Magazine

Compliance Consult | PLANADVISER March/April 2017

Fiduciary Rule Litigation

The DOL may become more active

By David Kaleda editors@planadviser.strategic-i.com | March/April 2017

PAJF16_Article-Image-Comp-Con-_David-Kaleda-Portrait_Tim-Bower.jpgArt by Tim BowerThe Department of Labor (DOL)’s final rule expanding the definition of “investment advice,” its issuance of related new prohibited transaction exemptions (PTEs) and changes to long-existing exemptions through rulemaking have thus far survived several legal challenges. While under the prior administration these litigation victories would have paved the way for implementation of the rule, the presidential election has made the rule’s future uncertain.

Indeed, the Trump administration has already signaled that it might pull the rule back. On February 3, the administration issued a presidential memorandum directing the DOL to review the viability of the rule, and, on February 27, the department issued a proposed rule delaying the applicability date. In view of these and other unfolding events, it is increasingly likely that—by the time this column is published—a delay will be in effect.

Notwithstanding this uncertain future, the favorable litigation outcomes may have numerous implications regarding how the DOL views its rulemaking and interpretive authority, and may also embolden its future litigation and enforcement efforts. This may be the case even if the current five-part test for determining whether an adviser provides investment advice, as set forth in the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code (IRC), and the pre-rulemaking PTEs remain the law of the land for the foreseeable future. In this respect, the courts’ decisions clarify and confirm several aspects of the DOL’s authority, both generally and regarding the rule, specifically.

First, the DOL has broad and substantial authority to regulate the financial services industry to the extent that financial institutions provide advisory services to ERISA-covered plans, individual retirement accounts (IRAs) and other qualified accounts.

Further, through the issuance of class and individual PTEs, the DOL can control how advisers sell their products and services. This can be accomplished by grouping certain advice-related prohibited transactions under one exemption, e.g., the Best Interest Contract (BIC) exemption, and others under another exemption, e.g., Prohibited Transaction Exemption 84-24. On the other hand, the DOL may simply choose not to issue an exemption, thus possibly precluding the sale of certain products and services to qualified accounts altogether.

Second, the DOL’s authority to regulate the financial services industry is separate from the authority conferred on the Securities and Exchange Commission (SEC), Financial Industry Regulatory Authority (FINRA) and state insurance, and other, regulators. Notwithstanding the potential conflicts and overlaps, the courts appear to believe that the DOL and other regulators can co-exist and effectively regulate together. Notably, the District Court for the Northern District of Texas opined that part of the purpose of ERISA was to fill regulatory gaps, which presumably include those left by other regulatory regimes and their related agencies.

Third, with respect to the particular issue of investment advice, one of the courts specifically agreed with the DOL’s long-held view that the concept of “incidental” advice does not apply under ERISA and the IRC. In other words, the test regarding whether an adviser provides investment advice is not whether any of the advice is incidental to a securities recommendation, but rather whether the advice occurs by reason of the current five-part test or other definitions pursuant to DOL regulation.

Fourth, the Northern District of Texas agreed with the DOL’s position that the prohibited transaction rules under ERISA and the IRC—even pre-rulemaking—require that compensation paid to a fiduciary or nonfiduciary service provider because of services supplied to an ERISA-covered plan, IRA or other qualified account must be “reasonable compensation” as set forth by ERISA. Regardless of the future of the rule, this point will surely have lasting implications.

In light of the foregoing, advisers cannot simply ignore the litigation over the rule on the belief that the status quo will return if the Trump administration pulls the rule back. This is not necessarily the case. The DOL’s recent litigation victories provide important takeaways on the extent of its interpretive and enforcement authority and may thus embolden the agency, regardless of the future of the rule.

In this uncertain time, advisers should certainly review how they provide services to determine whether they are, in fact, fiduciaries under the five-part test. Further, both fiduciary and nonfiduciary advisers should consider whether they provide services in accordance with the pre-rulemaking prohibited-transaction regime.

The DOL will be under new political leadership in the coming weeks or months, so it is difficult to predict the priorities of its Employee Benefits Security Administration (EBSA), the author and overseer of the rule.

David Kaleda is a principal in the fiduciary responsibility practice group at Groom Law Group, Chartered, in Washington, D.C. He has an extensive background in the financial services sector. His range of experience includes handling fiduciary matters affecting investment managers, advisers, broker/dealers, insurers, banks and service providers. He served on the Department of Labor’s ERISA Advisory Council from 2012 through 2014.