Supreme Court Clarifies Pleading Standard for ERISA Prohibited Transaction Claims

In a highly anticipated decision, the U.S. Supreme Court recently resolved a circuit split over the requirements for pleading ERISA prohibited transaction claims. Cunningham v. Cornell University, 604 U.S. __, Case No. 23–1007, slip op. (2025). The Court unanimously held that, to state a claim, a plaintiff need only allege the elements of a prohibited transaction under ERISA § 406 without negating the applicability of the statutory exemptions set forth in ERISA § 408. Id. at 1. The Court acknowledged the risk that its holding could encourage plaintiffs to bring “barebones” suits under ERISA § 406, and encouraged district courts to use existing tools to screen out meritless claims at the pleading stage and manage prohibited transaction litigation thereafter.

Background and Lower Court Decisions

ERISA plans often contract with third parties to provide various services, such as recordkeeping or investment advice. But ERISA § 406 prohibits a fiduciary from “engag[ing] in a transaction” that “constitutes a direct or indirect … furnishing of goods, services, or facilities between the plan and” a service provider. 29 U.S.C. § 1106(a)(1)(C). This language would seem to prohibit many routine arrangements that are necessary to operate a defined contribution plan. ERISA § 408, however, provides numerous exemptions from Section 406(a)’s prohibitions, including an exemption covering “reasonable arrangements” for “necessary” services if no more than “reasonable compensation” is paid. 29 U.S.C. § 1108(b)(2)(A).

In 2017, current and former participants in Cornell University’s defined contribution plans sued the university and other plan fiduciaries, claiming they had violated ERISA’s prohibited transaction provisions by causing the plans to paying excessive fees for recordkeeping services. The district court dismissed the claim, holding that a claim under ERISA § 406(a)(1)(C) required allegations of “self-dealing or other disloyal conduct” that the plaintiffs had not provided.

The Second Circuit affirmed the dismissal ruling on a different rationale. The court recognized that ERISA § 406, read “in isolation,” “would appear to prohibit payments by a plan to any entity providing it with any services.” Cunningham v. Cornell Univ., 86 F.4th 961, 973 (2d Cir. 2023), rev’d and remanded, No. 23-1007 (U.S. 2025). But the Second Circuit held that the Section 408 exemptions were “incorporated directly” into the definition of a prohibited transaction under Section 406(a). A plaintiff therefore needed to affirmatively plead that the exemptions do not apply by alleging, for example, “that [the] transaction was unnecessary or involved unreasonable compensation.” Id. at 975 (emphasis removed). 

The Second Circuit’s decision departed from those of several other courts of appeals. The Third, Seventh, and Tenth Circuits had declined to read ERISA § 406 broadly to “prohibit fiduciaries from paying third parties to perform essential services in support of a plan,” but had avoided that result by different means than the Second Circuit. The Eighth and Ninth Circuits, by contrast, had embraced a broader reading of the statute and permitted prohibited transaction claims to proceed without negating the Section 408 exemptions. See Bugielski v. AT&T Servs., Inc., 76 F.4th 894 (9th Cir. 2023); Braden v. Wal-Mart Stores, Inc., 588 F.3d 585, 601 (8th Cir. 2009).

The Supreme Court’s Reading of Section 406

The Supreme Court sided with the Eighth and Ninth Circuits, holding that plaintiffs bringing claims under ERISA § 406(a)(1)(C) “need only plausibly allege each of [the] elements of a prohibited-transaction claim” specified in that provision. Cunningham, 604 U.S., slip. op. at 1. The Court characterized the ERISA § 408 exemptions as affirmative defenses that defendants bear the burden of pleading and proving and rejected as “illogical” the argument that to survive dismissal, plaintiffs must affirmatively plead that the exemptions do not apply. Id. at 6–8. 

The Court’s decision, authored by Justice Sotomayor, relied primarily on principles of statutory construction. The Court noted that it had previously held that when a statute has “exemptions laid out apart from the prohibitions” and the exemptions “expressly refe[r] to the prohibited conduct,” the exemptions ordinarily constitute “affirmative defense[s].” Cunningham, 604 U.S., slip. op. at 7. The Court further observed that there was no principled basis for concluding that some, but not all, of the exemptions in Section 408 are incorporated into Section 406, and reasoned that incorporating all 21 of the statutory exemptions as elements of a claim under Section 406(a) would frustrate the purpose of the prohibited transaction rules. Id. at 11.

Other Tools for Addressing Meritless Claims

The Court recognized that its reading of the statute raised “serious concerns” about meritless litigation and advised district courts to “use existing tools at their disposal to screen out meritless claims before discovery.” Cunningham, 604 U.S., slip. op. at 14. The Court highlighted five options for district courts to manage Section 406 suits going forward: (i) require the plaintiff to file a reply under Federal Rule of Civil Procedure 7(a)(7) when a defendant asserts an exemption as an affirmative defense in its answer, (ii) dismiss claims that fail to identify a concrete injury under Article III, (iii) exercise discretion to expedite or limit discovery, (iv) impose Rule 11 sanctions, or (v) order cost shifting under § 1132(g)(1). Id. 

The Court’s embrace of Rule 7(a)(7) as a potential solution for screening out meritless claims is particularly notable. This seldom-used procedure may allow courts to dispose of meritless claims on the pleadings even if plaintiffs are not required to negate the Section 408 exemptions before a defendant has invoked them. The question is whether lower courts will take the Supreme Court up on its suggestion. If the Rule 7(a)(7) procedure catches on, it could actually improve defendants’ chances of securing dismissal of prohibited transaction claims before discovery, especially in the Eighth and Ninth Circuits, where courts previously declined to consider the Section 408 exemptions at all at the pleading stage. All parties, especially plan sponsors, fiduciaries and their counsel, will be watching lower courts to see how they implement the Supreme Court’s suggestions. 

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Shannon Barrett, an O’Melveny Partner licensed to practice law in the District of Columbia and Illinois; Brian Boyle, an O’Melveny Partner licensed to practice law in California and the District of Columbia; Deanna M. Rice, an O’Melveny Partner licensed to practice law in the District of Columbia and New York; Catalina Vergara, an O’Melveny Partner licensed to practice law in California; Meaghan VerGow, an O’Melveny Partner licensed to practice law in the District of Columbia and New York; Kevin Kraft, an O’Melveny Counsel licensed to practice law in California; William D. Pollak, an O’Melveny Counsel licensed to practice law in California and New York; and Alexander Reed, an O’Melveny Counsel licensed to practice law in the District of Columbia and Maryland, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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