Death of DOL Fiduciary Rule May Not Be Imminent

If one follows the recent onslaught of articles and blogs, Donald Trump's election to the presidency has placed a target squarely on the back of a Department of Labor (DOL) rule that imposes a fiduciary standard on those who provide investment advice in connection with employer retirement plans and Individual Retirement Accounts (IRA). Yet reports of the rule's demise may be premature. Whether its death knell is sounded depends on how the new administration chooses to navigate certain political, legislative, and regulatory obstacles.

Fiduciary Rule

The DOL issued the final rule on April 6, 2016, as part of the Obama Administration's aggressive, consumer-oriented regulatory platform, setting an initial rollout date of April 10, 2017. In essence, the rule requires broker-dealers to either agree to act as fiduciaries when advising investors with regard to retirement accounts, or move away from certain fee structures, including those that are commission-based, for such services.

By entering into a “Best Interest Contract,” or “BIC,” that obligates broker-dealers to act in the best interest of their customers, financial advisers can continue to receive commissions that would otherwise be prohibited by the rule, absent the BIC. Thus, the rule aims to eliminate the financial incentives that could influence financial advisers to give conflicted advice.

The rule has generated anxiety in the securities industry, not only because of the anticipated costs of compliance, but also due to the fear that it represents the first step toward transforming how financial products are sold. In addition, financial firms are concerned that the rule will open the floodgates to investor complaints, arbitrations and class-action lawsuits. Firms have already expended substantial resources to become compliant with the rule. Some, like Bank of America, have abandoned commission-based retirement accounts in favor of those charging fixed management fees, while others have opted to stop including exchange traded funds and certain types of mutual funds in their retirement accounts offerings.

The rule has also generated staunch opposition from Republican politicians, industry lobby groups and certain sectors of the financial press, all of whom have characterized the rule as regulatory overreach that will have the unintended effect of driving up fees and reducing investment options. They also argue that the DOL lacks the requisite market experience to competently enforce the rule and that the DOL's presence will only add confusion and overlap to an already over-crowded regulatory field.

Not surprisingly, the rule has generated numerous legal challenges. In National Ass'n for Fixed Annuities v. Perez, No. 16-cv-01035, the plaintiff claimed that the rule unlawfully created a private right of action, and was arbitrary and capricious, promulgated in excess of statutory jurisdiction, void for vagueness, and a violation of the Regulatory Flexibility Act of 1980, 5 U.S.C. §§ 601-612 (2016), due to its failure to consider the rule's impact on small businesses. See 2016 WL 6573480 (D.D.C. Nov. 4, 2016). On Nov. 4, 2016, the District Court for the District of Columbia granted the DOL summary judgment, securing an early round victory for the rule. See id.

Other cases are pending in Texas, Kansas and Minnesota. On Nov. 17, 2016, a Texas District Judge heard oral arguments in Chamber of Commerce v. Perez, No. 16-cv-01476 (N.D. Tex. June 1, 2016), a case raising similar and additional issues, including a challenge on First Amendment grounds.

Speculation has mounted that Trump's Administration will move quickly to spike the rule before its implementation. As reported in the Nov. 15, 2016 edition of The Wall Street Journal, the legislative agenda that House Speaker Paul Ryan is beginning to craft with Trump's transition team includes a strategy related to the rule. In addition, Rep. Ann Wagner (R, MO), one of the rule's most strident opponents, has said that congressional Republicans are prepared to renew their efforts to eliminate it. “I am confident that our Republican-led Congress and President Trump will work together to end this egregious rule,” Wagner told the New York Law Journal.

Political Considerations

Despite the growing momentum to stop the rule's implementation, it is far from clear that it is destined for the scrap heap. President Trump himself has said nothing about the rule. The closest he came was in an August campaign speech in which he called for a temporary moratorium on new agency regulations. While eliminating the rule presents a fertile opportunity to take a symbolic ax to the type of regulatory excess that Trump campaigned against, he also faces political considerations, at least in the early stages of his term. The President may decide to spend his start-up political capital on more mainstream issues, such as tax reform, immigration, national security, and trade.

Even if Trump decides to pursue some regulatory reform, he may choose to concentrate his efforts on the Dodd-Frank Wall Street Reform and Consumer Protection Act, 12 U.S.C. §§ 5301-5641 (2016). In addition, he may not want to risk antagonizing the sizable demographic of older voters and aging baby-boomers, who may perceive attempts to roll back the rule as inimical to their interests. Finally, in that many financial firms have already expended substantial resources to comply with the rule, Trump might conclude that rescinding it would only sow more disruption in the industry.

Legislation

Even if these political considerations do not kick in, the President's path to eliminating the rule is still strewn with significant challenges. One option open to the new administration is to let the Republican-controlled Congress do the heavy lifting through legislative action. In fact, even while the rule was in process, the House proposed legislation to counter it. On Oct. 27, 2015, the House passed H.R. 1090, called the Retail Investor Protection Act, which, if enacted, prohibits the DOL from instituting new rules defining when an individual is a fiduciary before the Securities and Exchange Commission (SEC) issues a final rule on the matter.

