Less than a month after its release, the Department of Labor’s (DOL) conflict of interest rule continues to be a lightning rod for opponents who weren’t happy with changes to the safe harbor for commission-based advice.
In addition to recent efforts to thwart the rulemaking in Congress, 10 industry groups filed lawsuits in two federal district courts on June 1 and 2, 2016, to postpone the April 10, 2017, compliance date, at a minimum, and ultimately to overturn the rule.
was filed June 1 in a Dallas federal district court. It was joined by several national trade groups, including the Financial Services Roundtable, the Financial Services Institute, and the Securities Industry and Financial Markets Association. The second lawsuit was filed in Washington, D.C., federal district court on June 2 by the National Association for Fixed Annuities (NAFA).
In addition to standard claims that the DOL acted contrary to law and violated the federal Administrative Procedure Act (APA), both lawsuits assert that the Department unlawfully created a private right of action to enable investor lawsuits based on violations of the Best Interest Contract Exemption (BICE). Both also claim that the Department’s decision to include fixed-indexed annuities under BICE instead of a relatively less-onerous prohibited transaction exemption (84-24) was arbitrary and capricious. And both seek court injunctions to stop implementation of the fiduciary rule during the legal challenge.
Plaintiff claims that the DOL rule violates two constitutional amendments involving freedom of speech and delegating what opponents called a vague definition of “reasonable compensation” to state court judges and juries and forum-shopping for a favorable court are among the unusual twists in this long-running controversy.
Constitutional violation claims. The lawsuit alleges that in addition to First Amendment protection for commercial speech, the First Amendment also protects against “compelled silence.” As such, plaintiffs claim that the fiduciary rule abridges their ability to engage in “truthful, non-misleading speech related to their products and services” by subjecting the fiduciary relationship to significant regulatory burdens.
The lawsuit contends that the “reasonable compensation” requirement of the rule violates the due process clause of the Fifth Amendment because the Department’s compensation standard is, under various prohibited transaction exemptions, including BICE, “so vague to be without meaning.”
Some observers view these as “Hail Mary” passes thrown in to the mix. Many view the APA violation claims as the strongest argument, given the success of Gibson Dunn attorney Eugene Scalia, son of the late Supreme Court Justice Antonin Scalia, in overturning several rulemakings by the Securities and Exchange Commission. Scalia is now the lead attorney on the suit, and is a former DOL solicitor in the George W. Bush administration.
Forum-shopping. Several Texas affiliates in the Dallas area, Lubbock, and Houston joined the national chamber’s lawsuit. Some legal experts consider the northern Texas district court to be “injunction friendly” as well as the New Orleans-based U.S. Court of Appeals for the Fifth Circuit, which would hear any appeals. Given the stakes in this fight, most observers consider an appeal will happen.
’s lawsuit was filed in federal district court in Washington, D.C. An appeal there would go up to the U.S. Court of Appeals for the District of Columbia, which often is referred to as the second most-powerful court in the United States after the U.S. Supreme Court. Many legal challenges to federal rules are heard there, and often judges on the Circuit, such as Chief Judge Merrick Garland, are nominated to fill Supreme Court vacancies.
While the Fifth Circuit may be considered more industry-friendly, the Washington, D.C. Circuit views may be changing. In recent years the D.C. Circuit has become top-heavy with Democratic-appointed judges who now outnumber Republicans seven to four on the Court. Because the customary three-judge panel to hear appeals is always selected on a random basis, the odds now are in favor of a 2-1 ratio of Democrats to Republicans. In the Fifth Circuit, the Democrat-Republican ratio is somewhat reversed, at three-to-four.
Of course, this does not mean that Democrat-appointed judges will side automatically with the Barack Obama administration’s fiduciary rule, or vice-versa. Additionally, a wild card is in the mix. Both circuits have a “reserve” bench of senior judges when the active pool of judges is busy or otherwise conflicted out of a case. The senior judge count heavily favors Republicans on both courts. One of the six senior judges on the D.C. circuit, and only five of 10 senior judges on the Fifth Circuit, are Democrats.
What if the Dallas district judge agrees to an injunction and the D.C. judge does not? The decision would be binding only in that district, hence the motivation to appeal and apply the injunction more broadly at the circuit level. And what if the circuits disagreed? If the issue is significant, the U.S. Supreme Court is more likely to accept the case. However, a 4-4 decision would leave the lower court decision intact.
Some observers, including this column, had expected a lawsuit to be filed within a few days of the April 6, release of the final rule. However, the DOL surprised many by including several concessions that reduced the recordkeeping and disclosure burden under BICE and also eliminated a requirement that restricted the list of available assets to less-risky investments.
Even , a mutual funds ratings service, seemed to offer two different views when it published seemingly contradictory headlines after the final rule was released. One column was entitled, “New Fiduciary Rules More Lenient Than Expected,” and the other stated, “New Fiduciary Rule More Pro-Investor Than Previous Iteration.”
The presiding judges may have similar conflicting opinions. And another court could join them soon in the mix. As reported widely, the American Council of Life Insurers is expected to file a third legal challenge within a few days.