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5th Circuit Short Circuits Fiduciary Rule

By Nevin Adams

The Labor Department finally came up short in federal court — but trade industry headlines notwithstanding, like Mark Twain, the rumors of the fiduciary rule’s “demise” might be a bit premature.

It was the first loss in court (U.S. Chamber of Commerce v. DOL, 5th Cir., No. 17-10238, order reversing district court decision, vacating fiduciary rule 3/15/18) for the Labor Department in litigation regarding the fiduciary rule, and it came in the U.S. Court of the Appeals for the 5th Circuit in the form of a split 2-1 decision, with Judge Edith H. Jones writing the opinion, joined by Judge Edith Clement, with Chief Judge Carl Stewart dissenting.

The challenge to the fiduciary rule had been brought by a group of plaintiffs (and what had initially been three separate pieces of litigation), including the U.S. Chamber of Commerce, the Financial Services Institute and the Securities Industry and Financial Markets Association (SIFMA), which had been first to file suit against the fiduciary rule.

Jones had led a bout of spirited questioning during oral arguments last August, and the ruling – which reversed the decision by the lower court and “vacated the Fiduciary Rule in toto” was just as spirited in its rejection of the Labor Department’s authority in establishing the fiduciary rule. “The stated purpose of the new rules is to regulate in an entirely new way hundreds of thousands of financial service providers and insurance companies in the trillion dollar markets for ERISA plans and individual retirement accounts (IRAs),” Jones wrote.

“As might be expected by a Rule that fundamentally transforms over fifty years of settled and hitherto legal practices in a large swath of the financial services and insurance industries, a full explanation of the relevant background is required to focus the legal issues raised here,” she continued, proceeding to outline the history of the legislation, changes in the industry, and the stances that regulators had traditionally held before turning to the impact of the rule.

‘Vast and Novel’ Ways

Telegraphing her conclusion, Jones cautioned that expanding the scope of DOL regulation in “vast and novel ways” was valid only if authorized by ERISA Titles I and II, and that a regulator’s authority is constrained by the authority that Congress delegated it by statute.

“Critically,” Jones wrote, referring to advice, “the new definition dispenses with the ‘regular basis’ and ‘primary basis’ criteria used in the regulation for the past forty years.” Definitions – and their proper application to the analysis featured prominently in both the majority opinion and the dissent. The majority leaned heavily on common law, and the legislative and regulative history in concluding that, “DOL’s interpretation of an ‘investment advice fiduciary’ relies too narrowly on a purely semantic construction of one isolated provision and wrongly presupposes that the provision is inherently ambiguous.” Jones stated that, “properly construed, the statutory text is not ambiguous,” while taking issue with the Labor Department’s argument that the common law is only “a starting point” and the presumption “is displaced if inconsistent with the language of the statute, its structure, or its purposes.”

She went on to note that if Congress had intended to include as a fiduciary any financial services provider to investment plans, “it could have written ERISA to cover any person who renders any investment advice for a fee,” commenting that “only in DOL’s semantically created world do salespeople and insurance brokers have ‘authority’ or ‘responsibility’ to ‘render investment advice.'” Jones went on to charge that the Labor Department was, with its interpretation, attempting “to rewrite the law that is the sole source of its authority. This it cannot do.”

The majority was inclined to see the 1975 regulation as one that flowed directly from a definition of “investment advice for a fee,” in the context of an “intimate relationship” between adviser and client beyond ordinary buyer-seller interactions. “The Fiduciary Rule is at odds with that understanding,” Jones wrote.

Chevron Doctrine

Key to the analysis of the court here – as it had been in the lower court — was the two-step process outlined in Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc. (467 U.S. 837 (1984)). That process starts by determining “whether the intent of Congress is clear,” and if “Congress has directly spoken to the precise question at issue.” If so, that’s the end of it, and the court “must give effect to the unambiguously expressed intent of Congress.” If not, there’s a second step, where the court “must defer to the agency’s interpretation of ambiguous statutory language if it is based on a permissible construction of the statute.”

Here Judge Jones took the position that there was some ambiguity in the phrase “investment advice for a fee.” In that case, the Chevron doctrine requires that DOL’s regulatory interpretation be upheld if it is “reasonable.” However, she concluded that “it took DOL forty years to ‘discover’ its novel interpretation further highlights the Rule’s unreasonableness,” and further dismissed the Labor Department’s position that it had “broad power to exempt ‘prohibited transactions’ in its creation of the Best Interest Contract Exemption (BICE) as an abuse of that power.

“DOL adopted the BICE provisions after redefining ‘investment advice fiduciary’ for two essential reasons,” Jones wrote. “DOL had to create exemptions not exclusively for the statutory purposes, but to blunt the overinclusiveness of the new definition. Were it not for DOL’s ahistorical and strained interpretation of ‘fiduciary,’ there would be no rationale for the BICE exemptions,” she wrote, going on to note that “the BICE supplants former exemptions with a web of duties and legal vulnerabilities.”

