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On October 4, 2024, the Supreme Court granted certiorari (agreed to hear) plaintiff participants’ petition in Cunningham v. Cornell University, asking the court to overturn a Second Circuit decision dismissing plaintiffs’ claim that defendant fiduciaries caused the plan to enter into a prohibited transaction. In this case, the Second Circuit held that, in order to proceed with such a claim, the plaintiffs must not only plead that the plan had entered into a prohibited transaction but that there was no exemption available with respect to that transaction.
Why this case matters to plan sponsors
The issue here – and in the related case of Bugielski v. AT&T Services, Inc. – sounds technical and procedural. But the issue of who has the burden of pleading that (as in these cases) a recordkeeper’s compensation is reasonable (and therefore complies with ERISA’s service provider exemption) or unreasonable (and therefore does not comply) may determine the outcome of many of these cases.
And given that the main issue with respect to the availability of the exemption in these cases is the reasonableness of the service provider’s compensation, this case may be viewed as another version of 401(k) fee litigation, focused on the issue of what a plaintiff has to allege to survive a motion to dismiss.
We also note (as perhaps even more significant) that the underlying issue in Buglielski is whether and to what extent a plan fiduciary has a duty to monitor the indirect compensation being paid a service provider, in connection with its obligation to assure that the service provider’s compensation is reasonable.
In what follows, we lay out the specifics of the issue presented to the Supreme Court and conclude with a brief discussion of its practical implications for plan sponsors.
Issue presented to the court
Let’s begin by noting that, as a general matter, plan participants can sue plan fiduciaries for violating ERISA’s prohibited transaction rules, and that is the element of these cases that is before the Supreme Court.
The formal statement of the issue presented to the Court is:
Whether a plaintiff can state a claim by alleging that a plan fiduciary engaged in a transaction constituting a furnishing of goods, services, or facilities between the plan and a party in interest, as proscribed [ERISA’s prohibited transaction rules], or whether a plaintiff must plead and prove additional elements and facts not contained in the provision’s text.
ERISA’s prohibited transaction rules and the service provider exemption
The drafters of ERISA were concerned that there were certain transactions between a plan and persons with some sort of relationship to the plan – “parties in interest,” including (as relevant in these cases) plan service providers – that were inherently suspect. ERISA takes the approach of “outlawing” all of these transactions (as “prohibited transactions”) and then carving out exemptions allowing certain types of transactions that are necessary to plan operations or a net benefit to the plan and plan participants.
Involved in these cases (Cunningham and Bugielski) is the prohibition against service provider-parties in interest violating ERISA’s prohibition of any “direct or indirect furnishing of services between the plan and a party in interest.”
Obviously, most plans will need services from outside providers, and ERISA contains an exemption for:
Contracting or making reasonable arrangements with a party in interest for office space, or legal, accounting, or other services necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid therefor. (Emphasis added.)
The question before the Court in these cases is whether, in addition to alleging that a plan fiduciary has committed a prohibited transaction by contracting for services with a service provider, a plaintiff must also allege that there is no exemption available. In these cases, that would generally involve alleging (to the satisfaction of federal pleading standards) that the compensation paid to the service provider was unreasonable.
Divided circuits
The Courts of Appeal have come to different conclusions on this issue.
Quoting the petition for certiorari in Cunningham:
The Eighth and Ninth [e.g., in Buglielski]Circuits have applied the text of this prohibition as written. The Second, Third, Seventh, and Tenth Circuits have, on the other hand, required plaintiffs to allege additional elements to state a claim, because a “literal reading” of [ERISA’s prohibited transaction rules] would purportedly produce “results that are inconsistent with ERISA’s statutory purpose.” (Citing Albert v. Oshkosh Corp.)
While a literal reading of the statute does support the approach taken by the Eighth and Ninth Circuits, the other Courts of Appeal characterize that approach as “absurd.” And one can understand why – interpreting the law literally would seem to allow a lawsuit to be brought against nearly every plan in the country, requiring plan fiduciaries to go into court and “prove” that the service provider exemption is available to them. And, indeed, one of the main objections to the arguments of plaintiffs is that a decision allowing these sorts of cases will result in a (classic) “flood of litigation.”
Some practical considerations
Thus, what is the proper approach – critically who has the burden to allege and prove the reasonableness of fees paid to a recordkeeper – is what the Court has undertaken to decide.
More practically, the Court will (at least implicitly) be deciding “how much slack” it will give fiduciaries with respect to the provider arrangements they cause a plan to enter into. That, in effect, is the difference between a defendant having to prove that a service provider’s compensation was reasonable vs. a plaintiff having to prove it was unreasonable.
We note that in deciding this case, the Court will (in all likelihood) also be deciding the same issue in Bugielski. And there is, lurking in that litigation, what may be a more significant issue. As we discuss in our article on that case, Bugielski raises the question of the extent to which plan fiduciaries must understand and include in their evaluation of the reasonableness of a recordkeeper’s compensation pay-to-play payments (AKA “indirect compensation”) paid by Financial Engines to the recordkeeper. Plaintiffs have, prior to Bugielski, generally been unsuccessful in bringing this issue before a court, and the defendant fiduciaries in Bugielski have also asked the Supreme Court to review the Ninth Circuit’s decision (allowing plaintiffs to proceed) in that case on the same issue raised in Cunningham.
Bottom line: the Supreme Court’s decision in this case may have implications for the future of fee litigation, especially litigation over recordkeeper fees.
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We will continue to follow this issue.