The ERISA trial bar has a fetish for suing AT&T under fiduciary liability law. But when it came to conjuring excessive fee imprudence claims against the AT&T-sponsored defined contribution plan, there was a problem: the fees were not excessive. In fact, the recordkeeping fee was so low – only $20 per participant – even the most gullible federal court judge would be loath to allow fiduciary malpractice claims. The trial bar’s well-worn “asleep at the wheel” playbook wasn’t going to work.
So the plaintiffs lawyers tried a different strategy. They recast standard breach of fiduciary duty prudence claims as prohibited transaction claims to avoid having to plead what the fees were, or how they compared to a supposed more reasonable fee amount. When the plan added managed account and brokerage link services from the plan’s recordkeeper, plaintiffs claimed this constituted a prohibited transaction with a party-in-interest. And to complete the end-run around the plausibility standard for prudence claims, against which most judges would require some kind of meaningful comparison to suggest that the fees at issues were actually excessive, plaintiffs argued that the necessary and reasonable exemption for prohibited transaction claims constitutes an affirmative defense that can only be proven at trial. Consequently, there would be no way for AT&T to dismiss the case at the pleading stage as speculative or frivolous. AT&T would be stuck having to prove a negative – that its rock-bottom $20 recordkeeping was not the result of fiduciary malpractice.
The end-run strategy worked. The Ninth Circuit Court of Appeals in AT&T Services v. Robert J. Bugielski agreed to this plaintiff-friendly pleading standard for prohibited transaction claims. This would allow participants to challenge the fiduciary prudence of any amendment or revision to a service provider contract as a per-se prohibited transaction without even circumstantial evidence of wrongdoing. It created a circuit split with the Third and Seventh Circuits that viewed this sort of per-se prohibited transaction claim involving routine service provider arrangements as “absurd.”
To be clear, plaintiffs in the AT&T case survived a motion to dismiss without ever having to compare AT&T’s plan administrative fees against any other valid comparison. They got an automatic pass into discovery. And given that most cases that survive a motion to dismiss settle for seven-figure amounts because of litigation expense and potential liability, plaintiff lawyers created serious settlement leverage even though the claim is based on pure speculation without any basis to assume that AT&T fiduciaries failed to follow a rigorous fiduciary process in selecting service providers.
On May 9, 2024, a group of plan sponsor organizations filed an amicus curiae brief authored by lawyers at Seyfarth Shaw urging the Supreme Court to accept a writ of certiorari of the Ninth Circuit’s decision in the AT&T case. The persuasive amicus brief highlights the potential for an increase in the already fever pitch of abusive class action litigation and makes four key points:
- Unless the Ninth Circuit’s decision is corrected, every plan fiduciary is at risk of having to prove a negative – that routine service provider arrangements are not unlawful;
- the Ninth Circuit’s decision produces what other circuit courts have called an “absurd” result of turning every transaction with a service provider into a “per se prohibited transaction”;
- the risk is that the decision will provide “a path to end-run established pleading standards for duty-of-prudence claims by repackaging them as prohibited transaction claims”; and
- the amicus brief also highlights the lack of uniformity facing plan sponsors when courts continue to articulate inconsistent interpretations of the pleading standard for ERISA fiduciary liability.
We analyze these key themes in the AT&T case below. While we agree that there is a heightened risk that plan sponsors will eventually stop providing voluntary benefits, we end with a correction to the claim that the fever pitch of litigation has caused fiduciary insurance premiums to skyrocket. Contrary to the outdated articles cited in the amicus brief, quality fiduciary insurance coverage at reasonable premiums remains readily available from a highly competitive market. Fiduciary insurance companies remain on the front lines of defending the tidal wave of capricious ERISA class action litigation.
ISSUE #1: A Plausible Prohibited Transaction Claim Must Allege that the Service Provider Transaction Failed to Satisfy the Necessary and Reasonable Statutory Exemptions.
