Fifth Circuit Vacates DOL Fiduciary Rule While SEC Pushes Forward with Goal of Fiduciary Duty Reform

On March 15, 2018, the United States Court of Appeals for the Fifth Circuit elected, in a 2-1 decision, to vacate the Department of Labor’s (DOL’s) Fiduciary Rule (Chamber of Commerce of the U.S.A., et al. v. U.S. Dep’t of Labor, et al.).  In doing so, the Fifth Circuit overturned the Fiduciary Rule in its entirety, including its new definition of fiduciary advice under the Employee Retirement Income Security Act of 1975 (ERISA) and the Internal Revenue Code (Code), as well as the various new exemptions and revisions to existing exemptions that it features.  It is uncertain whether the DOL will request that the Fifth Circuit rehear the case, appeal the case to the United States Supreme Court, or do nothing.  The Fifth Circuit’s decision, however, has not deterred the Securities and Exchange Commission (SEC) from continuing to discuss implementing its own fiduciary rule.

According to the Fifth Circuit’s majority opinion, the DOL exceeded its authority in adopting the new fiduciary investment advice definition in the Fiduciary Rule, finding the definition inconsistent with the plain text of ERISA and the Code. The Fifth Circuit also concluded that the DOL acted “arbitrarily and capriciously” in, among other things, requiring people providing services to IRAs to sign a contract under the Best Interest Contract exemption in which they admit that they are fiduciaries and can be sued. Therefore, the Fifth Circuit concluded that “the Rule fails to pass the tests of reasonableness of the [Administrative Procedures Act].”

The Fifth Circuit’s ruling is expected to go into effect May 7th of this year.  If the DOL does not request a rehearing or appeal the case to the Supreme Court, those specializing in retirement accounts in the Fifth Circuit will be obligated to follow the old “five-part” definition of fiduciary investment advice implemented in 1975 and the prohibited transactions exemptions in place prior to 2016.  Whether the Fifth’s Circuit’s decision will have an effect beyond the three states under its jurisdiction, Texas, Louisiana, and Mississippi, remains unclear.

Until at least May 7th, investment advisory firms should continue to adhere to the Fiduciary Rule and any policies and procedures adopted to comply with the Fiduciary Rule. If the DOL seeks to overturn the Fifth Circuit ruling, it will almost certainly ask for a stay in the Fifth Circuit’s ruling pending final resolution, in which case the Fiduciary Rule would remain in effect during the period of the stay. Even if and when the Fiduciary Rule is fully overturned, firms should continue to comply with any policies and procedures adopted to comply with the Fiduciary Rule until they make changes to those policies and procedures, otherwise they could face regulatory problems.

The Fifth Circuit’s decision has not deterred the SEC from meeting its goal of fiduciary reform.  At a compliance conference hosted by the Securities Industry and Financial Markets Association (SIFMA), SEC Chairman Jay Clayton announced that the Fifth Circuit’s ruling has not discouraged the SEC from making efforts to draft its own fiduciary rule.  Clayton admitted that he has not “had any discussions with the Department of Labor on what it means from a broader perspective of administrative law and the approach to administrative law.  We’ll see, but as far as I’m concerned, we’re moving forward.”

According to Clayton, the SEC’s fiduciary rule ought to set the standards for monitoring a client’s interactions with an investment adviser or broker-dealer.  He also pointed out that his goals for the SEC’s possible fiduciary rule include a new standard of care for broker-dealers, making the investment adviser fiduciary standard clearer, and making the difference between investment advisers and broker-dealers more certain.  Clayton did not give an exact time frame regarding when the SEC would propose its own fiduciary rule.  However, he did indicate that he would prefer to propose it sooner rather than later.


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