High court sets low bar for ERISA prohibited transaction claims 

April 30, 2025

Excessive fee lawsuits targeting ERISA plans often include prohibited transaction claims alongside allegations of fiduciary breach. The US Supreme Court’s unanimous ruling in Cunningham v. Cornell Univ. (No. 23-1007 (April 17, 2025)) will likely make it more difficult for fiduciaries in these cases to defeat a prohibited transaction allegation on a motion to dismiss. The decision sets a low bar for what plaintiffs must plead in these cases to avoid dismissal and proceed to the costly discovery phase of litigation. The court recognizes that while its decision could lead to more prohibited transaction lawsuits and settlements, lower courts have tools available to discourage meritless claims. The ultimate effect on sponsors and fiduciaries will likely depend on whether lower courts are willing to employ these strategies.

Sponsors of both retirement and health and welfare plans routinely hire third-party service providers to administer plan benefits. Excessive fee lawsuits have already increased awareness that hiring a service provider is a fiduciary act that must meet ERISA’s standards of prudence and loyalty. However, until now ERISA’s complex and often-technical prohibited transaction provisions have received far less attention.

Prohibited transactions. ERISA’s prohibited transaction rules supplement fiduciaries’ general duties of prudence and loyalty by categorically barring transactions that Congress considered likely to injure plans. The particular transaction at issue in this case is ERISA’s prohibition on a fiduciary entering into a services arrangement — such as the provision of recordkeeping services to a retirement plan — with a “party in interest.” Under ERISA, a party in interest includes not only sponsors and fiduciaries, but also (in a somewhat circular manner) anyone providing services to a plan.

Prohibited transaction exemptions. ERISA also includes exemptions that enable fiduciaries to engage in transactions that ERISA otherwise prohibits if they meet conditions designed to protect the plan and its participants. One of these exemptions allows fiduciaries to arrange for services necessary to the plan’s operation, as long as the plan pays no more than reasonable compensation. As with many of ERISA’s statutory prohibited transaction exemptions, the Department of Labor has issued regulations interpreting and implementing this exemption. These regulations include several additional requirements that retirement plan fiduciaries must meet to rely on the exemption but that aren’t in the statute (e.g., receiving disclosures from certain service providers).

The fiduciaries for two Cornell University 403(b) retirement plans retained TIAA and Fidelity Investments to provide recordkeeping services, including offering a menu of investment options. Under the arrangements, TIAA and Fidelity were compensated for their recordkeeping services through revenue-sharing payments from the plan’s investment options. The plaintiffs — participants and beneficiaries who participated in the plans — sued Cornell, claiming the recordkeeping contracts with TIAA and Fidelity were transactions with parties in interest that violated ERISA’s prohibited transaction rules.

The district court granted Cornell’s motion to dismiss, finding the plaintiffs hadn’t alleged that fiduciaries engaged in self-dealing or disloyal conduct. The appellate court upheld the dismissal but did so on different grounds, ruling that the plaintiffs hadn’t sufficiently alleged that fiduciaries failed to comply with the exemption (i.e., by asserting that the services were unnecessary or involved unreasonable compensation).

Additional fiduciary breach claims not before the court. Plaintiffs rarely allege prohibited transaction claims in isolation. The plaintiffs in this case also claimed plan fiduciaries breached their ERISA duties of loyalty and prudence for various reasons. Their fiduciary breach claims included many of the allegations raised in similar lawsuits in recent years against other university-sponsored 403(b) plans — including the use of multiple recordkeepers, allegedly excessive number of investment options, the inclusion of retail share classes instead of cheaper institutional share classes, and the reasonableness of related compensation arrangements. The Supreme Court didn’t consider these fiduciary claims, all of which lower courts dismissed or resolved in favor of the defendants (except the retail share class claims, which the parties settled). The sole issue before the high court concerned the dismissal of the remaining prohibited transaction claim.

In accepting the plaintiffs’ request to hear the case, the Supreme Court considered whether ERISA’s prohibited transaction exemptions are affirmative defenses that plan fiduciaries must assert, not something plaintiffs have to proactively address in their pleadings (as the lower court had determined). Because courts typically won’t consider affirmative defenses at the motion to dismiss stage, Cornell argued that such a ruling would increase sponsors’ and fiduciaries’ litigation risk and defense costs by allowing plaintiffs to more easily proceed to the discovery phase with prohibited transaction claims, even when fiduciaries have diligently complied with the exemption.

Despite acknowledging that Cornell raised “serious concerns,” the court unanimously agreed with the plaintiffs, finding that they had to allege only that the fiduciaries caused the plan to engage in a prohibited transaction by hiring a service provider. The court ruled that ERISA’s exemptions are affirmative defenses to a prohibited transaction claim, and the plaintiffs weren’t required to preemptively negate all of the defendants’ possible affirmative defenses in their pleadings to survive a motion to dismiss. The court explained that this is the only possible interpretation of ERISA’s prohibited transaction and exemption provisions as Congress drafted them: The prohibited transaction rules are in one section of the statute (ERISA Section 406), while the exemptions appear in a different statutory provision (ERISA Section 408). The ruling is procedural and doesn’t indicate that the plaintiffs will ultimately prevail on their prohibited transaction claim, which must now return to the lower court for further consideration.

By requiring plaintiffs to allege only that a transaction with a party in interest occurred — without also asserting that fiduciaries failed to comply with an exemption — the Supreme Court has likely made it easier for plaintiffs in these cases to survive a motion to dismiss and proceed to the costly discovery phase of litigation. In a concurring opinion, Justice Samuel Alito notes that surviving a motion to dismiss “is often the whole ball game” because defendants facing the costs of discovery often conclude that settling the lawsuit would be more efficient than defending it, even when they can likely prevail on the merits.

Recognizing these concerns, the Supreme Court explained that lower courts have existing tools to screen out meritless prohibited transaction claims. If a defendant files an answer to a plaintiff’s prohibited transaction allegation and asserts that an exemption applies, the district court can require the plaintiffs to submit a reply with specific factual allegations showing the exemption doesn’t apply and dismiss the claim if they can’t plausibly do so. However, the high court acknowledged lower courts have rarely used this procedure. If a claim proceeds past the motion to dismiss, the district court can also expedite or limit discovery to mitigate the costs. For truly frivolous claims, the district court can require plaintiffs to pay defendants’ costs or even sanction the plaintiffs and their counsel. But using these tools is completely within a district court’s discretion.

Have participants established standing? The Supreme Court also noted that plaintiffs must always demonstrate standing to pursue a prohibited transaction claim but didn’t address whether the plaintiffs in this case had done so. To have standing, plaintiffs must show that they suffered a concrete injury as a result of the transaction, such as having their plan account reduced by the payment of allegedly unreasonable fees to a service provider. It is not sufficient for plaintiffs to merely assert a violation of ERISA’s prohibited transaction rules.

While the ruling is a win for the plaintiffs, whether it will lead to more unfavorable outcomes for plans and fiduciaries in excessive fee litigation remains to be seen. The ultimate effect on sponsors and fiduciaries defending these claims will likely depend on whether district courts are willing to consistently employ the strategies identified by the Supreme Court to screen out meritless claims. Prohibited transaction claims are rarely brought on a stand-alone basis but instead combined with fiduciary breach claims in more wide-ranging excessive fee lawsuits. The likelihood of a prohibited transaction claim getting dismissed or proceeding to discovery may not be the only factor that defendants consider when deciding whether to settle or continue litigating a case.

• Cunningham v. Cornell Univ., No. 23-1007 (US April 17, 2025)
• ERISA Fiduciary Advisor elaws webpage (Labor Department)