On 15 March, the United States Court of Appeals for the 5th Circuit vacated in its entirety the Department of Labour’s revised investment advice Fiduciary Rule, which it had issued under the Employee Retirement Income Security Act 1974, as amended (ERISA).

This decision might be the final nail in the rule's coffin, with nationwide effect. Assuming that there are no challenges to it, or no adverse pronouncements from other circuit judges for cases that are open and under appeal at the moment, it is likely that the 'old' rule of 1975 (the original rule) will be reinstated. Although some people believe that other recent decisions in other circuits to do with the Fiduciary Rule may now result in a “split among the circuits,” no decision about the underlying legality of the rule appears more sweeping or broad than the decision from the 5th Circuit. Because of the constitutional nature of this decision, future administrations — regardless of party — may have difficulty resurrecting the rule (or similar sweeping changes to the original rule of 1975) in the absence of congressional action.

On 16 March, the day after the decision was released, the Department of Labour announced that it was not enforcing any aspect of the Fiduciary Rule before it had reviewed the case. Before that, it had adopted a 'good faith' approach to investment advisors' and brokers' compliance with the rule, with full compliance scheduled for July this year. Of course, the department’s position does not necessarily affect private litigants as long as the Fiduciary Rule continues to remain in effect.

As discussed further below, the 5th Circuit’s actions are not necessarily the end of the story — at least not yet. The Department of Labour could challenge the decision and there are other actions that people could take that might prolong the agony. Some institutions that do business in jurisdictions where other circuit courts have weighed in on previous challenges to the Fiduciary Rule may feel compelled — rightly or wrongly — to approach the 5th Circuit decision with caution. Needless to say, the Department of Labour’s next steps will help to clarify the situation.

Still applicable for now, but what happens next?

Although the 5th Circuit has vacated the rule, it is still technically in effect because the case will remain under the jurisdiction of the 5th Circuit until it issues a 'mandate,' giving the Department of Labour a limited period (which might last until 7 May, 45 days after the judgment) in which it can contest the decision. It may appeal either en banc or to the Supreme Court and the 5th Circuit’s decision may be stayed during that time. Of course, should the department go to the Supreme Court, additional delays would be likely. In addition, an appeal in the District of Columbia Court of Appeals has been 'on hold' pending the outcome of this 5th Circuit case, so new developments might come from that quarter.

Assuming that the Fiduciary Rule expires on or about 7 May, the original rule’s five-part test will be reinstated. A return to the status quo ante may not be as simple as it first appears, however, at least in the short term. Many legal and commercial problems are likely to remain.

Explanation of holding

The 5th Circuit revoked not only the Fiduciary Rule itself, but also the new 'prohibited transaction' exemptions that were designed to limit the scope of the rule and changes to existing exemptions. In voicing an opinion that can only be described as a colourful, the 5th Circuit’s 2-1 decision in favour of the challenge that the Chamber of Commerce and other associated trade organisations were making to the rule rejected the District Court’s finding that the rule complied with the Administrative Procedures Act (APA). Indeed, noting that “Congress does not hide elephants in mouseholes," and that “[w]hen Congress has acted with a scalpel, it is not for the [Department of Labour] to wield a cudgel,” the 5th Circuit’s opinion regarded the Fiduciary Rule as an “abuse” of the Department of Labour’s authority. As the court noted:

"The Fiduciary Rule conflicts with the plain text of the 'investment advice fiduciary' provision as interpreted in [the] light of contemporary understandings, and it is inconsistent with the entirety of ERISA’s “fiduciary” definition. DOL therefore lacked statutory authority to promulgate the rule with its overreaching definition of 'investment advice fiduciary.'"

Here are some examples of the court’s flavourful language in the opinion. BICE, incidentally, stands for Best Interest Contract Exemption.

• “This is the vice in BICE”;
• “DOL is occupying the Dodd-Frank turf”;
• “Moreover, that it took DOL (the Department of Labour) forty years to ‘discover’ its novel interpretation further highlights the rule’s unreasonableness”;
• “[T]he rule’s status is not salvaged by the BICE, which as noted was designed to narrow the rule’s overbreadth. The Supreme Court addressed such a tactic when it held that agencies ‘are not free to adopt unreasonable interpretations of statutory provisions and then edit other statutory provisions to mitigate the unreasonableness.’”;
• “When agencies within the Executive Branch defy Congressional limits, they lord it over the people without proper authority. It is not hard to spot regulatory abuse of power when ‘an agency claims to discover in a long-extant statute an unheralded power to regulate a significant portion of the American economy...’”

Interestingly, the court could also be thought to have cast some doubt on the department’s historic position about the interpretation of the statutory definition of “rendering” of “investment advice for a fee” under the original rule.

"Stockbrokers and insurance agents are compensated only for completed sales (“directly or indirectly”), not on the basis of what they say to their clients. Investment advisors, on the other hand, are paid fees because they render investment advice. [Emphasis supplied]."

And perhaps more tellingly:

"When enacting ERISA, Congress was well aware of the distinction, explained further below, between investment advisers, who were considered fiduciaries, and stockbrokers and insurance agents, who generally assumed no such status in selling products to their clients. The Fiduciary Rule improperly dispenses with that distinction. Had Congress intended to include as a fiduciary any financial services provider to investment plans, it could have written ERISA to cover any person who renders any investment advice for a fee."

Later in its opinion, the court also noted that “there is no doubt that the Supreme Court has been sceptical of federal regulations crafted from long-extant statutes that exert novel and extensive power over the American economy.”

The court also noted that in passing the Dodd-Frank Wall Street Reform and Consumer Protection Act during the Obama administration, and in particular s913 which specifically calls for a universal standard of care for retail investors, “Congress had to be aware of the enormous impact of IRA investors on the overall market for personalised investment advice to retail customers.”

Therefore, the court continued, it would be "[u]nreasonable to presume that Congress would not have referred to — or carved out — DOL’s claimed broad power over ERISA’s Title II transactions. Instead, the lack of any reference or carve-out in Dodd-Frank strongly suggests Congress, like DOL itself (until after 2016) did not suppose such DOL power was hidden in the interstices of ERISA."

* Steven Rabitz can be reached on 212-806-6568 or at srabitz@stroock.com