Cornell University’s recent victory in a lawsuit alleging retirement plan mismanagement added to the growing debate over whether routine contracts between employers and retirement plan service providers can be challenged under ERISA rules aimed at curbing conflicted and self-interested transactions.
The US Court of Appeals for the Second Circuit’s Nov. 14 decision favoring Cornell answered a question of first impression in the circuit: what plaintiffs must adequately allege that a retirement plan’s arrangement with a service provider violates an ERISA rule prohibiting transactions between plans and interested parties. According to the Second Circuit, a prohibited transaction claim based on money paid to a retirement plan service provider must include allegations that the services were unnecessary or that the compensation was unreasonable.
The question is an important one, because employers routinely rely on third-party service providers to handle various aspects of retirement plan administration. The Second Circuit’s opinion, which came three months after the Ninth Circuit offered its own take on these issues, added to a widening circuit split over how easy it is to challenge these arrangements in court.
These decisions have ratcheted up the chances that the US Supreme Court will agree to consider ERISA’s prohibited transaction rules in a future case, according to attorneys interviewed by Bloomberg Law.
Circuit Split
Circuits are split on how to interpret an Employee Retirement Income Security Act rule prohibiting transactions that furnish goods or services between a benefit plan and an interested party. The disagreement stems in part from how the statute is written: one section of ERISA defines prohibited transactions in broad terms, while another provides multiple exemptions that allow a transaction to remain legal if, for example, it’s backed by reasonable compensation.
The Second Circuit’s Cornell decision is “directly opposite” to the approach used by the Eighth Circuit in 2009’s Braden v. Wal-Mart Stores, Inc., said Andrew Holly, a partner with Dorsey & Whitney LLP in Minneapolis.
Under the plaintiff-friendly Braden ruling, retirement plan investors can get past a motion to dismiss by alleging that the plan provided goods or services to an interested party without having to show that the arrangement was overpriced or unreasonable. This means it can be “very easy” to get a prohibited transaction claim into the “costly and burdensome discovery phase,” which creates incentives to both file claims within that circuit and settle them, Holly said.
But plaintiffs in the Second Circuit now have a “much higher burden,” Holly said, calling this a “clear circuit split.”
“Under the Second Circuit’s construct, the defendant has the ultimate burden of persuasion as to the exemptions, but the plaintiff must raise the exemptions in their complaint,” said Dawn E. Murphy-Johnson, counsel for Miller & Chevalier Chtd. in Washington.
Varying Approaches
Appeals courts considering these issues have taken a number of different approaches.
The Third, Seventh, and Tenth circuits have issued recent rulings rejecting prohibited transaction claims that weren’t accompanied by some indication of a conflict of interest or ill intent. The Second Circuit appeared to repudiate this defendant-friendly approach, emphasizing in its Cornell opinion that prohibited transaction claims don’t require specific allegations of self-dealing or disloyal conduct.
The Ninth Circuit recently announced its own approach in an August decision reviving prohibited transaction claims involving
Attorneys agreed that the Cornell opinion conflicts more with the Eighth Circuit’s Braden approach than with the Ninth Circuit’s AT&T decision, which was reviewing a summary judgment ruling instead of a ruling on a motion to dismiss.
According to Murphy-Johnson the Second Circuit’s analysis may be on a “collision course” with the Labor Department’s “long-held doctrine” that all transactions between a plan and a party in interest are prohibited and the burden is on the defendant to show that a statutory exemption applies.
But the “big question” is whether the Supreme Court will step in and resolve the issue once and for all, Holly said.
Any petition for Supreme Court review is a “long shot,” but there’s “a very reasonable chance” the court will deem this issue worthy of its attention, he said.
The case is Cunningham v. Cornell Univ., 2d Cir., No. 21-88, 11/14/23.