The Supreme Court heard oral arguments Jan. 22 about a long-running legal battle between Cornell University and former participants in two university 403(b) plans that could have broad implications for the retirement industry.
The key issue is whether contracts between plan sponsors and service providers are prohibited transactions under ERISA, as well as who is responsible for proving or disproving claims of ERISA violations and exemptions to the prohibitions.
The dispute also focuses on how much information ERISA plaintiffs need to convince federal District Courts to reject a defendant’s motion to dismiss. It featured a clash of amicus briefs to the Supreme Court with the Department of Labor supporting the former participants and large employer organizations, such as the U.S. Chamber of Commerce, backing the university.
The former participants, who have lost their complaint at the federal District Court and federal appeals court levels, asked the Supreme Court to establish a uniform legal standard because, they argue, different appeals courts have issued different rulings on prohibited transactions.
The university countered that there is no so-called circuit split, asking the Supreme Court to uphold the lower-court decisions in Cunningham et al. vs. Cornell University et al.
The former participants appear to be seeking “an automatic ticket to go past the motion to dismiss,” said Justice Brett M. Kavanaugh, referring to amicus briefs filed by several large employer organizations. These briefs paint a “pretty bleak picture,” Kavanaugh said.
According to amicus briefs supporting Cornell, the former participants' assertions could lead to an "expanded litigation threat (that) would be nearly limitless because every college and university relies on third-party service providers," Kavanaugh said.
“It’s not a blank check,” responded Xiao Wang, director of the Supreme Court Litigation Clinic at the University of Virginia School of Law, representing the former participants.
Wang said the pro-Cornell decisions from a New York District Court and the 2nd U.S. Circuit Court of Appeals in New York conflict with prohibited-transactions rulings by several other federal appeals courts.
The pro-Cornell rulings cited insufficient information offered by the former participants in their issuing and upholding Cornell’s motion to dismiss. Wang said the former participants’ request for information was thwarted by the university, indicating that the courts should have rejected the motion to dismiss and to allow discovery.
Motions to dismiss are the first line of defense for plan sponsors and service providers in ERISA cases. Their expenses increase substantially when providing data and testimony during discovery.
Justice Samuel A. Alito Jr. worried that all plaintiffs had to do is “plead something innocuous” get past a motion to dismiss.
"What exactly is the injury" to participants via the university's actions, Justice Clarence Thomas asked.
The harm to the plans was the university's hiring of two record keepers that did more than provide record-keeping services, Wang said. "They bundled them with investment products, and those investment products, in turn, had operating expenses," he said. "Those operating expenses were then shared via revenue sharing to the plan to pay for record keeping."
The bundling resulted in the record keepers "pushing" their own actively managed products, "leading to higher expense ratios and, therefore, greater record-keeping fees," Wang said.
Much of the oral arguments centered on how courts can reconcile two sections of ERISA — one that describes prohibitions and the other that describes exemptions.
Prohibited transactions include self-dealing by fiduciaries, improper contracts and transactions that carry a high risk to plan assets because of contracts that transfer to third parties responsibilities reserved for fiduciaries.
ERISA’s exemptions include providing investment advice, loans to plan participants, loans to employee stock ownership plans and contracts for life insurance or annuities.
"Petitioners' view is that pleading the mere fact of a service provider transaction defeats a motion to dismiss and the case goes forward," said Nicole A. Saharsky, a partner at law firm Mayer Brown, representing Cornell.
"That can't possibly be right," Saharsky said, adding that plaintiffs need to show wrongful conduct, unnecessary services or unreasonable fees for a complaint to survive a motion to dismiss. Otherwise, "it would force settlement of meritless litigation."
When Justice Ketanji Brown Jackson asked Saharsky who must prove fees are unnecessary, the lawyer said the burden falls to plaintiffs in an ERISA lawsuit.
The former participants filed their initial lawsuit in August 2016. Among their various allegations, they accused university fiduciaries of allowing excessive record-keeping fees, arguing that the contracts with two record keepers were prohibited transaction provisions of ERISA. The record keepers, TIAA-CREF and Fidelity Investments, are not parties in the case.
The oral arguments addressed only the issue of prohibited transactions — whether a plaintiff can state a claim by alleging an ERISA provision “or whether a plaintiff must plead and prove additional elements and facts not contained in the provision's text,” according to a court document.