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Fifth Circuit Vacates DOL's Fiduciary Rule
Practical Law Legal Update w-013-7701 (Approx. 8 pages)
Fifth Circuit Vacates DOL's Fiduciary Rule
by Practical Law Employee Benefits & Executive Compensation
| Published on 19 Mar 2018 • USA (National/Federal) |
In Chamber of Commerce of the United States of America v. United States Department of Labor, the US Court of Appeals for the Fifth Circuit held that the US Department of Labor's (DOL) expansion of the scope of the final fiduciary investment advice regulation (the fiduciary rule) to include a broker-dealer and insurance agents both conflicts with the plain text of the Employee Retirement Income Security Act of 1974 (ERISA) and violates the Administrative Procedure Act (APA). The Fifth Circuit vacated the fiduciary rule.
On March 15, 2018, in Chamber of Commerce of the United States of America v. United States Department of Labor, the US Court of Appeals for the Fifth Circuit:
- Held that the DOL's expansion of the scope of the final fiduciary investment advice regulation (the fiduciary rule):
- conflicts with the plain text of ERISA; and
- violates the Administrative Procedure Act (APA) because it is unreasonable under the rule established in Chevron U.S.A., Inc. v. NRDC, Inc., 467 U.S. 837 (1984) (Chevron).
- Vacated the fiduciary rule.
For more information on the fiduciary rule, see:
Background
In April 2016, the DOL issued the fiduciary rule, which amends the definition of fiduciary investment advice in 29 C.F.R. Section 2510.3-21 and replaces it with a new definition for purposes of ERISA. Specifically, the fiduciary rule broadens the types of advice that constitutes fiduciary investment advice under ERISA Section 3(21)(A)(ii) (29 U.S.C. §1002(3)(21)) and Section 4975(e)(3)(B) of the Internal Revenue Code (Code) (26 U.S.C. § 4975(e)(3)(B)), subject to specific exclusions for particular types of communications that are non-fiduciary in nature. In connection with the final rule, the DOL also issued two new prohibited transaction exemptions (PTEs) (the Best Interest Contract PTE (BICE) and the Principal Transactions PTE), as well as revisions to several existing PTEs (see Practice Notes, Best Interest Contract Prohibited Transaction Exemption and Principal Transactions Exemption Under ERISA). The fiduciary rule applies to both ERISA-governed employee benefit plans and individual retirement accounts (IRAs).
The fiduciary rule was scheduled to become effective on April 10, 2017, but the applicability date was delayed several times as a result of several Trump Administration actions:
- On February 3, 2017, President Trump issued a memorandum indicating that the fiduciary rule may not be "consistent" with the priorities of his administration and directing the DOL to review the fiduciary rule (see Legal Update, DOL Delays Applicability of Fiduciary Investment Advice Rule by 60 Days).
- On April 4, 2017, the DOL issued a final rule that delayed the applicability date of the fiduciary rule by 60 days, to June 9, 2017 (see Legal Update, DOL Issues Final Rule Delaying Applicability Date of Fiduciary Rule and Related Prohibited Transaction Exemptions).
- The DOL issued guidance on enforcement of the fiduciary rule during the transition period (see Legal Updates, DOL Issues FAQs Clarifying Required Fiduciary Status Disclosures under ERISA Section 408(b)(2) During Fiduciary Investment Advice Rule Transition Period and DOL Issues FAB 2017-02 Announcing No Claims Against Fiduciaries During Phased Implementation Period and FAQs Addressing Transition Issues).
- Most recently, the DOL issued a final rule on November 27, 2017, that extends by 18 months the transition period for the Principal Transactions PTE and BICE related to the fiduciary rule (see Legal Update, DOL Extends Transition Period for BICE and Principal Transactions Exemption Until July 1, 2019). As a result, the applicability date of these exemptions is extended to July 1, 2019, rather than January 1, 2018. The final rule also delays by 18 months the applicability date for certain amendments to PTE 84-24.
In 2016, several business groups filed lawsuits challenging the fiduciary rule in federal court. On February 8, 2017, in Chamber of Commerce of the United States of Am. v. Hugler, the Federal District Court for the Northern District of Texas rejected all of these challenges (231 F. Supp. 3d 152 (N.D. Tex. 2017)). The plaintiffs appealed to the Fifth Circuit.
Outcome
The Fifth Circuit held that the DOL's expansion of the scope of the fiduciary rule:
- Conflicts with the plain text of ERISA Section 3(21)(A)(ii) (29 U.S.C. § 1002(21)(A)(ii)), which defines who is a fiduciary for purposes of ERISA.
- Is unreasonable under Chevron.
Fiduciary Rule Conflicts with the Statutory Definition of Fiduciary
The Fifth Circuit found a conflict between the fiduciary rule and the plain text of ERISA's definition of fiduciary because the definition of "investment advice fiduciary" in ERISA Section 3(21)(A)(ii) is unambiguously limited to the common law definition of fiduciary (like many other terms in ERISA, which are presumptively interpreted according to their common law definition).
