By Jennifer Kirby, Compliance Alliance
Nearly a year ago, a Texas district court judge completely rejected investment industry advocacy groups’ arguments that the Department of Labor exceeded its authority in crafting the Fiduciary Rule. On March 15, the United States Court of Appeals for the Fifth Circuit reversed the judgment of the district court and vacated, in its entirety, the Department of Labor’s Fiduciary Rule by a two-to-one majority. The Fifth Circuit held that the Department of Labor’s Fiduciary Rule was arbitrary, capricious and exceeded the agency’s regulatory authority under ERISA.
In April of 2016, the Department of Labor issued the Fiduciary Rule, which expands who is a “fiduciary,” together with amendments to six existing exemptions, and two new exemptions to the prohibited transaction provision in both the Employee Retirement Income Security Act of 1974 (ERISA), and the Internal Revenue Code. The stated purpose of the Fiduciary Rule is to regulate in an entirely new way, hundreds of thousands of financial service providers and insurance companies who provide retirement investment recommendations or solicitations, even on a one-time basis. As the Fifth Circuit’s opinion explained, the Department of Labor had “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.”
The U.S. Chamber of Commerce, the Securities Industry and Financial Markets Association (“SIFMA”), the Financial Services Institute (“FSI”), the Financial Services Roundtable (“FSR”), the Insured Retirement Institute (“IRI”), and other leading trade associations filed suits challenging the Fiduciary Rule promulgated by the Department of Labor in April 2016. The plaintiffs’ challenge succeeded on multiple grounds, including: “(a) the Rule’s inconsistency with the governing statutes; (b) DOL’s overreaching to regulate services and providers beyond its authority; (c) DOL’s imposition of legally unauthorized contract terms to enforce the new regulations; (d) First Amendment violations; and (e) the Rule’s arbitrary and capricious treatment of variable and fixed indexed annuities.”
Specifically, the Fifth Circuit reasoned that the Department of Labor’s new definition of “fiduciary” was inconsistent with the plain text of ERISA and the Internal Revenue Code, as well as with the common-law meaning of “fiduciary,” which depends upon a special relationship of trust and confidence; that the Department of Labor impermissibly abused its authority to grant exemptions from regulatory burdens as a tool to impose expansive new duties that were beyond its power to impose; and that the rule impermissibly created private rights of action against brokers and insurance agents when Congress had not authorized those claims. The Fifth Circuit therefore held that the Fiduciary Rule and the exemptions adopted alongside it were arbitrary, capricious, and unlawful under the Administrative Procedure Act (“APA”) and vacated them “in toto.”
There had been some confusion as to whether the Fifth Circuit’s ruling had a nationwide effect in light of other courts upholding the rule. Just two days prior to the decision in the Fifth Circuit, the Court of Appeals for the Tenth Circuit upheld the rule on a narrower set of challenges, including whether the Department of Labor provided sufficient notice and procedures in regulating “fixed indexed annuities.” However, the Tenth Circuit made it clear that it was not addressing two threshold issues that had not been presented: whether the Department of Labor had authority to promulgate the Fiduciary Rule and whether the Fiduciary Rule permissibly defined the term “fiduciary.” Furthermore, the United States District Court for the District of Columbia also upheld the Fiduciary Rule. However, the appeal of that decision was held in abeyance pending the Fifth Circuit’s decision and then voluntarily dismissed after the Fifth Circuit opinion was handed down.
It appears the Fifth Circuit’s ruling will apply nationwide because under the APA, courts have the power to “set aside agency action” by issuing a vacatur. Under the APA, “vacatur” is a remedy by which courts “set aside agency action” that is arbitrary and capricious or otherwise outside of the agency’s statutory authority. Vacaturs strike the regulation from the Code of Federal Regulations and nullify any potential legal consequences the regulations may have. Its effect is to “nullify or cancel; make void; invalidate.” Because the effect of vacatur is, in essence, to remove a regulation from the books, its effect is nationwide. Also, while the Tenth Circuit upheld the rule under the APA, the court reviewed a narrower set of questions. It did not address the initial threshold issues that had not been presented: whether the Department of Labor had authority to promulgate the Rule and whether the Rule permissibly defined the term “fiduciary.” The plaintiffs in the Fifth Circuit, however, did directly challenge the Department of Labor’s statutory authority, and the Fifth Circuit determined that the action to redefine the term “investment advice fiduciary” exceeded the Department of Labor’s power under ERISA. Thus, because the Fifth Circuit vacated the Rule on grounds the Tenth Circuit did not address, no “circuit conflict” is presented by the two decisions and will be of nationwide effect. However, the future could include a rehearing by the entire Fifth Circuit, an appeal to the Supreme Court, or both.
It will be interesting to see if the Department of Labor will seek en banc review by the Fifth Circuit. The deadline for doing so is May 6, 2018. Given the two-to-one decision, and the fact that the dissenting judge in the 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 Department of Labor will petition the Supreme Court for certiorari. In the case of either a rehearing en banc to the entire Fifth Circuit or an appeal to the Supreme Court, the Fifth Circuit two-to-one majority decision striking down the Fiduciary Rule would likely be stayed. In the meantime, the Department of Labor has indicated that pending further review it will not enforce the Fiduciary Rule. We will continue to monitor the status of the Fiduciary Rule and the Department of Labor’s guidance on compliance to keep you informed.
Jennifer Kirby is a compliance specialist with Compliance Alliance. She has more than 15 year’s experience in the financial services industry. She began her career with a national bank in San Antonio, Texas while receiving her Bachelor of Business Administration degree in Finance. She continued her interest in finance through law school and focused her course work on creditor and transactional issues. While in law school, Jennifer worked at a commercial litigation law firm with a specific focus on creditors’ rights and collection litigation matters. Since 2011, Jennifer has been part of a leading team of attorneys and compliance experts who assist all levels of bank personnel with a wide range of compliance issues.