‘Vice in the BICE’

Jones invoked the Supreme Court in noting that agencies “are not free to adopt unreasonable interpretations of statutory provisions and then edit other statutory provisions to mitigate the unreasonableness,” going on to state: “This is the vice in BICE, which exploits DOL’s narrow exemptive power in order to ‘cure’ the Rule’s overbroad interpretation of the ‘investment advice fiduciary’ provision.” Jones went on to note that the Labor Department had admitted that without the BIC Exemptions, there could be “serious adverse unintended consequences.” She continued, “That a cure was needed should have alerted [the agency] that it had taken a wrong interpretive turn.” She noted, “The BIC Exemption is integral to retaining the Rule. Because it is independently indefensible, this alone dooms the entire Rule.”

She further noted that “DOL may not create vehicles for private lawsuits indirectly through BICE contract provisions where it could not do so directly,” but explained that the Labor Department did not apply the BIC Exemption enforceability provisions to ERISA employer-sponsored plan fiduciaries “precisely because ERISA already subjects those entities to suits by private plaintiffs. This action admits DOL’s purpose to go beyond Congressionally prescribed limits in creating private rights of action.

“If the BICE-mandated provisions are intended to authorize new claims under the fifty states’ different laws, they are no more than an end run around Congress’s refusal to authorize private rights of action enforcing Title II fiduciary duties.”

Referring to “DOL’s assumption of non-existent authority to create private rights of action” as “unreasonable and arbitrary and capricious,” she went on to note that, “there is no doubt that the Supreme Court has been skeptical of federal regulations crafted from long-extant statutes that exert novel and extensive power over the American economy … DOL has made no secret of its intent to transform the trillion-dollar market for IRA investments, annuities and insurance products, and to regulate in a new way the thousands of people and organizations working in that market.”

Large portions of the financial services and insurance industries have been “woke” by the Fiduciary Rule and BIC Exemption. Jones summarized their concerns as follows: “DOL utilized two transformative devices: it reinterpreted the 40-year-old term “‘investment advice fiduciary’ and exploited an exemption provision into a comprehensive regulatory framework,” she wrote. “And, although lacking direct regulatory authority over IRA ‘fiduciaries,’ DOL impermissibly bootstrapped what should have been safe harbor criteria into ‘backdoor regulation.’ The Fiduciary Rule thus bears hallmarks of ‘unreasonableness’ under Chevron Step Two and arbitrary and capricious exercises of administrative power.”

Dissenting Opinion

Writing in dissent, Chief Judge Carl E. Stewart referred to the fiduciary rule as “an expansive-but-permissible shift in DOL policy.” He wrote that “the statutory definition of ‘fiduciary’ does not unambiguously foreclose the DOL’s updated regulatory definition of ‘investment-advice fiduciary,’” and that “the text and structure of the statute support this conclusion, and the panel majority’s reliance on common law presumptions and extra-statutory interpretations of ‘renders investment advice for a fee’ do not upset this conclusion.

“Accordingly, I conclude that the DOL acted well within the confines set by Congress in implementing the challenged regulatory package, and said package should be maintained so long as the agency’s interpretation is reasonable,” Stewart wrote.

Embracing the Chevron standards of deference unless the actions were deemed arbitrary or capricious, Stewart wrote that “The DOL’s interpretation of ‘renders investment advice’ is reasonably and thoroughly explained,” he noted, concluding that “the new interpretation fits comfortably with the purpose of ERISA, which was enacted with ‘broadly protective purposes’” and which “commodiously imposed fiduciary standards on persons whose actions affect the amount of benefits retirement plan participants will receive.”

As for the BIC, Stewart said that rather than create a private right of action, “[I]t merely dictates terms that otherwise-conflicted financial institutions must include in written contracts with IRA and other [Title II] owners in order to qualify for the exemption.” In Stewart’s assessment, “any action brought to enforce the terms of the written contract created pursuant to the BIC Exemption would be brought under state law, and state law would ultimately control the enforceability of any of the required contractual terms.

“I would hold that the DOL acted well within its regulatory authority — as outlined by ERISA and the Code — in expanding the regulatory definition of investment-advice fiduciary to the limits contemplated by the statute, and would uphold the DOL’s implementation of the new rules.”

What’s Next?

Count on lots of speculation, but in the 5th Circuit there is a 14-day stay following the issuance of an opinion, longer when it involves a government agency such as the Labor Department, according to legal experts. It is possible that the Labor Department will use that window to file a request for an en banc hearing (by the full panel of judges), and perhaps (simultaneously) ask for a further stay. It is also possible that the Trump administration could decide to withdraw the rule rather than take it to the Supreme Court to resolve the conflict in the circuits. (Remember it was just this week that the U.S. Court of Appeals for the 10th Circuit backed the Labor Department, which had already prevailed in the U.S. District Court for the District of Columbia.) There is also a possibility that the DOL may not seek a rehearing, in which case the 5th Circuit’s mandate will issue and its ruling will become effective on April 30.

Drinker Biddle & Reath’s Brad Campbell, a former Assistant Secretary of Labor in the Bush administration, explains that,“While this is a big win on the merits in a 2-1 decision that strikes down the Rule and all of the exemptions nationally, it will not be applicable for some time. The earliest the ruling could become applicable is about May 7, and then only if DOL does not appeal. If DOL does appeal, it could be several more months before we know the outcome.”

In the short term, Campbell notes that advisors need to keep on following the DOL fiduciary rule and the policies and procedures their financial institutions have adopted. “This is a big win that changes the course of the fight in the courts, but it is not yet the final word.”

Stay tuned.