On March 15, 2018, in Chamber of Com. of the U.S. v. U.S. Dep’t. of Labor (No. 17-10238, 5th Cir. Mar. 15, 2018), the Fifth Circuit entered an order enjoining enforcement of the Department of Labor’s (DOL) fiduciary rule (Fiduciary Rule), finding that the DOL exceeded its statutory authority in promulgating the rule, and that the rule was arbitrary and capricious. The Fiduciary Rule would have had the effect of increasing the number of financial advisors who would be considered “fiduciaries” when providing advice relating to retirement plans governed by the Employee Retirement Security Act (ERISA) and the Internal Revenue Code (IRC), such as 401(k) plans and Individual Retirement Accounts (IRAs). The Fiduciary Rule has been the subject of controversy because fiduciaries are held to very high standards, and must act in the best interests of their clients at all times (see, e.g., 29 U.S.C. § 1104(a)(1)(A)-(B)). As the Fiduciary Rule broadens the definition of “fiduciary,” the financial industry has had to take significant steps, at substantial cost, to ensure compliance with the rule. The Fiduciary Rule was scheduled to fully go into effect on July 1, 2019, but the Fifth Circuit’s ruling suspended the operation of the rule nationwide—at least pending further judicial review—effective May 7, 2018.
The crux of the matter for the Fifth Circuit was the definition of the term “fiduciary,” as Congress understood it at the time it enacted ERISA, and whether the expanded definition of that term under the Fiduciary Rule was consistent with that understanding. To start with, the court determined that the common law definition of the term “fiduciary” presumptively applies, unless Congress clearly intended to change the meaning of the term by statute. At common law, a fiduciary relationship is one in which the “very essence [is] . . . trust and confidence,” and not just any arms-length relationship between two parties. Given the way that the term “fiduciary” is used in ERISA, the court determined that Congress did not intend to change its meaning, that the common law definition of the term applied, and that the broader use of the term in the Fiduciary Rule therefore impermissibly conflicted with the meaning of “fiduciary” at common law.
As further support for its analysis, the court turned to Congress’s use of the term “investment advice” within the definition of fiduciary under ERISA and IRC: “a person . . . [who] renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of [a retirement] plan.” 26 U.S.C. § 1002(21)(A)(ii); 26 U.S.C. § 4975(e)(3)(B). At the time ERISA became effective in 1974, the term “investment advice” was understood to mean “‘regular’ work on behalf of a client and the client’s reliance on that advice as the ‘primary basis’ for her investment decisions,’” which is in line with the common law definition of “fiduciary.” By contrast, the Fiduciary’s broader definition of “fiduciary” would capture not just those who perform “regular work” on behalf of a client, but also those who have one-time contact with the client in providing services or selling financial products in the retirement investment context. The court found that this, too, was contrary to Congress’s intent when it enacted ERISA.
Separately, the court also found that the Fiduciary Rule is arbitrary and capricious because it imposes fiduciary duties with respect to individual IRA account advisors, even though those accounts are regulated under a separate Title of ERISA—under which the DOL’s power to regulate is more circumscribed. Although the DOL argued that it also promulgated exemptions for those individuals that are in line with ERISA’s statutory purposes, the court held that the DOL could not save the rule simply by creating exemptions to an otherwise overbroad rule.
The effect of the Fifth Circuit’s decision is a major one, invalidating the Fiduciary Rule in toto, and with it, the Fiduciary Rule’s potentially sweeping impact on the financial industry. Although the Fifth Circuit’s decision may yet be stayed or overturned by an en banc panel—which the DOL has until April 30, 2018, to request—or the Supreme Court, the decision is set to go into effect on May 7, 2018. LenderLaw Watch will continue to monitor developments relating to the fiduciary rule, and bring you updates as they occur.