5th Circuit Ruling Leaves DOL’s Fiduciary Rule in Limbo

Plan sponsors should stay vigilant regarding conflicted investment advice

Stephen Miller, CEBS By Stephen Miller, CEBS March 20, 2018
5th Circuit Ruling Leaves DOL’s Fiduciary Rule in Limbo

updated on June 14, 2018

Update: The U.S. Department of Labor (DOL) let pass an April 30, 2018, deadline to seek a rehearing of the 5th Circuit decision, discussed below. Three states—California, New York and Oregon—and AARP had petitioned the 5th Circuit for the right to defend the DOL's fiduciary rule since the DOL had declined to do so, but on May 2 the 5th Circuit denied their motion

The DOL also declined to ask the U.S. Supreme court to reconsider the appeals court’s decision, as the deadline to do so expired on June 13, 2018. Once June 13 passes and if there are no petitions filed, then this version of the fiduciary rule is dead," said attorneys at the law firm Winstead.

The U.S. Securities and Exchange Commission on April 18, 2018, issued its own proposals to enhance the quality and transparency of investors' relationships with advisors and brokers, although final regulations could be years away.

On June 21, 2018, the U.S. Fifth Circuit Court of Appeals confirmed its March 15 decision to strike down the Department of Labor's fiduciary rule, leading to the definitive headline "It's official: DOL fiduciary rule is dead."

To learn more, see the SHRM Online article What the Demise of the DOL’s Fiduciary Rule Means for Plan Sponsors.

The Dallas-based 5th Circuit Court of Appeals struck down the Department of Labor's (DOL's) controversial fiduciary rule on March 15, 2018, just two days after the Denver-based 10th Circuit upheld the same rule. "Pending further review, the [Labor Department] will not be enforcing the 2016 fiduciary rule," a DOL spokesman said in a statement to CNBC.

Prior to the 5th Circuit decision, Labor Secretary Alexander Acosta said that the DOL was considering public input about revising the regulation and, if necessary, would propose changes in consultation with the Securities and Exchange Commission (SEC) and other regulators.

However, unless the fiduciary rule is definitively repealed or replaced, employers that sponsor 401(k) and similar defined contribution plans should continue to take it seriously and closely monitor their vendor arrangements, benefits advisors said.

"This is just the latest development in the Kafkaesque saga of the fiduciary advice rule, which has been in a transition period until June 2019," while the DOL reconsiders the regulation, said John Ryan, a partner in Seward & Kissel's employee benefits group in New York City.

Participants' Best Interests

The Obama administration's regulation, formally known as Definition of the Term "Fiduciary"; Conflict of Interest Rule-Retirement Investment Advice, began taking effect in stages in June 2017. The rule requires anyone being paid to give investment advice to retirement savers—whether to participants in a 401(k) or similar employer-sponsored plan or to those with individual retirement accounts (IRAs)—to follow the fiduciary standard of conduct under the Employee Retirement Income Security Act (ERISA).

In other words, investment advisors can only make recommendations that reflect loyalty to the "best interests" of plan participants without regard to commissions and fees rather than investments that are just "suitable," and must disclose any potential conflicts of interest. Failure to do so means that advisors—and the plan sponsors that hire them—could face class-action lawsuits brought by participants and ERISA-violation penalties.

Conflicting Decisions

In the 5th Circuit ruling, a three-judge panel split 2-1 in vacating the rule where the court has jurisdiction—Texas, Louisiana and Mississippi. At the earliest, the ruling will take effect on May 7, and it could be delayed longer as hearings and appeals take place.

The court, in particular, held that the DOL went too far in extending the fiduciary standard to advice provided to IRA savers. "IRA plan 'fiduciaries,' though defined statutorily in the same way as ERISA plan fiduciaries, are not saddled with these duties, and DOL is given no direct statutory authority to regulate them," the majority opinion stated.

Days earlier, in a March 13 decision, the 10th Circuit held that the fiduciary rule was the result of a sound regulatory process. "Relying on the record before it, the DOL could reasonably conclude that the benefits to investors outweighed the costs of compliance," the two-judge panel said.

