Supreme Court Lowers Bar to Pleading Prohibited Transactions, Despite “Serious Concerns” of Meritless Litigation

Seyfarth Synopsis: In a unanimous decision reversing dismissal of prohibited transaction claims based on fees paid to defined contribution plan recordkeepers, the Supreme Court held that ERISA’s prohibited transaction exemptions are affirmative defenses, and do not present additional pleading elements plaintiffs must satisfy to state viable claims. While acknowledging the decision may allow plaintiffs to survive dismissal with “barebones” allegations, the Court held that the practical concerns of an increase in meritless litigation cannot overcome the statutory text and structure.

On April 17, 2025, the United States Supreme Court issued its opinion in the closely-watched Cunningham v. Cornell University case, resolving a circuit split on the pleading standards for prohibited transaction claims under ERISA. In its ruling, the Court reversed the decision of the Second Circuit Court of Appeals, which had affirmed dismissal of a claim asserting that the plans’ fiduciaries had caused prohibited transactions by allowing the plans to pay compensation to third-party recordkeepers. In reaching its decision, the Second Circuit held that ERISA’s prohibited transaction exemptions should not “be understood merely as affirmative defenses,” but should instead be incorporated into the prohibitions themselves, such that to survive dismissal plaintiffs must affirmatively plead they do not apply.

In a concurring opinion by Justice Alito, the Supreme Court acknowledged that while the Second Circuit had “attempted to achieve an admirable goal” by “weed[ing] out plainly unmeritorious suits at the pleading stage,” it would reverse. Relying on a “well-settled general rule of statutory construction,” the Court reasoned that, where Congress structures a statute such that exemptions are laid out separately from prohibitions, the exemptions constitute affirmative defenses on which the defendant bears the burden of proof, and should not be read as elements of the prohibitions that plaintiffs must satisfy in their pleadings.

While Section 1106(a) (which sets out the prohibited transactions) begins with the language “[e]xcept as provided in section 1108 of this title,” the Court rejected defendants’ arguments that the clause incorporated Section 1108’s exemptions into the prohibitions. In light of the fact that Section 1108 contains 21 separate exemptions, and allows the Secretary of Labor to create others by regulation, the Court reasoned that reading that many exemptions as elements of prohibited transaction claims would frustrate Congress’s intent to categorically bar certain transactions. The Court further stated that defendants’ argument lacked a “principled basis” to read only some of the exemptions as elements of a prohibited transaction.

Despite its unanimous ruling, the Court acknowledged the serious practical problems this ruling may create for plan sponsors and fiduciaries. Modern administration of an ERISA plan requires reliance on third-party service providers, who are paid for the services they provide. There is, as the concurrence stated, “nothing nefarious about any of that.” Still, both the Court’s opinion and the concurrence acknowledge that, to state a claim after this ruling, all a plaintiff needs to allege to state a claim that will survive dismissal is to allege that the plan paid money to a “party in interest.” The Court found that the practical risk that this will open the floodgates to frivolous litigation “cannot overcome the statutory text and structure.”

The Court did offer some guidance to lower courts presented with barebones prohibited transaction claims. The Court proposed, for example, invoking the rarely-used provisions of Fed. R. Civ. P. 7(a)(7) to require plaintiffs to file a reply to an answer to plead how an exemption does not apply (and then dismissing suits if plaintiffs cannot do so). The Court also cautioned that Rule 11 sanctions and ERISA’s fee-shifting provision can be used as deterrents where plaintiffs seek to capitalize on the lower pleading standard created by this opinion.

Only time will tell if lower courts take this guidance, and exercise this authority to prevent meritless prohibited transaction claims. If they do not, defendants will face the difficult choice of balancing the costs, burdens, and uncertainty of litigation against the possibility of settlement, even in situations such as those noted in the concurrence where they are “convinced that they would win if the litigation continued.” We will continue to closely monitor the evolution of prohibited transaction litigation in the wake of this ruling.