Fifth Circuit vacates fiduciary rule as unreasonable exercise of DOL authority

A divided Fifth Circuit panel has vacated the fiduciary conflict of interest rules, including the Best Interest Contract Exemption (BICE) and revised Prohibited Transaction Exemption (PTE) 84-24, as an invalid exercise of regulatory authority by the Department of Labor. The fiduciary rule, in expanding the parties subject to loyalty and prudence as investment advice fiduciaries, the panel opined, conflicts with the traditional common law understanding of fiduciary responsibility expressed in ERISA and was an unreasonable, arbitrary and capricious exercise of authority in an area best left to Congress. A pointed dissent found the rule to be well reasoned and consistent with the DOL’s authority to prescribe rules necessary to carry out the protective purposes of ERISA.
Note: The variant reactions that followed the court’s sweeping ruling must be tempered by the fact that the opinion was written by one of the most conservative judges (Edith Jones) from one of the most conservative appellate courts in the country. The opinion (which reads in part more like an appellate brief) to the extent it is not modified by the full court, may also be limited to states within the Fifth Circuit (Louisiana, Mississippi, and Texas). Moreover, the decision is at clear odds with a recent ruling from the Tenth Circuit, upholding the DOL’s regulation of fixed indexed annuities under BICE (see Market Synergy Group, Inc. v. United States Department of Labor, CA-10 (2018), No. 17-3038). Thus, while the unanimous panel decision is subject to reversal following review by the full Tenth Circuit, the divergence in the Circuits clearly invites review by a Supreme Court that, as currently constituted, may be receptive to claims of executive and regulatory overreach.

Effect of APA vacatur.

There is some uncertainly as to the scope of the Fifth Circuit’s ruling. The opinion may be limited to parties within the Fifth Circuit. However, practitioners have noted that, pursuant to the vacatur remedy under the APA, when an agency’s action is set aside as arbitrary and capricious or otherwise unlawful, the rule is effectively invalidated nationwide. Thus, the impact of vacating the rule would not be limited to individual petitioners or to the states within the jurisdiction of the reviewing court.

DOL enforcement moratorium.

Following the Fifth Circuit’s ruling, the DOL has indicated that it will not be enforcing the fiduciary rule, pending further review. Thus, while the fiduciary rule has not been definitively invalidated (outside the Fifth Circuit), the DOL also will not be enforcing the rule anywhere in the country. However, the Fifth Circuit opinion may certainly factor into the DOL review of the rule, which it has been conducting pursuant to a directive from the White House in April 2017. Accordingly, short of defending the rules as written, the DOL may propose new regulations or exemptions to address the Fifth Circuit’s concerns, such as by further excluding transactions involving brokers and insurance agents that the court targeted as constituting “mere sales conduct.”

Fiduciary rule challenged as beyond DOL authority

The U.S. Chamber of Commerce, the Indexed Annuity Leadership Council, and the American Council of Life Insurers brought suit challenging the fiduciary rule of ERISA Reg. 2510.3-21, the Best Interest Contract Exemption, and the amendment to PTE 84-24 (collectively, the “fiduciary rule”), essentially alleging that the scope and terms of the rule exceeded DOL authority. In addition to upending compensation structures and exposing Title II advisers to liability, the business groups argued that the new rule would effectively deprive millions of IRA investors of professional investment advice.
In a remarkably thorough opinion, a Texas federal trial court ruled that the fiduciary rule does not exceed the DOL’s statutory authority under ERISA (Chamber of Commerce of the United States of America v. Hugler, DC TX (2017), 231 F. Supp 3d, 152). The fiduciary rule, the court concluded, “better comports” with the broad remedial purposes of ERISA.

Governing standard of review

Under the applicable two-step Chevron analysis, if the intent of Congress is clear and it has spoken directly to the precise question at issue, courts must give effect to the unambiguously expressed intent of Congress (Chevron, USA Inc. v. Natural Resources Defense Council, Inc., (U.S. Sup Ct (1984), 476 U.S. 837)). However, under Chevron Step Two, if Congress has not directly addressed the issue, a court will defer to an agency’s interpretation of ambiguous statutory language that is based on a “permissible construction of the statute.”

Chevron Step One

The trial court initially ruled that the text of ERISA does not foreclose the DOL’s interpretation of what it determined to be an inherently ambiguous statutory provision. ERISA does not specifically define “investment advice,” and expressly authorizes the DOL to prescribe such regulations as it finds necessary or appropriate to carry out the provisions of that statute.
The Fifth Circuit reversed the trial court, finding that the definition of an investment advice fiduciary in ERISA Sec. 3(21)(a)(ii) was not ambiguous, as properly construed, and must be interpreted as reflecting the common law understanding of fiduciary status that requires a relationship of “trust and confidence” between a fiduciary and a client. The fiduciary rule, the court concluded, improperly dispenses with the long-established distinction between fiduciary investment advisers and stock brokers and insurance agents who generally do not assume fiduciary status by merely selling products because they do not have authority or responsibility to render investment advice.

Rule improperly subjects mere sales conduct to fiduciary duties.

Central to the court’s ruling was its understanding of the fiduciary rule as improperly extending fiduciary responsibility to “mere sales conduct,” dispensing with the common law and long standing DOL understanding that investment advice for a fee requires an “intimate,” substantial and ongoing relationship between the adviser and client, which does not typically include sales transactions conducted by stockbrokers and insurance agents. According to the court, had “Congress intended to abrogate both the cornerstone of fiduciary status-the relationship of trust and confidence- and the widely shared understanding that financial salespeople are not fiduciaries absent that special relationship, one would reasonably expect Congress to say so.”

Fiduciary rule breaches statutory harmony.

