The U.S. Supreme Court’s unanimous decision in Cunningham v. Cornell University has left many in the industry worried about a new wave of litigation, as workers’ claim of a “prohibited transaction” was deemed sufficient to survive a motion to dismiss.

In its decision last week, the Supreme Court determined that plaintiffs are not required to plead and prove that the myriad of exemptions to the Employee Retirement Income Security Act’s prohibited transaction rules do not apply to their case.

The court ruled that plaintiffs alleging a “prohibited transaction” under ERISA Section 406 need to only allege that a transaction occurred—such as hiring a service provider—to survive a motion to dismiss. They are not required to plead that the transaction failed to meet a statutory exemption, such as the exemption for reasonable services at reasonable fees under Section 408(b)(2).

As a result of the Supreme Court’s opinion, the earlier judgment of the U.S. 2nd Circuit Court of Appeals was reversed, and the case was remanded to the district court for further proceedings.

In the Cornell case, 28,000 university employees, represented by law firm Schlichter Bogard LLP, accused the school’s 403(b) plans of paying excessive fees, in part by keeping too many investment options in the investment menu and working with multiple recordkeepers. The case was originally filed in 2016 in the U.S. District Court for the Southern District of New York.

Wider Ramifications

The decision means that the case against Cornell may continue at the district court level. But it may have a significantly greater effect on plan sponsors across the country.

“This ruling effectively invites a new wave of litigation that could burden plan fiduciaries for doing what ERISA expressly permits—engaging necessary service providers at reasonable fees,” said Tim Rouse, executive director of the SPARK Institute, in a statement. “The decision rewards legal technicalities over practical realities and will ultimately harm plan participants by increasing costs and discouraging plan innovation.”

SPARK [the Society of Professional Asset Managers and Recordkeepers], alongside the American Benefits Council and the ERISA Industry Committee, filed an amicus brief in the case arguing that the circuit court’s standard was “more consistent with ERISA’s text and purpose.” The organizations urged the Supreme Court to affirm that plaintiffs should be required to plausibly allege that no exemption applies when claiming a prohibited transaction.

SPARK is now calling on Congress to revisit ERISA’s litigation framework and explore reforms that will “discourage frivolous lawsuits while continuing to protect participants.”

8th Circuit Already Held Same Standard

Jerry Schlichter, who represents the plaintiffs in the Cornell case, says he is pleased with the Supreme Court’s decision and argues that pleading in a complaint the absence of the dozens of affirmative defenses would be “impossible.”

“The court rightly interpreted the language of the statute to say that the burden of bringing forward an affirmative defense is [on] the defendant,” Schlichter says.

Schlichter argues that this decision will not open the floodgates to more litigation. Because these cases are expensive for both the plaintiffs and the plaintiffs’ attorneys who are risking expenses, Schlichter argues that there is already a screening process that determines which  cases are brought forward.

He also emphasizes that the Supreme Court’s standard has already been applicable practice in the jurisdiction of the 8th Circuit Court of Appeals for about a decade, and he claims there has not been any “opening of the floodgates.” The 8th Circuit hears cases from federal districts in Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota and South Dakota. The 9th Circuit Court has also upheld this law.

Other Options to Limit Frivolous Complaints

Allie Itami, a partner in Lathrop GPM LLP, disagrees with Schlichter and believes there will be an increase in lawsuits, at least in the short term, that will survive initial motions to dismiss. Itami says this will likely result in more settlements than under the standards previously in place in most appellate court jurisdictions, excepting the 8th and 9th Circuits.

“There does seem to be a majority of the federal court that doesn’t want to see [an uptick in litigation] as the outcome,” Itami says. “That’s why the circuits, other than the 8th and the 9th, have really tried to be creative about how to stop these types of lawsuits.”

For example, she says, the U.S. 2nd Circuit Court of Appeals and the Southern District of New York both required plaintiffs to have elements of the exemptions as part of the claim.

Itami believes that federal district courts will likely use some of the tools to which the Supreme Court pointed in its opinion to help screen out meritless litigation. This includes Federal Rule of Procedure 7, which empowers district courts to “insist that a plaintiff file a reply putting forward specific, nonconclusionary factual allegations” showing the exemption does not apply.

“Federal district courts are not huge fans of how many ERISA litigation suits there are,” Itami says. “I think in the short term, there’s going to be an increase, but it’s only going to take a couple of orders that rely on the Rule 7, or have issued limited discovery, to create a sort of new norm.”

Bradley Fay, a partner in Seward & Kissel LLP, adds that the Supreme Court’s decision creates a roadmap for lower courts regarding the ways they should address unmeritorious claims.

“ERISA is a very complicated area of the law, and sometimes district courts may have trouble, especially early on, … in addressing the specifics of the ERISA pleading standards,” Fay says. “So, potentially, lower courts can use [the Supreme Court’s decision] as a tool to address, at an earlier stage, those issues that sometimes arise later.”

Schlichter says the Cornell case will go forward in district court and proceed to trial.