On February 8, 2017, five days after the release of a Presidential Memorandum directing the U.S. Department of Labor (DOL) to examine the final conflict of interest regulation's economic and legal underpinnings, Chief Judge Barbara Lynn of the United States District Court for the Northern District of Texas delivered the DOL a sweeping victory in the third decided challenge to the final conflict of interest regulation and related exemptions (the Fiduciary Rule). The win adds to the DOL's scorecard, but the Fiduciary Rule's toughest test yet may be the Presidential Memorandum, issued on February 3, 2017.

Presidential Memorandum and the Future of the Fiduciary Rule

Despite the attention garnered by the litigation over the past eight months, the fate of the Fiduciary Rule under the new Administration has been the subject of speculation since election day. An answer came, in part, three months later. The Presidential Memorandum ordered the DOL to reconsider the Fiduciary Rule and prepare an updated economic and legal analysis that must at least consider whether the Fiduciary Rule will cause: (i) potential harm to investor access to certain retirement savings products or financial advice; (ii) dislocations or disruptions within the retirement services industry that may harm investors; or (iii) an increase in litigation, and an increase in costs to investors for access to retirement services. If the DOL finds that the Fiduciary Rule will cause any of those three results, or if the DOL concludes that the Fiduciary Rule is inconsistent with stated Trump Administration priorities – empowering Americans to make their own financial decisions to facilitate their ability to save for retirement, build their individual wealth, and withstand unexpected financial emergencies – the Presidential Memorandum instructs the DOL to issue a proposed rule rescinding or revising the Fiduciary Rule. The DOL's same-day response to the Presidential Memorandum was a terse one-liner: "The Department of Labor will now consider its legal options to delay the applicability date as we comply with the President's memorandum."

Notably, Chief Judge Lynn's opinion either directly or indirectly addresses these three items. 

• Access to Retirement Products and Financial Advice. This factor reflects the argument made by the U.S. Chamber of Commerce, American Council of Life Insurers, Indexed Annuity Leadership Council, and other industry groups (collectively, the industry groups) that the DOL failed to consider the costs of decreased access to investment advice and certain retirement savings products. Chief Judge Lynn explained that the DOL analyzed the relevant evidence and concluded that access to affordable investment advice would increase due to fewer conflicts of interest, increased transparency, and increased market efficiency. Like Judge Randolph Moss in the first decision addressing the Fiduciary Rule out of the United States District Court for the District of Columbia, the Texas court referenced favorably the DOL's analysis of similar, but more aggressive, regulations placed on the United Kingdom's investment products, which did not result in decreased investor access to retirement products. The chief judge was also dismissive of the claim that the Fiduciary Rule would reduce investor access to certain retirement products, specifically fixed indexed annuities (FIAs) and variable annuities, commenting in a footnote that the argument was unpersuasive. 
• Harm to Investors from Disruption Caused by the Fiduciary Rule. Although Chief Judge Lynn did not directly address disruption within the retirement services industry (while at the same time noting the existence of "viable options" to adapt to the Fiduciary Rule), the court did find that the Fiduciary Rule would benefit, not harm, investors. The court adopted the DOL's statistic that accepting conflicted financial advice could cause an investor to "lose 6 to 12 and possibly as much as 23 percent" of the value of his or her retirement savings over 30 years of retirement, a conclusion echoed by Judge Moss. 
• Increase in Litigation and Costs to Investors. Chief Judge Lynn found that the DOL adequately considered the increase in litigation and costs to investors and provided several cogent reasons to dismiss the argument. First, the best interest contract exemption (BIC Exemption) permits advisors and financial institutions to require mandatory arbitration of individual claims, enabling claims to be resolved outside of court. Second, the chief judge believed that the DOL "thoroughly" explained the best interest standard in the BIC Exemption, limiting the possibility for litigation over ambiguities, and, she articulated, it can be further defined by referencing the Employee Retirement Income Security Act (ERISA) and the common law of agency and trusts, which underlie the best interest standard. Third, citing several court opinions involving individual retirement account (IRA) transactions, Chief Judge Lynn dismissed the concerns with potential conflicting results across the states, explaining – as Judge Moss also concluded – that these issues would have arisen prior to the BIC Exemption, since state courts have always been a forum in which to litigate wrongs arising from IRA transactions. Finally, regarding the threatened rise of class actions, the court observed that the DOL is not required to specifically quantify potential class action litigation costs and pointed out the significant hurdles built into the class action procedures.

