Last week, a panel of the U.S. Court of Appeals for the Fifth Circuit vacated in its entirety the U.S. Department of Labor's Fiduciary Rule, only two days after the Tenth Circuit had upheld it. With the split in the circuits created by the Fifth Circuit decision, Chamber of Commerce v. U.S. Department of Labor, the issue may be headed for the U.S. Supreme Court.

The DOL’s Fiduciary Rule, issued during the Obama Administration, expands the definition of a “fiduciary” beyond those “investment advice fiduciaries” who render advice regularly and as the primary basis for a client’s investment decisions. The Rule covers any financial transaction involving a plan under the Employee Retirement Income Security Act or an Individual Retirement Account where “advice” plays a part and a fee, whether direct or indirect, plays a role.

The removal of the requirement that investment advice be provided on a regular or primary basis means one-time IRA rollovers and annuity transactions are covered by the Rule, even though there is no relationship of trust and confidence between the financial salespeople or insurance agents and their clients. Virtually all financial and insurance professionals who do business with ERISA plans and IRA holders are covered by the Rule, absent an exemption.

The DOL overreached

The Fifth Circuit found the DOL overreached in expanding the definition of “fiduciary.” According to the Court, the Rule conflicted with the plain meaning of “investment advice fiduciary” as well as the entirety of ERISA’s “fiduciary” definition. Rather than being ambiguous, the court said, the word “fiduciary” under ERISA was intended by Congress to be given its established common-law meaning, involving a relationship of trust and confidence. The DOL failed to establish that the longstanding “trust-and-confidence” standard was inconsistent with ERISA’s definition of “fiduciary.” 

In addition, the Court found that the Rule conflicted with ERISA’s “investment advice fiduciary” provision by encompassing ordinary dictionary definitions of the words “investment” and “advice” instead of terms of art used in the financial industry. Noting that Congress does not “hide elephants in mouseholes,” the Court reasoned that if Congress had intended to cover stockbrokers and insurance agents as fiduciaries, it would have written the “investment advice fiduciary” provision to account for sales of investment products and not just the rendering of investment advice for a fee. According to the Court, the DOL’s inclusion of salespeople and insurance brokers is contrary to the DOL's own prior interpretations of "rendering investment advice for a fee," as well as case law, and interpretations used in the industry. These other interpretations indicated a more confidential and intimate, ongoing relationship. It is the position of trust and confidence the investment adviser creates that makes the adviser a fiduciary, the Court said.

"Unreasonable, arbitrary, and capricious"

Even if there were some ambiguity in ERISA’s phrase “investment advice for a fee,” the Court said, the DOL’s interpretation was unreasonable, and arbitrary and capricious. For example, the DOL’s expanded definition of “fiduciary” conflicted with 40 years of prior interpretation by the DOL itself as well as current regulatory, statutory, court, and industry interpretations. It should not have taken 40 years for the DOL to “discover” its novel interpretation of an “investment advice fiduciary," the Court said, noting that such a long delay is typically suspect, particularly where it involves regulation of the American economy. Then, recognizing its overreach, the DOL used its narrow exemption powers to carve out those actors and transactions that it knew Congress did not intend to be covered. The DOL accomplished this carve-out by redefining its prohibited transactions exemptions to include a “Best Interest Contract Exemption.” The Court explained that the BICE has the effect of imposing new duties and obligations (and thus potential liability) on previously-excluded actors and transactions as a condition of continuing to claim exemption from the Fiduciary Rule. The Court also found that the Rule impermissibly subjected IRA financial service providers to DOL supervision similar to that provided to ERISA plans, even though Title II of ERISA provides for no such complex supervision of the former. 

Finally, the Court concluded that the DOL acted unreasonably, and arbitrarily and capriciously, in modifying Prohibited Transaction Exemption 84-24 to remove fixed indexed annuities from prohibited transaction relief. The Court ruled the change disadvantaged such annuities in the marketplace, depriving sellers and investors of those products. It recognized that major companies have withdrawn from certain segments of the brokerage and retirement investor market, or otherwise changed their compensation schemes, out of fear that their compensation schemes would conflict with the Fiduciary Rule requirements. According to the Court, the DOL infringed on the authority of the Securities and Exchange Commission and other agencies to regulate brokers and dealers.

Because it was unable to simply "cut" the offending parts from the Rule, the Court vacated the entire Rule. A DOL spokesman quoted Friday in Bloomberg BNA's Daily Labor Report said that the Agency will not enforce the Rule until further notice. However, according to an industry analyst quoted in the article, the real concern is not the DOL but private lawsuits by individual investors outside the Fifth Circuit states of Louisiana, Mississippi, and Texas.

It remains to be seen whether the DOL will seek rehearing by the full Fifth Circuit, seek Supreme Court review, wait for the SEC to issue additional regulations regarding brokers and dealers, or modify the Fiduciary Rule on its own.

Image Credit: From flickr, Creative Commons license, by Charles LeBlanc.