ERISA has a backwards presumption that every contract between an employee benefit plan and a service provider is prohibited unless there is an exemption. Recognizing that the prohibited transaction rule would encompass legitimate plan contracts for essential plan services, Congress paired the rule with a statutory exemption to validate routine plan contracts with service providers that are “necessary” and “reasonable.”
The trial bar has exploited this backwards statute by arguing that any exemption to a prohibited transaction claim constitutes an affirmative defense that must be proven at trial. This would allow the trial bar to challenge any plan service provider contract in a lawsuit without allowing a court to weed out meritless claims at the motion to dismiss stage. It is an end run around the normal pleading requirements for imprudence claims in which most courts require a comparison to a meaningful benchmark. The litigation tactic seeks an automatic right to challenge even the most basic plan service contracts, particularly when they are amended or renewed.
While many ERISA fiduciary concepts are complex, the merits of the AT&T case are not, as it involves one simple mistake in failing to consider the entire statutory provision. The Ninth Circuit said it was enforcing the prohibited transaction statute from ERISA, but it made a rudimentary mistake by failing to read every word of the Section 1106(a) statute. The Ninth Circuit omitted the impact of the precursor and limiting language in Section 1106(a), which starts with the words “Except as provided in section 1108 of this title.” In turn, section 1108(b) says the “prohibitions . . . in section 1106 . . . shall not apply” to “[c]ontracting . . . for . . . services necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid therefor.” 29 U.S.C. § 1108(b) (emphasis added). In sum, the Ninth Circuit holding is based on an incorrect and incomplete reading of the statute. Read correctly, a prohibited transaction claim under section 1106(a) must include allegations that the transaction was not necessary or the compensation was not reasonable. The exemptions are integral parts of the affirmative claim.
The Ninth Circuit’s rudimentary error of statutory construction has significant ramifications that are prejudicial to plan sponsors. The ruling produces what other courts have dubbed an “absurd” result of turning nearly every transaction with a service provider into a “per se prohibited transaction.” On a practical level, it allows the trial bar to challenge every essential plan service provider contract, even when perfectly lawful.
As the Second Circuit recently held in Cunningham v. Cornell Univ., 86 F.4th 961,973 (2d Cir. 2023), reading § 1106(a)(1)(C) “in isolation” prohibits payments by a plan to any entity providing it with any services. This is the precise mistake by the Ninth Circuit in the AT&T case. The Second Circuit held that the limiting provision of section 1106(a) incorporates the exemptions of Section 1108 directly into Section 1106(a). In practice, this means – rather than prohibiting all service provider arrangements – Section 1106(a) prohibits only those arrangements alleged to unnecessary or for which more than reasonable compensation is paid.
To avoid the unworkable effect of the Ninth Circuit’s reading of section 1106(a)(1(C), both the Third and Seventh Circuits have required plaintiffs to plead an intent to benefit a party in interest. The Seventh Circuit in Albert v. Oshkosh, 47 F.4th 570, 585-86 (7th Cir. 2022), went further to hold that the prohibited transaction provisions should not be read to prohibit plan fiduciaries from paying third parties in exchange for plan services, because “[e]mployee benefit plans would no longer be able to outsource tasks like recordkeeping, investment management, or investment advising.” In other words, these Circuits require prohibited transaction claims to plead an intent to benefit the party in interest. Under this higher standard, a complaint needs to plausibly suggest that the service provider arrangements were not reasonable or necessary to operate the plan.
By contrast, the Ninth Circuit’s standard would require, as the amicus brief explained, every plan fiduciary “to prove a negative” – that routine service provider arrangements are not unlawful. Defined contribution plans are complex and require the hiring of service providers. But despite the ubiquity and necessity of service provider relationships in offering employer-sponsored retirement plans, the Ninth Circuit interpreted ERISA to make those relationships presumptively unlawful. The Ninth Circuit held that any modification or renegotiation of existing service provider agreements would be a prohibited transaction, absent the defendant’s showing that the “transaction” fits within one of the statutory prohibited transaction exemptions.”
