Small dental practice wants Supreme Court to settle a big ERISA dispute

The operator of a small retirement plan is asking the Supreme Court to make a big change in ERISA guidelines.

Having lost at the federal district court and federal appeals court levels, D.L. Markham DDS MSD Inc. wants the Supreme Court to clarify complex ERISA provisions: What constitutes a prohibited transaction and what is a party-in-interest.

“The lower courts are splintered on what service transactions between plans and providers are prohibited…unless exempt” under ERISA, said the March 13 petition to the Supreme Court in the case of D.L. Markham DDS, MSD, Incorporated 401(k) Plan et al vs. Variable Annuity Life Insurance Company et al.

The petitioners — the dental practice and its 401(k) plan — want the Supreme Court to address this “circuit split” by establishing a uniform standard. Eight of 12 federal appeals courts have differing views on prohibited transactions and parties-in-interest, the lawsuit said.

ERISA is filled with descriptions of what providers and sponsors cannot do such as improper contracts, transactions that carry a high risk to plan assets, self-dealing by fiduciaries and contracts that transfer to third parties responsibilities reserved for fiduciaries.

A party-in-interest can be, among other examples, a fiduciary, plan executive or service provider. They are subject to prohibited transactions rules — absent an exemption — for lending money, furnishing goods or services, transferring assets and other activities.

The exemptions list is broad, enabling plans to conduct certain transactions with a party-in-interest. Loans to plan participants, transactions between the plan and a pooled investment fund, the providing of investment advice, contracts for life insurance or annuities and loans to employee stock ownership plans are just some examples.

The Auburn, Cal.-based dental practice — and its $1.3 million retirement plan — is fighting its former record keeper over a $20,703 surrender charge imposed when the dental practice switched record keepers, arguing that the ex-record keeper committed a prohibited transaction.

The reaction to the lawsuit far exceeded the dollar dispute. At the federal appeals court level, the Department of Labor filed an amicus brief supporting the dental plan. The U.S. Chamber of Commerce and the American Council of Life Insurers supported the record keeper.

The DOL said the prohibited transaction rules as providing greater protection to sponsors against transactions that may not be in the best interest of participants. The Chamber and ACLI warned that the DOL’s approach would encourage more ERISA lawsuits and harm the relationship between sponsors and service providers.

If the Supreme Court decides to hear the case, it won’t be during the current session that ends June 30. Its oral argument schedule is full, and justices rarely hear cases in May or June.

The Variable Annuity Life Insurance Company and its VALIC Financial Advisers Inc. have not yet responded to the dental plan’s Supreme Court petition. (They are now subsidiaries of Corebridge Financial, which was spun off as a separate company in 2022 by American International Group, the former parent of VALIC.)

The dental practice hired VALIC in May 2018 to be record keeper and service provider for its 401(k) plan, which included a fixed and variable deferred annuity contract, said the initial complaint filed in January 2021 in a U.S. District Court in Sacramento, Calif. (The case was later transferred to a court in Houston.)

By January 2020, the dental practice — complaining about fees plus disappointing services and investment returns — told VALIC it wanted to cancel the contract and seek another record keeper. The sponsor requested a waiver of the surrender charge, saying the contract permitted a waiver under certain conditions, but the request was rejected, the lawsuit said. When the dental practice transferred its 401(k) account to another record keeper, VALIC withheld $20,703 as a surrender charge.

The dental practice and its retirement plan sued, saying VALIC was a party-in-interest. "The furnishing of services to a plan by a party-in-interest constitutes a prohibited transaction, absent an exemption," the lawsuit said.

They contended that there was no exemption, maintaining that the contract terms were not reasonable and adding that VALIC should have granted the waiver because the plan gave adequate notice. "A contract for services is not reasonable unless it permits the plan to terminate the contract without penalty on reasonably short notice," the lawsuit said.

A U.S. District Court judge in Houston dismissed the complaint in October 2022. The plaintiffs appealed to the 5th U.S. Circuit Court of Appeals in New Orleans, which upheld the lower court ruling in December 2023. Even though VALIC could have waived the surrender charge, VALIC had the right to retain it. "VALIC merely adhered to the contract by collecting the previously bargained-for compensation," they wrote.

“Accepting predetermined compensation that was agreed to by a plan's named fiduciary does not constitute control over the management of a plan or disposition of the plan's assets," they wrote.