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In a recent legal triumph, Cornell University emerged victorious in a lawsuit that alleged mismanagement of its retirement plan. This victory has ignited a broader discussion on the ability to challenge routine contracts between employers and retirement plan service providers under ERISA rules. The debate centers on whether such challenges can curb conflicted and self-interested transactions within retirement plans.
Second Circuit’s Landmark Decision
The US Court of Appeals for the Second Circuit issued a groundbreaking decision on November 14, settling a crucial question of first impression within the circuit. The court addressed what plaintiffs must adequately allege to demonstrate that a retirement plan’s arrangement with a service provider violates ERISA rules prohibiting transactions between plans and interested parties. According to the Second Circuit, a claim based on prohibited transactions must include allegations that either the services were unnecessary or the compensation was unreasonable.
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This decision is particularly significant because employers routinely engage third-party service providers to manage various aspects of retirement plan administration. The Second Circuit’s opinion, three months after the Ninth Circuit provided its perspective on similar issues, deepened the divide among circuits on the ease of challenging these arrangements in court.
Growing Circuit Split
Circuits are currently divided on interpreting an Employee Retirement Income Security Act (ERISA) rule prohibiting transactions furnishing goods or services between a benefit plan and an interested party. The divergence arises from the broad definition of prohibited transactions in one section of ERISA and multiple exemptions in another section that can render a transaction legal under certain conditions, such as reasonable compensation.
The Cornell decision from the Second Circuit starkly contrasts the approach taken by the Eighth Circuit in Braden v. Wal-Mart Stores, Inc. (2009). In the plaintiff-friendly Braden ruling, it is easier for retirement plan investors to advance past a motion to dismiss without proving that the arrangement was overpriced or unreasonable. This creates incentives to file and settle claims within that circuit.
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Burden of Proof Shift
The Second Circuit’s decision places a higher burden on plaintiffs, differing significantly from the Braden approach. Plaintiffs in the Second Circuit must now demonstrate that the defendant has the ultimate burden of persuasion regarding exemptions while still raising these exemptions in their complaint.
This shift in burden has raised concerns about a potential collision between the Second Circuit’s analysis and the long-held doctrine of the Department of Labor. The department traditionally maintains that all transactions between a plan and a party in interest are prohibited, placing the burden on the defendant to prove the applicability of a statutory exemption.
Varying Approaches Across Circuits
Various appeals courts have adopted divergent approaches to similar issues. The Third, Seventh, and Tenth Circuits have recently rejected prohibited transaction claims that lack indications of conflict of interest or ill intent. In contrast, in its Cornell opinion, the Second Circuit emphasized that prohibited transaction claims don’t require specific allegations of self-dealing or disloyal conduct.
The Ninth Circuit, in an August decision involving AT&T Services Inc.’s 401(k) plan, revived prohibited transaction claims. The Ninth Circuit asserted that ERISA’s broad and unambiguous rules encompass arm’s-length service transactions between plans and vendors. However, the court left room to consider whether the arrangements were reasonable and backed by fair compensation.
Potential Supreme Court Intervention
Legal experts suggest that these conflicting decisions increase the likelihood of the US Supreme Court reviewing ERISA’s prohibited transaction rules in a future case. While a petition for Supreme Court review is considered a long shot, there is a reasonable chance that the court might find this issue worthy of attention.
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