The Ninth Circuit’s decision should be reversed to require prohibited transaction claims to plead the statutory exemptions that the service contract was not necessary and was contracted for unreasonable compensation.
ISSUE #2: Plan Sponsors Need the Ability to Dismiss Meritless Lawsuits
The amicus brief asserts that “[i]n the nearly fifty years since ERISA was enacted, the challenge posed by frivolous and speculative ERISA claims has never been greater.” The decision “threatens to further open retirement plan fiduciaries and service providers to a flood of litigation that will have far-reaching consequences that harm plan sponsors, fiduciaries, service providers, and participants.” Indeed, the decision will provide “a path to end-run established pleading standards for duty-of-prudence claims by repackaging them as prohibited transaction claims.”
While we are far from impressed at the incoherent and inconsistent way in which federal courts have applied the Supreme Court’s context-specific plausibility pleading standard for imprudence claims, the AT&T case demonstrates the continued need for an ERISA pleading standard that weeds our meritless cases. If you read the briefs in the motion to dismiss of the AT&T case in the lower court, you will learn that the recordkeeping fee for the plan with over 260,000 participants was only $20 per participant. Plaintiffs know this is reasonable. It is well below most of the purported comparisons used in comparison charts in typical breach of fiduciary duty complaints. Nevertheless, plaintiffs are arguing that the $20 fee should have been reduced when Financial Engines added managed account services or Fidelity added brokerage link services. But they do not even attempt to validate their excessive fee claims with the reasonable cost for these plan services. The complaint alleges malpractice for excessive fees without any context as to how the fees are excessive.
Simply put, if the Ninth Circuit’s decision is allowed to stand, the trial bar will have an open license to assert that any plan service contract is imprudent when renewed or amended. They will not need any proof to support their claims. This will continue the unfair and prejudicial trend in which low-fee plans continue to be sued for fiduciary malpractice. The prejudice is real, as we have documented in many blogpost. In our experience, the cost to litigate these claims ranges from $2 to $15 million through trial. It is common to spend over $1 to $2 million or more just on the motion to dismiss stage. The amicus brief summarizes the Chubb white paper in which it documents $5 million in defense fees at the pleadings stage. And it is not just the defense lawyer fees. We have seen experts charge over $3 million for damage analyses in these cases. In sum, given the high cost to defend even the most frivolous claims, plan sponsors need the ability to dismiss meritless claims at the initial pleading stage.
ISSUE #3: Plan Sponsors Deserve a Uniform National Fiduciary Standard
ERISA class action complaints invariable start with the admonition that fiduciary duties are the highest known to law, and that the purpose of ERISA was to protect plan participants. That is true, but Congress intended ERISA as a balance of competing interests between employees and employers. On one hand, Congress had the desire to offer employees enhanced protection for their benefits. On the other hand, Congress had a desire not to create a system that is so complex that administrative costs or litigation expenses unduly discourage employers from offering benefit plans in the first place.
As part of the desire to encourage the formation of voluntary employee benefit plans, ERISA was intended as a uniform standard by which ERISA plans can be created and operated, compared to the prior system of varying standards state-by-state. Nevertheless, the recent onslaught of ERISA class action litigation has led to different pleading standards by Circuit, and even different pleading standards within each circuit. We have seen different rulings on imprudence challenges to the exact same investment and fee structures. The current state of play is a crapshoot in which plan sponsor are subject to different fiduciary standards depending on which judge is assigned an excessive fee case. The same crapshoot applies to other issues, like whether a court will allow a jury trial for an ERISA case, or whether a court will enforce an arbitration clause in a plan document. The uniformity goal for ERISA fiduciary law has not been achieved, and it is getting more variable.
The AT&T decision is another example of the lack of uniformity in how ERISA is enforced. The split between the Ninth Circuit and the Third and Seventh Circuits establishes significant differences in how prohibited transaction claims are litigated. The amicus brief notes that “[i]t sets up the even more absurd result where, for example, a routine service provider contract would be presumptively lawful if challenged in the Third or Seventh Circuits, and presumptively unlawful if challenged in the Ninth Circuit.”
