Case Law Update: Supreme Court Resolves Circuit Split, Opens Floodgates for New ERISA Litigation

IN BRIEF: In April of this year, the Supreme Court issued its unanimous opinion in Cunningham v. Cornell University, holding that in order to successfully state a claim that a defendant entered into a prohibited transaction in violation of Section 406 of ERISA, a plaintiff need not also plead that an exception to that prohibited transaction under ERISA Section 408 does not apply; rather, the defendant bears the burden of pleading any affirmative defenses to a violation of ERISA’s prohibited transaction rules.  The Supreme Court’s ruling resolves a split among the federal Circuit courts and makes it easier for plaintiffs to advance ERISA prohibited transaction claims beyond the pleading stage.

WHO: In 2017, former and current participants in one or more Section 403(b) plans sponsored by Cornell University filed suit against the plans’ fiduciaries.

WHY:  Among other things, the plaintiffs alleged that the fees the plans had paid to the plans’ recordkeepers were not reasonable.  Because recordkeepers, as plan service providers, are deemed “parties in interest” under ERISA, the plaintiffs specifically alleged that the recordkeeping contracts entered into by the plans’ fiduciaries were prohibited transactions that violated ERISA Section 406(a)(1)(C), which states that a plan fiduciary shall not “cause the plan to engage in a transaction” that the fiduciary knows “constitutes a direct or indirect . . . furnishing of . . . services . . . between the plan and a party in interest.”  Notably, however, the plaintiffs did not also allege in their complaint that an exemption (under ERISA Section 408) to the alleged prohibited transaction did not apply. 

Lower Court Rulings:  The District Court granted the fiduciaries’ motion to dismiss the ERISA Section 406(a) claim, stating that the plaintiffs’ claim was defective because it failed to also allege that a prohibited transaction exemption under ERISA Section 408 did not apply.  The Second Circuit Court of Appeals agreed, finding that a plaintiff may only state a claim under ERISA Section 406(a) if it also sufficiently alleges that an exemption to that rule under Section 408 does not apply.  The Second Circuit’s ruling was contrary to prior rulings by other Circuit courts, causing a Circuit split to be decided by the Supreme Court.

Supreme Court Ruling: The Supreme Court reversed the Second Circuit, holding that a plaintiff “need only plausibly allege each of [the] elements of a prohibited-transaction claim” specified in ERISA Section 406(a) to state a claim for a violation of that statute. In other words, the Court held that in order to survive a motion to dismiss, plaintiffs alleging a prohibited transaction under Section 406(a) do not also need to allege that a prohibited transaction exemption under ERISA Section 408 does not apply. This is because the prohibited transaction exemptions found in ERISA Section 408 are “affirmative defenses” and defendants (not plaintiffs) bear the burden of pleading and proving an affirmative defense.

Significance to Plan Sponsors:  The Supreme Court’s ruling affirms a lower standard for plaintiffs to file suit against plan fiduciaries under ERISA Section 406, a holding that could open the floodgates for more ERISA litigation in the future.  In order to avoid an adverse determination on a motion to dismiss and thereby prolong the litigation process (which will inevitably and substantially increase litigation costs), a plaintiff need now only allege that a prohibited transaction occurred.  It will be up to the defendant to plead and prove the satisfaction of an exemption to ERISA’s prohibited transaction rules.

Now more than ever, plan sponsors and fiduciaries should focus on engaging in prudent, compliant, and well-documented administrative actions up front to effectively manage litigation risks with respect to their benefit plans.  Processes for vetting and selecting plan service providers should be frequent, thorough, reasoned, and well-documented.  Plan sponsors and fiduciaries should perform all fiduciary functions with ERISA’s fiduciary standard in mind and with an eye toward ensuring that a clear prohibited transaction exemption applies when engaging plan service providers.