Supreme Court Grants Review in ERISA Class Action Challenging Plan Sponsor’s Recordkeeping Arrangement

Key takeaway: The Supreme Court granted certiorari to address the pleading standards for prohibited-transaction claims under 29 U.S.C. § 1106(a).

On October 4, 2024, the Supreme Court granted certiorari in Cunningham v. Cornell to address the pleading standards for alleging that a transaction between an employer-sponsored benefit plan and certain people or entities (a “party in interest”) qualifies as a prohibited transaction barred by the Employee Retirement Income Security Act of 1974 (ERISA). The ERISA provision at issue in this case (29 U.S.C. § 1106(a)(1)(C)) prohibits transactions involving the “furnishing of goods, services, or facilities between the plan and a party in interest.” But § 1106 expressly provides that the specified transactions are prohibited “[e]xcept as provided in section 1108,” which contains exemptions that allow plans to enter into precisely the types of transactions specified in § 1106, particularly when doing so is beneficial for benefit plans and their participants. For example, § 1108(b)(2) permits transactions between plans and service providers in which the services provided—things like legal, accounting, and recordkeeping services—are “necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid therefor.” In Cunningham, the Supreme Court granted certiorari to resolve the following question: “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 by 29 U.S.C. § 1106(a)(1)(C), or whether a plaintiff must plead and prove additional elements and facts not contained in the provision’s text.” As stated, the question involves the interplay at the pleading stage between prohibited transactions and their exemptions.

Cunningham is one of several civil actions filed across the country alleging that university pension plans have been mismanaged in violation of ERISA. In Cunningham, individual plaintiffs, representing a class of current and former employees who participated in either of Cornell University’s two retirement plans (the “Plans”) sued in the Southern District of New York alleging that Cornell and its appointed fiduciaries failed to employ adequate processes for monitoring the Plans, resulting in the retention of underperforming investment options and the payment of excessive fees. In addition, the plaintiffs alleged that the defendants had engaged in transactions prohibited under 29 U.S.C. § 1106(a).

Cornell’s Plans are defined-contribution plans in which the participants maintain individual accounts and choose their investments from a menu of investment options selected by plan administrators. During the relevant time, Cornell contracted with two companies that not only provided investment options for plan participants (in exchange for investment-management fees) but also provided recordkeeping services for the investment options on their respective platforms (in exchange for recordkeeping fees). According to the plaintiffs, these arrangements resulted in the payment of excessive fees by the plan in violation of ERISA’s prohibited-transaction provisions and ERISA’s fiduciary duty of prudence. (As noted above, the plaintiffs also challenged certain investment options that were available under the Plans, but those claims are no longer at issue in the case.)

As relevant here, the District Court dismissed the plaintiffs’ prohibited-transaction claim at the pleading stage because the plaintiffs had not alleged facts plausibly suggesting “self-dealing or other disloyal conduct”—a requirement that the District Court concluded was required by § 1106(a)(1)(C). Plaintiffs objected to that decision. They argued that they had sufficiently plead a violation of § 1106(a)(1)(C) simply by alleging that the recordkeepers, who are “parties in interest,” had been engaged to “furnish[] goods, services, or facilities” with the Plans. In their view, they did not have to allege any self-dealing or disloyal conduct (as the District Court had required), nor did they have to allege facts demonstrating that any potentially relevant exemptions contained in § 1108 were inapplicable. Instead, the plaintiffs would have courts defer the application of § 1108 until after the pleading stage. In other words, the plaintiffs contend that the only allegation necessary at the pleading stage is an allegation that an ERISA plan retained a service provider.

The question before the Second Circuit, and now before the Supreme Court, is what elements plaintiffs must plead when alleging a prohibited transaction under § 1106. Courts have typically viewed the exemptions in § 1108 as affirmative defenses, and so one of the primary disagreements between the parties is whether plaintiffs must plead around those exemptions—i.e., allege facts demonstrating that those exemptions do not apply—in order to state a viable prohibited-transaction claim. The Second Circuit adopted the more defendant-friendly interpretation, holding “as a matter of first impression that to state a claim for a prohibited transaction pursuant 29 U.S.C. § 1106(a)(1)(C), it is not enough to allege that a fiduciary caused the plan to compensate a service provider for its services; rather, the complaint must plausibly allege that the services were unnecessary or involved unreasonable compensation, see id. § 1108(b)(2)(A).” 86 F. 4th 986.