The amicus brief makes the point that we have espoused numerous times, that plan sponsors need and deserve a uniform set of fiduciary rules. ERISA is supposed to be a law of process, but the variable pleading standard has opened up liability for plan fiduciaries who are advised by professional advisors and follow all best practices. The ability to sue for fiduciary imprudence is too easy in most federal courts. An automatic or per-se prohibited transaction claim is not fair to diligent plan sponsors.
The Encore Perspective
The amicus brief is very effective. It warns that the explosion of litigation could cause plan sponsors to stop offering voluntary employee benefits. We have echoed this warning on multiple occasions. The heightened liability risk has not caused any plan sponsor to discontinue voluntary benefits, but it could happen in a recession when the unemployment rate is higher. We have seen, however, employers become more risk adverse because of the litigation risk, which has influenced investment choices offered to plan participants. It will also reduce the desire of plan sponsors to choose plan innovations. A good example is whether plan sponsors will adopt the new annuity options being offered by investment providers for fear that the annuity fees will be challenged. Plan participants want annuities, but the litigation risk needs to be considered by any plan fiduciary choosing these new options.
There is one important issue that the amicus brief got wrong: The cost of fiduciary insurance is not “sky-rocketing.” The amicus brief cites to a 2021 Bloomberg article during a brief time period in which the fiduciary insurance market went through some dislocation because of the high frequency of ERISA class action litigation and the high cost of the defense of these cases. For a short period of time, fiduciary premiums increased for 2020 and 2021 renewals, and plan sponsors of jumbo defined contribution plans had new excessive fee or class action retentions added to the fiduciary coverage. But it is important to note that fiduciary premiums have historically been sold for very low amounts. The premium is often sold as part of a package with D&O and employment practices liability coverage, and sold at a substantial discount to those coverages – often at less than 10 or 20 percent of the higher-priced D&O or EPL coverages. To the extent that fiduciary insurance premiums increased for a temporary time period, it was because fiduciary premiums for the industry were priced below rate adequacy. Any increase in fiduciary premiums was from a subsidized or artificially low basis.
Despite the high losses for fiduciary insurance carriers, premiums have stabilized after the short period of increases early in this decade. Many plan sponsors might even receive decreases for 2024 renewals. Deductibles remain higher than before 2020, but plan sponsors can still pass on most litigation risk to their fiduciary insurer. Like premiums, retentions have moderated. The reason is that the fiduciary market remains competitive, with many carriers willing to offer quality fiduciary coverage for plan sponsors. Fiduciary carriers are underwriting the risk more closely, but we have seen quality coverage offered even to plan sponsors with a higher risk profile. We have seen fiduciary coverage offered to leveraged ESOPs, which is proof positive of a healthy fiduciary insurance market for even the highest risk profiles. From our perspective, the premium rates for fiduciary insurance are highly competitive and well below the current level of fiduciary risk.
In sum, the fiduciary insurance market is healthy and any headlines of skyrocketing premiums are outdated and incorrect. The entire management liability insurance market remains stuck in a protracted soft market based on excessive competition in which supply outstrips demand. Lloyds recently characterized the D&O insurance underwriting market as “moronic.” We do not believe that fiduciary insurance underwriters deserve this characterization, but we believe that we are at an inflection point in which the high fiduciary risk environment does not match the softening market. Defense costs alone have gone up with the cost of inflation, with defense rates going up several hundred dollars per hour. Even the modest increases in fiduciary premiums in 2020 and 2021 failed to capture the inflation in lawyer fees, not to mention record settlements in three successive years.
From our experience, plan sponsors do not want to pay the level of fiduciary premiums that are necessary to fund the cost of defense and indemnity for the increasing flood of litigation. That is why retentions are necessary and likely will continue as part of fiduciary coverage. But any notion that fiduciary insurance rates are skyrocketing does not match the healthy fiduciary insurance market that is available to plan sponsors.