"Another possible outcome of the 5th Circuit's decision, once final, is that the fiduciary advice rule is invalid under Administrative Procedures Act and that this effect is nationwide," said Ryan. "However, there are many contingencies still at play," he noted. For instance:

  • The DOL has 45 days to petition for panel rehearing or for rehearing en banc by the entire 5th Circuit, and 90 days to petition the Supreme Court to hear the case.
  • A separate challenge to the fiduciary rule before the D.C. Circuit Court of Appeals should provide insight as to the DOL's position on the fiduciary rule going forward.
  • The SEC's 2018 Regulator Agenda included as a short-term initiative its own investment advice rule.

[SHRM members-only toolkit: Designing and Administering Defined Contribution Retirement Plans]

Down, Not Out

"It is not impossible that [the 5th Circuit decision] is finally the beginning of the end for the rule," said Andrew Oringer, co-chair of Dechert LLP's employee benefits and executive compensation group in New York City. "Will the DOL even resist the decision? And, if it does not, where does that leave the rule? The one thing we do know for sure is that the rule has been dealt a devastating blow."

The 5th Circuit's majority opinion "uses terms like 'burdensome' and 'onerous' to describe the requirements placed on financial industry participants," said Brendan McGarry, an attorney at Kaufman Dolowich & Voluck in Chicago who advises broker dealers and advisors. "Opponents of the rule will likely hail this as a resounding victory…. It will be interesting to see if the DOL tries to appeal this decision, given the change in leadership since the rule was implemented."

At this point, "It's not clear whether the DOL will take further administrative action to stay or revise the existing rule," said Patrick DiCarlo, counsel at Alston & Bird's employee benefits and executive compensation group in Atlanta.

"There is a substantial possibility the Supreme Court ends up addressing this, but it is definitely not a certainty," since the Supreme Court could decline to hear the case, he said.

Squaring Off on Consumer Protection

"The 5th Circuit's decision is a terrible setback in the fight for the simple, common sense principle that Americans saving for retirement deserve investment advice that is in their best interest," said a statement from Better Markets, a nonprofit that supports financial reform initiatives.

The plaintiffs in the case, however—business groups such as the U.S. Chamber of Commerce, the Financial Services Institute and the Financial Services Roundtable—have contended that the rule will make investment advice prohibitively expensive for those with modest portfolios. They issued a statement that said, "The court has ruled on the side of America's retirement savers, preserving access to affordable financial advice."

For Plan Sponsors, Now What?

In light of this uncertainty, plan sponsors should "apply common sense and view all fiduciary issues, and investment advice particularly, from the perspective of the best interests of the plan and its participants," DiCarlo noted.

"The fiduciary rule generally did not do much to affect the responsibilities of most of those who were already plan fiduciaries," such as plan sponsors and members of the administrative committees they create to oversee their plan's management and operations, said Dominic DeMatties, a partner in Alston & Bird's employee benefits and executive compensation group in Washington, D.C. The rule, however, "did broaden what is considered fiduciary conduct and brought in additional persons as fiduciaries"—such as third-party investment advisors—"which does affect certain decisions and considerations by plan sponsors and their delegated fiduciaries."

Plan sponsors "need to keep track of developments with respect to the rule going forward, in order to determine whether anything that changes with respect to the rule will require responsive steps or changes in practices," DeMatties said.

"Neither the 5th Circuit's decision in the Chamber of Commerce case nor the DOL's non-enforcement announcement will insulate employers from the obligation to monitor their plan's investment advisors," noted Gregory Ash, a partner in Spencer Fane's Overland Park, Kan., office, where he is leader of the firm's employee benefits group. "Plan fiduciaries should continue to evaluate whether advisors and consultants are operating under a conflict of interest, and whether their advice is in the best interest of the plan and its participants."

Staying the Course

Employers should continue to look at "specific fee models that contain obvious conflicts of interest," such as commissions and even some revenue-sharing arrangements if they are not exempted from the rule, said Chris Carosa, chief contributing editor at FiduciaryNews.com.

"The DOL may seem like it's targeting service providers, but the true intent is to protect employee investors, and that means plan sponsors are on the hook, too," he noted.

Related SHRM Articles:

Start of Fiduciary Rule Application Means It's Time to Ensure Compliance, SHRM Online Benefits, May 2017

How the Fiduciary Rule Affects Retirement Plan Sponsors, SHRM Online Benefits, April 2016

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