In 2017, several private universities were hit with ERISA class actions alleging various breaches of fiduciary duty and prohibited transactions—including claims that these universities’ defined contribution plans charged unreasonable recordkeeping costs. One such university was Cornell in the case of Cunningham v. Cornell University.
As relevant here, the Cunningham district court granted Cornell’s motion to dismiss the prohibited transaction claims targeting the plan’s recordkeeping fees, and the Second Circuit Court of Appeals affirmed this dismissal in November 2023. The case presented an issue of first impression in the Second Circuit: what must a plaintiff allege to state a plausible claim for a prohibited transaction under 29 USC § 1106(a)(1)(C)?
Citing ERISA’s statutory language, the plaintiffs argued that Section 406(a)(1)(C) of ERISA states simply that any transaction for services with a “party in interest” is presumptively prohibited, which would include any payments by a plan to any entity providing it with any services.
In the plaintiffs’ view, questions about whether the arrangement was unreasonable or unnecessary relate only to whether an exemption applies under Section 408 of ERISA, which they maintained constitutes an affirmative defense a fiduciary must establish. That is, the plaintiffs’ position was that the existence of any transaction or payment with a service provider alone is enough to allege a prohibited transaction, and the burden should then shift to the fiduciaries to show that the conditions of an exemption were satisfied. Here, this is the exemption under ERISA § 408(b)(2) that allows for arrangements for reasonable and necessary services where the plan pays no more than reasonable compensation for the services and certain other conditions are met.
Cornell, on the other hand, argued that merely alleging that a plan entered a contract with, or made payments to, a party in interest for services to the plan is not enough alone to allege a plausible claim. If ERISA were read this strictly, it would rope in virtually every service provider arrangement under an ERISA plan and would prohibit fiduciaries from paying any third party to provide necessary services to the plan. Here, Cornell argued that the plaintiffs did not allege facts sufficient to suggest that the plan’s recordkeeping arrangements were unreasonable, unnecessary, or otherwise a prohibited transaction.
The Second Circuit ultimately sided with Cornell, holding that it was not enough to state a viable prohibited transaction claim to simply allege that a plan engaged an outside recordkeeping vendor and paid fees for its services. Rather, participants must allege sufficient facts that would plausibly suggest the arrangement was unreasonable or unnecessary, such as allegations that a lower-cost alternative existed or that the challenged services were unnecessary. The Second Circuit reasoned that the prohibitions in Section 406(a) of ERISA cannot be read in complete isolation from the exemptions in Section 408 as the two sections work in tandem to advance Congress’s purposes in enacting ERISA’s prohibited transaction framework.
This decision deepens a circuit split on the appropriate standard for plausibly alleging a prohibited transaction claim based on arrangements for goods and services with a party in interest—and therefore surviving a motion to dismiss. The Eighth Circuit Court of Appeals, for example, has in the past adopted a more plaintiff-friendly standard, allowing a prohibited transaction claim to survive dismissal by simply alleging a transaction with any party in interest, without a requirement to plausibly allege the arrangement was unreasonable (as this pertained to the exemptions in Section 408, which should be treated as affirmative defenses). The Ninth Circuit Court of Appeals followed a similar path in Bugielski v. AT&T Services, Inc.
On the other hand, the Third, Seventh, and Tenth Circuits have declined to follow such a literal reading of the statute. The Third Circuit—in another university ERISA case, Sweda v. University of Pennsylvania (3d Cir. 2019)—held that a plaintiff must include allegations of an “intent to benefit” the party in interest. The Seventh Circuit meanwhile held in Albert v. Oshkosh Corp. (7th Cir. 2022) that a plaintiff must allege a transaction that “looks like self-dealing,” rather than “routine payments for plan services.” And the Tenth Circuit held in Ramos v. Banner Health (10th Cir. 2021) that although payments to an existing party in interest may suffice, a plaintiff must allege that “some prior relationship” existed with the service provider to bring the transaction within the scope of ERISA § 406.
Considering these varying permutations of the pleading standard for ERISA prohibited transaction claims, the US Supreme Court granted the plaintiffs’ petition for writ of certiorari in Cunningham on October 4, 2024. This will be the second of these university cases to make its way to the Supreme Court, with Hughes v. Northwestern decided in early 2022.
The Court recently schedule oral argument for January 22, 2025. It is hard to predict the outcome at this stage, particularly where the Court will be faced with a textualist or strict-construction argument based on ERISA that plaintiffs claim favors their interpretation of the statute. Either way, the Court’s decision should provide some much-needed clarity on the pleading standard for ERISA prohibited transaction claims.
The case may also provide an opportunity for the Court to weigh in more generally on the appropriate pleading standard for ERISA challenges to recordkeeping fees, though as it did in Hughes, the Court is likely to confine itself to deciding a narrower question, in this case the pleading standard for prohibited transaction claims. At the least, the Court’s opinion may include some helpful language for plan fiduciaries to cite in future cases alleging breaches of fiduciary duty related to recordkeeping or other fees.