The U.S. Supreme Court’s recent decision Cunningham v. Cornell University, 145 S.Ct. 1020 (2025) significantly lowers the pleading standard for prohibited transaction claims under Section 406(a) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). In effect, the decision allows a plaintiff’s prohibited transaction claims to survive a motion to dismiss by alleging conduct that is nearly universal among sponsors of employee pension benefit plans – the use of plan assets to pay the plan’s recordkeeper. The tools identified by the Court to mitigate against the risk of meritless litigation will require further development by district courts if they are to stem the tide of ERISA fiduciary breach and prohibited transaction litigation. Accordingly, counsel to ERISA plan fiduciaries would do well to familiarize themselves with the tools identified by the Court, particularly Federal Rules of Civil Procedure, Rule 7(a)(7) (“Rule 7(a)(7)”).
Background
The Cornell decision, published April 17, 2025, concerns a lawsuit filed by current and former Cornell University employees who participated in two of Cornell’s defined-contribution retirement plans from 2010 to 2016. The plaintiffs alleged that Cornell and the fiduciaries for the retirement plans (i.e., the CHRO and members of the Retirement Plan Oversight Committee) breached their fiduciary duties under ERISA by causing the plans to overpay for recordkeeping services provided by TIAA and Fidelity. They further alleged that the overpayment constituted a prohibited transaction under Section 406(a)(1)(C) of ERISA.
Section 406(a)(1)(C) generally prohibits the furnishing of goods, services, or facilities between a plan and a “party in interest.” The phrase “party in interest” is broadly defined to include, among others, plan fiduciaries, employers whose employees participate in the plan, and any service provider to the plan. Thus, in isolation, Section 406(a)(1)(C) classifies any payment of plan assets to a plan service provider—such as the plan’s recordkeeper, legal counsel, or investment advisor—as a prohibited transaction. Fortunately, there is an important and broadly used exemption to the prohibited transaction restrictions under ERISA Section 408(b)(2), which allows a plan to contract with a party in interest for services necessary for the operation of a plan so long as the plan pays no more than reasonable compensation for the services.
Recognizing this broadly used exemption, the U.S. District Court for the Southern District of New York granted Cornell’s motion to dismiss the Plaintiffs’ prohibited transaction claim, holding that in addition to pleading the prohibited transaction elements in ERISA Section 406(a)(1)(C), the plaintiffs must also allege some evidence of self-dealing or other disloyal conduct. The U.S. Court of Appeals for the Second Circuit affirmed on different grounds, holding that the ERISA Section 408(b)(2) exemption is incorporated into the Section 406 prohibitions and, as a result, the plaintiffs were required to plead that the plan fiduciaries’ decision to retain TIAA and Fidelity was “unnecessary or involved unreasonable compensation.” Because the Second Circuit decision followed decisions of the U.S. Courts of Appeals in the Third and Seventh Circuits but conflicted with decisions of the U.S. Courts of Appeals in the Eighth and Ninth Circuits,[1] the Supreme Court was asked to decide whether a plaintiff could state a claim under ERISA Section 406(a)(1)(C) without also pleading that the Section 408(b)(2) exemption does not apply.
“Untoward Practical Results”
Much to the dismay of retirement plan sponsors, the Supreme Court held that to state a claim under ERISA Section 406(a)(1)(C), a plaintiff need only plausibly allege the elements contained in that provision itself, without addressing potential exemptions under ERISA Section 408. The Court reasoned that when a statute lays out exemptions separately from the prohibition, and those exemptions expressly refer to the prohibited conduct, they should be treated as affirmative defenses, rather than as a necessary element of a plaintiff’s claim. The result of the decision is a substantially lower pleading standard for plaintiffs who allege that a plan fiduciary causing the plan to pay a recordkeeper (or any service provider) from plan assets is a prohibited transaction.
In its analysis, the Court rejected three arguments presented by Cornell. First, the Court rejected a statutory construction argument based on the inclusion of the phrase “[e]xcept as provided in section 408” at the outset of Section 406(a). Second, it rejected an argument based on precedent from an 1872 case, finding that the case established a pleading rule applicable only to criminal actions. Finally, the Court concluded that Cornell’s practical concerns about the proliferation of meritless litigation could not overcome the statutory text and structure of Sections 406 and 408 of ERISA.
