James W. Watkins, III, J.D., CFP Emeritus^TM, AWMA®

SCOTUS may soon have yet another ERISA-related case to review. AT&T Services, Inc. recently petitioned SCOTUS for a writ of certiorari to review the Ninth Circuit’s decision in Bugielski v. AT&T Services, Inc. (AT&T). AT&T presented the question for the Court as follows:

Whether a fiduciary to an employee benefit plan causes the plan to engage in a prohibited transaction under Section 406(a)(1)(C) of the Employee Retirement Security Act of 1974 by entering into a routine, arm’s-length agreement for plan services.

The Ninth Circuit had answered the question in the affirmative. I thought the Ninth Circuit’s decision was well-reasoned and technically correct.

People often ask me to explain the concept of “prohibited transactions” in the context of ERISA. I have entered the cite for the Ninth Circuit’s decision into my phone so that I can now answer said question by simply providing with the cite for the Ninth Circuit’s decision. In my opinion,the strength of the Ninth Circuit’s decision was the fact that the court relied heavily on DOL and EBSA documents and opinions, as well as ERISA itself.

Whether SCOTUS grants cert remains to be seen. However, given my experience that few plan sponsors and other plan fiduciaries have a true understanding of (1) what ERISA requires them to do and not to do, and (2) the rules regarding prohibited transactions, I thought a review of the Ninth Circuit’s decision might be helpful

The Ninth Circuit’s opinion is nineteen pages long. So, my guess is that very few plan sponsors are going to take the time to read and/or do whatever is necessary to understand the Ninth Circuit’s decision or the general rules applicable to prohibited transactions. That is a shame, as it means they probably are in violation of such rules and simply do not realize their potential liability exposure.

In this post, I want to discuss some of the key fundamental points that the Ninth Circuit discussed in hopes of raising the consciousness of plan sponsors and other plan fiduciaries to the point that they realize a need to seek out experienced and knowledgeable ERISA counsel to address any concerns.

Normally, I omit internal cites in quotes in my posts. Several colleagues suggested that I leave them in to help readers who may want research the issues addressed without having to go back and forth to the “Notes” section.

The Employee Retirement Income Security Act of 1974 (“ERISA”) establishes standards for employee benefit plans to protect the interests of plan participants. See 29 U.S.C. § 1001. To that end, ERISA imposes a duty of prudence upon those who manage employee retirement plans, prohibits plans from engaging in transactions that could harm participants’ interests, and mandates disclosures to the United States Department of Labor.¹

Specifically, Plaintiffs argue that this transaction was not exempt under §408(b)(2), which exempts from § 406’s bar service contracts or arrangements between a plan and a “party in interest” if (1) the contract or arrangement is reasonable, (2) the services are necessary for the establishment or operation of the plan, and (3) no more than reasonable compensation is paid for the services. 29 U.S.C. § 1108(b)(2); 29 C.F.R. § 2550.408b-2(a). For the contract or arrangement to be “reasonable,” the party in interest must disclose to the plan’s fiduciary all compensation the party expects to receive “in connection with” the services provided pursuant to the contract or arrangement. 29 U.S.C. § 1108(b)(2)(B), 29 C.F.R. § 2550.408b-2(c)(1)(iv); see also Reasonable Contract or Arrangement Under Section 408(b)(2)—Fee Disclosure, 77 Fed. Reg. 5632-01 (Feb. 3, 2012).²  

Under § 406(a)(1)(C), a fiduciary “shall not cause the plan to engage in a transaction, if he knows or should know that such transaction constitutes a direct or indirect … furnishing of goods, services, or facilities between the plan and a party in interest.” 29 U.S.C. § 1106(a)(1)(C). A “party in interest” includes “a person providing services to such plan.” Id. § 1002(14)(B).³

The Ninth Circuit pointed out that since the prohibited transaction rule is a per se rule, whether or not the violation caused any harm is immaterial. As the court pointed out repeatedly throughout the decision, ERISA and the associated regulations provide exemptions to allow plans to enter into “’service transaction” that keep plans running smoothly,” e.g., bookkeeping and administrative services.

