In Cunningham v. Cornell, the Supreme Court unanimously held that a plaintiff can state a prohibited transaction claim under ERISA § 406(a) by simply alleging that a plan fiduciary caused the plan to engage in a transaction with a "party in interest" as proscribed by § 406(a).1 Prior to Cunningham, courts were divided over the allegations necessary to state a prohibited transaction claim under ERISA § 406(a). Although ERISA § 406(a) prohibits a plan fiduciary from causing the plan to engage in a transaction with a "party in interest," including transactions involving the furnishing of services to the plan, § 408 authorizes the Secretary of Labor to grant administrative exemptions from those prohibitions, and also provides a number of statutory exemptions for many common types of plan transactions. One of those statutory exemptions provides relief for "reasonable arrangements" for services provided to the plan, as long as the services are "necessary" for the plan's operation and the amount paid for the services is "reasonable."
Like the Supreme Court in Cunningham, the Eighth Circuit had previously ruled that a complaint asserting a prohibited transaction claim involving the provision of services must allege only that ERISA § 406(a)(1)(C) was violated, and need not address the exemption for services in § 408(b)(2) to survive a motion to dismiss.2 Other courts, however, including the Third, Tenth, and Seventh Circuits,3 had concluded that reading § 406(a)(1)(C) in isolation from the § 408(b)(2) exemption for services would lead to "absurd results," because it would appear to "prohibit fiduciaries from paying third parties to perform essential services in support of a plan,"4 including "recordkeeping and administrative services."5
The plaintiffs in Cunningham had brought an ERISA action alleging, among other things, that the fiduciaries of two defined contribution plans sponsored by Cornell University had caused the plans to engage in prohibited transactions with providers of recordkeeping services in violation of ERISA § 406(a)(1)(C). The Second Circuit affirmed the lower court's dismissal of that claim, reasoning that the § 408 exemptions could not "be understood merely as affirmative defenses to the conduct proscribed in § 406(a)," and that "at least some of those exemptions—particularly, the exemption for reasonable and necessary transactions codified by § 408(b)(2)(A)—are incorporated into § 406(a)'s prohibitions."6 Although fiduciary defendants would still bear the ultimate "burden of persuasion" regarding the applicability of the § 408 exemptions,7 the Second Circuit held that a complaint asserting a § 406(a)(1)(C) violation must plausibly allege that the transaction "was unnecessary or involved unreasonable compensation."8
The Supreme Court reversed, holding that the exemptions in ERISA § 408 are affirmative defenses, and that fiduciary defendants "bear the burden of pleading and proving that a § 408 exemption applies to an otherwise prohibited transaction under § 406." In particular, the court held that a plaintiff must plausibly allege only three elements to state a § 406(a)(1)(C) claim— namely, (1) a fiduciary caused the plan "to engage in a transaction," (2) that the fiduciary "knows or should know . . . constitutes a direct or indirect . . . furnishing of goods, services or facilities" (3) "between the plan and a party in interest."9 In concluding that the exemptions did not impose any additional pleading requirements, the court emphasized that the exemptions "are enumerated separately" in § 408, and that § 408 itself expressly refers back to the prohibitions in § 406.10
The court rejected the argument that the "except as provided" language at the outset of ERISA § 406 required that the § 408(b)(2) exemption for services be incorporated as an element of any prohibited transaction claim under § 406(a)(1)(C). In the court's view, that argument not only ignored that the § 408(b)(2) exemptions were written "in the orthodox manner of an affirmative defense," but also implied that all of the § 408 exemptions must be incorporated as elements of every § 406(a) violation, thus "putting the onus on plaintiffs to plead and disprove any potentially relevant . . . exemptions."11
The court acknowledged that its ruling could lead to "an avalanche of meritless litigation" and allow plaintiffs to "easily get past the motion-to-dismiss stage and subject defendants to costly and time-intensive discovery."12 Recognizing these as "serious concerns," the court suggested several tools district courts can use to "screen out meritless claims before discovery," including dismissal of prohibited transaction claims that fail to allege the requisite injury for Article III standing, expediting or limiting discovery as necessary to reduce unnecessary costs, imposing Rule 11 sanctions where appropriate, and fee shifting under ERISA § 502(g)(1).13
The court also suggested another tool, however, which the concurring opinion described as "perhaps the most promising."14 If a defendant files an answer asserting that an ERISA § 408 exemption provides an affirmative defense to an alleged prohibited transaction, Federal Rule of Civil Procedure 7(a)(7) authorizes a district court to order the plaintiff to file a reply "'putting forward specific, nonconclusory factual allegations' showing the exemption does not apply."15 Once a reply is filed, the defendant can then move for judgment on the pleadings under Federal Rules of Civil Procedure 12(c). A defendant who wishes to pursue this route presumably would not only file an answer asserting the § 408 exemption as an affirmative defense, but also file a separate motion asking the court to order a reply to any such affirmative defense. This Rule 7(a)(7) mechanism should provide plan fiduciaries with a useful tool for challenging meritless prohibited transaction claims before plaintiffs are allowed to proceed with costly discovery.
Footnotes
1 Slip Op. at 6.
2 Braden v. Walmart Stores, Inc., 588 F.3d 585, 601 (8th Cir. 2009); see also Bugielski v. AT&T Services, Inc., 76 F.3d 894, 901 (9th Cir. 2023).
3 Sweda v, University of Pennsylvania, 923 F.3d 320, 324 (3d Cir. 2019); Albert v. Oshkosh Corp., 47 F.4th 570, 584 (7th Cir. 2022); Ramos v, Banner Health, 1 F.4th 769, 787 (10th Cir. 2021).
4 Slip Op. at 5 (quoting Cunningham v. Cornell, 86 F.4th 961, 973 (2d Cir. 2024)).
5 86 F.4th at 973 (quoting Albert, 47 F.4th at 585).
6 Id. at 975.
7 Id. at 977.
8 Id. at 975 (emphasis in original).
9 Slip Op. at 6.
10 Id. at 7-8.
11 Id. at 9-11.
12 Id. at 13-14.
13 Id.
14 Justice Alito wrote a concurring opinion, in which Justice Thomas and Justice Kavanaugh joined.
15 Slip Op. at 14.
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