(Article from Securities Law Alert, Year in Review 2025)
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Supreme Court: Settles Circuit Split on Pleading Standards for Prohibited-Transaction Claims
On April 17, 2025, the Supreme Court unanimously reversed and remanded the Second Circuit’s dismissal of an ERISA claim that was brought by plan participants alleging that their university employer and other plan fiduciaries violated Section 1106(a)(1)(C)[1] by causing the plans to engage in prohibited transactions for recordkeeping services. Cunningham v. Cornell Univ., 145 S. Ct. 1020 (2025) (Sotomayor, J.). The Second Circuit had held that “the exemptions to §1106(a)’s prohibited transactions contained in §1108 imposed additional pleading requirements.” Disagreeing, the Court held “that 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. Plaintiffs are not required to plead and prove that the myriad §1108 exemptions pose no barrier to ultimate relief.”
In 2017, defined-contribution retirement plan participants alleged that defendants violated Section 1106(a)(1)(C) by causing the plans to engage in prohibited transactions for recordkeeping services when the university retained two financial services companies to offer plan participants investment options and to also furnish recordkeeping and administrative services. Affirming the district court’s dismissal, the Second Circuit held that “the exemptions to §1106(a)’s prohibited transactions contained in §1108 imposed additional pleading requirements.”[2] In the Second Circuit’s view, the exemption for reasonable and necessary transactions codified by Section 1108(b)(2)(A)[3] was incorporated into Section 1106(a)’s prohibitions. The Second Circuit concluded that plaintiffs had failed to affirmatively plead both that there was a prohibited transaction and that the transaction was unnecessary or involved unreasonable compensation.
Justice Sotomayor, writing for the Court, held that “under §1106(a)(1)(C), plaintiffs need only plausibly allege each of those [three] elements of a prohibited-transaction claim.” The Court explained that Section 1106(a)(1)(C) creates a categorical bar, such that any transaction that satisfies its three elements is presumptively unlawful. Justice Sotomayor noted that “[n]othing in that section removes from its categorical bar transactions that were necessary for the plan or involved reasonable compensation.” Justice Sotomayor stated that “[t]he exemptions set forth in a different part of the statute, §1108, do not impose additional pleading requirements to make out a §1106(a)(1) claim.” Justice Sotomayor pointed out that if “plaintiffs bring barebones §1106(a)(1)(C) suits” district courts have “existing tools . . . to screen out meritless claims before discovery.” Among other options, Justice Sotomayor noted that Federal Rule of Civil Procedure 7 empowers district courts to require the plaintiff to file a reply to an answer with “specific, nonconclusory factual allegations showing the exemption does not apply.” In any event, a claim under Section 1106(a)(1)(C) remains subject to ERISA’s other restrictions, including the statute of limitations under 29 U.S.C. Section 1113.
Supreme Court: The Court Hears Oral Argument As To Whether a Private Right of Action Exists Under Section 47(b) of the Investment Company Act
After granting four closed-end funds’ petition for a writ of certiorari in June, the Supreme Court heard oral argument on December 10, 2025 concerning whether Section 47(b) of the Investment Company Act of 1940 Act (ICA) gives shareholders of registered investment companies a private right of action to bring lawsuits to rescind contracts that allegedly violate the ICA. FS Credit Opps. Corp. v. Saba Cap. Master Fund, Ltd., No. 24-345. This issue is critical for registered investment companies because registered investment companies conduct virtually all of their operations through contracts with external service providers, and are governed by state law instruments (bylaws and declarations of trust) that are considered contracts under state law.