Its provisions have since been rolled into House Financial Services Committee Chairman Rep. Jeb Hensarling's (R-TX) Financial CHOICE Act, whose primary aim is to roll back Dodd-Frank. However, these and other legislative efforts to dismantle the rule are vulnerable to a Democratic filibuster. While Republicans maintained their majority in the upper house, they still lack the supermajority of 60 seats needed to end a filibuster through cloture. Thus, if the Democratic minority concludes that the rule is worth fighting for, it could obstruct any efforts to legislate it out of existence.

New Rulemaking

Opponents of the rule can also consider administrative action. The new Secretary of Labor can initiate a new rulemaking process to rescind, modify, or replace the rule. However, these efforts must conform to the Administrative Procedure Act (APA). Under the APA, a court may set aside an agency action if it is found to be “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law.” 5 U.S.C. §7 06(2)(A).

In order to avoid this fate, the DOL would need to establish that: 1) Congress has not directly spoken to the precise question at issue; and 2) its interpretation is reasonable, i.e., supported by a satisfactorily articulated explanation and rational connection between facts found and the choice made. SeeEncino Motorcars v. Navarro, 136 S. Ct. 2117, 2126 (2016); Chevron, U.S.A. v. Natural Res. Def. Council, 467 U.S. 837, 842-44 (1984); Motor Vehicle Mfrs. Ass'n of United States v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983).

The Supreme Court has held that the same “arbitrary and capricious” standard that applies to the promulgation of rules also applies to their rescission. See Encino Motorcars, 136 S. Ct. at 2125-26.

Conclusion

Donald Trump's presidency has fueled speculation that the DOL Fiduciary Rule will be among the casualties of his administration's plan to reconfigure the federal government and how it operates. Yet before the President can move to eliminate the rule, he must engage in an informed political calculus and then, if he decides to move forward with its elimination through either legislation or administrative action, he must navigate the process with care and skill. Given these requirements, the demise of the rule is by no means a foregone conclusion.

*****
Jeff Kern is special counsel at Sheppard Mullin. Reach him at [email protected]. Christopher Bosch, an associate at the firm, contributed to this article, which also appeared in the New York Law Journal, an ALM sibling publication of this newsletter.

If one follows the recent onslaught of articles and blogs, Donald Trump's election to the presidency has placed a target squarely on the back of a Department of Labor (DOL) rule that imposes a fiduciary standard on those who provide investment advice in connection with employer retirement plans and Individual Retirement Accounts (IRA). Yet reports of the rule's demise may be premature. Whether its death knell is sounded depends on how the new administration chooses to navigate certain political, legislative, and regulatory obstacles.

Fiduciary Rule

The DOL issued the final rule on April 6, 2016, as part of the Obama Administration's aggressive, consumer-oriented regulatory platform, setting an initial rollout date of April 10, 2017. In essence, the rule requires broker-dealers to either agree to act as fiduciaries when advising investors with regard to retirement accounts, or move away from certain fee structures, including those that are commission-based, for such services.

By entering into a “Best Interest Contract,” or “BIC,” that obligates broker-dealers to act in the best interest of their customers, financial advisers can continue to receive commissions that would otherwise be prohibited by the rule, absent the BIC. Thus, the rule aims to eliminate the financial incentives that could influence financial advisers to give conflicted advice.

The rule has generated anxiety in the securities industry, not only because of the anticipated costs of compliance, but also due to the fear that it represents the first step toward transforming how financial products are sold. In addition, financial firms are concerned that the rule will open the floodgates to investor complaints, arbitrations and class-action lawsuits. Firms have already expended substantial resources to become compliant with the rule. Some, like Bank of America, have abandoned commission-based retirement accounts in favor of those charging fixed management fees, while others have opted to stop including exchange traded funds and certain types of mutual funds in their retirement accounts offerings.

The rule has also generated staunch opposition from Republican politicians, industry lobby groups and certain sectors of the financial press, all of whom have characterized the rule as regulatory overreach that will have the unintended effect of driving up fees and reducing investment options. They also argue that the DOL lacks the requisite market experience to competently enforce the rule and that the DOL's presence will only add confusion and overlap to an already over-crowded regulatory field.

Not surprisingly, the rule has generated numerous legal challenges. In National Ass'n for Fixed Annuities v. Perez, No. 16-cv-01035, the plaintiff claimed that the rule unlawfully created a private right of action, and was arbitrary and capricious, promulgated in excess of statutory jurisdiction, void for vagueness, and a violation of the Regulatory Flexibility Act of 1980, 5 U.S.C. §§ 601-612 (2016), due to its failure to consider the rule's impact on small businesses. See 2016 WL 6573480 (D.D.C. Nov. 4, 2016). On Nov. 4, 2016, the District Court for the District of Columbia granted the DOL summary judgment, securing an early round victory for the rule. See id.

