Texas two step: DOL fiduciary rule halted by Texas district courts

The next day, on July 26, 2024, the U.S. District Court for the Northern District of Texas (the “Northern District of Texas Court”) issued its own stay of the 2024 Fiduciary Rule, along with the remainder of the exemptions issued by the DOL in connection with the release of the 2024 Fiduciary Rule.

This means that the 2024 Fiduciary Rule will not take effect in September as originally scheduled, and retirement advisers will get a temporary reprieve from having to comply with the 2024 Fiduciary Rule, unless the DOL appeals and succeeds in getting these two court decisions overturned.

Background

The 2024 Fiduciary Rule^[1] sought to redefine the term "investment advice fiduciary" for purposes of ERISA and the U.S. Internal Revenue Code (the “Code”). The 2024 Fiduciary Rule had notably eliminated the long-standing “five-part test” for determining whether a person is an investment advice fiduciary with respect to an employee benefit plan or IRA, which had been reinstated by the Fifth Circuit in 2018 in Chamber of Commerce v. DOL (“Chamber”) when it vacated a similar rule proposed by President Barack Obama in 2016 (the “2016 Fiduciary Rule”).^[2] The 2024 Fiduciary Rule also amended prohibited transactions (“PTEs”) 75-1, 77-4, 80-83, 83-1, 84-24, 86-128 and 2020-02. The rule was scheduled to become effective on September 23, 2024, with a one-year phase-in period for the amendments to PTE 2020-02 and PTE 84-24.

Overview of the Eastern District of Texas Court case

On May 2, 2024, a group of plaintiffs, including a trade organization of insurance agents and independent marketing organizations, filed a lawsuit in the Eastern District of Texas, challenging the validity of the 2024 Fiduciary Rule and seeking either a stay of its effective date or a preliminary injunction to prevent its enforcement.^[3] The plaintiffs alleged that the 2024 Fiduciary Rule conflicts with the text and purposes of ERISA and the Code, exceeds DOL's statutory authority, and is arbitrary and capricious in violation of the Administrative Procedure Act (“APA”). On July 25, 2024, the Court granted the plaintiffs' motion and postponed the effective date of the 2024 Fiduciary Rule and the related amendment to PTE 84-2 until further order of the court.

In granting the plaintiffs motion, the Court held that the 2024 Fiduciary Rule suffered from many of the same problems as the 2016 Fiduciary Rule, and similar to the Fifth Circuit court which vacated the 2016 Fiduciary Rule, the Court found that the 2024 Fiduciary Rule conflicts with ERISA in several ways.

• The Eastern District of Texas Court found that the 2024 Fiduciary Rule’s removal of the "regular basis" and "primary basis" criteria and expansion of the definition of “investment advice fiduciary” to include one-time recommendations, regardless of whether the adviser was paid for advice, conflicted with the ERISA's text, which requires a relationship of trust and confidence between the fiduciary and the client, and the Fifth Circuit's decision in 2018 to vacate the similar 2016 Fiduciary Rule.
• The Eastern District of Texas Court also held that the rule's amendment to PTE 84-24, which imposed duties of loyalty and care on IRA service providers as a condition of receiving commissions, was an unreasonable and arbitrary exercise of DOL's regulatory power, that the amendment imposed virtually the same "Impartial Conduct Standards" imposed in the 2016 Fiduciary Rule, including duties of loyalty and care that Title II does not include, and that the amendment exposed IRA service providers to breach-of-fiduciary-duty liability, essentially recreating the 2016 Rule's private cause of action. Thus, the Eastern District of Texas Court agreed with the plaintiffs that the 2024 Fiduciary Rule ignored the distinction between DOL's regulatory authority under Title I, which is expansive, and Title II, which is limited.
• Finally, the Eastern District of Texas Court determined that the plaintiffs would suffer irreparable harm in the absence of relief, as they would face significant compliance costs, potential liability, and market disruption. The court also concluded that the balance of equities and the public interest weighed in favor of a stay and that the rule was likely unlawful as to the plaintiffs and all other similarly situated investment professionals. Therefore, the Eastern District of Texas Court did not limit the stay to the parties in the case but applied it to all similarly situated investment professionals, noting the nationwide scope and impact of the 2024 Fiduciary Rule.

Overview of the Northern District of Texas Court case

The decision from the Eastern District of Texas Court gained momentum in a similar case brought in the Northern District of Texas Court.^[4] On May 24, 2024, American Council of Life Insurers and a coalition of trade associations filed the lawsuit against DOL, seeking a preliminary injunction or a stay of the effective date of the 2024 Fiduciary Rule. The plaintiffs argued that the 2024 Fiduciary Rule was unlawful, arbitrary, and capricious and would cause them irreparable harm. On July 26, 2024, the Northern District of Texas Court issued the order, granting the motion to stay the effective date of the 2024 Fiduciary Rule and the PTE amendments, pending the final judgment and any appeal.

