9th Cir. AT&T Ruling ‘Watershed Moment’ for Benefit Contractors

A circuit court ruling reviving a class action targeting AT&T Inc.‘s 401(k) plan could leave employers exercising more caution in the way they interact with and oversee third-party service providers that deliver workplace benefits.

The US Court of Appeals for the Ninth Circuit Aug. 4 reversed a lower court’s summary judgment ruling for AT&T, finding the company had entered into prohibited transactions under federal benefit law by amending existing recordkeeping contracts to add brokerage and investment advisory services.

By remanding to the district court an analysis of whether AT&T qualified for an exception to the law, the Ninth Circuit panel took a literal approach to broad restrictions under the Employee Retirement Income Security Act of 1974 (Pub. L. No. 93-406). The decision splits from the Third and Seventh circuits, raising the prospect of a US Supreme Court review and introducing new doubts over what kinds of contracts require exemptive relief.

Expanding the arrangements that qualify as prohibited transactions implicates workplace health and retirement plans’ routine activities, benefits attorneys told Bloomberg Law. The decision could hasten a new wave of litigation that targets plans for violating their duties to act in the best interest of plan participants by zeroing in on the companies they tap to enroll participants, track records, and distribute information.

The decision is a “shot across the bow to service providers to both retirement and health plans,” said Nicholas J. Bullard, a partner at Dorsey & Whitney LLP in Minneapolis.

Whose Interests?

Plaintiffs for a class of more than 245,000 AT&T 401(k) plan participants have alleged that their employer failed to adequately consider the compensation recordkeeper Fidelity Workplace Services would receive by adding on more services.

The contract amendments adding these services constituted prohibited transactions, the Ninth Circuit ruled, bolstering participants’ claim that AT&T breached its duty of prudence to oversee the compensation paid to vendors and its duty of candor to disclose it to regulators.

Attorneys for the plaintiffs have focused their argument on proving that AT&T entered into a prohibited transaction because it supports their added claim that the company violated ERISA’s fiduciary duties, said John J. Nestico, senior counsel for Schneider Wallace Cottrell Konecky LLP, who represents the plaintiffs.

The arrangement served Fidelity’s own interests at the expense of plan participants, Nestico said.

The Ninth Circuit’s expanded view of prohibited transactions could make plaintiffs more eager to bring these claims, said Mark G. Boyko, a partner with Bailey & Glasser LLP in Missouri. Such claims can be difficult to overcome on a motion to dismiss, he said.

Prohibited transaction exemptions are affirmative defenses in most courts, which typically means that defendants can’t raise them in a motion to dismiss, Boyko said. That’s an expensive proposition for both plaintiffs and defendants, and it increases the pressure to settle, he added.

‘Nonsensical’ Approach

ERISA’s prohibited transaction rules are aimed at putting guardrails on arrangements between benefit plans and interested parties.

An arrangement that qualifies as a prohibited transaction under ERISA can still be legally compliant if it meets one of the statute’s exemptions, which are largely focused on ensuring that plan participants are treated fairly and that any money made off the transaction is reasonable.

The Ninth Circuit remanded to the US District Court for the Central District of California the question of whether AT&T qualified for an exemption, rejecting the company’s claim that it had no fiduciary obligation to monitor the fees Fidelity made from its proprietary brokerage provider, and through an arms-length contract with investment advice provider Financial Engines Advisors LLC.

That’s a “key outstanding question,” said Jennifer Eller, a principal at Groom Law Group Chartered in Washington. “What interest does a plan provider have to take in the outside compensation its service providers receive?”

The US Labor Department amended its disclosure rules related to the service provider prohibited transaction exemption in 2010 (77 Fed. Reg. 5631), emphasizing a fiduciary’s duty to keep a watchful eye over compensation “in connection with” the services provided.

The Ninth Circuit panel relied heavily on regulators’ interpretation, disagreeing with the Seventh Circuit’s ruling in Albert v. Oshkosh Corp. that applying those added duties to the prohibited transaction determination would be “nonsensical.”

“We are hard-pressed to find the best reading of the statutory text, as corroborated by the agency tasked with administering the relevant regulations, ‘nonsensical,’” the Ninth Circuit panel stated.

Wholesale Implications

By rejecting Oshkosh, and a similar Third Circuit ruling in Sweda v. Univ. of Pa., the court suggested that amending a service provider contract or even hiring an outside firm to help deliver benefits at all could be a prohibited transaction, said Daniel Aronowitz, managing principal and owner of Euclid Fiduciary Managers LLC.

“This is a watershed moment because it’s opening up for liability almost all essential service contracts,” Aronowitz said.

The Oshkosh court juggled the question over whether ERISA’s prohibition of deals involving “parties in interest” to a plan could be triggered by first contracting with a service provider and then paying that provider for the services rendered. At face value, that would implicate all contracts with all outside service providers, leading to the Seventh Circuit’s “nonsensical” finding.

The AT&T case involved an amended contract with an existing service provider, rather than an initial service contract. It’s possible that the court’s broad language could also encompass new contracts with new service providers, but the “best reading” of the opinion is that it applies only to amended contracts with existing providers, Dorsey & Whitney’s Bullard said.

Uncertainty surrounding the Ninth Circuit’s ruling may put benefits advisers on edge. A broad reading could be particularly relevant for ERISA health-care plans, which Boyko said haven’t been “operating with the same level of oversight” as defined-contribution retirement plans.

Several attorneys told Bloomberg Law they expect AT&T to file a petition for rehearing or even seek an appeal before the Supreme Court.

An AT&T spokesperson said company officials are “disappointed with aspects of the court’s ruling and are evaluating our options.”

The case is Bugielski v. AT&T Servs., 2023 BL 268056, 9th Cir., No. 21-56196, 8/4/23.