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Appeals Court Throws Out the DOL's Fiduciary Rule

By Miriam Rozen March 16, 2018

In a significant setback for the Department of Labor’s fiduciary rule, an appeals court has vacated the measure in its entirety, paving the way, possibly, to further appeal — or to the administration of U.S. President Donald Trump either dropping the matter entirely or letting the SEC tackle it on its own.

On Thursday, a three-judge panel of a New Orleans-based federal appeals court overturned in its entirety the DOL’s fiduciary rule. The Fifth Circuit Court of Appeals two-to-one ruling agreed with industry trade organizations, challenging the DOL fiduciary rule, which included the Securities Industries and Financial Markets Association and the U.S. Chamber of Commerce.

The DOL’s rule requires that brokers act in the best interest of their clients in their retirement accounts. The Fifth Circuit ruling determined that the DOL exceeded its statutory authority under the Employment Retirement Income Security Act when it established that fiduciary rule, which it first formally issued in April 2016.

In the new opinion, Fifth Circuit Judge Edith Jones, writing for the majority, predicts that if the DOL’s fiduciary rule were to remain in place,“It is likely that many financial-service providers will exit the market for retirement investors rather than accept the new regulatory regime.”

Jones concludes: “Millions of IRA investors with small accounts prefer commission-based fees because they engage in few annual trading transactions. Yet these are the investors potentially deprived of all investment advice as a result of the”DOL’s“Fiduciary Rule, because they cannot afford to pay account management fees, or brokerage and insurance firms cannot afford to service small accounts, given the regulatory burdens, for management fees alone.”

But the Fifth Circuit’s opinion may not represent the last word on the DOL’s fiduciary rule.

The DOL could decide to ask the full Fifth Circuit to rehear the dispute, or seek a hearing before U.S. Supreme Court.

In addition, another federal circuit appellate court, based in Washington, D.C., has a case pending brought by challengers of the DOL fiduciary rule.

Because that court has jurisdiction separate from the Fifth Circuit, its judges could disagree with the ruling just issued. Moreover, on March 13, two days before the Fifth’s ruling, the Denver, Colorado-based Tenth Circuit Court of Appeals issued an opinion upholding the DOL rule and rejecting a narrower challenge of some of its specific provisions brought by an insurance distributor.

But the Fifth Circuit’s opinion will draw notice chiefly because it vacates all parts of the DOL rule.

Beyond that, Jones in her 46-page opinion expresses extensive views about the limits by which federal regulators must abide, the changing times in the financial markets, and even deference to U.S. President Donald Trump. His White House has directed the Labor department “to re-examine the Fiduciary Rule and prepare an updated economic and legal analysis” of it, Jones notes.

“DOL’s interpretation of an ‘investment advice Fiduciary’ relies too narrowly on a purely semantic construction of one isolated provision” of the Employee Retirement Income Security Act“and wrongly presupposes that the provision is inherently ambiguous,” Jones writes.

When they wrote Erisa in the 1970s, federal legislators wanted simply to use the common law definition of fiduciary, Jones concludes. She bases that conclusion on Congress not putting“fiduciary” in quotation marks, as the lawmakers had for other terms in the statute, which it explicitly defined, such as “beneficiary” and “participant.”

“DOL’s interpretation of an ‘investment advice Fiduciary’ relies too narrowly on a purely semantic construction of one isolated provision of Erisa and wrongly presupposes that the provision is inherently ambiguous.”
Edith Jones
Fifth Circuit Court of Appeals

“When enacting Erisa, Congress was well aware of the distinction between investment advisers, who were considered fiduciaries, and stockbrokers and insurance agents, who generally assumed no such status in selling products to their clients,” Jones writes. “ Fiduciary Rule improperly dispenses with this distinction.”

Jones goes on. “Congress chose not to require advisers to individual retirement plans to bear the duties of loyalty and prudence required of Title I Erisa plan fiduciaries,” she writes. “That times have changed, the financial market has become more complex, and IRA accounts have assumed enormous importance are arguments for Congress to make adjustments in the law, or for other appropriate federal or state regulators to act within their authority.”

In clarifying the last clause, Jones opines that “a perceived ‘need’ does not empower DOL to craft de facto statutory amendments or to act beyond its expressly defined authority.”

Jones identifies a pathway for the federal government to issue a more widely accepted definition of a fiduciary.

It would start at the SEC, not the DOL, Jones writes. “The SEC has the expertise and authority to regulate brokers and dealers uniformly, she writes. DOL should not have infringed on “SEC turf,” she says. Rather, the department should have “conferred with and supported SEC practices to assist IRA and all other individual investors,” Jones writes.

In a dissenting opinion, Fifth Circuit Judge Carl Stewart concludes that the challengers and the two other judges on his panel “skew valid agency action that demonstrates an expansive-but-permissible shift in DOL policy as falling outside the statutory bounds of regulatory authority set by Congress.”

The judges in the majority may have “qualms with these regulatory changes and the effect the DOL’s exercise of its regulatory authority might have on certain sectors of the financial services industry,” Stewart argues. But that is beside the point since, he concludes: the DOL’s exercise was “lawful and consistent with the Congressional directive.”

Jeffrey Gordon, a professor at Columbia Law School in New York, who writes extensively about the regulation of financial institutions, forecasts no objections to the Fifth Circuit panel’s majority ruling by the Trump Administration.

“I think the Trump administration will not appeal this ruling,” Gordon tells FA-IQ. The administration will use it as an opportunity to argue that the fiduciary issues “should be resolved uniformly by the SEC, which already has a regulatory effort underway to heighten the duties of brokers to their clients,” Gordon says.

Leaving things to the SEC alone would garner wide support from the financial-service industry, according to Gordon. “The industry is generally supportive of the SEC raising standards,” he says. “Many firms have already adopted a ‘fiduciary’ standard in part because they think that a ‘fee for advice’ model may work better than extracting commissions or loads on the sale of products.” 

Meanwhile, adds Gordon: “Investors are becoming more sophisticated about the availability of low cost products, like index funds and ETFs.”

But the Fifth Circuit overturning of the DOL rule also might allow the Trump administration enough breathing space to drag its feet on making any immediate changes.

“This reduces pressure for the SEC to do anything, and ‘deregulatory’ sentiment is strong.  Administration attitudes about the work of the CFPB” — that's the Consumer Financial Protection Bureau — “may carry over to the SEC’s final disposition,” Gordon says.