The Northern District of Texas Court agreed with and incorporated the analysis of the Eastern District of Texas Court, but was more expansive in some respects. Some noteworthy points from the Northern District of Texas Court’s order and opinion include the following:

• They granted the order in part for the stay but declined in part on issuing a preliminary injunction, finding that a stay would provide the plaintiffs with complete relief and that the absence of a stay would result in a substantial threat of irreparable harm to the plaintiffs. The stay order of the Northern District of Texas Court was more comprehensive than that of the Eastern District of Texas Court because it halts the effective date of 2024 Fiduciary Rule as well as all of the PTE amendments.
• The Northern District of Texas Court aligned with the Eastern District of Texas Court by finding that the plaintiffs are “virtually certain” to succeed based on the merits of their claim. The court agreed with the plaintiffs that the DOL exceeded its statutory authority, making remand inefficient and a potential waste of judicial resource. It also agreed that the balance of equities and the public interest favored the plaintiffs’ position.
• On the other hand, the Northern District Court of Texas Court stated that the arguments made by DOL and the other defendants were nothing more than an attempt to relitigate the Fifth Circuit’s decision in Chamber, which should be made to the Fifth Circuit or the U.S. Supreme Court.

Additional ongoing legal challenges

Until the courts decide the merits of the plaintiffs' challenges or issue final orders, implementation of the 2024 Fiduciary Rule and the related PTE amendments are now paused. Additionally, the DOL may appeal these two decisions. However, as noted by the Eastern District of Texas Court in giving deference to ERISA’s text rather than DOL’s interpretation thereof, the challenge against the DOL’s authority rides a wider wave of challenges against agency authorities following the recent overturn of the Chevron doctrine.^[5] The growing skepticism toward governmental agencies likely signals an uphill battle for the DOL. While the courts in these cases contemplate their final decisions, interested parties may seek further judicial review of the 2024 Fiduciary Rule and the related PTE amendments in higher courts, either in the Fifth Circuit or the U.S. Supreme Court.

On the legislative front, federal lawmakers have introduced resolutions seeking to block the 2024 Fiduciary Rule under the Congressional Review Act.^[6] The resolution advanced in the House of Representatives in July, with its outcome to be monitored. A similar resolution to disapprove the 2016 Fiduciary Rule failed to pass, as it was vetoed by President Barack Obama in June 2016.^[7]

Considerations for investment advisors and investors

While the pause on the 2024 Fiduciary Rule from these two cases may provide a brief respite for investment advisers who would have otherwise needed to be in compliance with the 2024 Fiduciary Rule prior to its effective date, investment advisers and investors should continue to monitor the legal developments surrounding the 2024 Fiduciary Rule, review their existing policies and procedures, and consider the impact of the recent court rulings on their businesses. In this regard, advisers may wish to:

• consult with a legal advisor to understand and consider the potential impact of the different outcomes surrounding the 2024 Fiduciary Rule;
• continue to become familiar with requirements under the 2024 Fiduciary Rule, consider compliance planning, and prepare for potential updates to existing disclosures in offering materials containing fiduciary rule language;
• keep in mind the one-year transition period during which written acknowledgment of fiduciary status is required in connection with the continued reliance on PTEs 2020-02 and PTE 84-24, along with compliance with the Impartial Conduct Standards, in the event that the 2024 Fiduciary Rule survives these challenges; and
• for plan sponsors and investors, conduct due diligence on prospective investment advisers and communicate with current investment advisers to ensure that they are monitoring these developments and to understand how they plan to comply with the 2024 Fiduciary Rule if it survives legal challenges.

We invite you to ask your A&O Shearman contact to discuss how uncertainties surrounding the 2024 Fiduciary Rule may impact your business.

Footnotes 

[1] https://www.aoshearman.com/en/insights/new-final-fiduciary-rule-dol-redefines-investment-advice-fiduciary-again

[2] Chamber of Commerce v. Department of Labor, 885 F. 3d 360 (5th Cir. 2018).

[3] Federation of Americans for Consumer Choice, Inc. et al v. U.S. Department of Labor, et al (E.D. Tex. 2024).

[4] American Council of Life Insurers, et. al. v. U.S. Department of Labor, et. al. (N.D. Tex. 2024).

[5] Loper Bright Enterprises v. Raimondo (603 U.S. ___ (2024), in which the U.S. Supreme Court overturned the Chevron doctrine used by courts to give deference to reasonable governmental agency interpretations of ambiguous statutes or unclear laws).

[6] S.J. Res.79. H.J.Res.142 (https://allen.house.gov/uploadedfiles/fiduciary_cra_xml.pdf).

[7] H.J.Res.88 (https://www.congress.gov/bill/114th-congress/house-joint-resolution/88).