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From Securities Regulation Daily, March 16, 2018

DOL’s ‘Fiduciary Rule’ vacated in its entirety

By Nadine E. Roddy, J.D.

A Final Rule promulgated by the Department of Labor in April 2016 expanding the definition of "investment advice fiduciary" conflicts with the text of ERISA and the Internal Revenue Code and is unreasonable under Chevron and the APA, the Fifth Circuit has held. Known as the "Fiduciary Rule," the rule not only departs from the common law definition without good reason, it also breaks with 40 years of established regulatory interpretation. Because its provisions are not severable, the rule was vacated in its entirety. Chief Judge Stewart dissented (Chamber of Commerce of the United States of America v. U.S. Department of Labor, March 15, 2018, Jones, E.).

Background. Three business groups filed separate suits challenging the rule, which is a package of seven different rules reinterpreting the term "investment advice fiduciary," and redefining exemptions to provisions concerning fiduciaries, that appear in ERISA and the IRC. The stated purpose of the rule was to regulate in a new way financial service providers and insurance companies in the markets for ERISA plans and IRAs. Consolidated by the district court, the business groups’ challenges proceeded on multiple grounds, including (1) the rule’s inconsistency with the governing statutes, (2) the DOL’s overreaching to regulate services and providers beyond its authority, (3) the DOL’s imposition of legally unauthorized contract terms to enforce the new regulations, (4) First Amendment violations, and (5) the rule’s arbitrary and capricious treatment of variable and fixed indexed annuities. The district court rejected all of the challenges, entering judgment for the DOL.

Meanwhile, in April 2017, the president directed the DOL to reexamine the rule and prepare an updated economic and legal analysis of its provisions, and the effective date of some provisions was extended to July 1, 2019.

Mootness. The Fifth Circuit first declared that the case had not been rendered moot by the presidential directive, as the rule had already spawned significant market consequences, including the withdrawal of several major companies from some segments of the brokerage and retirement investor market. The court believed it likely that many more financial service providers would exit the market rather than accept the new regulatory regime.

Rule conflicts with statutory text. The court noted that the DOL had expanded the statutory term "fiduciary" by redefining one out of three provisions explaining the scope of fiduciary responsibility under ERISA and the IRC. The second of the three provisions states that a person is a fiduciary with respect to a plan to the extent that he renders investment advice for a fee or other compensation with respect to any moneys or other property of the plan, or has any authority or responsibility to do so. For the past 40 years, the DOL had considered the hallmarks of an "investment advice" fiduciary’s business to be its "regular" work on behalf of a client and the client’s reliance on that advice as the "primary basis" for her investment decisions. The court concluded that the DOL’s new interpretation of an "investment advice fiduciary" relied too narrowly on a purely semantic construction of one isolated provision of the statute and wrongly presupposed that the provision was inherently ambiguous. Properly construed, the statutory text was not ambiguous.

The court explained that Congress’s use of the word "fiduciary" triggered the settled principle of interpretation that, absent other indication, Congress intends to incorporate the well-settled meaning of the common law terms it employs. This general presumption is particularly salient in analyses of ERISA, which has its roots in the common law of trusts. Further, the term "fiduciary" falls within the scope of this presumption. Noting that under the common law, fiduciary status turns on the existence of a relationship of trust and confidence between the fiduciary and client, the court believed that the rule’s new definition departed from the common law without good reason.

Rule fails "reasonableness" test. Assuming arguendo that some ambiguity was present in the statutory phrase "investment advice for a fee," the court then held that the rule failed the "reasonableness" test of Chevron U.S.A., Inc. v. NRDC, Inc. and the APA. Under Step 2 of Chevron, if the governing statute is silent or ambiguous with respect to the specific issue, the question for the court becomes whether the regulatory agency’s position is based on a permissible construction of the statute. If the regulatory interpretation is reasonable, it must be upheld. In addition, the regulation must withstand APA review, ensuring it is not arbitrary, capricious, contrary to law, or in excess of statutory authority. In this case, the court had little trouble concluding that the rule was unreasonable as well as arbitrary and capricious. Not only did the rule depart from the common law without good reason, it also conflicted with the statutory text. Moreover, the fact that it took the DOL over 40 years to "discover" its new interpretation further highlighted the rule’s unreasonableness.

Rule not subject to severance. Declaring that "this comprehensive regulatory package is plainly not amenable to severance," the court reversed the district court’s judgment and vacated the rule in toto.

Dissent. The Chief Judge, dissenting, observed that over the last 40 years, the retirement-investment market had experienced a shift from pension plans controlled by large employers and professional money managers toward individually controlled retirement plans and accounts. In response to these changes, the DOL had recalibrated and replaced its previous regulatory framework. Because the judge believed that the DOL had acted within its regulatory authority in expanding the definition of "investment advice fiduciary" to the limits contemplated by ERISA and the IRC, the judge would have upheld the rule.

The case is No. 17-10238.

Attorneys: Eugene Scalia (Gibson, Dunn & Crutcher) for Chamber of Commerce of the United States of America, Financial Services Institute, Inc., and Financial Services Roundtable. Joseph Robert Guerra (Sidley Austin) for Indexed Annuity Leadership Council. David W. Ogden (WilmerHale) for American Council of Life Insurers. Michael Shih, U.S. Department of Justice, for the U.S. Department of Labor.

Companies: Chamber of Commerce of the United States of America; Financial Services Institute, Inc.; Financial Services Roundtable; Indexed Annuity Leadership Council; American Council of Life Insurers

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