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Supreme Court Adopts Simplified Pleading Requirements for ERISA Prohibited Transaction Claims, While Pointing to Procedural Mechanism to Limit Such Claims

Plausible, bare-bones allegations of a prohibited transaction under ERISA § 406 are enough to allow such breach-of-fiduciary-duty claims to proceed, as stated in a unanimous decision of the U.S. Supreme Court in Cunningham v. Cornell University. Plaintiffs need not articulate or reference the statutory exceptions contained in ERISA § 408; rather, defendants may answer and defend on the basis of those exceptions.

This holding will impact ERISA breach of fiduciary pleadings and procedural practice. Defendants’ ability to obtain a dismissal of prohibited transaction claims under Rule 12 will be severely limited. However, the Court points defendants to another procedural mechanism to curtail unfettered ERISA fiduciary duty litigation: Rule 7(a) of the Federal Rules.

The Cunningham Case – A Typical ERISA Excessive Fee Lawsuit 

The Cunningham case is a class action brought by participants in Cornell University’s retirement plans asserting ERISA breaches of fiduciary duty against certain fiduciaries of the plans. The basic allegations are that the plans paid excessive fees and costs in the operation of the plans. In addition to claims under ERISA’s general fiduciary provisions in section 404, the plaintiffs alleged that the fiduciaries engaged in transactions prohibited under section 406.

This is a typical scenario in ERISA excessive fee litigation cases. Challenges to service provider costs and fees are made under ERISA’s general fiduciary provisions in Section 404 and are also claimed to be specifically prohibited in ERISA section 406. In response, defendants generally bring a motion to dismiss under Fed. R. Civ. P. 12, as the Cornell University defendants did here.

Prohibited Transaction Claims Related to Services in ERISA Excessive Fee Litigation

Section 406(a)(1)(C) of ERISA prohibits a fiduciary from causing a plan to engage in a transaction for goods, services or facilities with a party in interest. Section 408 of ERISA lists 21 exemptions to section 406. As to section 406(a)(1)(C) transactions, if the transaction provides services necessary for the operation of the plan and for no more than reasonable compensation, the transaction is allowed. ERISA § 408(b)(2).

In seeking to dismiss the ERISA 406 prohibited transaction claims, the Cornell University defendants argued that the plaintiffs had to plead more than the existence of the fiduciaries hiring certain services for the plans. Rather, they argued the plaintiffs needed to plead facts that the transactions were unnecessary or that the compensation for the services was unreasonable, thus incorporating the 408-exception response into the complaint.

The Second Circuit agreed with Cornell University, upholding dismissal of the prohibited transaction claims. The Second Circuit noted that the Third, Seventh and Tenth Circuits also require more criteria to make out a prohibited transaction claim, although the Second Circuit’s criteria was different from those courts. The Second Circuit’s holding was directly contrary to the Eighth Circuit, which allows simplified pleading.

U.S. Supreme Court - Pleading the Three Elements of the Prohibited Transaction Statute is Sufficient 

The Supreme Court reversed the Second Circuit, holding that a plaintiff need only plead the three elements of ERISA section 406(a)(1) for a case to proceed: (1) that a fiduciary caused a plan to engage in a transaction; (2) that the fiduciary knows or should know is a direct or indirect furnishing of goods, services or facilities; and (3) the transaction is between the plan and a party in interest.

The Court states, “Section 1106(a)(1(C)’s bar is categorical: Any transaction that satisfies its three elements is presumptively unlawful. Nothing in that section removes from its categorical bar transactions that were necessary for the plan or involved reasonable compensation.”

The Supreme Court did note that just because a plaintiff properly pleads a 406(a) claim, it does not mean the plaintiff will prevail. If a defendant establishes that a section 408 exemption applies, the 406(a)(1)(C) claim will ultimately fail.

Defendants May Seek a Reply to Their Answer From Plaintiffs

The Supreme Court addressed the concern that allowing liberal pleading in an area already rife with litigation will only lead to more costly and protracted litigation. The Court urged district courts to rely on existing tools to screen out meritless claims at the pleadings stage. As one such countermeasure, the Court directs litigants to a little-used mechanism contained within the federal rules: a reply to an answer under Rule 7(a)(7). Rule 7(a)(7) authorizes a district court to order a reply to an answer. In Cunningham, the Court encourages district courts to use this tool in circumstances where a fiduciary believes an exemption applies to bar a plaintiff’s suit, and files an answer showing as much.

We will be monitoring excessive fee litigation going forward to see if district courts heed the Supreme Court’s advice. The Supreme Court also listed Rule 11 sanctions and ERISA’s own cost-shifting mechanism in ERISA § 502(g)(1) as tools for combating meritless litigation. While those may be available in certain cases, it remains to be seen if those tools will be used to stem the tide of litigation in light of the lessened pleading standards. 

If you have specific questions about the decision in Cunningham or other issues in ERISA, please contact Kutak Rock’s ERISA Fiduciary and Benefits Litigation group.