for the exemption and avoid prohibited transaction penalties.
The DOL took the position that reinterpretation was necessary to fill perceived gaps for those who provide investment advice to ERISA plans and individual retirement accounts (IRAs), but did not fit within the prior five-part test. Under the Fiduciary Rule, service providers, such as broker-dealers, who do business with ERISA plans and IRA holders would be exposed to the fiduciary obligations and duties under ERISA. As the Fifth Circuit recognized, the Fiduciary Rule "is of monumental significance to the financial services and insurance sectors of the economy." The regulation runs 275 pages, and DOL estimated that it could cost regulated parties $31.5 billion over ten years to comply with the rule.
The U.S. Chamber of Commerce and other business groups challenged the DOL's Fiduciary Rule. Among other things, they argued that DOL's construction of the rule was unreasonable and arbitrary that DOL had embarked on an "ambitious new regulatory scheme…to circumvent its lack of authority over…IRAs."
The Fifth Circuit's Decision
The Fifth Circuit Court found that the DOL's reinterpretation of "investment advice fiduciary" did not align with the long-standing common law definition of fiduciary and that the new definition no longer took into account the regular basis and primary basis criteria that were historically used in ERISA. Consequently, the Fiduciary Rule encompasses virtually all financial and insurance professionals who do business with ERISA plans and IRA holders.3 The Fifth Circuit Court held that the DOL's expanded definition was not a reasonable interpretation of the term "fiduciary" in ERISA and that the Fiduciary Rule did not align with the legislative intent of Congress. Furthermore, the Court noted that when Congress enacted ERISA, "it 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."4
In addition, the Fifth Circuit Court stated that the DOL exceeded its authority in promulgating the Fiduciary Rule based on a false assumption that Congress had given the DOL the power to do so under ERISA and the IRC, and, accordingly, the Court struck down the DOL's Fiduciary Rule and relevant exemptions.
What Next?
The DOL can appeal the Fifth Circuit Court's ruling by seeking either en banc review by the full Fifth Circuit or review by the Supreme Court. It remains unclear whether DOL will appeal. In that regard, in February 2018, President Trump directed DOL to reconsider the Fiduciary Rule because it may not be "consistent with the policies of my Administration." If the DOL does not appeal, although other federal courts have upheld the Fiduciary Rule, some commentators have argued that the decision could apply nationwide, thus effectively vacating the rule in all jurisdictions.
The SEC chairman recently stated that the SEC is still moving forward with its fiduciary rule, and its work will not be affected by the Fifth Circuit's decision. Yet it remains unclear what the SEC's rule will ultimately look like.
For firms that have implemented policies designed to comply with the DOL's Fiduciary Rule, the best course will be to maintain those policies until there is more clarity from DOL as to how it intends to proceed in regard to appealing the Fifth Circuit's decision or further action is taken by the Administration or Congress. As for changes to those policies, firms should consider the effects of this decision if they were intending to rely on the Best Interest Contract Exemption where they received conflicted compensation.
[1] Chamber of Commerce of the United States of America, et al. v. United States Department of Labor, 2018 U.S. App. LEXIS 6472 (5th Cir. 2018)
[2] "The Fiduciary Rule provides that an individual 'renders investment advice for a fee' whenever he is compensated in connection with a 'recommendation as to the advisability of' buying selling or managing 'investment property.'" Id. at 8.
[3] Id. at 8.
[4] Id. at 19.