Fifth Circuit Strikes Down DOL Fiduciary Rule

Steven Lofchie Commentary by Steven Lofchie

On June 21, 2018, the Fifth Circuit issued a mandate finalizing its March 2018 decision vacating the DOL's 2016 regulation that, among other things, expanded the scope of persons subject to fiduciary obligations (the "fiduciary rule"). The final decision relates to the definition of investment advice under ERISA, and certain related new prohibited transaction exemptions and amendments to existing prohibited transaction exemptions.

The appellants challenged the fiduciary rule on multiple grounds, claiming:

  • inconsistencies between the fiduciary rule and governing statutes;
  • the DOL overreached "to regulate services and providers beyond its authority";
  • the DOL imposed "legally unauthorized contract terms to enforce the new regulations";
  • First Amendment violations; and
  • "arbitrary and capricious treatment of variable and fixed indexed annuities."

The Court's majority found that (i) the fiduciary rule's interpretation of "investment advice fiduciary . . . conflicts with the statutory text and contemporary understandings" and (ii) the fiduciary rule failed the "reasonableness test" of Chevron USA, Inc. v. NRDC, Inc. and the Administrative Procedure Act.

In striking down the rule, the Court observed that the fiduciary rule had already had significant negative consequences for both customers and service providers. The Court observed that:

"The Fiduciary Rule has already spawned significant market consequences, including the withdrawal of several major companies . . . from some segments of the brokerage and retirement investor market. . . . Confusion abounds — how, for instance, does a company wishing to comply with the BICE exemption document and prove that its salesman fostered the 'best interests' of the individual retirement investor client? The technological costs and difficulty of compliance compound the inherent complexity of the new regulations. . . . It is likely that many financial service providers will exit the market for retirement investors rather than accept the new regulatory regime."

The DOL did not seek a rehearing of the March 2018 Fifth Circuit decision and did not petition the Supreme Court for certiorari within the relevant time frame. The deadline to file a petition for a writ of certiorari was June 13, 2018.

Commentary

From the standpoint of securities regulatory policy, this is a good result. It simply makes no sense to have one set of rules apply to the relationship between a broker-dealer and an individual client and another set of rules that applies to the relationship with the individual client's IRA.

Notably, the Court pointed out that the DOL Fiduciary Rule is a prime example of a well-intended act having negative consequences — in this case, the inability of certain investors to obtain commission-based transactional services because it is no longer worthwhile, given the legal risk, for broker-dealers to provide such services. It is to be hoped that the SEC will likewise consider these unintended consequences as it reviews comments on its Best Interest Requirements. See generally BD Best Interest Requirement; see also memorandum Choose One: Best Interest or Full Service.

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