Attorneys from the Labor and Justice Departments intend to mounta vigorous defense of most of the fiduciary rule before the 5^thCircuit Court of Appeals in New Orleans at the end of the month,even as regulators consider massive revisions to the landmarkregulation.

In court papers filed this week by the Labor Department’s actingsolicitor, government attorneys argue that a sweeping lower courtdecision in Texas upholding the fiduciary rule should be affirmedon appeal, with the exception of one prominent provision of therule.

Last February, Judge Barbara Lynn, chief judge for the U.S.District Court for the Northern District of Texas, issued adecisive ruling dismissing the most wide-ranging of four lawsuitsbrought by industry stakeholders. The plaintiffs in that case,which include the U.S. Chamber of Commerce and the SecuritiesIndustry and Financial Markets Association, promptly filed anappeal.

Among the eight challenges in the lawsuit is a claim that aprovision in the rule’s Best Interest Contract Exemption restrictingclass-action waivers violates the Federal Arbitration Act, whichprotects the enforceability of private arbitration agreements thatprohibit parties from bringing class-action claims.

Now, the Labor and Justice Departments are dropping the defenseof that claim.

The ramifications of Labor’s new strategy are considerable.

The restriction on writing class-action waivers into the BICExemption was designed as the rule’s primary enforcement mechanism.Prior to the rule, individual IRA owners’ breach of contract claimscould be arbitrated, or heard in state courts. But contracts withIRA investors could prohibit class-action claims, making breach ofcontract allegations much easier, and cheaper for financialinstitutions to defend.

Labor’s attorneys say they are dropping the defense of theclass-action provision based on an existing Supreme Court ruling,and on the agency’s position in NLRB v. Murphy Oil USA,Inc., an FAA case waiting to be heard by the High Court.

In previous rulings, the Supreme Court has struck down statelaws that override the FAA by restricting class-action waiverclauses in contracts.

That precedent forbids the Labor Department from doing what itdid with the BIC Exemption—“conditioning a regulatory exemption ona regulated party’s refraining from entering into an arbitrationagreement that would prevent class litigation,” according to papersfiled by the Labor and Justice Departments.

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Labor’s flip flop

Proponents of the rule are heartened by much of the argumentLabor filed with the 5^th Circuit, which defends theDepartment’s statutory authority in promulgating the rule, craftingthe BIC Exemption, and the agency’s adherence to the AdministrativeProcedure Act.

“It’s really encouraging that the government has so stronglydefended the rule the way it has,” said Micah Hauptman, an attorneywith the Consumer Federation of America, a prominent supporter ofthe rule.

But the decision to drop the defense of the BIC’s restrictionson class-action waivers is troubling, Hauptman toldBenefitsPRO.

“We think the government is wrong on this issue. The actingsolicitor’s interpretation of recent precedent on arbitrationagreements and class-action waivers is incorrect,” he said, notingthat Labor’s original defense of the prohibition on class-actionwaivers persuaded Judge Lynn in the lower court.

“Having the right to collective action when there are systemicabuses by industry is a really important protection for consumerswhen they are harmed. Labor correctly argued the restriction onclass-action waivers in the district court. For the government tonow flip flop for no legitimate reason is concerning,” addedHauptman.

Impact of new strategy on 5^th Circuit

The irony of Labor’s defense of the rule, notwithstanding itsamended position on class-action waivers, is thick.

On the one hand, the Trump administration and Labor SecretaryAlexander Acosta have made no bones about wanting to revise therule, or even pull it altogether. Labor’s recent request forinformation on the rule raises the possibility of stripping therestriction on class-action waivers from the BIC, and eveneliminating all contractual requirements.

On the other hand, Trump administration attorneys will argue thefundamental necessity of the fiduciary rule to the 5^thCircuit, and the need for new regulations that protect retirementinvestors from conflicted advice.

One option the Trump administration had was to drop its defenseof the fiduciary rule in court, a tactic it has taken in otherchallenges to Obama-era regulations.

Some experts speculated that would be the administration’scourse with the fiduciary rule in the immediate aftermath ofTrump’s election.

But at a symposium hosted by the American Bar Association inFebruary, a representative from the AARP, perhaps the most powerfuladvocate of the fiduciary rule, said the association would step into defend the rule if the government dropped its defense.

“The administration didn’t have the luxury of just dropping itsdefense of the case,” said Erin Sweeney, and ERISA attorney withMiller & Chevalier. “Someone was going to defend this rule incourt, so it was in the administration’s interest to stay in thedriver’s seat.”

That the Labor Department has dropped its defense of theclass-action provision is obviously a strategy arrived at inconsultation with the administration and Sec. Acosta, notedSweeney.

But it does not mean that the panel of appellate judges on the5^th Circuit will automatically strike down theclass-action waiver restrictions.

“The 5^th Circuit will look at the entire decisionfrom the lower court—they have to determine how the rule of law wasapplied by Judge Lynn,” said Sweeney. Labor’s new defense willcertainly inform the panel, “but it’s the actual decision itselfthat is in front of the court.”

The finalized fiduciary rule included a severability clause thatsaid if courts were to strike down the restrictions on class-actionwaivers, the BIC Exemption would still survive.

The plaintiffs have argued that a decision to invalidate theclass-action restrictions would require the entire rule to bevacated. While Labor will argue that the restrictions should beremoved, they will also say that rule’s severability clause allowsthe BIC Exemption to go forward.

“DOL clearly indicated that it would have adopted the BICExemption even if the exemption’s anti-arbitration condition issevered,” wrote the government in its brief filed in the5^th Circuit.

“The Obama administration knew they were not on the firmestground when they wrote the right for every investor to participatein a class action into the rule,” explained Sweeney.

“By adding the severability clause, they tried to inoculate theoverall regulation—even if that part of the BIC was found to beinvalid, you could snap it off and the rest of the BIC would liveon,” she said.

A decision from the 5^th Circuit siding with thegovernment’s new position on class-action restrictions would givethe Labor Department more justification to carve-out the provisionas it determines how to legally revise the rule, said Sweeney. Shepredicts the Appellate Court will issue a decision before thescheduled January 1, 2018 applicability date for the BIC.

“All indications are that the court is aware of the rule’stimeframe,” said Sweeney. “This is fast for a Circuit Court tooperate—sometimes it takes a year before oral arguments arescheduled. The Court likely wants to be impactful before thequestion becomes moot. I expect a decision before the end of theyear.”

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