Other cases are pending in Texas, Kansas and Minnesota. On Nov. 17, 2016, a Texas District Judge heard oral arguments in Chamber of Commerce v. Perez, No. 16-cv-01476 (N.D. Tex. June 1, 2016), a case raising similar and additional issues, including a challenge on First Amendment grounds.

Speculation has mounted that Trump's Administration will move quickly to spike the rule before its implementation. As reported in the Nov. 15, 2016 edition of The Wall Street Journal, the legislative agenda that House Speaker Paul Ryan is beginning to craft with Trump's transition team includes a strategy related to the rule. In addition, Rep. Ann Wagner (R, MO), one of the rule's most strident opponents, has said that congressional Republicans are prepared to renew their efforts to eliminate it. “I am confident that our Republican-led Congress and President Trump will work together to end this egregious rule,” Wagner told the New York Law Journal.

Political Considerations

Despite the growing momentum to stop the rule's implementation, it is far from clear that it is destined for the scrap heap. President Trump himself has said nothing about the rule. The closest he came was in an August campaign speech in which he called for a temporary moratorium on new agency regulations. While eliminating the rule presents a fertile opportunity to take a symbolic ax to the type of regulatory excess that Trump campaigned against, he also faces political considerations, at least in the early stages of his term. The President may decide to spend his start-up political capital on more mainstream issues, such as tax reform, immigration, national security, and trade.

Even if Trump decides to pursue some regulatory reform, he may choose to concentrate his efforts on the Dodd-Frank Wall Street Reform and Consumer Protection Act, 12 U.S.C. §§ 5301-5641 (2016). In addition, he may not want to risk antagonizing the sizable demographic of older voters and aging baby-boomers, who may perceive attempts to roll back the rule as inimical to their interests. Finally, in that many financial firms have already expended substantial resources to comply with the rule, Trump might conclude that rescinding it would only sow more disruption in the industry.

Legislation

Even if these political considerations do not kick in, the President's path to eliminating the rule is still strewn with significant challenges. One option open to the new administration is to let the Republican-controlled Congress do the heavy lifting through legislative action. In fact, even while the rule was in process, the House proposed legislation to counter it. On Oct. 27, 2015, the House passed H.R. 1090, called the Retail Investor Protection Act, which, if enacted, prohibits the DOL from instituting new rules defining when an individual is a fiduciary before the Securities and Exchange Commission (SEC) issues a final rule on the matter.

Its provisions have since been rolled into House Financial Services Committee Chairman Rep. Jeb Hensarling's (R-TX) Financial CHOICE Act, whose primary aim is to roll back Dodd-Frank. However, these and other legislative efforts to dismantle the rule are vulnerable to a Democratic filibuster. While Republicans maintained their majority in the upper house, they still lack the supermajority of 60 seats needed to end a filibuster through cloture. Thus, if the Democratic minority concludes that the rule is worth fighting for, it could obstruct any efforts to legislate it out of existence.

New Rulemaking

Opponents of the rule can also consider administrative action. The new Secretary of Labor can initiate a new rulemaking process to rescind, modify, or replace the rule. However, these efforts must conform to the Administrative Procedure Act (APA). Under the APA, a court may set aside an agency action if it is found to be “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with the law.” 5 U.S.C. §7 06(2)(A).

In order to avoid this fate, the DOL would need to establish that: 1) Congress has not directly spoken to the precise question at issue; and 2) its interpretation is reasonable, i.e., supported by a satisfactorily articulated explanation and rational connection between facts found and the choice made. See Encino Motorcars v. Navarro, 136 S. Ct. 2117, 2126 (2016); Chevron, U.S.A. v. Natural Res. Def. Council , 467 U.S. 837, 842-44 (1984); Motor Vehicle Mfrs. Ass ' n of United States v. State Farm Mut. Auto. Ins. Co. , 463 U.S. 29, 43 (1983).

The Supreme Court has held that the same “arbitrary and capricious” standard that applies to the promulgation of rules also applies to their rescission. See Encino Motorcars, 136 S. Ct. at 2125-26.

Conclusion

Donald Trump's presidency has fueled speculation that the DOL Fiduciary Rule will be among the casualties of his administration's plan to reconfigure the federal government and how it operates. Yet before the President can move to eliminate the rule, he must engage in an informed political calculus and then, if he decides to move forward with its elimination through either legislation or administrative action, he must navigate the process with care and skill. Given these requirements, the demise of the rule is by no means a foregone conclusion.

*****
Jeff Kern is special counsel at Sheppard Mullin. Reach him at [email protected]. Christopher Bosch, an associate at the firm, contributed to this article, which also appeared in the New York Law Journal, an ALM sibling publication of this newsletter.