In Matter of First Impression, Second Circuit Adopts Pleading Standard for Prohibited Transaction Claims under ERISA

In Cunningham v. Cornell Univ., No. 21-114-CV, __F.4th__, 2023 WL 7504142 (2d Cir. Nov. 14, 2023), the Second Circuit decided a matter of first impression in one of several similarly filed lawsuits against fiduciaries of university 403(b) plans alleging various ERISA violations concerning the management of plan assets. Plaintiffs in this class action case are participants and beneficiaries of the Cornell University Retirement Plan for Employees of the Endowed Colleges at Ithaca (“Retirement Plan”) or the Cornell University Tax Deferred Annuity Plan (“TDA Plan”) (together, the “Plans”). They allege that Defendants, the Plans’ appointed fiduciaries, failed to adequately monitor the Plans which resulted in the retention of underperforming investment options and payment of excessive fees. Plaintiffs also alleged that Defendants engaged in prohibited transactions of plan assets. The district court granted Defendants’ motions to dismiss and for summary judgment and denied their motion to strike the jury demand. Plaintiffs appealed and Defendants conditionally cross-appealed. The Second Circuit affirmed the district court.

Plaintiffs allege that Cornell violated 29 U.S.C. § 1106(a)(1)(C) by causing the Plans to engage in prohibited transactions with its recordkeepers, TIAA-CREF and Fidelity. In a matter of first impression in this circuit, the Second Circuit held that in order to plead a prohibited transaction claim between a plan fiduciary and party in interest, a complaint must plausibly allege that the fiduciary caused the plan to engage in a transaction that constituted furnishing of services between the plan and party in interest, where that transaction was unnecessary or involved unreasonable compensation, thereby supporting an inference of disloyalty. The court left undisturbed its prior decisions holding that it is ultimately the defendant fiduciary that bears the burden of persuasion with regard to the applicability of the § 1108 exemptions.

Based on the above pleading standard, the court held that Plaintiffs failed to state a claim alleging that Cornell University entered into a prohibited transaction, in violation of its fiduciary duty under ERISA. The court also held that the district court did not improperly parse Plaintiffs’ failure to monitor and offer appropriate investment options claim (Count V) at the motion to dismiss stage. Within Count V are six separate allegations, and the district court found that four of the allegations failed to state a claim. “[I]t is clear that the district court’s decision on the motion to dismiss was not an improper ‘parsing’ of Count V, but rather a refining of it so as to identify clearly the theories upon which Plaintiffs had stated a claim.”

With respect to the district court’s grant of summary judgment to Defendants, the court found that Plaintiff’s evidence did not demonstrate a genuine dispute of material fact as to whether the Plans suffered loss because of the recordkeeping fees paid to TIAA and Fidelity. The court also concluded that no reasonable jury could find that CAPTRUST, an outside consultant that helped launch a multi-year process focused on redesigning and streamlining the investment menu, was imprudent in its conduct. Lastly, the court concluded that no reasonable factfinder could conclude that Cornell could have forced, or tried harder to force, TIAA to offer the Plans lower-cost share funds at an earlier date. In sum, the court concluded that Defendants were not liable for breach of the duty of prudence under ERISA.