In an ERISA fiduciary breach lawsuit, plaintiffs’ attorneys must allege actions by fiduciaries that violated the law’s fiduciary standards and then, at trial, they must prove those facts. However, the Supreme Court’s decision in Cunningham v. Cornell University turns that process on its head by holding that the burden of proof for an exemption from prohibited transactions is not on the plaintiffs, but instead is on the defendants—the plan fiduciaries. As a result,  lawsuits that allege prohibited transactions are more likely to proceed to trial and perhaps increase the risk of loss for plan fiduciaries. More on this later in the article.

Let’s start with the prudent person rule, which would be the basis for a fiduciary breach lawsuit. ERISA section 404(a) provides that plan fiduciaries must act:

…for the exclusive purpose of:

1. providing benefits to participants and their beneficiaries; and
2. defraying reasonable expenses of administering the plan;

with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims;…

A fiduciary breach complaint would typically allege that the plan fiduciaries had failed to satisfy the prudent person rule by alleging facts that violate that standard, e.g., not evaluating the recordkeeper’s direct and indirect compensation and therefor overpaying for those services. Similar claims are made about overly expensive investments. Assuming that the complaint was well pled, and that the case did not settle, the plaintiffs’ attorneys would then need to prove those factual allegations at trial.

The prohibited transactions are found in section 406 of ERISA and the exemptions in section 408. For example, 406(a) provides, in relevant part:

1. Transactions between plan and party in interest
   Except as provided in [section 408]:
   1. A fiduciary with respect to a plan shall not cause the plan to engage in a transaction, if he knows or should know that such transaction constitutes a direct or indirect—
      1. sale or exchange, or leasing, of any property between the plan and a party in interest;
      2. lending of money or other extension of credit between the plan and a party in interest;
      3. furnishing of goods, services, or facilities between the plan and a party in interest;
      4. transfer to, or use by or for the benefit of a party in interest, of any assets of the plan;…[Bolding added by me]

The bolded language means, in essence, that a plan can’t obtain and pay for services from a service provider. (The definition of a party in interest includes service providers.) Obviously, that doesn’t make any sense. Every plan needs and uses service providers. The system works, though, because of exemptions, or exceptions. But the starting point is that engaging a service provider is a prohibited transaction, literally prohibited.

The relief is found in the reference to section 408. Section 408(b)(2) of ERISA provides:

2. Enumeration of transactions exempted from section 406 prohibitions:The prohibitions provided in section 106 of this title shall not apply to any of the following transactions:……
   (2) (A) Contracting or making reasonable arrangements with a party in interest for office space, or legal, accounting, or other services necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid therefor.
   [Bolding added by me]

In other words, if the services are necessary for the plan, and the arrangement and compensation are reasonable, the 406(a) prohibitions do not apply. Pretty straightforward, right?

Maybe, maybe not. The Cornell decision held that the burden of proof of satisfying those conditions was on the defendant fiduciaries and not on the plaintiffs. So, if a complaint alleges that a plan hired and paid service providers, and the defendants want to defend by showing that they satisfied the 408(b)(2) statutory exemption, they bear the burden of proving that.

Where plan fiduciaries and their advisers have regularly reviewed and benchmarked the compensation of their service providers, and they have written documentation in their files that the compensation of the service providers is reasonable, they will be in a position to prove compliance.

But where there is not written documentation of compliance (e.g., benchmarking the total compensation—direct and indirect—of a recordkeeper against that of other recordkeepers for plans with similar assets and participants), it will probably be an uphill battle to demonstrate that the fiduciaries determined that the arrangement and compensation were reasonable. As a result, the Supreme Court’s shifting of the burden of proof will likely result in plaintiffs routinely including claims of prohibited transactions in their complaints. Obviously, that will be problematic for plan fiduciaries who do not regularly benchmark their service providers against appropriate peer groups (i.e., similar services for similarly situated plans).

Concluding Thoughts

For plan sponsors, the lesson is that they should regularly benchmark their plan service providers. There is not a defined time period for repeating the benchmarking. The law says it should be done at appropriate intervals. Many in the industry use a 3-year rule of thumb. But, even there, an interim benchmarking should be done whenever there are material changes, e.g., a plan merger.

While there are other ways of obtaining industry data for benchmarking (e.g., RFPs), the most common method is through firms that provide benchmarking services. As a word of caution, make sure the benchmarking information is based on, at the least, plans with similar assets; plans with similar number of participants; service providers offering a similar suite of services.

For plan advisors, make sure your services to plan sponsors and fiduciaries include the regular benchmarking. While that has been important in the past, it is now critical because of the Cornell decision.

The material contained in this communication is informational, general in nature and does not constitute legal advice. The material contained in this communication should not be relied upon or used without consulting a lawyer to consider your specific circumstances. This communication was published on the date specified and may not include any changes in the topics, laws, rules or regulations covered. Receipt of this communication does not establish an attorney-client relationship. In some jurisdictions, this communication may be considered attorney advertising.

The views expressed in this article are the views of Fred Reish, and do not necessarily reflect the views of Faegre Drinker.