This outcome is concerning to plan fiduciaries and their counsel, who are acutely aware that the settlement calculus shifts significantly in favor of plaintiffs once a claim survives a motion to dismiss. In fact, Justice Alito used his concurrence (joined by Justices Thomas and Kavanaugh) to highlight this issue, warning that the Court’s decision may cause “untoward practical results” and recognizing that “in modern civil litigation, getting by a motion to dismiss is often the whole ball game because of the cost of discovery. Defendants facing those costs often calculate that it is efficient to settle a case even though they are convinced that they would win if the litigation continued.”
To mitigate this concern, the Court’s opinion identifies five tools that district courts may use to discourage meritless prohibited transaction claims. As outlined in the following table, each tool identified has a significant weakness in application:
Rule 7(a)(7)
Rule 7(a)(7) permits a court, in response to a motion from a party or upon its motion, to compel a plaintiff to file a reply to the answer filed by a defendant or third party. This Rule, although infrequently used, appears to be the most direct approach for a court to review the availability of the ERISA Section 408(b)(2) prohibited transaction exemption at the motion-to-dismiss stage of a proceeding. It also appears to be the approach favored in Justice Alito’s concurrence, in which he identified the Rule as “[p]erhaps the most promising” of the suggested tools and stated that “[d]istrict courts should strongly consider utilizing this option…”
Unfortunately, the various district courts will need to familiarize themselves with the rarely used Rule and, in some cases, will need to overcome precedent in their circuits concerning the Rule’s application if it is to be a meaningful tool. There is a dearth of case law regarding the application of the Rule since it was restyled in 2007. In addition, the standard for directing a reply under the scant case law that does exist is relatively high, with some courts holding that an order directing a reply will not be granted unless there is a clear and convincing factual showing of necessity or other extraordinary circumstances of a compelling nature. Moviecolor Ltd. v. Eastman Kodak Co., 24 F.R.D. 325, 326 (S.D.N.Y. 1959). Finally, precedent in some circuits holds that replies to affirmative defenses are generally not required or permitted without a showing of some additional cause. See id.; FDIC v. First Nat’l Fin. Co., 587 F.2d 1009, 1012 (9th Cir. 1978); Thomas-Ikomoni v. McCalla Raymer, LLC, No. 1:07-CV-1511-RWS/AJB, 2008 WL 11412165, at *4 (N.D. Ga. July 17, 2008), report and recommendation adopted, No. 1:07-CV-1511-RWS, 2008 WL 11412167 (N.D. Ga. Sept. 2, 2008). Such precedents could make employing this tool difficult as, under the Cornell holding, the ERISA Section 408(b)(2) exemption is to be pled as an affirmative defense.
Ultimately, attorneys for ERISA fiduciaries must hope that the district courts can quickly develop a body of case law under Rule 7(a)(7) that will allow them to screen out meritless prohibited transaction claims. At the very least, litigation counsel for ERISA fiduciaries should become familiar with case law concerning application of the Rule in their Circuit and prepare to file motions for an order requesting a Rule 7(a)(7) reply in each lawsuit where a prohibited transaction count is alleged.
[1] Compare Sweda v. University of Pennsylvania, 923 F.3d 320 (3d Cir. 2019) (holding that plaintiff must allege intent to benefit a party in interest to state a claim for a prohibited transaction under Section 406(a)(1)(C) of ERISA) and Albert v. Oshkosh Corp., 47 F.4th 570 (7th Cir. 2022) (same) with Braden v. Wal-Mart Stores, Inc., 588 F.3d 585, 601 (8th Cir. 2009) (holding that the statutory exemptions established by Section 408 of ERISA are defenses that must be proven by defendant) and Bugielski v. AT&T Servs., Inc., 76 F.4th 894 (9th Cir. 2023), cert. denied, No. 23-1094, 2025 WL 1211782 (U.S. Apr. 28, 2025) (holding there is no requirement to plead self-dealing intent to state a claim under Section 406(a)(1)(C) of ERISA).