In ERISA Section 3, Congress did not place the defined term fiduciary in quotation marks, unlike other defined terms in that section. This indicates that Congress decided that the common law meaning of fiduciary was self-explanatory and, therefore, addressed fiduciary status under ERISA in terms of enumerated functions. Absent other indications, Congress intended to incorporate the common law definition of fiduciary. Under the common law, fiduciary status is based on the existence of an underlying relationship of trust and confidence between the fiduciary and the client. The Fifth Circuit wrote that the presumption in favor of the common law definition of fiduciary should not be displaced by other considerations, such as the structure and purpose of ERISA, because there is nothing inherently inconsistent between the common law definition and ERISA's definition of fiduciary.
The Fifth Circuit also rejected the DOL's reliance on dictionary definitions of investment and advice. Examining the DOL's 1975 regulation defining "investment advice fiduciary," SEC rulings, federal and state statutes governing investment advice fiduciary status and broker-dealers, and case law, the Fifth Circuit concluded that "investment advice for a fee" has been interpreted to include the relationship of trust and confidence that is embodied in the common law definition of fiduciary status.
Furthermore, the fiduciary rule makes the second part of ERISA's fiduciary status definition in ERISA Section 3(21)(A)(ii), which lacks any requirement of a special relationship, inconsistent with the other two parts of that definition in ERISA Section 3(21)(A)(i) and (iii), which define a fiduciary based on control and authority.
Finally, the Fifth Circuit rejected the DOL's argument that the fiduciary rule promotes the purposes of ERISA and the plaintiffs' position in this case would undermine those purposes. Notions of a statute's purpose cannot overcome the words of its text, and the DOL cannot impose a de facto statutory amendment.
Applied in the retirement plans context, the common law definition of fiduciary incorporated into ERISA only applies to one who renders advice regularly and as the primary basis for clients' investment decisions. The DOL's expansion of the scope of its "fiduciary rule" beyond the trust and confidence standard, to include broker-dealers and insurance agents who simply sell products to clients, conflicts with the plain text and meaning of ERISA. Therefore, the DOL lacked statutory authority to issue the fiduciary rule.
Chevron and the APA
Under step two of the Chevron analysis, the court looks at whether an agency's rule is based on a permissible interpretation of a statute if the statute is silent or ambiguous on a particular issue. If there is ambiguity, the agency's interpretation will be upheld if it is a reasonable interpretation. The Fifth Circuit identified seven reasons why the fiduciary rule is an unreasonable interpretation of ERISA under the Chevron analysis and therefore violates the APA:
- The fiduciary rule ignores the fact that ERISA Titles I and II distinguish between the DOL's authority over ERISA employer-sponsored plans and individual IRA accounts.
- To the extent the fiduciary rule defines "investment advice fiduciary" to include anyone who makes a suggestion to a specific advice recipient regarding the advisability of a particular investment decision, the rule includes nearly any broker or insurance salesperson who deals with IRA clients. Under ERISA, however, fiduciaries are generally prohibited from selling financial products to plans.
- The fiduciary rule is not made reasonable by the BICE, which was designed to narrow the fiduciary rule's overbreadth.
- The BICE does not simply create conditional exemptions to ERISA's prohibited transactions provisions, but deliberately extends ERISA Title I statutory duties of prudence and loyalty to brokers and insurance representatives who sell to IRA plans, even though ERISA Title II does not have such requirements.
- The BICE provisions regarding lawsuits violate the separation of powers under the Constitution. The DOL may not create vehicles for private lawsuits (for IRA owners under ERISA Title II) indirectly through the BICE contract provisions. (The Fifth Circuit held that another unsustainable feature of the BICE, which was disavowed by the DOL for purposes of this lawsuit, is the forced rejection of contractual provisions that would have allowed arbitration of class action claims regarding transactions involving transaction-based compensation, which violates the Federal Arbitration Act.)
- Through the fiduciary rule, the DOL "outflanked" two Congressional initiatives under the Dodd-Frank Act to secure further oversight of broker-dealers handling IRA investments and the sale of fixed-indexed annuities.
- The fiduciary rule is crafted from a long-extant statute and exerts novel and extensive power over the American economy. The Supreme Court has been skeptical of such regulations. Specifically, the DOL:
- reinterpreted the 40-year-old term investment advice fiduciary;
- exploited an exemption provision into a comprehensive regulatory framework; and
- although lacking direct regulatory authority over IRA fiduciaries, "impermissibly bootstrapped" what should have been safe harbor criteria into "backdoor regulation."
The Fifth Circuit concluded that the fiduciary rule is a comprehensive regulatory package that is not amenable to severance, and therefore reversed the judgment of the district court and vacated the fiduciary rule in its entirety.
Practical Implications
All retirement plan sponsors, administrators, and their counsel, as well as broker-dealers, insurance agents, and other actors who are covered by the fiduciary rule, must take heed of the Fifth Circuit's decision to vacate the fiduciary rule in its entirety, which undoes a years-long regulatory process conducted by the DOL and makes the fiduciary rule unenforceable in the Fifth Circuit.
Other courts, including the Tenth Circuit in Market Synergy Group, Inc. v. United States Department of Labor, have upheld the fiduciary rule ( (10th Cir. Mar. 13, 2018)) (see Legal Update, Tenth Circuit Upholds Exclusion of Fixed Indexed Annuities from PTE 84-24). Practitioners should continue to monitor these developments and watch for an appeal by the DOL to the entire Fifth Circuit and depending on developments, potentially the US Supreme Court. For more information on the impact of the Fifth Circuit's decision see, Article, Expert Q&A on Chamber of Commerce of the United States of America v. United States Department of Labor.