Supreme Court holds that plaintiffs’ prohibited transaction complaint need not address the (possible) availability of an exemption

On April 17, 2025, the Supreme Court handed down its decision in Cunningham v. Cornell University, holding that, to survive a motion to dismiss, a plaintiff bringing an ERISA prohibited transaction claim against plan fiduciaries need not plead that there was no available exemption with respect to it.

In this article we review the Court’s decision and consider some of its implications for plan sponsors.

Summary

Justice Sotomayor, writing for a unanimous Court, held that:

• To survive a motion to dismiss, a plaintiff bringing a prohibited transaction claim against a plan fiduciary does not have to plead that no exemption is available.

• In this context, however, lower courts have tools to prevent “meritless litigation,” e.g., “a district court may insist that a plaintiff file a reply to an answer that raises one of the [ERISA section 408] exemptions as an affirmative defense.” This generally would take place before costly discovery.

Background

This case includes a claim by plaintiffs that defendant plan fiduciaries caused the plan, Cornell University’s ERISA-covered/individual account-based 403(b) plan, to enter into a prohibited transaction by retaining TIAA-CREF and Fidelity Investments to provide recordkeeping services to the plan.

ERISA generally defines service providers as “parties in interest,” and ERISA section 406 generally prohibits transactions between a party in interest and a plan. A separate provision of ERISA, section 408(b)(2)(A), provides an exemption from that prohibition for service providers for “reasonable arrangements” for the provision of necessary services “if no more than reasonable compensation is paid therefor.”

Treating the retention of a service provider by a plan as a prohibited transaction seems a little absurd, in as much as the overwhelming majority of individual account plans do use an outside recordkeeper, and the plan fiduciary responsible for hiring the recordkeeper does therefore (“technically”) cause the plan to enter into a prohibited transaction.

ERISA’s prohibition/exemption scheme, in effect, provides a set of standards for the retention of service providers. The service must be necessary, the contract for services must be reasonable, and – the critical issue in these cases – the service provider’s compensation must be reasonable. And it is the plan fiduciary’s job to determine that those standards have been met and that the “prohibited transaction” is therefore “exempt.”

The Supreme Court’s decision

The issue in this and similar cases is, given that every plan fiduciary who hires a service provider is causing the plan to enter a prohibited transaction (under ERISA section 406), who has the burden of pleading, at the motion to dismiss stage, the availability or non-availability of the service provider exemption (under ERISA section 408)?

Why does the motion to dismiss stage matter? 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 Cunningham v. Cornell University, the Supreme Court held (9-0) that plaintiffs did not have to plead the absence of an available exemption, reversing the Second Circuit’s decision to the contrary and remanding the case “for further proceedings consistent with this opinion.” Their rationale was (as Justice Alito put it in a concurring opinion) ERISA section 408 “sets out affirmative defenses, and it is black letter law that a plaintiff need not plead affirmative defenses.”

But – lower courts still have tools to weed out meritless claims

But Justice Sotomayor, in delivering the opinion of the Court, recognized the “serious concerns” raised by defendants that allowing these claims on “barebones” pleading could lead to “meritless litigation … harm[ing] the administration of plans and forc[ing] plan fiduciaries and sponsors to bear most of the associated costs.”

To address these concerns, she identified five “tools” lower courts could use “to screen out meritless claims before discovery”:

• [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 Consitiution] 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].

Justice Alito, in his concurrence, singled out as “most promising” the first tool in this list: “a district court may insist that a plaintiff file a reply to an answer that raises one of the [ERISA section 408] exemptions as an affirmative defense.”

A dispute over the reasonableness of the service provider’s compensation

Lower courts will now have to sort out how – in light of the Court’s decision – these sorts of service provider-related prohibited transaction claims are to proceed.

Ultimately, these claims will come down to a dispute over whether the service provider’s compensation is – as required by the exemption – “reasonable.” Lower courts will have to work out, e.g., where the defendant plan fiduciary asserts in its answer that the service provider exemption is available, how much facts/specificity they will require from defendant before they “insist” (per Justice Alito) that plaintiff reply to this assertion. E.g., will they require the defendant to allege facts (and if so, what facts?) in support of its claim that the “reasonable compensation” element of the exemption has been met? And what specificity in reply will they insist upon from the plaintiff?

Interestingly, in contrast to a prudence claim, where the ultimate issue is the reasonableness of the fiduciary’s process, and where comparisons of fees under the plan with fees under other comparable plans are simply a proxy (preliminary to discovery) for an imprudent process, here the issue is the “objective” reasonableness of the service provider fees themselves, where those comparisons are the main issue.

We also note that there is an open issue as to what constitutes compensation for purposes of the “reasonable compensation” requirement of the service provider exemption. 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 recordkeeper compensation (in that case, “pay-to-play” payments made by Financial Engines to Fidelity with respect to the plan).

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We will continue to follow this issue.