Fiduciary rule put to test in conservative 5th Circuit
August 8, 2017 by Nick Thornton
A three-judge panel in the 5thCircuit Court of Appeals, considered among the most conservative of the federal circuits, heard oral arguments Monday in the most wide-ranging of four lawsuits seeking to vacate the Labor Department’s fiduciary rule.
Earlier this year, the District Court for the Northern District of Texas upheld the fiduciary rule, dismissing a suit brought by a consortium of business and financial industry trade groups, led by the U.S. Chamber of Commerce and the Securities Industry and Financial Markets Association.
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The lower court ruling was a sweeping victory for the Obama-era Labor Department. The rule has also been upheld in the District of Columbia and District of Kansas.
The 5th Circuit was the first to hear industry appeals to those lower court rulings, and may prove to be the venue most favorable to the plaintiffs’ claim that the Labor Department exceeded its statutory authority in crafting the fiduciary rule, which requires all investment advice on qualified retirement accounts to be in the best interest of investors.
The panel consisted of two Republican-appointed judges and one appointed by President Clinton.
In arguing for the plaintiffs, Eugene Scalia, a partner at Gibson, Dunn & Cruthcher, said the rule has created the most radical changes to the investment and insurance industries since enactment of the Investment Company Act of 1940.
Those changes “are not by Congress, not by the Securities and Exchange Commission, and not by the states which regulate insurance markets, but done by an agency that lacks regulatory power over IRAs, broker-dealers, and insurance agents,” said Scalia.
The Labor Department is “not the federal retirement insurance agency,” added Scalia.
In defense of the rule, Michael Shih, an attorney for the Department of Justice, said a core claim by the plaintiffs—that the Labor Department does not have regulatory authority over IRAs—is “simply not true.”
“Title II of ERISA says the Department of Labor gets to determine who is a fiduciary with respect to transactions involving IRAs,” said Shih. “It further says the Department gets to interpret the prohibited transaction provisions with respect to IRAs. Since the Carter Administration the Department of Labor has been the sole interpreter of the Tittle II provisions with respect to IRAs and has in fact exercised that authority.”
Hostile questioning
The hour-long hearing was dominated by inquiries from Judge Edith H. Jones (pictured above), a Reagan appointee, who early in the proceedings expressed disbelief that the Labor Department has the authority to regulate IRAs.
During one exchange with Shih, Judge Jones said, “The Department of Labor is labor—that’s supposed to be employment relationships.”
“How does the Department of Labor have any expertise whatsoever in the market for individual investor advice?” asked Judge Jones.
“Her questioning was clearly hostile to the Labor Department,” said Erin Sweeney, a labor attorney with Miller & Chevalier who attended the hearing. “This judge is going to try to find a principled way to blow the rule up.”
Much of the plaintiffs’ argument was focused on the distinction between sales and advice under the common law of trusts, on which the original definition of fiduciary in the Employee Retirement Income Security Act was based.
Under ERISA, Congress gave the Labor Department broad deregulatory authority by issuing exemptions to the law’s fiduciary requirements. In crafting the fiduciary rule, Labor converted its deregulatory authority into regulatory authority in a way that Congress did not intend when it passed ERISA in 1975, according to the plaintiffs.
At one point, Judge Jones called Labor’s use of its exemption authority “creative.”
Jones spent considerable time inquiring about existing prohibited transaction exemptions in ERISA, questions neither the plaintiffs or the government were prepared to answer.
Judge Jones’ line of questioning seemed to suggest the new exemptions in the fiduciary rule are required to harmonize with older exemptions.
“She kept coming back to that question, and spent half of DOL’s oral arguments chasing around these issues,” said Sweeney. “Judge Jones wouldn’t let DOL get a word in edgewise.”
On the question of whether or not the fiduciary rule’s new prohibited contract exemptions need to be harmonized with existing exemptions, Sweeney said they “absolutely do not,” calling that a collateral issue.
“Its’ unfortunate that half of DOL’s argument was focused on an extraneous issue,” said Sweeney. “The DOL has a lot of good arguments they didn’t get to articulate.”
Judge Edith Brown Clement, a George W. Bush appointee, was mostly silent, but at one point asked Scalia how the rule would benefit investors. “I’m sort of befuddled how this whole hornets’ nest was created,” said Clement.
Chief Circuit Judge Carl E. Stewart, a Clinton appointee, directed questions on the plaintiffs’ claim that the rule violates industry professionals’ First Amendment free speech rights by restricting how they can communicate with retirement investors.
The government argued that the rule does not restrict free speech, but just the conduct of selling investments.
Furthermore, if the court were to find the rule violates investment professionals’ First Amendment rights, then that would make all other regulatory guidelines governing the fiduciary standard and the suitability standard also unconstitutional, because they too place parameters on how brokers and advisors communicate with investors, the government argued.
Some legal analysts sympathetic to industry’s opposition to the rule have called the First Amendment argument the weakest part of their case.
During the hearing before the 5th Circuit, the plaintiffs asked that the First Amendment question only be considered if the court ruled that the Labor Department did not violate its regulatory authority.
But Judge Jones seemed to place a higher imperative on the First Amendment question, calling the lower court’s discussion on the matter the “weakest” part of its decision.
Each side has 10 days to file new papers outlining all of the previous exemptions in ERISA, to help the court determine if sales activity rises to the level of fiduciary advice.
But Sweeney doesn’t expect new details on old exemptions to ultimately impact the ruling.
“I don’t think these briefs will resolve anything. They won’t answer the question of whether a sale is investment advice,” said Sweeney.
Sweeney said handicapping a decision is difficult, notwithstanding Judge Jones’ open opposition to the Labor Department.
“It’s hard to read the tea leaves because the other two judges were so silent,” said Sweeney, who expects a ruling before the end of the year.
