DOL Rule Opponents Have Good Day In Appeals Court

The Fifth Circuit Court of Appeals lived up to its reputation for being tough on government regulators Monday during a hearing on the controversial Department of Labor fiduciary rule.

The 68-minute hearing was marked by several spirited clashes between government attorney Michael Shih and Judge Edith H. Jones over the DOL’s authority to regulate individual retirement accounts and how investment advice works in practice.

The appeals court, which has a reputation for narrowly defining federal powers, can throw out the rule if it chooses. The so-called "Harkin amendment" in the Dodd-Frank Act of 2010 gives it reason to do so, said Eugene Scalia, plaintiff attorney. Initiated by former Sen. Tom Harkin, D-Iowa, the amendment bars the SEC from regulating fixed-indexed annuities as securities, as it tried to do with Rule 151A.

At one point, Shih earned the judge’s ire by interrupting her description of an advisor to a long-term plan.

“I’m getting to what I think is the decisive point,” Jones shot back. “They said that this fellow was no different from a car salesman in that when you walk onto the floor, the car salesman is trying to find out what you’re interested in for a car.”

“With respect, your honor, the department has looked at the record before the agency and determined that’s not how that market works today,” said Shih, a Department of Justice attorney.

The industry plaintiffs are consolidated from three lawsuits that were filed last summer in U.S. District Court for the Northern District of Texas. While the plaintiffs lost the federal court decisions, the Dallas court was chosen specifically because appeals would go to the Fifth Circuit.

The Fifth Circuit is generally considered the most conservative in the country, with decisions that frequently define the government’s role narrowly. In addition to tossing the rule, court has two other options: affirm the rule, or send it back to lower court on a minor issue.

Scalia, attorney for the U.S. Chamber of Commerce, the lead plaintiff, opened with a smooth presentation outlining familiar arguments: the DOL lacks the authority to regulate advisors, acted in an “arbitrary and capricious” manner, and violated plaintiffs’ First Amendment rights.

“When an agency declares that it’s curing a harm, it needs to establish the presence of the harm,” Scalia said. “They failed to do that here.”

At Last, A Friendly Court

The first phase of the fiduciary rule went into effect June 9. It requires advisors and agents to act as fiduciaries, make no misleading statements and accept only “reasonable” compensation.

Still, opponents are aiming mostly at phase two rules that establish a class-action right to sue under the Best Interest Contract Exemption. The BICE will be required to sell fixed indexed and variable annuities beginning Jan. 1, 2018.

The DOL continues to work regulatory channels to reshape phase two of the rule and many expect the Jan. 1 date to be delayed. A win at the appeals level would reshape the entire DOL rule debate.

After a string of federal court losses last year, DOL rule opponents finally found a friendly court.

“If they can do that, then [the Department of Health and Human Services] could declare that the doctor-patient relationship is one of a fiduciary duty, right?” asked Judge Edith Brown Clement.

It could, Scalia responded, adding that HHS would have more grounds for that decision than the DOL does with its fiduciary rule.

The three-judge panel gave both sides 10 days to submit follow-up briefs. A ruling could come by late September or early October, said Erin M. Sweeney, a lawyer with Miller & Chevalier in Washington, D.C., who attended the hearing.

“It was a very unusual hearing,” she said. “Every single thing was openly hostile to the Department of Labor’s view.”

Jones repeatedly asked Shih for opinions on various cases and/or Department of Labor interpretations of the rule and exemptions. On the latter points, Shih demurred and promised to submit a brief outlining the DOL positions.

The DOL has regulated IRAs “since the Carter administration,” Shih argued, and has full authority to do so.

“Opposing counsel said the department has no regulatory authority over IRAs,” he told Jones. “That is simply not true.”

Jones appeared to favor a more narrow interpretation of DOL authority, pointing out that “it is the Department of Labor,” emphasizing the last word should limit it to employer plans.

“The Department of Labor admits that it’s trying to transform what was a pretty lenient treatment of IRAs,” the judge added, “into an architecture of regulation.”

‘No, Your Honor’

ERISA authors never intended to allow regulators to create a new private right of action, Scalia argued. Only Congress has that power, he added, citing the Alexander vs. Sandoval as case precedent.

The private right of action refers to the right to sue contained in the Best Interest Contract Exemption. Plaintiffs consider that contract provision the most loathsome part of the DOL rule.

But federal court judges have consistently ruled that Sandoval does not apply.

Again, Jones appeared to favor a narrower view, telling Shih: “You are deliberately creating fiduciary duties” and a new cause of action.

The fiduciary standard already exists, Shih countered.

“No, your honor, there is a very significant difference,” he said. “Simply specifying the terms of what a contract may contain does not create a cause of action.”

In addition to the chamber, other plaintiffs include the American Council of Life Insurers, National Association of Insurance and Financial Advisors, the Insured Retirement Institute, and many others.

InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. John may be reached at [email protected].

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InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. John may be reached at [email protected]. Follow him on Twitter @INNJohnH.