The DOL is assessing its options for delaying the Fiduciary Rule's April 10, 2017 implementation deadline. One option is to seek a 180-day delay on an interim final basis subject to notice and comment, followed by a request for information to address the concerns raised by the Presidential Memorandum. After evaluation of the material submitted, the DOL may issue a proposed rule that differs in relevant ways from the current version.

As the DOL considers its options to delay the Fiduciary Rule, Congress is also considering legislation to delay the implementation date. The judicial branch, however, has so far been unanimous in finding no legal basis on which to delay the Fiduciary Rule, with the Texas decision being the most recent.

The Texas Court Decision

A full-throated endorsement of the Fiduciary Rule, Chief Judge Lynn's decision categorically set aside each of the arguments made by the industry groups, adding to the victories that the DOL has already chalked up in the United States District Courts for the District of Columbia and Kansas. On November 4, 2016, Judge Moss issued a resounding victory for the DOL in the DC suit brought by the National Association for Fixed Annuities (NAFA). Later that month, Judge Daniel Crabtree rejected Market Synergy Group, Inc.'s narrower preliminary challenge in the Kansas litigation and is now considering the merits.

In issuing her ruling, the chief judge pointedly made good on her February 2, 2017 promise to deliver her decision no later than February 10, 2017, even rebuffing the DOL's motion to stay the proceeding in light of the Presidential Memorandum. The DOL argued that "it would not serve judicial economy to issue a ruling at this point; nor would it be efficient for this Court, for the Court of Appeals for this Circuit, or for the parties to be confronted by a range of appellate issues at this time." The DOL further argued that issuing a decision following the release of the Presidential Memorandum could be confusing to the public. "[A] judicial decision on a rulemaking as complex as this while the [DOL] is undertaking the examination and potential promulgation of a proposal pursuant to the Presidential Memorandum can be expected to cause confusion with the affected public, whether parties to this litigation or not." While the industry groups could technically appeal to the Fifth Circuit for an emergency stay, pointing to the Presidential Memorandum to distinguish its request from NAFA's failed bid to the DC Circuit to stay Judge Moss's decision, they could well suffer the same fate.

The Fiduciary Rule Did Not Exceed the DOL's Authority. Chief Judge Lynn held that the DOL's expanded definition of fiduciary investment adviser is reasonable under ERISA. ERISA does not, as the industry groups argued, limit "investment advice" to only advice "provided on a regular basis and through an established relationship," as required under the prior five-part test. Nor is it the case that financial professionals who receive sales commissions for selling financial products are only rendering incidental, not investment, advice. As the industry groups conceded during briefing, insurers compensate agents and broker-dealers for the "significant effort involved in learning about, marketing, and selling annuities." This, the court stated, "fits comfortably within the description of someone who renders investment advice for indirect compensation ..." and "compensation" under the statute includes direct and indirect compensation.

The court also explained that ERISA departs from the common law of trusts in several areas, including the scope of fiduciary duties, and therefore Congress did not restrict the DOL's interpretation of investment advice to the common law of trusts. Furthermore, the court opined that the DOL's interpretation does not conflict with the Investment Advisers Act, which provides an exclusion for broker-dealers rendering incidental investment advice, because Congress did not replicate this exclusion under ERISA.

The BIC Exemption and Prohibited Transaction Exemption (PTE) 84-24 Comply with Applicable Law. Chief Judge Lynn devoted a substantial portion of the opinion striking down multi-pronged attacks on the BIC Exemption and PTE 84-24.

