The U.S. Court of Appeals for the Fifth Circuit has formally put an end to the fiduciary rule.
The court issued a mandate on June 21 that certifies its decision to vacate the Labor Department’s fiduciary rule. The mandate had been expected on May 7.
In issuing the mandate, the court formally puts an end to Labor’s fiduciary rule, and its Impartial Conduct Standards, which had remained in effect despite the two-to-one appellate decision in March overturning a lower court decision that upheld the fiduciary rule.
“The big news is that the case is over, after 2 years and 20 days,” said Kevin Walsh, an attorney with The Groom Law Group. The U.S. Chamber of Commerce, Securities Industry and Financial Markets Association, and what ultimately became a consolidated consortium of 20 other plaintiffs, filed suit on June 1, 2016 in the U.S. District Court for the Northern District of Texas.
Attorneys have told BenefitsPRO that the mandate’s six-week delay was unusual. Some lawyers tracking the case speculated that the 5th Circuit may have been exploring internal procedures that would have allowed for an en banc review, or rehearing of the March decision, before the full panel of Appellate judges on the court.
“Opponents of the rule are breathing a sigh of relief that the mandate was finally issued,” said Walsh. “But it does leave financial institutions in a bit of an uncertain place. For those that have taken steps to comply with the rule, it leaves them wondering what they get for their efforts.”
Along with reversing the sweeping decision upholding the fiduciary rule by the Dallas district court last year, the 5th Circuit also ordered the Labor Department to pay appellate legal fees to the original plaintiffs. Federal appellate rules call for such payments unless courts order otherwise.
While the mandate marks an official time of death for Labor’s fiduciary rule, it by no means closes the discussion on whether existing regulations for broker-dealers and registered advisors adequately protect the interests of retail investors.
“While it’s important to recognize this as a real victory for opponents of the rule, it’s not the end of the best interest discussion,” said Walsh.
The Securities and Exchange Commission has proposed rules that it says will raise the standard of care for broker-dealers. And several states have issued or proposed new investor protections.
“It’s a safe bet that proponents of Labor’s rule won’t view this defeat as the end of the discussion for investment advice standards of care,” added Walsh.
Ideal of a unified fiduciary standard “still very much alive”
Jon Stein, co-founder and CEO of Betterment, the largest independent robo-advisory and a strong advocate for Labor’s fiduciary rule, called the release of the mandate “upsetting.”
Morningstar and other industry analysts were projecting digital advice providers to flourish under the fiduciary rule.
“We were hopeful for a different outcome and, while not surprised at the ruling, we are still disappointed about the negative impact it will have in the immediate and long term. It’s a sad day for not only those of us in the industry that have fought hard against this, but also—and more so—America’s 75 million hard-working retirement savers,” said Stein in a statement.
A week ago, the Labor Department let pass a deadline to petition the Supreme Court to review the 5th Circuit’s decision. The 10th Circuit upheld a more narrow reading of the rule, while the District Court for the D.C. circuit was the first to rule that the Obama administration was well within its authority under the Administrative Procedure Act to promulgate the fiduciary rule.
“The fiduciary rule has now died several deaths, but the promise of a unified fiduciary standard is still very much alive,” said Rob Foregger, co-founder of NextCapital, a provider of managed account platforms for investment companies and record keepers.
“The DOL rule has irreversibly accelerated the entire investment industry toward client-advisor alignment– and a fiduciary future. The industry’s transformation will slow without this rule, but the principles will not quickly fade,” Foregger told BenefitsPRO.
5-plus years, 3 public comment periods, numerous hearings
The Obama-era Labor Department finalized the fiduciary rule in April of 2016. The complex regulation was more than five years in the making, and was designed to address conflicts of interest on advice to retail investors holding qualified retirement accounts.
The Obama administration claimed IRA investors lose $17 billion a year in savings to high fees resulting from brokers’ and insurance agents’ conflicted advice.
The Labor Department revised an initial proposal, held a three-day open public forum in Washington, D.C. to receive input from stakeholders, and opened three public comment periods throughout the rule-making process, as was required by law.
The Obama administration routinely argued its good faith, “big tent” approach was designed to create regulations that would protect investors with industry’s input. Some critics of the administration suggested there was more sizzle than stake in that effort.
Congress also held numerous hearings on the fiduciary rule, and Republican lawmakers advanced legislation in the House of Representatives to kill it.
All along, critics of the rule claimed that its Best Interest Contract Exemption, which would be required to charge brokerage commissions on product recommendations, was onerous, unworkable, and favored fee-based advisory accounts over brokerage accounts.
The BIC Exemption included a private right of action, allowing investors to bring class-action lawsuits against investment providers. The Obama Labor Department designed that provision as the rule’s primary enforcement mechanism. Industry charged it would be a boon to the plaintiffs’ bar and result in streams of frivolous claims that would be expensive to defend—costs that would ultimately be passed on to investors.
To comply with the rule, and avoid the prospect of lawsuits, firms would migrate brokerage accounts to advisory accounts, making investing more expensive for buy-and-hold investors, claimed critics of the rule.
In 2016, industry readied to prepare for the rule’s implementation deadlines—the first was originally scheduled for April of 2017–despite four lawsuits filed across the country seeking to overturn the rule.
But the surprise election of President Trump in November of 2016 immediately brought the rule’s fate into question. In February of 2017, Trump issued a memorandum ordering the Labor Department to reexamine the rule. Days later a Dallas federal court would uphold the rule in what was considered a favorable venue for industry plaintiffs. Two other district courts had upheld the rule by then.
By the end of 2017, the Trump administration’s Labor Department had delayed final, full implementation of the rule until July 2019, as regulators considered issuing new exemptions to the rule. Labor issued a non-enforcement policy, so long as were providers were making good-faith efforts to comply with the components of the rule that were already in place.
But ultimately, it was the three-judge appellate panel in the 5th Circuit that sealed the rule’s fate. On March 15, the court vacated the rule, finding regulators were “arbitrary, capricious, and not in accordance with the law,” in crafting the rule.
“DOL has made no secret of its intent to transform the trillion-dollar market for IRA investments, annuities and insurance products, and to regulate in a new way the thousands of people and organizations working in that market,” wrote Judge Edith Jones for the majority.
“Although lacking direct regulatory authority over IRA ‘fiduciaries,’ DOL impermissibly bootstrapped what should have been safe harbor criteria into ‘backdoor regulation’,” added Judge Jones, who was appointed to the 5th Circuit in 1985 by President Ronald Regan.
Chief Judge Carl Stewart dissented in the decision, just as he did in issuing the mandate and requiring the Labor Department to cover industry’s legal fees.
“The DOL acted well within the confines set by Congress in implementing the challenged regulatory package,” wrote Chief Stewart, whom President Bill Clinton appointed to the 5th Circuit in 1994.