Justices Likely To Stay In ERISA’s Bounds On Pleadings

Source: Law360

The U.S. Supreme Court heard oral arguments on Jan. 22 in Cunningham v. Cornell University, a case that should resolve a circuit split on the pleading standards participants must meet when asserting prohibited transaction and excess fee claims against Employee Retirement Income Security Act retirement plan fiduciaries.

The justices sometimes seemed unsure how to resolve a conflict between statutory language addressing prohibited transactions, allowable exceptions and the facts a plaintiff must plead.  

That is, does a plaintiff merely need to show a plan paid a third party for services and force plan fiduciaries to go through costly discovery to show an exception exists, or must a plaintiff also show harm or plead that no exception exists — effectively converting affirmative defenses into an element of the claim?

At the core is a conflict between what the statute says and the reality that nearly all plans engage and pay service providers for administrative work, which can subject any plan to costly litigation and discovery.

As Justice Sonia Sotomayor explained, “whatever we decide, someone’s going to be potentially unfairly treated.”

Class actions against retirement plan fiduciaries have increased significantly in recent years, challenging the fees plans pay to service providers and whether such engagements are prohibited transactions under ERISA. The law prohibits the use of qualified retirement plan assets to benefit a party in interest, which includes anyone providing services to a plan.[1]

The law separately lists numerous exceptions to prohibited transactions that a fiduciary may plead as affirmative defenses, which include reasonable arrangements with a party in interest for services necessary for the establishment and operation of the plan, if no more than reasonable compensation is paid.[2]

As argued by the plaintiff plan participants, when a plan merely engages a third party to perform recordkeeping services, the plan has engaged in a prohibited transaction, and it would be up to a plan’s fiduciaries to demonstrate an exception exists.

As most qualified plans engage third parties to perform recordkeeping services, nearly all plans could be liable for engaging in prohibited transactions and forced into costly discovery.

Justice Samuel Alito explained that the court could issue an easy opinion upholding that conclusion under the law but that such a ruling would “close its eyes to the reality of what’s going on.” As put another way by Justice Brett Kavanaugh, “that seems nuts.”

Federal circuit courts have been split on how easy or difficult it should be to bring a suit under ERISA statutes governing prohibited transactions and their exceptions.

The U.S. Courts of Appeals for the Eighth and Ninth Circuits have held that a plaintiff need only bring a bare-bones complaint asserting that a prohibited transaction exists under one section of ERISA, for instance Section 406,[3] and force a defending fiduciary to affirmatively assert an exception under a separate section of ERISA, for instance Section 408,[4] in their answer.

The U.S. Court of Appeals for the Second Circuit in Cunningham v. Cornell held differently and requires a plaintiff to plead not just that a transaction exists under ERISA Section 406, but also that the services obtained were unnecessary or overpriced. This requires a plaintiff to plead that exemptions under ERISA Section 408 do not exist and essentially converts those affirmative defenses into elements of the claim.

Meanwhile, the U.S. Courts of Appeals for the Third, Seventh and Tenth Circuits require plaintiffs to allege something in addition to the elements of ERISA Section 1106, such as fraud or self-dealing. Notably, pursuant to Rule 9(b) of the Federal Rules of Civil Procedure, claims for fraud must be pled with particularity.

The Supreme Court is positioned to resolve this circuit split and clarify how two sections of ERISA work together. A ruling upholding the Second Circuit’s standard would make it more difficult for plaintiffs with potentially legitimate claims to survive a motion to dismiss and prevent them from engaging in discovery to obtain evidence of any wrongdoing by fiduciaries and parties in interest.

Justice Ketanji Brown Jackson questioned the fairness of such asymmetry where participants have little information while fiduciaries are the ones who entered the transaction at issue and have control over all relevant information.

Meanwhile, a ruling that overturns the Second Circuit’s holding and establishes a lesser pleading standard would continue to subject any plan, even properly managed plans, to extensive and costly discovery, which has caused many plans to settle class actions to prevent lengthy litigation and the related attorney fees and costs.

That lower pleading standard is what Justice Kavanaugh said would be an “automatic ticket to pass go” to force discovery without demonstrating any wrongdoing.

Faced with either deviating from ERISA’s language to make it harder for participants to sue their plans or closely following ERISA’s text to allow a bare-bones pleading standard that makes it easy to sue and survive motions to dismiss, the justices pursued a line of questioning exploring guardrails to prevent what Justice Kavanaugh described as an “expanded litigation threat [that] would be near limitless because every college and university relies on third-party service providers.”

As the justices further noted, these issues are not restricted to colleges and universities, but apply to any qualified retirement plan that uses third-party providers to administer its plans.

Counsel for participants suing Cornell’s plan argued that guardrails already exist to prevent burdensome bare-bones litigation against plans. Those potential guardrails include the costs plaintiffs must bear for bringing litigation, fee shifting, sanctions and standing. The justices seemed skeptical that most of these would be sufficient guardrails.

Justice Alito even pressed Cunningham’s counsel on how many ERISA lawsuits that firm had filed against universities and suggested it was more than counsel had estimated when asked during oral argument — all while the guardrails asserted by Cunningham’s counsel were already in place.

In particular, Justice Alito questioned whether Rule 11 of the Federal Rules of Civil Procedure sanctions are really “going to do the job.” Although not discussed at oral argument, the fees and costs plaintiffs must bear in bringing suit may not be a meaningful guardrail in a class action context handled under a contingent fee arrangement.

The justices seemed interested in standing serving as a guardrail already in place, as plaintiffs must show they have suffered some particularized harm due to a fiduciary’s actions and that a favorable ruling would redress the injury.