[W]e know that Congress recognized that § 406(a)(1)(C) would prohibit necessary services; that is why it created an exemption. See 29 U.S.C. § 1108(b)(2)(A) (exempting contracts for “services necessary for the establishment or operation of the plan”)….[I]t would be “nonsensical” to read § 406(a)(1) “to prohibit transactions for services that are essential for defined contribution plans, such as recordkeeping and administrative services.” Id. at 584-85.⁴ 

The Department of Labor’s Employee Benefits Security Administration’s (“EBSA”) explanation for amending the regulation implementing § 408(b)(2) confirms our reading of § 406. In pertinent part, that explanation provides:

The furnishing of goods, services, or facilities between a plan and a party in interest to the plan generally is prohibited under section 406(a)(1)(C) of ERISA. As a result, a service relationship between a plan and a service provider would constitute a prohibited transaction, because any person providing services to the plan is defined by ERISA to be a “party in interest” to the plan. However, section 408(b)(2) of ERISA exempts certain arrangements between plans and service providers that otherwise would be prohibited transactions under section 406 of ERISA.⁵

The agency noted that “[p]ayments from third parties and among service providers can create conflicts of interest between service providers and their clients.” Id. at 5650. ⁶ 

The court then addressed a common situation in plans where a company that provides recordkeeping and/or administrative service also offers investment and/or investment advice, including proprietary products:

Finally, we are persuaded by the Department of Labor’s advisory opinion that a company that “provide[d] recordkeeping and related administrative services to retirement plans” and made available to those plans “a variety of investment options, including its own insurance company separate accounts and affiliated and unaffiliated mutual funds,” would be “a party in interest with respect to the plan” because it was “a provider of services.”^[3] U.S. Dep’t of Labor, Opinion No. 2013-03A. (emphasis added) ⁷ 

The Ninth Circuit then addressed the potential impact of fees and the need for greater transparency between plans and a party in interest:

Expenses, such as management or administrative fees, can sometimes significantly reduce the value of an account in a defined-contribution plan.” Tibble v. Edison Int’l, 575 U.S. 523, 526, 135 S.Ct. 1823, 191 L.Ed.2d 795 (2015). Therefore, if AT&T entered into bad deals—as Plaintiffs hypothesize—those fees could “significantly reduce” participants’ assets.⁸ 

The Court pointed out that ERISA does not necessarily prohibit such situations, but simply requires that greater disclosure and transparency is required in order to fulfill ERISA’s mission of protecting plan participants.

Instead, it simply ensures that, when transacting with a party in interest, a fiduciary understands the compensation the party in interest will receive from the transaction and determines that compensation is reasonable. See 29 C.F.R. § 2550.408b-2(a), (c), (d). This reading is consistent with ERISA’s broader aim to protect plan participants, as well as §§ 406 and 408’s aim to increase transparency around service providers’ compensation and potential conflicts of interest. See 29 U.S.C. § 1001; Reasonable Contract or Arrangement Under Section 408(b)(2)—Fee Disclosure, 77 Fed. Reg. at 5632. ⁹ 

Section 406(a)(1)(C) is not a complete ban; instead, it requires fiduciaries, before entering into an agreement with a party in interest, to understand the compensation the party in interest will receive, evaluate whether the arrangement could give rise to any conflicts of interest, and determine whether the compensation is reasonable. 29 C.F.R. § 2550.408b-2; see generally Reasonable Contract or Arrangement Under Section 408(b)(2)—Fee Disclosure, 77 Fed. Reg. 5632-01. Rather than frustrating “ERISA’s statutory purpose,” Oshkosh, 47 F.4th at 585, this scheme furthers it by ensuring fiduciaries understand the impact the transaction will have on participants’ interests. See 29 U.S.C. § 1001. ¹⁰

EBSA stated explicitly that the information the party in interest must disclose to the fiduciary about the compensation it expects to receive “in connection with” the services provided “will assist plan fiduciaries in understanding the services and in assessing the reasonableness of the compensation, direct and indirect, that the [party in interest] will receive.” Reasonable Contract or Arrangement Under Section 408(b)(2)—Fee Disclosure, 77 Fed. Reg. at 5635-36 (emphasis added). Put differently, the regulation contemplates that the fiduciary will assess the reasonableness of the compensation that the party receives “directly from the covered plan,” 29 C.F.R. § 2550.408b-2(c)(1)(viii)(B)(1) (defining “direct compensation”), and “from any source other than the covered plan,” id. § 2550.408b-2(c)(1)(viii)(B)(2) (defining “indirect compensation”). Reasonable Contract or Arrangement Under Section 408(b)(2)—Fee Disclosure, 77 Fed. Reg. at 5650. ¹¹ 

