Posted by: William James, Senior Content Specialist
Published: April 3, 2018
Disclaimer: William R. James is a Senior Editor at Kaplan Financial Education. The opinions expressed in this article are solely those of the author based on personal research and observations. They should not be viewed as legal advice.
The Ongoing Suitability v. Fiduciary Standard Clash
The Fifth and Tenth Circuit Courts Weigh In
Over the past year, Kaplan has kept you apprised of the potential impact of the U.S. Department of Labor (DOL) fiduciary rule. We have looked to decipher the rule and answer your questions, particularly regarding Investment Adviser Registration. We have given you background starting with the Employee Retirement Income Security Act of 1974 (ERISA), the statute that governs the non-tax aspects of the implementation and operation of an employee pension benefit plan; as well as the Employee Benefits Security Administration (EBSA) division of the U.S. Department of Labor (DOL), which is tasked with the administration of ERISA.
In 1975 the EBSA issued guidance interpreting the statutory definition of investment advice fiduciary found in ERISA. That guidance remains in effect today. That same EBSA began the process of updating the regulatory definition of investment advice fiduciary by issuing proposed regulations in 2010 that looked to substantially change the regulatory definition of investment advice fiduciary in effect for 43 years.
In short, over the past eight years, the Federal Government has looked to promulgate rules and laws that impact an enormous swath of American commerce at a compliance burden estimated by the government to cost somewhere near $32 billion over ten years. To say nothing of the unsettled nerves knowing that a fresh army of federal regulators will be descending to enforce the new rule with all the accompanying fines for infractions small and large. The comprehensive and apparently capricious rule (its treatment of variable and fixed index annuities) appears to be open for plenty of interpretation. This long developing DOL regulatory scheme has hit more than one roadblock.
The DOL’s 1,000-page fiduciary rule is seen by the plaintiffs in a recent case heard by the Fifth Circuit as an undiscovered country of regulatory bear traps. The Chamber of Commerce, SIFMA, and nearly two dozen other securities and insurance heavyweights argued against the U.S. DOL that the rule is corrosive to confidence and trust (ironically the heart of fiduciary behavior) between the lawmakers and the governed. Predictably, the DOL’s pledge to alleviate the concerns of regulated companies, particularly regarding vexing interpretative issues that will arise by offering them the same “broad assistance for regulated parties on the Affordable Care Act regulations,” did little to sooth apprehensions by the plaintiffs in this month’s successful case against the Department of Labor’s fiduciary rule.
The Fifth Circuit Court of Appeals agreed with three substantive plaintiff groups that 50 years of legal practices in the trillion-dollar retirement markets is, to all reasonable minds, settled. That the Department of Labor’s reach in April 2016 by looking to transform and regulate in entirely new ways many thousands of financial services providers and insurance companies for retirement plans, falls outside of what is reasonable and challenges the DOL on its ability to issue rules that fundamentally transforms settled legal practices in the financial services and insurance industries.
“Settled law” or “black letter law” is an expression that has come into common parlance in recent years as it is often used in legal arguments to add gravitas. The expression is sometimes used in-judiciously to argue for those laws and rules passed relatively recently, spurring controversy that works to unravel the so-called settled issue. Suggesting settled law, however, is persuasive only if in fact it is proven to be so over time. Settled law as used by the financial services and insurance industry was favorably argued to the Fifth Circuit.
Within days of the decision to vacate by the Fifth, the Tenth Circuit ruled against Market Synergy Group in its lonely bid to argue that it would never be able to reach the BICE, the Best Interest Exemption, and that the court should provide a door for them to work under an “84–24 Exemption,” perceived to be a workaround for commission-based compensation customarily used in the sale of fixed-index annuities. The Prohibited Transaction Exemption (PTE 84-24) permits traditional, variable commission compensation, but the purchase by a plan or IRA of a variable annuity contract or indexed annuity contract is carved out of PTE 84-24, leaving those in that industry scratching their heads.
Soon after taking the oath of office, President Donald Trump asked for a review of the rule, immediately delaying implementation until June 9, 2017, with a transition period for some exemptions extending to January 1 of this year. Full implementation was pushed back to July 1, 2019.
The Fifth Circuit Court of Appeals, vacating the rule as unreasonable and that it constitutes "an arbitrary and capricious exercise of administrative power,” matched with the Tenth Circuit’s decision in mid-March, throws this fiduciary rule into a harsh light. Circuit courts at odds with other circuit courts lines this rule up in the gun sights of a U.S. Supreme Court appeal. The DOL’s next stop could be en banc to the Fifth to hear again or up to the Supreme Court. Then again, it may be dropped entirely.
On March 19, the DOL told CNBC that "pending further review" it "will not be enforcing the 2016 fiduciary rule." I sense that the DOL will yield to the Securities and Exchange Commission to run with this ball. SEC Chairman Clayton has not shied away from his thoughts that there needs to be “clarity and harmony to investment advisor, broker-dealer standards of conduct.” With a full complement of commissioners, and the vacuum caused by the vacating Fifth Circuit, and a warmer feeling generally throughout the financial services industry that the Commission should have had their oar in this water from the beginning, we can almost certainly look for a complete redo of the Fiduciary Rule under the banner of the SEC in the year ahead.