Cunningham’s counsel argued that plan participants were harmed, not only by Cornell engaging third-party recordkeepers, but also because the recordkeepers also bundled their services with other products, and, as alleged in Cunningham’s brief, participants paid four to five times more for recordkeeping services than industry standards.

Justice Alito pressed Cunningham’s counsel on what must be pled and whether it is merely enough to plead that the fees were excessive to entitle a plaintiff to discovery, suggesting that it still may be a bare-bones pleading that could survive.

The justices similarly focused on alternative guardrails that would not alter the existing statutory system, but relieve plans from lengthy and costly discovery when a complaint makes only bare allegations.

Indeed, a key principle the Supreme Court explained in its 2010 decision in Conkright v. Frommert is that Congress enacted ERISA “to create a system that is not so complex that administrative costs, or litigation expenses, unduly discourage employers from offering [ERISA] plans in the first place.”[5]

Further, as the U.S. Court of Appeals for the Tenth Circuit explained in Murphy v. Deloitte & Touche in 2010, ERISA seeks a “fair and informed resolution of disputes and seeks to ensure a speedy, inexpensive, and efficient resolution” of claims.[6]

Notably, until the expansion of ERISA fee litigation cases against universities and other large employers, ERISA litigation was largely focused on such things as benefits disputes where court-established doctrine — and not ERISA itself — requires that a participant first exhaust administrative remedies prior to bringing suit.

ERISA also provides a specific process for addressing withdrawal liability disputes when participating employers in a multiemployer defined benefit pension plan cease making contributions.[7]

That process requires a notice of withdrawal liability to an employer, an employer’s right to demand a review by the plan assessing the liability, and mandatory arbitration of any and all issues — all before any party can bring suit.

Similarly, in a non-ERISA context, an employee claiming discrimination under Title VII of the Civil Rights Act must first file a charge of discrimination with the Equal Employment Opportunity Commission and go through the EEOC’s process before suing.

The established processes under ERISA are designed to alleviate burdens on employers and the benefit plans they sponsor. The prohibited transaction provisions in ERISA do not require such interim steps to alleviate any burden on employers sponsoring qualified retirement plans. It remains relatively easy to file a bare-bones complaint alleging a prohibited transaction exists and that a plan paid excessive fees.

A plaintiff need not have evidence of any wrongdoing. A plaintiff need only make allegations before being entitled to extensive and costly discovery that may force an employer sponsoring a plan to settle, and, as Justice Alito surmised, result in a “payday for the law firm.”

The justices discussed the merits of limited and expedited discovery, converting motions to dismiss into prompt motions for summary judgment for an expedited ruling, and using Rule 7 of the Federal Rules of Civil Procedure.

Rule 7, which Justice Kavanaugh noted was described in amicus briefings as being unknown to even the most ardent scholar of civil procedure, allows a district court judge to require a plaintiff’s reply to a defendant’s answer.[8]

While that rule may be unknown to many, seldom used and even disfavored, Justice Neil Gorsuch said that using Rule 7 is “not completely out of left field.” Justice Gorsuch explained that one occasion when it has merit is when there is an affirmative defense pled in the answer and the district court judge wants to see the plaintiff’s reply.

A reply to an answer under Rule 7 could give a district court judge a basis to conclude that no reasonable juror could doubt that the affirmative defense applied. That could help expedite such claims, prevent costly discovery in some cases and function as a deterrent to bare-bones complaints not supported by reasonable facts.

Based on the justices’ lines of questioning, it is likely the Supreme Court will seek a way to limit the burden placed on plan fiduciaries through existing guardrails without disturbing the statutory process Congress established in ERISA. That is, the justices seemed to believe that the statutory system is clear and Congress has declined to change it.

However, the justices also had concerns with how easy it was for plaintiffs to place a potentially unreasonable and undeserved burden on plans that merely engage and pay service providers for administrative work but have done nothing wrong.

It remains a “shoot first and ask questions later” system where a plaintiff need only fire off a complaint with minimal allegations that a plan paid a service provider and at most must allege the fees paid were too high.

The “questions asked later” come in the form of extensive and costly discovery even when a plaintiff has no evidence of any prohibited transaction, excessive fees or other wrongdoing.

The current guardrails argued by Cunningham have done little to slow the significant expansion of these cases and the burdens they place on plans. Further, they have not expedited such cases. Cunningham v. Cornell University itself has been pending since 2016.

These realities are contrary to the intent and purpose of ERISA, which Congress designed to both protect participants and prevent employers that sponsor benefit plans from costly disputes.

Practitioners should expect the Supreme Court to stay within the confines of ERISA, but instruct courts regarding what must be pled to survive a motion to dismiss, establish how a party must establish standing, and recommend use of Rule 7 to require replies to answers, and limited and expedited discovery.

Other changes would need to come from Congress, which has declined to amend ERISA to address these issues, even though it has made other significant changes to ERISA in recent years.

Ryan C. Curtis is a director and chair of the ERISA and employee benefits practice group at Fennemore Craig PC.

Fennemore of counsel Jenny Zhang and associate David Sieck contributed to this article.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of their employer, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

• ERISA § 406(a)(1)(c), codified at 29 U.S.C. § 1106(a)(1)(c).
• ERISA § 408(b)(2)(A), codified at 29 U.S.C. § 1108(b)(2)(A).
• ERISA § 406, codified at 29 U.S.C. § 1106.
• ERISA § 408, codified at 29 U.S.C. § 1108.
• Conkright v. Frommert, 559 U.S. 506, 517 (2010).
• Murphy v. Deloitte & Touche Grp. Ins. Plan, 619 F.3d 1151, 1163 (10th Cir. 2010).
• ERISA § 4201, et seq., codified at 29 U.S.C. § 1381, et seq.
• Fed. R. Civ. P. 7(a)(7).

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