ERISA-Just like that, the Fifth Circuit Strikes Down The New Fiduciary Rule

Introduction/ Holding.  In Chamber of Commerce of the United States v. United States Dep’t of Labor, No. 17-10238 (Fifth Cir. 2018), the Fifth Circuit Court of Appeals (the “Court”) struck down the “Fiduciary Rule” promulgated by the U.S. Department of Labor (the “DOL”) in April 2016.

In this case, three business groups had filed suit challenging the Fiduciary Rule.  As used in this case, the term “Fiduciary Rule” refers to a package of seven different rules that broadly reinterpret the term “investment advice fiduciary” and promulgate and redefine prohibited transaction exemptions to add provisions concerning fiduciaries that appear in ERISA at 29 U.S.C. § 1001 et seq, and the Internal Revenue Code, at 26 U.S.C. § 4975.  The stated purpose of the Fiduciary Rule is to regulate, in an entirely new way, hundreds of thousands of financial service providers and insurance companies in the trillion dollar markets for ERISA plans and individual retirement accounts (“IRAs”).

The business groups’ challenge proceeds on multiple grounds, including: (a) the Fiduciary Rule’s inconsistency with the governing statutes, (b) the DOL’s overreaching to regulate services and providers beyond its authority, (c) the DOL’s imposition of legally unauthorized contract terms to enforce the new regulations, (d) First Amendment violations, and (e) the Fiduciary Rule’s arbitrary and capricious treatment of variable and fixed indexed annuities.  The district court rejected all of these challenges.   Finding merit in several of these objections, the Court vacated the Fiduciary Rule.

Highlights Of The Fiduciary Rule.

The Revised Regulation– ERISA defines “fiduciary” in clauses (i), (ii) and (iii) of 29 U.S.C. Sec. 1002(21)(A). Clause (ii) includes in the definition any person who “renders investment advice for a fee or other compensation…” The regulations refine and expand this definition. See 29 C.F.R. § 2510.3-21(a)(1).

The Fiduciary Rule revised these regulations for purposes of clause (ii) in the statute.  Under the revised regulations, an individual renders investment advice for a fee whenever he is compensated in connection with a recommendation as to the advisability of buying, selling, or managing investment property. 29 C.F.R. § 2510.3-21(a)(1) (2017).  A fiduciary duty arises under ERISA, moreover, when the “investment advice” is directed to a specific advice recipient regarding the advisability of a particular investment or management decision with respect to the recipient’s investment property. 29 C.F.R. § 2510.3-21(a)(2)(iii) (2017).  Note that a communication which is not a recommendation, i.e., a communication in which the “content, context, and presentation” would not objectively be viewed as “a suggestion that the advice recipient engage in or refrain from taking a particular course of action,” 29 C.F.R. § 2510.3-21(b)(1) (2017), would not give rise to the fiduciary duty.

As such, the Fiduciary Rule encompasses virtually all financial and insurance professionals who do business with ERISA plans and IRA holders.  Stockbrokers and insurance salespeople, for instance, are exposed to ERISA requirements including the prohibited transaction rules. The newcomers are thus barred, without an exemption, from being paid whatever transaction-based commissions and brokerage fees have been standard in their industry segments because those types of compensation are now deemed a conflict of interest which violates ERISA.

The Best Interest Contract Exemption-The “Best Interest Contract Exemption,” (“BICE”) which, if adopted by “investment advice fiduciaries,” allows them to avoid prohibited transactions and the attendant penalties. To qualify for the protection of BICE, providers of financial and insurance services must enter into contracts with clients that, inter alia, affirm their fiduciary status; incorporate “Impartial Conduct Standards” that include the duties of loyalty and prudence; “avoid misleading statements;” and charge no more than “reasonable compensation.” It is noted that service providers to IRA clients are not subject to ERISA, and are thus not statutorily required to abide by its duties of loyalty and prudence. Yet, to qualify for BICE protection, the financial service providers must deem themselves fiduciaries to their clients. In addition, the contracts may not include exculpatory clauses such as a liquidated damages provision nor may they require class action waivers.

PTCE 84-24-The Fiduciary Rule is amended Prohibited Transaction Exemption (“PTE”) 84-24.  Since 1977, that exemption had covered transactions involving insurance and annuity contracts and permitted customary sales commissions where the terms were at least as favorable as those at arm’s-length, provided for “reasonable” compensation, and included certain disclosures.

As amended in the Fiduciary Rule, PTE 84-24 now subjects these transactions to the same Impartial Conduct Standards as in the BICE exemption. But the DOL removed fixed indexed annuities from the coverage of PTE 84-24, leaving only fixed-rate annuities within its scope. The fixed indexed annuities are now covered by BICE.  In practice, this situation places a disproportionate burden on the market for fixed indexed annuities, as opposed to competing annuity products.

The Court’s DiscussionIn analyzing the case, the Court said that the principal question is whether the new definition of an investment advice fiduciary comports with ERISA Titles I and II. Alternatively, is the new definition “reasonable” under Chevron U.S.A., Inc. v. NRDC, Inc., 467 U.S. 837 (1984) and not violative of the Administrative Procedures Act (APA), 5 U.S.C. § 706(2)(A) (2016)?

Beyond that threshold are the questions whether the BICE, including its impact on fixed indexed annuities, asserts affirmative regulatory power inconsistent with the bifurcated structure of Titles I and II and is invalid under the APA. Further, are the required BICE contractual provisions consistent with federal law in creating implied private rights of action and prohibiting certain waivers of arbitration rights? In answering these questions, the Court concluded that:

–The Fiduciary Rule conflicts with the statutory definition of fiduciary in clause (ii) of 29 U.S.C. Sec. 1002(21)(A) and the corresponding text in the prohibited transaction rules in 26 U.S.C. Sec. 4975(e)(3)(B). The DOL’s interpretation of an “investment advice fiduciary” in the Fiduciary Rule relies too narrowly on a purely semantic construction of one isolated provision and wrongly presupposes that the provision is inherently ambiguous. Properly construed, the statutory text is not ambiguous. Congress intended to incorporate into the statute the well-settled meaning of the term “fiduciary”—the very essence of which is a relationship of trust and confidence. The Fiduciary Rule does not apply this meaning. Further, the Fiduciary Rule renders clause (ii) of ERISA’s fiduciary status definition in tension with clause (i) and (iii), and therefore cannot stand.  The DOL lacked statutory authority to promulgate the Rule with its overreaching definition of “investment advice fiduciary.”

–The Fiduciary Rule fails the “reasonableness” test of Chevron step 2 and the APA.

In conclusion, the Court said that the APA states that a “reviewing court shall…hold unlawful and set aside agency action…found to be…arbitrary, capricious,…not in accordance with law” or “in excess of statutory …authority[] or limitations.” 5 U.S.C. § 706(2)(A), (C).  The DOL makes no argument concerning severability of the provisions making up the Fiduciary Rule and the BICE exemption (apart from an illegal arbitration waiver). In any event, this comprehensive regulatory package is plainly not amenable to severance. Accordingly, the Court reversed the judgment of the district court and vacated the Fiduciary Rule in toto.

NOTE:  Just a few days, earlier the 10th Circuit Court of Appeals upheld the Fiduciary Rule, in Market Synergy Group, Inc. v. United States Department of Labor, No. 17-3038. (10th Cir. 2018), albeit on some narrow grounds.  Given this split in the Circuit Courts, the exact status of the Fiduciary Rule is not clear, and it is likely that there will be more to say about the Fiduciary Rule in the futu

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