Attorneys from the Labor and Justice Departments intend to mount a vigorous defense of most of the fiduciary rule before the 5^th Circuit Court of Appeals in New Orleans at the end of the month, even as regulators consider massive revisions to the landmark regulation.

In court papers filed this week by the Labor Department’s acting solicitor, government attorneys argue that a sweeping lower court decision in Texas upholding the fiduciary rule should be affirmed on appeal, with the exception of one prominent provision of the rule.

Last February, Judge Barbara Lynn, chief judge for the U.S. District Court for the Northern District of Texas, issued a decisive ruling dismissing the most wide-ranging of four lawsuits brought by industry stakeholders. The plaintiffs in that case, which include the U.S. Chamber of Commerce and the Securities Industry and Financial Markets Association, promptly filed an appeal.

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

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

The ramifications of Labor’s new strategy are considerable.

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

Labor’s attorneys say they are dropping the defense of the class-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 state laws that override the FAA by restricting class-action waiver clauses in contracts.

That precedent forbids the Labor Department from doing what it did with the BIC Exemption—“conditioning a regulatory exemption on a regulated party’s refraining from entering into an arbitration agreement that would prevent class litigation,” according to papers filed by the Labor and Justice Departments.

Labor’s flip flop

Proponents of the rule are heartened by much of the argument Labor filed with the 5^th Circuit, which defends the Department’s statutory authority in promulgating the rule, crafting the BIC Exemption, and the agency’s adherence to the Administrative Procedure Act.

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

But the decision to drop the defense of the BIC’s restrictions on class-action waivers is troubling, Hauptman told BenefitsPRO.

“We think the government is wrong on this issue. The acting solicitor’s interpretation of recent precedent on arbitration agreements and class-action waivers is incorrect,” he said, noting that Labor’s original defense of the prohibition on class-action waivers persuaded Judge Lynn in the lower court.

“Having the right to collective action when there are systemic abuses by industry is a really important protection for consumers when they are harmed. Labor correctly argued the restriction on class-action waivers in the district court. For the government to now flip flop for no legitimate reason is concerning,” added Hauptman.

Impact of new strategy on 5^th Circuit

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

On the one hand, the Trump administration and Labor Secretary Alexander Acosta have made no bones about wanting to revise the rule, or even pull it altogether. Labor’s recent request for information on the rule raises the possibility of stripping the restriction on class-action waivers from the BIC, and even eliminating all contractual requirements.

On the other hand, Trump administration attorneys will argue the fundamental necessity of the fiduciary rule to the 5^th Circuit, and the need for new regulations that protect retirement investors from conflicted advice.

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

Some experts speculated that would be the administration’s course with the fiduciary rule in the immediate aftermath of Trump’s election.

But at a symposium hosted by the American Bar Association in February, a representative from the AARP, perhaps the most powerful advocate of the fiduciary rule, said the association would step in to defend the rule if the government dropped its defense.

“The administration didn’t have the luxury of just dropping its defense of the case,” said Erin Sweeney, and ERISA attorney with Miller & Chevalier. “Someone was going to defend this rule in court, so it was in the administration’s interest to stay in the driver’s seat.”

That the Labor Department has dropped its defense of the class-action provision is obviously a strategy arrived at in consultation with the administration and Sec. Acosta, noted Sweeney.

But it does not mean that the panel of appellate judges on the 5^th Circuit will automatically strike down the class-action waiver restrictions.

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

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

The plaintiffs have argued that a decision to invalidate the class-action restrictions would require the entire rule to be vacated. While Labor will argue that the restrictions should be removed, they will also say that rule’s severability clause allows the BIC Exemption to go forward.

“DOL clearly indicated that it would have adopted the BIC Exemption even if the exemption’s anti-arbitration condition is severed,” wrote the government in its brief filed in the 5^th Circuit.

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

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

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

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

Labor’s flip flop

Impact of new strategy on 5th Circuit

Impact of new strategy on 5^th Circuit

Instant Insights /

Labor drops its defense of fiduciary rule&rsquo;s class-action provision

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Labor drops its defense of fiduciary rule’s class-action provision