© 2018 The Texas Lawbook.
By Timothy G. Verrall and Ron Chapman, Jr. of Ogletree Deakins
(March 22) – Since 2010, the U.S. Department of Labor has been refining regulations – the so-called fiduciary rule – that significantly expand the existing fiduciary and conflict of interest requirements for investment advisers working with retirement plans and individual retirement accounts under ERISA and the Internal Revenue Code, but these efforts may have hit a fatal roadblock on March 15, courtesy of the 5th Circuit Court of Appeals.
In Chamber of Commerce of the United States, et al. v. U.S. Department of Labor, the 5th Circuit became the latest federal court to consider the fiduciary rule, and the first to jettison it in its entirety. Prior to this case, the DOL had prevailed in each of several prior challenges to the fiduciary rule, including as recently as a March 13th decision by the 10th Circuit.
The 5th Circuit’s decision introduces a new element of uncertainty into the regulatory equation and makes it significantly more likely that the fiduciary rule – which was already under internal DOL review – will not go into effect in final form on July 1, 2019, as previously scheduled, or perhaps at all.
Background
ERISA and the Internal Revenue Code extensively regulate the conduct of “fiduciaries” and proscribe many common transactions involving retirement plans and IRAs that may involve conflicts of interest. (ERISA generally applies only to retirement plans operated by private sector employers or employee organizations. IRAs are subject to similar but separate “prohibited transaction” rules under the Internal Revenue Code. Notably, the fiduciary conduct standards in ERISA do not apply to persons or entities associated with IRAs, and ERISA’s enforcement provisions – such as the ability of a plan participant or the DOL to sue a fiduciary – also do not apply to IRAs.)
Supplementing more general definitions of the term in the statute, the ERISA regulations include a detailed definition of fiduciary status that would apply to, for example, an investment adviser who provides regular recommendations about which investments a retirement plan should make and receives a fee for doing so.
Beginning in the late 1990s, the investment practices for retirement plans and IRAs began to shift to a more “DIY” approach than was historically the case, placing retirement plan participants and IRA owners in charge of choosing their own investments. In this environment, unbiased investment guidance was increasingly hard to come by, and concern about the risks of conflicted advice ultimately led the DOL to propose a significant expansion of the types of investment professionals who could be expected to have fiduciary status under ERISA or the Internal Revenue Code.
In general terms, the fiduciary rule expands the reach of ERISA’s fiduciary standards and the Internal Revenue Code’s prohibited transaction rules to reach any individual or entity who receives compensation of any kind in connection with even a single, one-time investment recommendation (for example, “You should buy this mutual fund” or “You should sell this stock and buy X instead”).
The fiduciary rule also modified related requirements to allow this new class of investment fiduciaries to avoid automatic liability under ERISA or the Internal Revenue Code if they agreed by contract to conduct their business in accordance with the existing standards of conduct applicable to fiduciaries since 1974.
The fiduciary rule was never especially popular among the investment professionals to which it applied, particularly since they already faced a large and growing body of regulatory requirements from the Securities and Exchange Commission and various state regulators. The fiduciary rule went through several rounds of internal reconsideration and revision before being finalized in April 2016.
The 2016 presidential election and subsequent change in personnel at the DOL led to further reconsideration of the “final” fiduciary rule and, ultimately, a delay in its effective date until July 1, 2019. During the internal administrative process, a number of business groups challenged the proposed rule on various grounds, including the group that brought the claims resolved by the 5th Circuit in Chamber of Commerce.
(Note that although many of the more burdensome aspects of the fiduciary rule have been delayed, the expanded definition of fiduciary status took effect on Jan. 1, meaning any individual or entity who fits into the expanded definition is – or was prior to Chamber of Commerce – required to use its good faith best efforts to follow the fiduciary standards of conduct in ERISA and the prohibited transaction rules in the Internal Revenue Code.)
The decision
Chamber of Commerce was decided by a split panel of the 5th Circuit on March 15 and vacated the fiduciary rule in its entirety. In its decision, the majority panel – consisting of Judges Edith H. Jones and Edith Brown Clement – focused on congressional intentions regarding the scope of the existing ERISA and DOL definition of the terms “fiduciary” and “investment adviser.”
The majority panel was troubled by the breadth of the fiduciary rule and the number of new investment fiduciaries it would create by regulation, which the court argued conflicted with existing ERISA provisions, historical understanding of the term “fiduciary,” and existing and developing investment industry practices and compliance obligations.
Having concluded that the fiduciary rule contravened 40 plus years of common understanding of what it means to provide investment guidance on a fiduciary basis, the majority panel ruled that the DOL’s stated rationales for the rule amounted to unreasonable extensions of ERISA’s coverage, and the rule itself was therefore invalid. In effect, while the majority panel appeared to acknowledge the reality of current investment practices in the retirement plan and IRA industry and the importance of unconflicted investment advice, even for one-off transactions, it concluded that the DOL’s statutory jurisdiction did not extend far enough to permit the fiduciary rule to take effect and left it to Congress, not the DOL, to take further action.
What now?
Chamber of Commerce vacates the fiduciary rule in its entirety, meaning at least for the moment new would-be investment fiduciaries may be able to breathe a bit easier. As noted above, although significant parts of the fiduciary rule were delayed until 2019, at least a few of its components were, before Chamber of Commerce, already effective and required action by covered investment advisers. Now, the entire rule is effectively shelved, pending further judicial review. The DOL has informally indicated that it will suspend any enforcement activities relating to the fiduciary rule for the time being, including outside the 5th Circuit.
However, this delay is not the end of the story. Many in the investment community have already entered into advisory agreements with retirement plans and IRA owners that track some or all of the fiduciary rule’s requirements. Neither this decision nor the DOL’s response to it would negate existing contractual obligations as a general rule. For investment advisers in this situation, the fiduciary rule effectively lives on.
In the shorter term, continuing uncertainty seems almost inevitable. It remains unclear whether the DOL will request a rehearing before either the panel or the entire 5th Circuit, appeal the ruling to the Supreme Court, or not seek any further review. As noted above, the DOL has been defending the fiduciary rule thus far, but it is possible that Chamber of Commerce will give it a convenient exit to avoid the need to revise or formally rescind the rule. In effect, the DOL could simply acquiesce to the 5th Circuit’s ruling and allow the fiduciary rule to remain shelved. On the other hand, the DOL might take a more aggressive posture, potentially raising the likelihood of eventual intervention by the Supreme Court to resolve the current difference of opinion between the 5th and 10th Circuits.
Regardless, for investment advisers in the fiduciary rule’s cross-hairs and other retirement plan fiduciaries and IRA owners, time will not stand still. For now, it seems likely that all affected parties will carry on cautiously with existing contractual arrangements and wait to see what the DOL will do.
Timothy G. Verrall is a shareholder in the Houston office of Ogletree Deakins and advises clients on a wide variety of issues under ERISA, the Internal Revenue Code, and related federal and state laws. Ron Chapman, Jr. is a shareholder in the Dallas office of Ogletree Deakins and represents employers in all areas of labor and employment law.
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