In Cunningham v. Cornell University, the U.S. Supreme Court held that to state a claim under ERISA’s prohibited transaction provisions, a plaintiff need only plausibly allege the elements contained in that provision itself, without addressing potential exemptions. This decision resolves a split among U.S. Circuit Courts of Appeal regarding whether the statutory exemptions from the prohibited transaction rules must be addressed in a plaintiff’s complaint or whether they are defenses to be proven by the plan fiduciary.
As background, ERISA prohibits plan fiduciaries from causing a plan to engage in certain transactions with parties that have a direct legal or financial stake in the matter; however, ERISA also exempts from these prohibitions any transaction that involves “[c]ontracting 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.”
The plaintiffs at Cornell University participated in two defined contribution retirement plans. These plaintiffs sued Cornell and other plan fiduciaries for allegedly causing the plans to engage in prohibited transactions for recordkeeping services. The plaintiffs claimed the plans paid its service providers substantially more than reasonable recordkeeping fees. The district court dismissed the prohibited-transaction claim, and the Second Circuit Court of Appeals affirmed.
In a unanimous decision, the Supreme Court reversed the Second Circuit decision, which means the plaintiffs can move past a motion to dismiss and proceed to the discovery stage, thus significantly increasing the defendant’s litigation costs. Because the court agreed with the plaintiffs’ claim that Cornell plan fiduciaries had the burden to prove that an exemption to the prohibited transaction rules applied in this instance, more of these types of lawsuits are likely to be filed, and plan fiduciaries will have an even greater incentive to settle these cases before spending significant money to defend them.
In its decision, the Supreme Court recognized ERISA plans’ “practical concerns” about meritless litigation but claimed that Congress created the issue with how it worded the statute: “Lastly, [Defendants] contend that there will be an avalanche of meritless litigation if disproving the applicability of [an exemption] is not treated as a required element of pleading [prohibited transaction] violations. …These are serious concerns but they cannot overcome the statutory text and structure. Here, Congress ’set the balance’ in ’creating [an] exemption and writing it in the orthodox format of an affirmative defense,’ so the Court must ’read it the way Congress wrote it.’”
The Supreme Court also pointed out that district courts have tools for screening out meritless claims. These include requiring plaintiffs to file a reply addressing a defendant’s answer that claims an exemption applies, dismissing claims that fail to identify a concrete injury, limiting discovery, imposing sanctions and ordering cost shifting (whereby a court awards attorney’s fee and costs of action to one of the parties).
Based on the Supreme Court’s decision, plaintiffs may start to file stand-alone prohibited transaction claims without any additional allegations of wrongdoing (e.g., that the payment between the parties was unreasonable). Some argue that this is unlikely since plaintiffs will still want to focus on those employers that they believe actually paid unreasonable compensation. In any case, because of the increased likelihood that plaintiffs will survive a motion to dismiss, this decision will put more pressure on employers to enter into settlement agreements.
Nonetheless, the Cornell decision could wind up having some positive effects if the criticism of the current statutory scheme leads courts to start using some of the tools mentioned by the Supreme Court, such as requiring reply briefs from plaintiffs and imposing sanctions for frivolous lawsuits. Our understanding, however, is that courts almost never use these tools.
This decision may also spur legislative changes that address the current litigation framework and explore reforms that would discourage baseless lawsuits.
In light of the Supreme Court decision in this case, employers should consider:
