The ultimate fate of the Labor Department’s fiduciary rule became even more uncertain in mid-March after the U.S. Court of Appeals for the 5th Circuit voted to vacate the rule in its entirety.
Employee Retirement Income Security Act attorneys and industry watchers were feverishly digesting the 65-page ruling — in which the three-judge panel was split 2-1 — and now are prognosticating what the ruling means for the full implementation of Labor’s rule as well as how the Securities and Exchange Commission will proceed with its fiduciary rulemaking in light of the 5th Circuit ruling.
The nine plaintiffs in the 5th Circuit case included the U.S. Chamber of Commerce, the Securities Industry and Financial Markets Association and the Financial Services Institute. The ruling came one day after Labor won a case in federal court brought against its fiduciary rule by Market Synergy Group, an insurance distributor.
“There are still cards to be played” after the 5th Circuit decision, Fred Reish, partner in Drinker Biddle & Reath’s employee benefits and executive compensation practice group in Los Angeles, told me after the ruling in mid-March.
Labor, Reish said, “needs to decide whether to request an en banc review by the full 5th Circuit, to file a petition with the Supreme Court, or to drop the matter.” There is a “delay in the [5th Circuit] decision to allow time for that.” Reish believes that Labor will request an en banc review, which means a rehearing to reconsider the decision by the full court of appeals judges.
“Regardless of what the 5th Circuit does, the losing party will most likely request the Supreme Court to take the case,” Reish opined. “It could be more than a year before we know whether the rule is effective, as is, or whether the old rule is restored.”
As a result, Reish warned, “there is risk in not complying with the provisions of the new rule before this is finalized.”
Karen Barr, president and CEO of the Investment Adviser Association, agreed during her comments at the group’s annual compliance conference in mid-March in Washington, that advisors “shouldn’t do anything differently based on the decision” at this time, as the next post-ruling move won’t be known “for several weeks, at least.”
While pondering potential further court action, Reish said that Labor will likely “propose to amend the [fiduciary] regulation and exemptions, acting in coordination with the SEC.”
SEC’s Next Move?
Neil Simon, vice president of government affairs for the IAA, told me during the group’s compliance conference, that the 5th Circuit ruling “appears to be an extremely significant decision, and is likely to give pause to the SEC with regard to its own fiduciary rulemaking.”
The ruling, Simon said, is likely to prompt some reconsideration by the SEC “of its fiduciary rulemaking,” and appears to signal that full implementation of DOL’s rule is likely over.
Barr added in comments at the IAA conference that “folks at the SEC are furiously reading the DOL decision, to see if SEC has statutory authority to do what it’s doing” in its own fiduciary rulemaking. As it stands now, the SEC, in cultivating its fiduciary rule, is taking a four-pronged approach, she explained.
The first part includes the agency writing a separate rule under the Securities and Exchange Act of 1934 to require a best-interest standard for broker-dealers; the second step is a disclosure document for brokers and advisors, which will be “short and concise” and will be given to investors; the third step is “interpretive guidance” under the Investment Advisers Act of 1940 setting out what it means to be a fiduciary; and the fourth component would be a provision on the use of titles.
Rick Fleming, the SEC’s Investor Advocate, who spoke at the IAA meeting, stated that while the SEC “will have to look at [the 5th Circuit decision] very carefully,” the agency “has very different statutory grounds [than Labor] to impose a fiduciary duty,” on brokers, and that he doesn’t see the ruling to vacate Labor’s rule creating “an impediment to the SEC” as the agency writes its own fiduciary rule.
Nuts & Bolts of Decision
The 5th Circuit ruling included a multitude of reasons for vacating the rule, explained by Ed Mills, Washington policy analyst for Raymond James, in his analysis released the day after the March 15 court ruling. First, the court found that the Labor exceeded its authority to “enact regulation implementing the [ERISA] and questioned why the DOL chose to undergo a complete overhaul of the regulations more than 40-years after its passage without specific direction from Congress.”
Labor also “incorrectly interprets the definition of ‘investment advice fiduciary’ to include an overly broad category of ‘salespeople and insurance brokers,’” the court found.
The court also argued that the Best Interest Contract (BIC) Exemption “is an overreach and the enforcement of the BIC is outside the statutory framework of ERISA.” In addition, its members believe the Labor’s fiduciary rule “is in contrast with the Dodd-Frank Act, as that Act gives the SEC the authority to establish a fiduciary rule (not DOL) and prohibits the federal regulation of fixed indexed annuities,” Mills said.
Judge Edith Jones, who wrote the 5th Circuit decision for the majority, stated that “DOL has 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.”
Large portions of the financial services and insurance industries, Jones wrote, “have been ‘woke’ by the Fiduciary Rule and BIC Exemption. DOL utilized two transformative devices: it reinterpreted the 40-year-old term ‘investment advice fiduciary’ and exploited an exemption provision into a comprehensive regulatory framework.”
On Life Support?
With the split 2-1 decision, Labor’s fiduciary rule “now appears to be on life support,” said Greg Valliere, chief global strategist for Horizon Investments, in his Capitol Notes commentary. “The anti-regulation Trump administration has been reviewing the Obama-era changes to financial advice and retirement plans,” Valliere said, noting the delay in full implementation of the rule until June of 2019.
As it stands now, the rule will likely be “in limbo for the foreseeable future,” and may eventually wind up in the Supreme Court, “or the 5th Circuit could instruct all of its judges to review it,” Valliere continued. Another option: Labor could “accept the ruling, which then would begin a lengthy process of re-writing (and softening) it,” perhaps with input from the Securities and Exchange Commission.
The “original” DOL fiduciary plan “will never be fully implemented,” Valliere opined. “Its legacy may be that while it burdened small firms, it has prompted tougher self-regulation by the industry as a whole.”
“The flawed DOL fiduciary rule is the epitome of regulatory overreach that would harm the very people it’s allegedly intended to help,” said House Financial Services Committee Chairman Rep. Jeb Hensarling, R-Texas, just after the ruling was announced.
“It is vital that we preserve access, choice and affordability for retirement planners, and in doing so, empower these hard-working Americans to make financial decisions that work best for their families,” Hensarling said, adding that he looks forward to continuing to work with Rep. Ann Wagner, R-Mo., — a vocal fiduciary rule opponent — “to enact a clear and workable standard that empowers Americans with their own futures, as opposed to unelected, unaccountable bureaucrats.”
Wagner said in a mid-March statement that the 5th Circuit ruling “reaffirms what I have always said, the Department of Labor fiduciary rule was an ill-advised, top-down assault on local financial advisers and broker-dealers.”
The Securities and Exchange Commission, Wagner said, “is the rightful regulator of the fiduciary rule and must fill that role in a way that protects consumers from bad actors, while allowing hard-working Americans access to affordable, sound financial advice to prepare for the future.”
Washington Bureau Chief Melanie Waddell can be reached at firstname.lastname@example.org