Recently, the United States Court of Appeals for the Fifth Circuit vacated the Department of Labor's ("DOL") fiduciary investment advice rule (the "Fiduciary Rule"). The groundbreaking decision was issued just days after the United States Court of Appeals for the Tenth Circuit issued a conflicting decision upholding a DOL regulatory action in a similar but not identical issue.
The Court of Appeals decisions create national uncertainty about the Fiduciary Rule's future. For now, however, the Rule continues to be applicable throughout most of the country and further developments are necessary before its fate is determined.
Background on the Rule
The Fiduciary Rule went into effect on June 9, 2017 (although certain exemptions published with the Rule were delayed to July 1, 2019). The complex rule defines who is a "fiduciary" with respect to an employee benefit plan or IRA (a "plan") and is, therefore, subject to the stringent fiduciary duties set out in the Employee Retirement Income Security Act ("ERISA") by reason of providing investment advice with respect to the plan. In very general terms, a person is a fiduciary under the Rule if the person provides, for a fee or other direct or indirect compensation, certain recommendations regarding the securities or investment property of a plan or related to the rollover of such securities or investment property and the recommendation is directed to a specific recipient, given pursuant to an agreement with the recipient, or the person providing the advice acknowledges that he or she is acting as a fiduciary.
The Fiduciary Rule revises a prior regulation that the DOL issued in 1975. Under that rule, a person would be considered a fiduciary under ERISA by reason of providing investment advice for a fee or other compensation only if the person satisfied a five-part test, which required, among other things, that the advice was provided on a "regular basis" and that it served as the "primary basis" for the investment decisions of a plan.
The revised Fiduciary Rule eliminated the five-part test and greatly expanded the scope of the 1975 rule by focusing only on the receipt of compensation. Under the revised rule, a person could be deemed a fiduciary by providing a recommendation related to a single transaction with respect to a plan. The revised rule thus expands fiduciary status to potentially cover securities brokers, insurance agents, and other financial services professionals who provide investment recommendations in connection with sales or exchanges involving plan assets. As fiduciaries, such persons must act in the best interests of the advice recipient and are prohibited from receiving certain compensation in connection with their recommendations unless they satisfy an exemption established by the DOL, such as the Best Interest Contract Exemption (the "BICE").
The Fifth Circuit Decision
In the recent Fifth Circuit decision, Chamber of Commerce of the United States of America v. Acosta, No. 17-10238 (5th Cir. 2018), associations representing business interests challenged the validity of the rule under the Administrative Procedures Act (the "APA"). In deciding whether the Fiduciary Rule violated the APA, the court's analysis focused on (i) whether the Rule conflicts with the statutory provision defining the term fiduciary under ERISA; and (ii) whether the Rule is based on a reasonable interpretation of that statuary provision.
First, the court concluded that the Fiduciary Rule conflicts with the statutory text of ERISA, because, among other reasons:
The Rule departs from the common law meaning of the term fiduciary, which requires a relationship of confidence and trust; instead, the Rule redefines the term fiduciary to include transaction-based relationships that are not founded on confidence or trust; and
The Rule runs counter to other prongs of the ERISA fiduciary definition, which make a person a fiduciary based on the extent of the person's control and authority with respect to a plan or its assets, not merely on the basis of having "any" such control or authority.
Second, the court concluded that the Fiduciary Rule was based on an unreasonable interpretation of the statute, because, among other reasons:
The Rule flatly contradicts the position set out in its previous regulations, and it took the DOL nearly 40 years after passage of ERISA to arrive at its current interpretation of the statute;
The Rule fails to properly distinguish between Title I of ERISA, which governs employer sponsored employee benefit plans and provides a private right to action for violations of ERISA's fiduciary duties, and Title II of ERISA, which governs IRAs through "prohibited transaction" provisions and imposes excise tax penalties for violations but does not create a private right to action for a violation of such provisions; instead, the Rule treats Title I and Title II of ERISA the same and creates a private right to action for both provisions; and
The Rule imposes drastic and unreasonable changes on fixed indexed annuities by its modifications of Prohibited Transaction Exemption 84-24.
Thus, in the court's view, the Fiduciary Rule expands the definition of a fiduciary beyond that set out in ERISA and imposes regulatory prohibitions on conduct not envisioned by Congress when it passed ERISA. Accordingly, the court found that the DOL's Fiduciary Rule violates the APA, and it vacated the Rule in total.
The Tenth Circuit Decision
The Fifth Circuit's decision was issued just days after the Tenth Circuit issued a contrary decision in favor of the DOL in Market Synergy Group, Inc. v. AARP. In that case, the court considered whether the DOL violated the APA by modifying Prohibited Transaction Exemption 84-24 (which occurred at the time that the Fiduciary Rule was published).
Prohibited Transaction Exemption 84-24 permits insurance companies and their agents to sell certain annuity products to plans and plan participants without becoming subject to excise taxes. As modified, the Exemption no longer applies to sales of fixed index annuities, and the sale of such annuities by an investment advice fiduciary to a plan or plan participant will constitute a prohibited transaction unless the onerous requirements of the BICE are satisfied.
In contrast to the Fifth Circuit, the Tenth Circuit rejected that the DOL's changes to Prohibited Transaction Exemption 84-24 were arbitrary or violated the APA, and it upheld the DOL's Exemption. The disagreement between the Fifth Circuit and the Tenth Circuit on the validity of the DOL's modifications to Prohibited Transaction Exemption 84-24 creates a split between the Circuits. It should be noted, however, that the Tenth Circuit did not consider the issue that was the centerpiece of the Fifth Circuit's decision: whether the Fiduciary Rule as a whole is invalid.
Meaning of the Court's Decision
The Fifth Circuit's decision, as well as reports that the DOL has informally announced that it will not enforce the Fiduciary Rule pending further review, cast doubt on the future of the Fiduciary Rule. In the Fifth Circuit's jurisdiction (Louisiana, Mississippi, and Texas), the Fiduciary Rule will not apply. In the rest of the country, the Rule continues to apply despite the informal reports that the DOL will not enforce it.
Until there are further developments, the financial services industry should carefully consider adhering to the various measures they have put in place to comply with the Rule.
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