The industry groups argued that the DOL exceeded its exemption-granting authority by imposing ERISA Title I fiduciary duties of loyalty and prudence on ERISA Title II fiduciaries (e.g., advisers to IRAs), duties which are not expressly included in Title II. The court disagreed, reasoning that "[c]ongressional silence does not overcome the DOL's express statutory authority to grant exemptive relief." Allowing the industry groups' arguments would effectively impose a "non-textual" limitation on the DOL's authority. Chief Judge Lynn found the BIC Exemption's conditions reasonable in light of the DOL's conclusion that commission-based compensation creates additional conflicts of interest. Further, she ruled that the DOL appropriately focused on whether the exemption is feasible for the DOL to apply, not whether it is feasible for the regulated industry to satisfy. Moreover, the industry groups' concern over the exemptions' impact on independent marketing organizations (IMOs), which are currently the largest distribution channels for FIAs but do not qualify for the BIC Exemption, received no sympathy. Chief Judge Lynn adopted the DOL's position, reasoning that the industry could adapt by, for example, having the affiliated broker or registered investment adviser serve as the financial institution, or through IMOs individually petitioning to become financial institutions.

Although the subject of the parties' supplemental briefing, the recently proposed class exemption for IMOs was not addressed by the court. Released on January 19, 2017, the Proposed Best Interest Contract Exemption for Insurance Intermediaries allows IMOs to act as financial institutions and receive compensation in connection with transactions involving FIAs. The proposed exemption retains the core BIC Exemption requirements – including the best interest contract and reasonable compensation rules – and adds rules specific to annuities and insurance intermediaries.

The BIC Exemption and PTE 84-24 Do Not Create a Private Right of Action. The court rejected the argument that the BIC Exemption and PTE 84-24 create a private right of action or federal cause of action under Title II. According to the chief judge, the exemptions do not impact the preexisting enforcement regime because state law would continue to supply the cause of action. Indeed, annuities held in IRAs were already subject to breach of contract claims under state law. Further, the court explained that other federal regulations, including certain ERISA prohibited transaction exemptions, require entities to enter into written contracts with mandatory provisions.

Moving FIAs from PTE 84-24 to the BIC Exemption Complies with the APA. The industry groups claimed the DOL did not provide adequate notice that it was contemplating moving FIAs from PTE 84-24 to the BIC Exemption, and therefore did not provide an opportunity to comment. The court rejected this argument, noting that several commenters, including one of the industry groups, expressly anticipated that FIAs might be covered by the BIC Exemption under the final regulations. Moreover, the court held that the DOL acted reasonably in this regard based on the higher complexity and risk of conflict of interest that FIAs generate compared to fixed rate annuities.

No First Amendment Violation. The industry groups argued that the Fiduciary Rule regulates commercial speech and would not withstand First Amendment scrutiny. The court disagreed, first holding that the industry groups waived their First Amendment challenge by failing to raise the argument during the six-year rulemaking process. Even if waiver did not apply, the court held that the Fiduciary Rule regulates professional conduct, not commercial speech, and therefore is not a speech restriction under the First Amendment.

What to Expect Next In Court

Although the three district courts to address the Fiduciary Rule have all sided with the DOL, perhaps reducing the possibility of a Circuit split, the fate of the Fiduciary Rule in litigation is far from clear. In the DC litigation, NAFA's appeal to the DC Circuit Court of Appeals is pending. While the Kansas district court has already denied Market Synergy's motion for a preliminary injunction, the court must still rule on the parties' cross-motions for summary judgment on the merits, which contest the narrower issue of whether the DOL illegally moved FIAs from PTE 84-24 to the BIC Exemption.

Further complicating these proceedings is the fact that the DOL may ask these courts, as it asked Chief Judge Lynn and Judge Susan Nelson – the presiding judge in the District of Minnesota case challenging the BIC Exemption's dispute resolution provisions – to suspend proceedings pending the DOL's review of the Fiduciary Rule under the Presidential Memorandum.  

For more information, please contact: 

Theresa S. Gee, tgee@milchev.com, 202-626-5928 

Erin M. Sweeney*

Yongo Ding*

Nicholas P. Wamsley*

*Former Miller & Chevalier attorney

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