Beware the Broker: Fifth Circuit Vacates the DOL Fiduciary Rule
In April 2016, the U.S. Department of Labor (DOL), under the Administration of President Obama, issued the “Fiduciary Rule”, which reinterpreted the term “investment advice fiduciary” under the Employee Retirement Income Security Act (ERISA). In U.S. Chamber of Commerce v. U.S. Dep’t of Labor, Dkt. No. 17-10238 (5th Cir. March 15, 2018), Plaintiffs, several business/industry groups, filed suit in the District Court of the Northern District of Texas, challenging the DOL rule. The Plaintiff made several arguments in support of their position that the Fiduciary Rule should be vacated: 1) the rule is inconsistent with governing statutes; 2) the DOL overreached to regulate service providers beyond its authority; 3) the DOL imposed legally unauthorized contract terms to enforce the new regulations; 4) the rule violated the First Amendment; and 5) the rule was an arbitrary and capricious treatment of variable and fixed indexed annuities.
The District Court rejected the Plaintiffs’ challenges to the rule, and the Plaintiffs appealed. On appeal, the Fifth Circuit Court of Appeals agreed with the Plaintiffs and vacated the Fiduciary Rule in its entirety.
By way of background, under ERISA, fiduciaries of employer or union-sponsored retirement and welfare plans are subjected to the duty of loyalty and prudence, and they are prohibited from engaging in certain transactions. Breach of this duty can subject the fiduciary to suit by the DOL, plan participants, or beneficiaries. Fiduciaries are defined under ERISA as persons exercising discretionary authority or control over management of the plan or disposition of its assets, or rendering investment advice for a fee or other compensation.
Under the 2016 Fiduciary Rule, the “investment advice fiduciary” definition was expanded. Under this rule, an individual renders investment advice for a fee under ERISA when he/she is compensated in connection with recommendation as to the advisability of buying, selling or managing investment property. While all communications are not “recommendations” under the Fiduciary Rule, the more individually tailored the recommendation it is, the more likely it is that the individual would be considered a fiduciary. Pursuant to this regulation, financial professionals working for a commission, such as brokers, are generally elevated to the level of a fiduciary, meaning that such persons must act in the best interests of their clients and put their clients’ interests above their own.
In a split 2-1 decision, the Fifth Circuit held that the DOL exceeded its statutory authority under ERISA when it implemented the Fiduciary Rule. It concluded that the regulation was arbitrary and capricious, not in accordance with applicable law, and in excess of statutory limitations imposed under ERISA. It therefore vacated the entire regulation. The Defendants have the option of seeking review of the matter by the full panel of the Fifth Circuit, or petitioning the Supreme Court to consider the case.
Care should always be taken when selecting a financial advisor or when engaging in financial transactions. For ERISA Funds, Trustees should be aware that if they are investing fund assets with brokers who do not provide investment advice, those individuals are not required to act as fiduciaries under ERISA.