The Second Circuit noted that the federal courts of appeal are split on the issue, explaining that the Third, Tenth, and Seventh Circuits had each “declined to read ERISA” in a way that “would prohibit fiduciaries from paying third parties to perform essential services in support of a plan,” including “recordkeeping and administrative services,” Albert v. Oshkosh Corp., 47 F.4th 570, 584–85 (7th Cir. 2022). These circuits were not all aligned in their disagreement, however—they had adopted “different means of narrowing the statute,” such as requiring allegations of an intent to benefit a party in interest, requiring a prior relationship between the fiduciary and the service provider, or requiring allegations of self-dealing. Cunningham, 86 F.4th at 973. On the other hand, the Eighth and Ninth Circuits had “embraced the expansive reading of the statute that the[] other circuits have rejected as absurd.” Id. at 974. The Second Circuit’s approach took a different path than the Third, Tenth, and Seventh Circuits, but one that it acknowledged would reach a similar end.

The Second Circuit reasoned that “[r]eading § 1106(a)(1)(C) in isolation of the exemptions in § 1108, ERISA would appear to prohibit payments by a plan to any entity providing it with any services.” 86 F.4th at 973. In the Second Circuit’s view, that would lead to absurd results: any plan sponsor could be sued simply for the ubiquitous act of transacting with a service provider. Considering the text of § 1106 closely, the court explained that it “begins with the carveout: ‘Except as provided in section 1108 of this title ....’” Id. at 975 (quoting 29 U.S.C. § 1106(a)). The exemptions set out in § 1108 are therefore “incorporated directly into § 1106(a)’s definition of prohibited transactions.” Id. “Typically, when a statute is drafted ‘with exemptions laid out apart from the prohibitions,’ the exemptions are understood to serve” as affirmative defenses. Id. 

However, that presumption does not apply when the exemptions are incorporated directly into the text. The Second Circuit also noted that the carveout language “is in contrast to the language of § 1106(b),” which governs a different set of prohibited transactions. Id. And when Congress uses certain language in one part of the statute and different language in another, the court assumes different meanings were intended. The Second Circuit also drew on the principle that when a prohibition is broad and an exemption is narrow, the exemption likely constitutes an affirmative defense. But when the exemption is not narrow, the opposite implication arises.

Turning to the facts alleged in Cunningham, the Second Circuit held that under its interpretation of the pleading requirements of § 1106(a), the plaintiffs had failed to state a claim and affirmed the District Court’s dismissal. The Cunningham plaintiffs petitioned for certiorari, arguing that the case was worthy of Supreme Court review due to the division among the federal courts of appeal over the standards for pleading a prohibited-transaction claim under § 1106(a)(1). Plaintiffs also alleged that the split was current and relevant, pointing to the Ninth Circuit’s recent decision in Bugielski v. AT&T Services, Inc., 76 F.4th 894, 897 (9th Cir. 2023), to join the Eighth Circuit’s side of the split. Plaintiffs argued that the lack of uniformity across the federal courts of appeals was particularly troublesome in the context of ERISA, which aimed to establish a uniform body of benefits law.

The Supreme Court granted certiorari. Oral argument has not yet been scheduled, but it will likely be heard in January. The Supreme Court has not issued a decision on whether it will grant certiorari in the Ninth Circuit case Bugielski v. AT&T, which also implicates the circuit split. The two cases are not precisely related—Bugielski was not a pleading-stage case, and so the holding of Cunningham might not directly impact the resolution of that case. But because both cases involve the interpretation of the same statutory provision, the Supreme Court will likely hold Bugielski until it has issued a decision in Cunningham.

The grant of certiorari will provide the Supreme Court with the opportunity to grapple with competing approaches to the pleading standards for a claim under § 1106—a statutory provision that has frequently befuddled courts and practitioners alike. While the plaintiffs will likely argue that the Supreme Court must choose between a plaintiff-friendly textual approach or a defendant-friendly policy-based approach, the arguments before the Court do not fall neatly into that dichotomy. To the contrary, both parties have textual arguments in their favor, which means that the Supreme Court may well divide based on differing approaches to textualism.

At a minimum, the Supreme Court’s decision could increase the uniformity of the circuit courts on this issue, which itself could be helpful to some degree to employers and employees alike. However, if the Supreme Court decides that the bar to pleading a prohibited transaction pursuant to § 1106(a) is a low one, then it will make it more difficult to weed out meritless claims at the motion to dismiss stage. The impact on that score could be very substantial because § 1106 can apply to a huge array of routine benefit plan transactions such as recordkeeping, investment management, or investment advising. If plans can be hit with hefty litigation and discovery costs (potentially forcing settlements) any time they outsource services to third parties—which most plans do, as employers typically do not have the resources and expertise to provide all services to run a plan in-house—then it will likely increase the costs of providing (and insuring) retirement plans.

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee similar outcomes.