As options run out for saving fiduciary rule, more states may take action

As industry awaits the release of a mandate from the U.S. Appellate Court for the Fifth Circuit that will officially vacate the Labor Department’s fiduciary rule, attention is expected to turn to investment sales standards at the state level.

The 5th Circuit’s mandate was slated for May 7. Under federal appellate procedures, courts have latitude to extend the release of mandates that enforce court decisions.

Last week, AARP and state attorneys-general from California, Oregon, and New York were denied a motion to intervene to defend the fiduciary rule by the 5th Circuit, after the Labor Department let pass a deadline to petition for a re-hearing of the March 15 decision vacating the rule.

That decision was widely regarded as the last legal option for proponents of the rule to defend it in court.

But a potential option remains, albeit one that legal experts don’t expect AARP and the states to pursue.

Under the Declaratory Judgment Act, a claimant could petition the 5th Circuit, or another Circuit, for clarification as to whether or not the decision to vacate the fiduciary rule applies nationwide, or merely in Texas, Louisiana, and Mississippi, the three states within the 5th Circuit.

In the immediate wake of the 5th Circuit’s split-decision vacating the rule, some legal experts speculated that the decision may not be enforceable nationwide. Previously, the 10th Circuit Court of Appeals upheld a more narrow aspect of the fiduciary rule.

AARP did not return an inquiry into whether it was considering filing a request for declaratory judgment.

It is likely that AARP and the states may not have the constitutional standing to request a judgment, say attorneys.

“It would be interesting to see how it would play out if filed in the 10th Circuit, on the grounds that the 10th Circuit upheld part of the fiduciary rule,” said Erin Sweeney, an attorney with Miller & Chevalier. “But I don’t believe there is a litigant with standing who is interested in bringing the case at the moment.”

Even if AARP and the states were granted standing by a court, a favorable declaratory judgment for proponents of the rule would be a long shot, says Marcia Wagner, managing director at The Wagner Law Group.

“Leaving aside procedural issues, such as standing, filing a declaratory judgment action would only make sense if they had substantial case law support for the proposition that vacating an order applies only in the Circuit in which the decision was rendered,” Wagner said.

“I would think if the 5th Circuit was asked, its position would be that its decision applied nationwide,” added Ms. Wagner.

A request for declaratory judgment would not be required before the 5th Circuit issues its mandate effectuating its decision, said Jamie Fleckner, chair of the ERISA Litigation Practice at Goodwin.

Still, Fleckner thinks the request would prove to be futile and leave AARP and the states looking “increasingly desperate.”

“The 5th Circuit left no doubt,” he said. “It was very clear that the ruling vacated the rule in its entirety. It would be highly unlikely for any other court to say the 5th Circuit impermissibly vacated the rule, and all of its exemptions, on a nationwide basis.”

Pivoting to state fiduciary regs

To date, New York, New Jersey, Nevada, and Connecticut have issued various regulations, and legislation, addressing conflicts of interest in the sales of investment products.

Nevada’s law, which went into effect last year, was the most sweeping. It requires a fiduciary standard of care on broker-dealers. New York’s proposed regulation would require a best interest standard on annuity sales. New Jersey’s proposal would make non-fiduciaries disclose that they are not required to serve clients’ best interests.

As options for defending Labor’s fiduciary rule in federal court seem all but exhausted, efforts to craft regulations at the state level could pick up steam.

“States seem more interested in focusing on new regulation as opposed to litigating over the 5th Circuit decision,” said Ms. Sweeney.

Inquiries to California’s and Oregon’s State Treasurers and securities regulation offices as to whether the 5th Circuit decision will expedite regulatory efforts in those states were not returned by press time.

Other states may be motivated to take action. In a March letter to Jay Clayton, Chairman of the Securities and Exchange Commission, 11 State Treasurers pledged their support for Labor’s fiduciary rule, and urged the SEC to promulgate a best interest standard that is at least as “robust” as Labor’s rule was.

Tobias Read, Oregon’s Democrat Treasurer, was among the signatories. So were Treasurers from Utah, Wyoming, South Carolina, and Iowa.

The fate of the SEC’s proposed Regulation Best Interest, which was released in April, may force more regulation at the state level.

Some in industry have already predicted an SEC rule may never be finalized, despite Chair Clayton’s prioritization of the rulemaking.

Others have criticized SEC’s proposal for inadequately addressing broker-dealers’ conflicts of interest.

“Even if the SEC proposal is finalized, there will still be significant gaps in protection for investors,” said Micah Hauptman, an attorney with the Consumer Federation of America, which was an ardent supporter of Labor’s fiduciary rule.

Hauptman said CFA has “serious concerns” with the SEC’s proposal.

“Regardless of what emerges from the SEC, there will be a role for states to play in this space,” added Hauptman.