The majority further noted that the investment advice prong of ERISA Sec. 3(21)is “bookended” by subsections that incorporate common law trust principles by defining individuals as fiduciaries to the extent that they exercise any discretionary authority or control over the management of a plan or its assets. Such control and authority, according to the majority, necessarily implies a special relationship beyond that of an ordinary buyer and seller. Accordingly, in the interest of statutory harmony, the investment advice prong also requires such a special relationship, which would exclude salespeople in ordinary buyer-seller transactions. By contrast, the fiduciary rule’s expansive definition of an investment advice fiduciary is not conditioned on such a special relationship, conflicts with the plain text of ERISA’s investment advice fiduciary provisions, and is inconsistent with the entirety of ERISA’s fiduciary definition. The promulgation of such an overreaching rule, the court held, exceeds the DOL’s statutory authority.

Remedial purpose of ERISA does not justify fiduciary rule.

The DOL, throughout the process of developing the fiduciary rule, justified the regulatory scheme as serving ERISA’s purpose of protecting individual retirement assets, thoroughly documenting the sea changes in the marketplace necessitating the rules. The Fifth Circuit panel, however, maintained that “vague notions” of a statute’s basic purpose cannot overcome unambiguous statutory text. In addition, the court noted that Congress was aware of the purposes of ERISA when it drafted Title II, excluding IRA advisers from the duties of loyalty and prudence. In a singularly revealing passage, the court stated: “That times have changed, the financial market has become more complex, and IRA accounts have assumed enormous importance are arguments for Congress to make adjustments in the law, or for other appropriate federal or state regulators to act within their authority. A perceived “need” does not empower DOL to craft de factostatutory amendments or to act beyond its expressly defined authority.”

Fiduciary rule fails reasonableness test

Assuming for the sake of argument some ambiguity in the phrase “investment advice for a fee,” the court next concluded that the DOL’s interpretation was: (1) unreasonable under Chevron Step 2; and (2) arbitrary and capricious, contrary to law, and in excess of statutory authority, in violation of the Administrative Procedures Act (APA). Generally, the court found that the fiduciary rule was unreasonable because it disregarded the “essential” common law trust and confidence standard and was in conflict with ERISA’s statutory text. The court also stated that the DOL’s 40-year process of discovering the “novel” interpretation highlighted the rule’s unreasonableness.
The court cited several specific reasons highlighting the unreasonableness of the fiduciary rule and its incompatibility with the APA.

Rule exceeds DOL authority under ERISA Title II.

The fiduciary rule ignores the statutory distinction in ERISA Title I and Title II delineating DOL authority over employer-sponsored plans and IRAs, impermissibly conflating ERISA plan fiduciaries with IRA financial services providers. The court focused especially on the potential liability (beyond authorized tax penalties) to which brokers and insurance agents are subject under BICE, but not Title II. On this “basic level,” the court ruled, the DOL unreasonably failed to follow statutory guidance and the clear distinction in the scope of its authority under ERISA Titles I and II.

Final rule covers nonfiduciary relationships.

The final rule encompasses relationships and transactions (e.g., sales transactions) that are not fiduciary in nature. The DOL could not rely on its narrow power to issue prohibited transaction exemptions to cure the overreach of the fiduciary rule by implementing BICE. The fact that BICE was “independently indefensible,” the court reasoned, “doomed the entire rule.”

Rule imposes new liabilities on parties previously subject only to tax penalties.

BICE exceeds the DOL’s authority to create conditional PT exemptions by imposing Title I statutory duties of prudence and loyalty on brokers and insurance representatives. According to the court, “the grafting of novel and extensive duties and liabilities on parties otherwise subject only to prohibited transaction penalties is unreasonable and arbitrary and capricious.”

Authorization of private cause of action violates separation of powers.

The BICE provision authorizing a private cause of action against Title II advisers violates the Constitutional separation of powers, as only Congress can create privately enforceable rights. The DOL’s “assumption of non-existent authority to create private rights of action was unreasonable and arbitrary and capricious,” the court stressed.

Fiduciary rule evades Dodd-Frank and infringes on SEC turf.

The final rule unreasonably outflanks Congressional initiatives under the Dodd-Frank Act to secure further oversight over broker-dealers handling IRA investments and the sale of fixed indexed annuities. Specifically, the court focused on provisions in Dodd-Frank prohibiting the SEC from eliminating broker-dealer commissions and the exemption of fixed indexed annuities from SEC regulation. Rather than “infringing on SEC turf,” the court advised, the DOL should have deferred to the Dodd-Frank delegations and supported SEC practices to assist IRA and individual investors.

Novel interpretation of established position.

The DOL’s novel re-interpretation of the established definition of an investment advice fiduciary and its “exploitation” of an exemption provision in a comprehensive regulatory framework is a regulatory abuse of power that, the court concluded, “bears the hallmarks of unreasonableness… and arbitrary exercise of administrative power.”

Fiduciary rule not subject to severance

Finally, the court held that the comprehensive regulatory package was “plainly not amenable to severance.” Accordingly, the court vacated the entire interlocking structure of the fiduciary rule.
Note: The dissent, written by Chief Judge Carl E. Stewart, generally found the DOL’s reinterpretation of the term “rendering investment advice” to be “reasonable and thoroughly explained” and a comfortable fit with ERISA’s broadly protective purposes. According to the dissent, the DOL acted within its delegated authority, and the fact that it imposed additional conditions on conflicted transactions was not contrary to any directive from Congress. The majority’s conclusion that the DOL exceeded its regulatory authority, the dissent maintained, was “premised on an erroneous interpretation” of the grant of authority given by Congress under ERISA and the Internal Revenue Code.

Source: Chamber of Commerce of the United States of America v. United States Department of Labor (CA-5)
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