This conclusion—that the fiduciary must consider all compensation the party in interest receives in connection with the services it provides the plan—is required by the text of the regulation, conforms to the structure and purpose of § 408(b)(2)’s requirements, and is reinforced by EBSA’s explanation for revising § 2550.408b-2. The first exemption requirement—that the contract or arrangement be “reasonable”—calls for the party in interest to disclose information to the fiduciary about the compensation the party in interest expects to receive in connection with the services provided under the contract with the plan. 29 C.F.R. § 2550.408b-2(c)(1)(iv). ¹²

The third requirement—that “no more than reasonable compensation is paid”—expects a fiduciary to consider this information….As EBSA explained, the point of disclosure is to provide information from which the fiduciary can make responsible decisions for the plan….the disclosed information “will assist plan fiduciaries in understanding the services and in assessing the reasonableness of the compensation” the party will receive). ¹³ 

EBSA was particularly concerned with the special risks presented by these fees. It recognized that “[p]ayments from third parties and among service providers can create conflicts of interest between service providers and their clients,” and these payments have “been largely hidden from view,” thereby preventing fiduciaries “from assessing the reasonableness of the costs for plan services.” Reasonable Contract or Arrangement Under Section 408(b)(2)—Fee Disclosure, 77 Fed. Reg. at 5650. (emphasis added)¹⁴

EBSA therefore implemented the regulation to “improve … transparency” and make it easier for fiduciaries to satisfy their “duty to consider compensation that will be received by a [party in interest] from all sources in connection with the services it provides to a covered plan” under the contract. (emphasis added)¹⁵ 

§ 408(b)(2) requires service providers to disclose all compensation they receive in connection with a plan because “plan fiduciaries need this information, when selecting and monitoring service providers,” to be able to “assess[] the reasonableness of the compensation paid for services and the conflicts of interest that may affect a service provider’s performance of services” and satisfy their duty of prudence).See Reasonable Contract or Arrangement Under Section 408(b)(2)—Fee Disclosure, 77 Fed. Reg. at 5632. ¹⁶

Going Forward
In my opinion, AT&T’s reaction to the Ninth Circuit’s decision and the resulting decision to seek cert can be summed up in one word – transparency. Transparency is the financial service industry’s kryptonite. Transparency may well result in greater liability for plan advisers/plan providers or, at a minimum, allow for a more meaningful comparison of available investment alternatives for plans, furthering ERISA’s goals of protecting plan participants and providing meaningful investment options within pension plans.

If I were SCOTUS, I would deny AT&T’s petition for cert, as the Ninth Circuit already addressed and properly dismissed AT&T’s arms-length argument by recognizing that under ERISA, a prohibited transaction, as defined under ERISA, is a per se violation…period.

Moreover, § 406(a)(1)(C) contains no language limiting its application to non-arm’s-length transactions, and accepting AT&T’s “statutory intent” argument would undermine the scheme Congress enacted. Specifically, § 408(b)(2) broadly exempts from § 406’s bar transactions for “services necessary for the establishment or operation of the plan.” 29 U.S.C. § 1108(b)(2)(A). And the definition of “necessary” is similarly broad: a service is necessary if it “is appropriate and helpful to the plan obtaining the service in carrying out the purposes for which the plan is established or maintained.” 29 C.F.R. § 2550.408b-2(b). In other words, ERISA already contains an exemption for those “service transactions” that keep plans running smoothly, which are the very transactions AT&T argues should be exempt. We see no reason to fashion a judge-made exemption when Congress has already provided a statutory exemption. ¹⁷

As I suggested in an earlier post, perhaps SCOTUS should consider having an ERISA week during its next term given the ERISA cases currently pending before the Court and the AT&T case, with the Home Depot case potentially heading toward SCOTUS once the Eleventh Circuit hands down its decision.

Notes
1. Bugielski v. AT&T Services, Inc., 76 F.4th 894, 897 (9th Circuit 2023) (AT&T)
2. AT&T, 899.
3. AT&T, 900.
4. AT&T, 907.
5. AT&T, 902.
6. AT&T, 902.
7. AT&T, 902-903.
8. AT&T, 905.
9. AT&T, 907.
10. AT&T, 908-909.
11. AT&T, 910.
12. AT&T, 911.
13. AT&T, 911.
14. AT&T, 911.
15. AT&T, 912.
16. AT&T, 912-913.
17. AT&T, 901.

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