Fallout from Supreme Court’s Cunningham ruling continues to reshape fiduciary liability landscape

The first lower court ruling is in after a landmark Supreme Court ruling that reshaped the legal landscape for fiduciary liability under ERISA, easing the path for plaintiffs to bring claims against retirement plan sponsors and fiduciaries. With more such rulings likely to come, the pressure is on sponsors and fiduciaries to build effective insurance programs and mitigate potential risks.

Lowering the bar for plaintiffs

Section 406 of the Employee Retirement Income Security Act of 1974 (ERISA) prohibits retirement plans from entering into certain transactions with “parties in interest,” such as plan fiduciaries and service providers, to avoid conflicts of interest and potential self-dealing to the detriment of plan participants. ERISA, however, outlines several exemptions to the list of prohibited transactions described in Section 406. These prohibitions and exemptions are codified in Title 29 of the United States Code, sections 1106 and 1108.

In 2017, several current and former employees of Cornell University filed a federal lawsuit against the school, alleging Section 406 violations in Cornell’s administration of the employees’ retirement plan. A district court dismissed the case, Cunningham v. Cornell University, and in 2023, the 2nd U.S. Circuit Court of Appeals upheld the lower court’s ruling. The appellate court held that in order for the lawsuit to move forward, the plaintiffs needed to disprove the applicability of the exemptions outlined under ERISA. This essentially introduced a higher standard of pleading for plaintiffs in suits alleging section 406 violations. Plaintiffs subsequently appealed the ruling to the Supreme Court, which issued its much-anticipated opinion in April (opens a new window). In a unanimous decision, the Supreme Court reversed the 2nd Circuit’s decision, holding that “it is defendant fiduciaries who bear the burden of pleading and proving that a §1108 exemption applies to an otherwise prohibited transaction under §1106… plaintiffs seeking to state a §1106(a)(1)(C) claim must plausibly allege that a plan fiduciary engaged in a transaction proscribed therein, no more, no less.”

More rulings to come

The Supreme Court’s decision effectively lowers the threshold for suits alleging violations of section 406. And citing Cunningham as precedent, the 2nd Circuit in August — in Collins v. Northeast Grocery — vacated part of a lower court’s decision to dismiss a similar suit filed by participants in a 401(k) plan. The appellate court held that plaintiffs in Collins met the new, lower bar established under Cunningham, with the onus on defendants to prove that exemptions under ERISA apply, thus negating plaintiffs’ allegations.

Collins is the first decision involving allegations of section 406 violations in the new post-Cunningham legal environment — and almost certainly not the last. This means plan sponsors and fiduciaries will face even more pressure than they were already facing from litigation. In 2020, three years after the plaintiffs in Cunningham filed suit, Section 406 litigation activity accelerated (opens a new window), according to data from Sompo Insurance. (See Figure 1.) Suits focusing on excessive fees charged by investment advisors and other vendors have been a major driver of litigation since 2020.

But other litigation threats are emerging. In addition to motivated plan participants, more new law firms are entering the ERISA litigation arena. Beyond adding to its ranks, the plaintiffs’ bar is growing more creative and fine-tuning new legal theories. 2024, for example, saw a significant uptick in:

• Forfeiture claims. These suits typically allege that the use of forfeited funds to offset future employer contributions rather than to pay reasonable plan expenses is a breach of fiduciary duty and constitutes a prohibited transaction under ERISA, as it involves self-dealing — specifically, an employer leveraging plan assets to lower its own contribution obligation, which is a conflict of interest.

• Pharmacy benefits manager (PBM) suits. In these suits, plaintiffs typically allege that plan sponsors have breached fiduciary duties by inflating the cost of prescription drugs through contracts with PBMs (opens a new window), which many employers hire to administer prescription drug benefits in employee-sponsored health insurance plans.

In the era of social inflation, verdicts and settlement values are growing larger as courts and juries seek to hold companies accountable for purported wrongdoing. This brings added uncertainty for sponsors and fiduciaries, whose defense costs are already rapidly rising — and may climb even higher. And it underscores the value of prudent risk management.

Building effective insurance programs

Fiduciary liability insurance policies can provide valuable protection to sponsors and fiduciaries in the face of allegations of mismanagement, negligence, or breaches of fiduciary duty in the administration of employee benefit plans, trusts or other fiduciary responsibilities. This coverage is especially important for fiduciaries overseeing employee benefit plans governed by ERISA, including 401(k) plans, pension plans, and health and welfare plans.

Fiduciary liability policies should protect both individual fiduciaries, such as benefit committee members, and organizations sponsoring covered plans. Policies typically provide coverage for:

• Legal defense costs, including attorney fees, court costs, and other expenses incurred in defending against related claims, even if those claims are unfounded.

• Settlements and damages resulting from covered claims, up to the policy limits.

For insurance buyers, the fiduciary liability market remains challenging but stable. Carriers are judiciously deploying capital, tightening limits and retentions, asking many questions during underwriting, and being highly selective about the risks they write. Most buyers are renewing insurance programs flat to slightly up, with more favorable pricing for policyholders that purchase fiduciary coverage via a package policy with directors and officers liability, employment practices liability, and other forms of insurance.

In this environment, and given the prospect of additional rulings like Collins, it’s vital that sponsors and fiduciaries work with their insurance brokers to ensure they have broad coverage under fiduciary liability insurance programs given their risk tolerance and other factors, including plan asset size and structure. Fiduciaries, organizations, and their brokers should seek to ensure policies have appropriate limits and retentions, and broad policy language to cover all relevant fiduciary activity and types of plans, with limited exclusions.

Mitigating fiduciary liability risks

It’s important for sponsors and fiduciaries to note that while insurance can be extremely valuable, it can only help companies transfer their risk; it does not eliminate their obligations to comply with ERISA and other laws. Taking additional steps to promote diligence in plan administration can help sponsors and fiduciaries mitigate their fiduciary liability risks and potentially reduce the likelihood of litigation.

Among other steps, sponsors and fiduciaries should:

• Perform due diligence reviews of plan fees and investment performance, confirming that plan fees are reasonable based on industry benchmarks.

• Review and analyze all plan recordkeeping fees to ensure they are offered on a low, per participant rate basis, instead of being based on assets.

• Conduct formal vender RFPs every three to five years, or more frequently, to ensure fees are competitive.

• Consider paying record-keeping fees on behalf of plan participants.

• Contact investment managers to certify they are offering to participants the lost cost funds available.