May 26, 2020

'Fiduciary Rule' Update: Financial Services Industry Should Prepare for Compliance

The U.S. Department of Labor (DOL) scored an initial victory in what is sure to be a long legal battle over the so-called "fiduciary rule." Judge Randolph D. Moss of the U.S. District Court for the District of Columbia issued a 92-page ruling denying a motion for summary judgment and motion for preliminary injunction filed by Plaintiff National Association of Fixed Annuities (NAFA) against the DOL. Judge Moss then granted the DOL's cross motion for summary judgment, holding that the DOL had the authority to amend the definition of who is a fiduciary and finding the DOL promulgated the fiduciary rule after sufficient rule-making and administrative process.

The decision, from an influential district court well versed in administrative procedure, may well impact other legal challenges to the fiduciary rule, including the U.S. Chamber of Commerce and the Securities Industry and Financial Markets Association (SIFMA) in U.S. District Court in Texas. However, the number of challenges – at least a half-dozen -- and divergent legal theories make it unlikely this decision is the last the securities industry will hear about the rule before it goes into effect April 1, 2017. Nonetheless, Judge Moss's decision sends a message to the financial services industry to prepare to comply with the rule.

The fiduciary rule changes the definition of "fiduciary" and will require brokers and financial advisers to put their clients' interests ahead of their own when recommending retirement investments. The purpose of the rule is to protect investors from situations where an adviser offers conflicted advice, such as where she or he is paid by a mutual fund company or another third party for recommending a particular investment, rather than acting in the best interests of the investor. Brokers can continue to earn commissions and engage in revenue-sharing arrangements related to sales of investment products, but they must enter into a contract with customers in which they pledge to act in their customers' best interest and disclose any relevant conflicts of interest. Brokers also will have to explain why they are recommending a particular product when a less expensive option is available, and may face increased scrutiny if they recommend complicated products.

NAFA challenged how the fiduciary rule will affect its members in the fixed annuities market. NAFA alleged the new rule would have devastating results on its members' business by effectively precluding NAFA members from selling their investment products. In particular, NAFA argued that the DOL had erred by:

  1. changing the definition of "fiduciary" in the final rule to remove the requirement that a fiduciary provide advice on a "regular basis;"

  2. extending fiduciary duties under the Employee Retirement Income Security Act of 1974 (ERISA) to entities not within the purview of ERISA;

  3. creating a new private cause of action under new rule's the best interest contract (BIC) exception;

  4. issuing an impermissibly vague standard of compensation under the BIC exception;

  5. altering in the final rule a prior exception for certain annuities in an arbitrary and capricious manner; and

  6. conducting an inadequate regulatory flexibility analysis.

Judge Moss rejected all of NAFA's arguments. Notably, Judge Moss was convinced by the DOL's arguments that investor-adviser relationships had changed in modern times, and found "the increased complexity and variety of financial products in the marketplace has sown 'confusion,' 'increased the potential for very costly mistakes,' left retail investors more dependent on expert advice, and exposed plan participants and IRA owners to unknown conflicts of interest." According to Judge Moss, this changing nature of the industry and the investor/adviser relationship rendered promulgation of the rule within the authority of the DOL.

Judge Moss distinguished a prior D.C. Circuit Court of Appeals decision, Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006), in which the appellate court struck down an SEC regulation that would have resulted in hedge fund managers being required to register under the Investment Advisers Act. In Goldstein, the D.C. Circuit "rejected the SEC's contention that evidence of market changes, including 'a rise in the amount of hedge fund assets, indications that more pension funds and other institutions were investing in hedge funds, and an increase in fraud actions involving hedge funds,' was sufficient to justify the amendment absent evidence that the relationship between the advisers and investors had also changed."

In another notable section of his opinion, Judge Moss held that the fiduciary rule does not create a new private cause of action. Rather, the fiduciary rule "merely dictates terms that otherwise-conflicted financial institutions must include in written contracts with IRA and other non-title I owners in order to qualify for the [BIC] exemption." Put another way, Judge Moss concluded that the fiduciary rule may make it easier for possible plaintiffs to prevail on their state-law breach of contract claims against investment advisors, but it does not actually create a new legal right.

Conclusion

Judge Moss's decision, which has already been appealed, provides precedent that will make it harder for challengers in other pending lawsuits to overturn or curtail the new fiduciary rule. However, Judge Moss's decision also may provide those challengers a road map of what not to argue. And, in yet another presidential election twist, President-Elect Donald Trump has indicated that the fiduciary rule may be a target of his administration in 2017. For now, however, the takeaway from the decision for players in the financial services industry is that the fiduciary rule survives, so preparations for its implementation on April 1, 2017 should remain on course.

© Polsinelli PC, Polsinelli LLP in California

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About this Author

Thomas Wagner, Litigation, Financial Services, Polsinelli Law FIrm
Associate

Tom is an associate with substantial litigation experience in the financial services industry. He resolves disputes by listening to clients and knowing how litigation affects their business. Tom’s legal skills, industry knowledge, and understanding of client goals help him obtain cost-effective resolutions to complex legal problems. 
Tom has successfully resolved:

  • Trade-secret disputes
  • Unfair competition cases
  • Breach of contract cases
  • Claims arising under federal and state consumer protection statutes
  • Business fraud and business divorce...
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Paul R. Wood, Polsinelli, customer fraud lawyer, raiding and recruitment attorney
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Paul Wood has tried more than 50 cases in federal and state courts and before arbitration panels in 17 states. He thrives on securing positive results for his clients and, over the course of his more than 30 years of practice, clients have come to expect these satisfying outcomes. 

He has represented securities broker/dealers and other financial services firms before FINRA and in court on a wide range of claims, including customer complaints, fraud, raiding and recruitment, and protocol for broker recruiting compliance. His deep knowledge of the financial services industry allows him to understand the clients’ business and formulate proactive litigation strategies which fit into their overall business goals, rather than simply react to the facts of a particular case. 

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