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The long and short of Bugielski is that the court found negotiation of a standard recordkeeping contract would be a prohibited transaction, unless the plan fiduciary could prove the arrangement met one of the applicable exemptions to those rules.
Under that interpretation, a plaintiff could sue a plan fiduciary based on an alleged prohibited transaction, asserting only that the plan entered into a contract (any contract) with a party that had some prior affiliation with the plan — and nothing more. This would allow plaintiffs to bring suits targeting standard retirement plan fees without providing any of the details they would need to meet the pleading standards for imprudent fee claims established by the Supreme Court in Hughes v. Nw. Univ., 142 S. Ct. 737 (2022).
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As everyone — including the Bugielski panel — is aware, a plan's engagement of a third-party service provider such as a recordkeeper or investment manager is commonplace and even necessary. Indeed, a recent study of plan sponsors showed that 94% of ERISA plans retain third-party advisers or consultants. Consequently, nearly every benefit plan will be impacted by the Bugielski opinion if it is left untouched.
Bugielski's impact is so great because of two significant flaws in the Ninth Circuit's reading of ERISA. First, they read the prohibited transaction rules in a way that produces a circular result, and would presumptively prohibit a plan from paying fees for services to an entity that performs services for a fee. Second, they compound the impact of that circular reading by adhering to a more widespread interpretation of ERISA that puts the burden to prove an exemption from the prohibited transaction rules on the defendants. In essence, Bugielski produces the result that every contract for plan-related services is prohibited unless shown otherwise.
The second problem with the Bugielski opinion results from a failure to account for language in the statute that indicates the prohibited transaction rules only come into play when it has been established that no exemption applies. That is, courts should start with a presumption that a contract is lawful, unless a plaintiff shows otherwise. This interpretation better aligns with the full text of the statute.
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The litigation impacts of this interpretation of ERISA are that plaintiffs looking to challenge retirement plan fees will face an extremely low pleading burden, and would not have to allege anything more than a transaction (even one that helps the plan) occurred between the plan and a party that had some prior relationship with the plan. As plan fiduciaries are acutely aware, courts have spent the last several years articulating the level of detail a plaintiff must plead to bring a claim of breach of the duty of prudence for excessive fees. Those courts require significantly more than the allegation that a transaction occurred. It is plaintiffs' burden to show some plausible basis to believe not just that fees were paid, but that the fees were actually excessive.
Adopting a reading of Section 406(a) that construes Section 408 not as an affirmative defense but as an essential element of the claim fixes the circular reading of Section 406(a) that would render routine service provider agreements presumptively unlawful. It also aligns with the panel's suggestion that "Congress has already set the balance" as to pleading on prohibited transaction claims, as it involves interpretation of the existing statutory language, not modification of it.
In interpreting a statute, as the panel did here, it is imperative that the words of the statute be read in context. The Bugielski panel, however, failed to consider how the language of Section 406 fits within the broader context of ERISA's remedial scheme. It makes little sense, in that context, to allow routine service provider contracts to be challenged as prohibited transactions, where the same allegations would be found insufficient to establish a claim of breach of the duty of prudence. But that is what this decision does. The panel's decision must be revisited to avoid crippling plan sponsors' and plan administrators' ability to operate plans in an orderly and efficient manner.
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Aside from the sprawling exposure and accompanying legal and insurance costs arising directly from this case, the panel's ruling will subject fiduciaries to potential liability — or at least defense costs — even where they have clear evidence of providing well-managed, prudently priced plans, aided by expert third-party service providers, providing best-in-class services to aid participants in planning for retirement. This simply cannot be what the Supreme Court envisioned when it emphasized the importance of lower courts "giv[ing] due regard to the range of reasonable judgments a fiduciary may make based on her experience and expertise." Hughes, 142 S. Ct. at 742.
We hope that reason prevails, and await the Ninth Circuit's ruling on the motion for rehearing.