Section 47(b) states:
(1)…a contract that is made, or whose performance involves, a violation of this subchapter … is unenforceable by either party … unless a court finds that under the circumstances enforcement would produce a more equitable result…
(2) To the extent that a contract described in paragraph (1) has been performed, a court may not deny rescission at the instance of any party unless such court finds that under the circumstances the denial of rescission would produce a more equitable result…
This litigation arose when, in reliance upon a purported private right of action under Section 47(b), an activist investor filed a lawsuit alleging that Section 18(i) of the ICA[4] was violated when the four funds’ boards adopted resolutions opting into a Maryland law[5] that makes it more difficult to gain control of a fund through acquiring a large block of common shares and sought rescission of the resolutions. The district court granted summary judgment in favor of the activist investor, ordered that the resolutions be rescinded, and the Second Circuit affirmed in an unpublished summary order.[6]
During oral argument before the Supreme Court, counsel representing the funds argued that Congress did not satisfy the high bar to create an implied private right of action in Section 47(b) based on the text and structure of the statute. In support of arguing that a private right of action exists, counsel for the activist investor primarily argued that Section 47(b) expressly recognized a private right of action for rescission (but not damages), that historically “at the instance of any party” meant the right to bring a suit in the first instance, and that Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11 (1979) held that § 215(b) of the Investment Advisers Act of 1940 created a private right of action for rescission and Section 47(b) of the ICA initially used the same language.[7]
The reaction of the justices at oral argument indicated that this is unlikely to result in a unanimous ruling. Justice Kavanaugh in particular stated, “I think this case is extremely close.” The justices focused on a variety of issues, including the relevance of Transamerica, the evolution of Section 47(b), the impact of a lack of ability to bring ICA rescission claims in federal court, the relevance of legislative history, and the Court’s overall move away from implied private rights of action. Justice Sotomayor in particular focused on statements in the legislative history around 1980 amendments to Section 47(b), whereas Chief Justice Roberts followed up by asking the litigants, “Did Congress pass the House report?” Justice Gorsuch, in response to the litigants’ arguments around whether Section 47(b) created an express or implied private right of action, wondered, “Do we have any more power to imply a modest cause of action as opposed to a substantial one?” Justice Kavanaugh also focused on whether it would be “anomalous” to “ remit the litigation of a federal right to the state courts” without some indication Congress wished for that result – a point that had been made in Transamerica.
The Court’s decision in this case is highly anticipated because of its potential consequences for the registered fund industry, and the potential it may have to signal to plaintiffs the availability of other purported private rights of action in federal statutes that previously may have been dismissed as unavailable.
[1] The three elements of Section 1106(a)(1)(C) prohibit “fiduciaries from (1) causing a plan to engage in a transaction (2) that the fiduciary knows or should know constitutes a direct or indirect furnishing of goods, services, or facilities (3) between the plan and a party in interest.”
[2] In doing so, the Second Circuit created a circuit split with the Eighth Circuit, which had held in Braden v. Wal-Mart Stores, Inc., 588 F. 3d 585 (8th Cir. 2009) that no additional pleading requirements beyond Section 1106(a)(1) apply to prohibited-transaction claims.
[3] Section 1108(b)(2)(A) of ERISA exempts any transaction that involves “contracting or making reasonable arrangements with a party in interest for office space, or legal, accounting, or other services necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid therefor.”
[4] Section 18(i) requires, in relevant part, that every share of a registered management company be a voting stock and have equal voting rights with every other outstanding voting stock.
[5] Under the Maryland Control Share Acquisition Act if the board of a closed-end fund registered under the 1940 Act adopts a resolution to become subject to the Act, then a person otherwise controlling at least 10% of shareholder voting power in such Maryland fund would not have voting rights with respect to shares in excess of that 10% threshold (“control shares”) unless approved by a two-thirds vote of other shareholders. Md. Code Ann., Corps & Ass’ns § 3–702.
[6] The significance of the Second Circuit affirming the lower court in an unpublished summary order is that while the Second Circuit determined that the district court did not abuse its discretion by granting rescission under Section 47(b), it “did not otherwise address whether Section 47(b) confers a private right of action.” Saba Cap. Master Fund, Ltd. v. Blackrock ESG Cap. Alloc. Tr., 2024 U.S. App. LEXIS 15648 (2d Cir. June 26, 2024).
[7] Congress changed the language of Section 47(b) in 1980.