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Every fiduciary of a plan that pays for recordkeeping can be sued
It is likely that those fiduciaries will have to prove that the recordkeeper’s compensation is reasonable
In that regard, third party payments to the recordkeeper may have to be considered
And the ultimate decision about reasonableness may be made by a jury
We have already written about the Supreme Court’s decision in Cunningham v. Cornell. That decision has proved so counter-intuitive, and its implications so far reaching, that they are quite challenging for plan sponsors and sponsor fiduciaries to process.
In this article we discuss what, in this context, is the “worst case” for ERISA service provider fee litigation, considering:
After Cunningham, the possibility that fiduciaries of nearly every plan with a service provider will be sued
After Bugielski, the possibility of fiduciary liability where third party fees have not been considered in evaluating service provider compensation
And, after the Second Circuit’s ERISA jury trial decisions, the possibility that the ultimate question of the reasonableness of service provider compensation will be decided by a jury.
1. Paying a service provider out of the plan is a prohibited transaction as to which a plaintiff can bring an ERISA fiduciary claim that cannot be disposed of with a motion to dismiss
In Cunningham, the Supreme Court held that retention of a service provider who is paid out of the plan is a prohibited transaction.
Many courts have recognized the counter-intuitive nature of this result, and some have tried to read ERISA differently. The Supreme Court (in a unanimous decision) said that that is what the law says: paying a service provider from a plan is an ERISA prohibited transaction.
Thus, an ERISA action may be brought by a participant against a fiduciary that makes the “barebones” allegation that the fiduciary caused a plan to enter into a prohibited transaction, simply by hiring a recordkeeper and paying it out of the plan. That claim cannot be disposed of with a motion to dismiss. However much it seems to fly in the face of common sense, the claim that there is an exemption available for this prohibited transaction (ERISA’s service provider exemption) is an affirmative defense the unavailability of which does not have to be part of plaintiff’s initial claim.
And, in this regard, the motion to dismiss is “the whole ball game.”As Justice Alito (in a concurring opinion) observed: “in modern civil litigation, getting by a motion to dismiss is often the whole ball game because of the cost of discovery. Defendants facing those costs often calculate that it is efficient to settle a case even though they are convinced that they would win if the litigation continued.” In other words, all a plaintiff’s lawyer needs to do to get paid is to file a claim and make it past a motion to dismiss.
2. These claims will ultimately resolve into an argument over whether the compensation paid the service provider was reasonable, and it is likely that defendant will bear the burden of proof on that issue
The Supreme Court in Cunningham recognized that its decision may allow a participant claim that proceeds to discovery against nearly every fiduciary in the country. The Supreme Court identified five “tools” a lower court could use to limit “meritless” litigation:
[I]f a fiduciary believes an exemption applies to bar a plaintiff ’s suit and files an answer showing as much, [the Federal Rules of Civil Procedure] empower[] district courts to “insist that the plaintiff ” file a reply “‘put[ting] forward specific, nonconclusory factual allegations’” showing the exemption does not apply. … Lower courts may then dismiss the suits of those plaintiffs who cannot plausibly do so.
District courts must also, consistent with Article III [of the Constitution] standing [requirements], dismiss suits that allege a prohibited transaction occurred but fail to identify an injury.
For … claims that do proceed past the motion to dismiss stage,… district courts retain discretionary authority to expedite or limit discovery as necessary to mitigate unnecessary costs.
[W]here an exemption obviously applies, and a plaintiff and his counsel lack a good-faith basis to believe otherwise, [Federal Rules] may permit a district court to impose sanctions against [plaintiffs].
Lastly, … ERISA itself gives district courts an additional tool to ward off meritless litigation: cost shifting [e.g., allowing reasonable attorney’s fee and costs of action to either party].
Bottom Line: In the best case, defendant fiduciaries will then have to come forward with facts showing that the arrangement with the service provider in fact satisfies the three requirements of the exemption: (1) the services must be necessary; (2) the contract for services must be reasonable; and (3) the compensation must be reasonable.
In real life, this litigation will come down to the last exemption requirement: was the compensation paid the service provider reasonable? And, since the availability of the service provider exemption is an affirmative defense, it is likely that defendant fiduciaries will bear the burden of proof on this issue.
3. Are third party payments considered in determining the amount of the service provider’s compensation?
Whether the compensation paid the service provider is reasonable is an inherently factual question that will be determined by the judge (or the jury – see below). But there is a legal question about what compensation is considered. DOL regulations under the exemption require consideration of indirect/third party payments. In its 2023 decision in Bugielski v. AT&T Services, Inc., the Ninth Circuit held that in determining the availability of the service provider exemption, a fiduciary must consider indirect/third party compensation in assessing the reasonableness of service provider compensation (in that case, “pay-to-play” payments made by Financial Engines to Fidelity with respect to the plan).
4. Right to jury trial?
Courts in the Second Circuit have recognized a right to a jury trial for certain ERISA fiduciary claims, under a provision of ERISA that makes a plan fiduciary “personally liable to make good to such plan any losses to the plan resulting from [the fiduciary’s] breach [of its fiduciary duty].”
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The foregoing describes what we see, in the current situation, as the “outer limits” of fiduciary litigation risk with respect to service provider fees.
In the right venue, with even marginal facts, plaintiffs (and their lawyers) may be able to extract significant dollars from defendant sponsors and sponsor fiduciaries.
Many view this situation as imposing an unreasonable – and for some sponsors, unsustainable – burden on what is supposed to be a voluntary system, with the possibility that a non-trivial number of sponsors will exit that system rather than continue to live with that litigation burden.
Some policymakers and advocates are considering ways to reduce that burden – either through legislation or (where possible) regulation. (In the latter regard, see our series on Litigation reform.)
We will continue to follow this issue.