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November 07, 2018 Top Story

Decision Vacating DOL’s Fiduciary Rule Creates Circuit Split

Appellate courts divide over whether the Department of Labor exceeded power to regulate investment advisors

By Martha L. Kohlstrand

The Department of Labor’s Fiduciary Rule regulating investment advisors is no more, following the mandate of a divided federal appellate court vacating the rule.

The U.S. Court of Appeals considered whether the Dept. of Labor exceeded its authority when dealing with IRAs

The U.S. Court of Appeals considered whether the Dept. of Labor exceeded its authority when dealing with IRAs

Pexels | Miguel Á. Padriñán

The decision in Chamber of Commerce of the United States of America, et al. v. United States Department of Labor, et al. creates a circuit split. With no final resolution of the Fiduciary Rule’s validity on the horizon, ABA Section of Litigation leaders advise that continued compliance is the safest path through the uncertainty.

A Tale of Two Fiduciary Rules

In Chamber of Commerce, the U.S. Court of Appeals for the Fifth Circuit considered whether the Department of Labor (DOL) exceeded its authority in promulgating the Fiduciary Rule. Title I of the Employee Retirement Income Security Act of 1974 (ERISA) authorizes the DOL to regulate employer- or union-sponsored retirement plans and to sue to enforce the statutory obligations of plan fiduciaries. Title I fiduciaries owe duties of loyalty and prudence, and are barred from receiving commissions from third parties, based on advice provided, considered conflicted and prohibited transactions.

Title II of ERISA governs tax-deferred individual retirement accounts (IRAs) and authorizes the IRS to tax prohibited transactions. The DOL’s power over IRA fiduciaries is limited to granting exemptions from the prohibited transactions provision, and defining “accounting, technical and trade terms.”

Both Title I and Title II define a “fiduciary” as one who “renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so.” In 1975, the DOL defined a fiduciary as a person who (1) “renders advice . . . or makes recommendation[s] as to the advisability of investing in, purchasing, selling securities or other property;” (2) “on a regular basis;” (3) “pursuant to a mutual agreement . . . between such person and the plan;” where the advice (4) “serves[s] as a primary basis for investment decisions with respect to plan assets;” and (5) is “individualized . . . based on the particular needs of the plan.” The 1975 rule covered “investment advisers,” but not “brokers or dealers” whose advice was “solely incidental” to their business.

The 2016 Fiduciary Rule expanded “fiduciary” to include anyone compensated for a recommendation as to the advisability of “buying, selling, or managing ‘investment property,” and imposed a fiduciary duty whenever “investment advice” is provided “to a specific advice recipient . . . regarding the advisability of a particular investment or management decision.” It also created a “Best Interest Contract Exemption” (BICE), which allowed fiduciaries to avoid prohibited transactions penalties by affirming their fiduciary status, and adopting “Impartial Conduct Standards” including duties of loyalty and prudence. Finally, it removed the prohibited transaction exemption for insurance and annuity contracts under certain conditions.

Fiduciary Rule Conflicts with ERISA and Is an Unreasonable Interpretation of the Statute

The Fifth Circuit vacated the Fiduciary Rule, applying the two-step analysis for evaluating an administrative agency’s decisions established in Chevron U.S.A., Inc. v. NRDC, Inc. The Chevron inquiry looks at “whether Congress has directly spoken to the precise question at issue,” and “if the statute is silent or ambiguous . . . whether the agency’s answer is based on a permissible construction of the statute.”

The majority found ERISA’s definition of an “investment advice fiduciary” to be unambiguous, applying the presumption that Congress intended to incorporate its common law meaning of “fiduciary.” At common law, a fiduciary relationship requires “a relationship of trust and confidence between the fiduciary and client.” The majority noted that nothing in ERISA required departing from the common law to effectuate its purpose.

The panel further observed that the statutory text comported with the common law, and the financial services industry’s custom and practice. The majority noted that the DOL ignored language limiting fiduciary status to one with “any authority or responsibility to [render investment advice].” The Fiduciary Rule thus erased ERISA’s distinction between investment advisors, considered fiduciaries, and stockbrokers and insurance agents, who were not, due to the arms-length and transactional nature of the relationship. The DOL previously held that broker-dealers earning commission could be a fiduciary only if they “provide[d] individualized advice on a regular basis pursuant to a mutual agreement,” and that receipt of commissions was “not necessarily dispositive” of whether “investment advice” had been dispensed. The Investment Advisors Act of 1940 likewise followed this distinction, as did other federal and state legislation, and contemporary case law. Because the DOL’s interpretation conflicted with ERISA’s requirement of a special relationship for fiduciary status, the majority concluded that the DOL lacked authority to promulgate the Fiduciary Rule.

Nevertheless, the Fifth Circuit also found the Fiduciary Rule to be unreasonable under Chevron’s second prong. It concluded the DOL impermissibly sought to regulate IRA “fiduciaries,” though its power was limited to ERISA “fiduciaries.” That in turn necessitated the creation of exemptions “to blunt the overinclusiveness of the new definition,” but the exemptions imposed additional obligations on those swept under the new rule. The court further determined that because the power to create private rights of action resided solely with Congress, BICE violated the separation of powers by creating vehicles for private lawsuits. It also undercut the Securities and Exchange Commission’s authority to regulate broker-dealers and investment advisers.

Changes in Retirement Investment Market Justifies the Fiduciary Rule

By contrast, the dissent reasoned that the DOL’s 1975 framework predated (and was not equipped to address) the growth in IRAs, which had incentivized investment advisors to provide conflicted advice. The dissent accordingly concluded that the DOL was within its power to effectuate ERISA’s purpose by expanding the definition of “fiduciary”, and that the court should defer to the DOL’s interpretation under Chevron’s second prong.

The dissent’s opinion was in accord with Market Synergy Group, Inc. v. U.S. Department of Labor, et al., in which the Tenth Circuit Court of Appeals upheld the portions of the Fiduciary Rule applying to fixed indexed annuity sales.

Safe Harbors Amidst Uncertainty

Following Chamber of Commerce, the DOL issued Field Assistance Bulletin 2018-02, a temporary enforcement policy providing that it would not pursue claims against fiduciaries complying in good faith with impartial conduct standards. It “essentially provides a safe harbor to fiduciaries to continue in the absence of the exemptions invalidated under the rule, and particularly BICE,” says Zachary G. Newman, New York, NY, cochair of the Section of Litigation’s Corporate Counsel Committee. “Additional regulation and guidance may ensue either from the Securities and Exchange Commission, Congress, or perhaps at the state level,” Newman predicts.

Until then, “the conservative approach for investment advisors is to assume the Rule is valid,” advises Michael S. Leboff, Newport Beach, CA, cochair of the Section’s Commercial & Business Litigation Committee.


Martha L. Kohlstrand is a contributing editor for Litigation News.

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