According to the Court, in order to state a claim under Section 406(a)(1)(C), a plaintiff needs to plead only that a defendant fiduciary has caused a plan to engage in a transaction that a defendant “knows or should know…constitutes a direct or indirect…furnishing of goods, services, or facilities” between the plan and a party in interest. This cements a low pleading bar that the Court itself acknowledged has the potential to increase what the Court described as “meritless litigation.”
Section 406(a)(1)(C) of ERISA prohibits fiduciaries of employee benefit plans subject to ERISA from engaging in any transaction for goods, services, or facilities with a “party in interest.” ERISA defines a “party in interest” to include any “person providing services to [the] plan.”2 As the general rule forbids transactions necessary for the administration of large benefit plans, Section 406(a) notes that these transactions are prohibited “except as provided” in Section 408, which provides twenty-one separate carve-outs to the general rule. Regulations promulgated by the Secretary of Labor provide hundreds more carve-outs. The prohibited transaction exemption at issue in Cornell permits “reasonable arrangements” for “office space, or legal, accounting, or other services necessary for the establishment or operation of the plan,” provided “reasonable compensation” is paid.3
Background
The case involves two defined-contribution retirement plans sponsored by Cornell University. The plaintiffs, a class of current and former Cornell employees who participated in the plans, “sued Cornell and other plan fiduciaries for allegedly causing the plans to engage in prohibited transactions for recordkeeping services,” in violation of Section 406(a)(1)(C) of ERISA.
The district court dismissed the prohibited transaction claim, and the Second Circuit affirmed, holding that “Section 408(b)(2)(A) of ERISA is incorporated into Section 406(a)'s prohibitions, requiring plaintiffs to plead that a transaction was ‘unnecessary or involved unreasonable compensation’ to survive a motion to dismiss.”4 The Second Circuit reasoned that this interpretation was necessary to avoid “absurd results” and to limit the reach of Section 406(a)(1)(C), which would otherwise prohibit any payment by a plan to a service provider. The Second Circuit split from the Eighth Circuit, which had held that no additional pleading requirements beyond Section 406(a)(1) apply to prohibited transaction claims.5
The Supreme Court’s decision
Section 406 prohibits fiduciaries from causing a plan to engage in a transaction that the fiduciary knows or should know constitutes a direct or indirect furnishing of goods, services, or facilities between the plan and a party in interest. Writing for a unanimous majority reversing the Second Circuit, Justice Sonia Sotomayor held that a complaint needs only to allege the elements contained in Section 406 to survive a motion to dismiss and that it does not need to allege the inapplicability of any of the exemptions. The fact that the exemptions were set forth in a separate statutory section evidenced Congress’s intent that they serve as affirmative defenses rather than elements of the claim. The Court also noted that it would be impracticable for a plaintiff to have to address all twenty-one statutory defenses in a complaint, not to mention the hundreds of additional regulatory exemptions.
The Court acknowledged the “serious concerns” that defendants raised about a rise in meritless litigation likely resulting from this low pleading standard. To combat this, the Court encouraged district courts to utilize the tools at their disposal to dismiss meritless claims or limit discovery. Such tools include requiring plaintiffs to file a reply addressing exemptions under Federal Rule of Civil Procedure 7(a), dismissing claims that fail to identify a concrete injury as required for a plaintiff to establish it has standing under Article III, limiting or expediting discovery to the issue of whether an exemption applies, imposing Rule 11 sanctions, and ordering cost shifting.
In a concurring opinion, Justice Samuel Alito emphasized the suggestion that district courts should consider requiring plaintiffs to file replies to defendants’ answers. Although Justice Alito acknowledged that this procedure was rarely used, he suggested it could allow “the prompt disposition of insubstantial claims.”
Potential impact of Cornell on plan sponsors and fiduciaries
The Court’s decision clarifies the pleading standards for ERISA prohibited transaction claims and resolves a circuit split that created uncertainty and inconsistency for plan fiduciaries and service providers. The decision also sets out what plaintiffs need to plead to survive a motion to dismiss. Because that bar is low, the Court’s decision potentially increases the risk of such lawsuits being brought and surviving motions to dismiss. Plan fiduciaries and service providers should consider the following implications of the decision:
- While the prevalence of excessive fee lawsuits has increased over the last decade, Cornell all but assures that even more ERISA prohibited transaction claims can be expected against plan sponsors and fiduciaries.
- Plaintiffs may also seek to challenge other types of plan-related transactions that fall within the scope of ERISA’s party in interest prohibited transaction rules, such as loans, leases, sales, or exchanges of property, or transfers of plan assets.
- Plan sponsors may face increased pressure to settle such claims, even if they have meritorious defenses, due to the potential cost and burden of discovery and litigation.
- In light of Cornell, plan fiduciaries may wish to review their existing contracts and arrangements to ensure compliance with the requirements of Section 408 or another available exemption to the party in interest prohibited transaction rules.
- Although uncommon in federal court, defendant plan sponsors and fiduciaries should consider including factual allegations to support the applicability of any exemptions asserted as affirmative defenses in their answers and then asking that a court direct the plaintiff to file a reply to its detailed answer.
- A detailed answer, coupled with an inadequate reply from a plaintiff, may allow a district court to decide the case based on the pleadings in advance of any discovery.
- Defendants should consider asking the court to use its discretion to limit discovery to the issue of whether an exemption applies and then expedite summary judgment practice on that issue and sanction meritless litigation where appropriate. Defendants should also consider employing the process for sanctions available under Federal Rule of Civil Procedure 11 when the arguments that an exemption does not apply are frivolous.
Footnotes
1. Cunningham et al. v. Cornell Univ. et al., -- U.S. – (2025)
2. Section 3(14) of ERISA
3. Section 408(b)(2)(A) of ERISA
4. Although the plaintiffs claimed that the plans paid certain service providers substantially more than reasonable recordkeeping fees, the Second Circuit held that this did not meet the additional pleading requirements it felt was necessary to demonstrate the prohibited transaction exemption in Section 408 of ERISA was inapplicable.
5. See Braden v. Wal-Mart Stores, Inc., 588 F.3d 585, 600-602 (8th Cir. 2009).