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The ERISA Edit: Supreme Court Asked to Review Prohibited Transaction Pleading Standard

Employee Benefits Alert

"Prohibited Transaction" Cases Head to the Supreme Court

Late last year, we predicted that the Supreme Court would be asked to resolve a circuit split concerning what a plaintiff must plead to assert a "prohibited transaction" under ERISA. Although we foresaw that the Supreme Court would ultimately confront the question, we did not necessarily expect that the Court would face three petitions at once.

As a refresher, ERISA § 406(a)(1)(C) bars certain transactions, including those that "constitute[] a direct or indirect furnishing of goods, services, or facilities between the plan and a party in interest." A "party in interest" includes "a person providing services" to an employee benefit plan. Another provision, ERISA § 408, exempts almost two dozen categories of transactions that would otherwise be barred by § 406. For instance, a plan fiduciary may "[c]ontract[] or mak[e] reasonable arrangements with a party in interest for . . . services necessary for the establishment or operation of the plan, if no more than reasonable compensation is paid therefor."

Before the Supreme Court, AT&T Services, Inc., which administers a defined contribution plan for eligible AT&T employees, seeks review of the Ninth Circuit's decision in Bugielski v. AT&T Servs., Inc., 76 F.4th 894 (9th Cir. 2023), previously discussed here. In that case, the Ninth Circuit joined the Eighth Circuit in construing § 406(a)(1)(C) literally, holding that a plan fiduciary engages in a prohibited transaction if he compensates any outside entity providing any services to the plan, and that § 408's exemption for reasonable compensation for services to the plan is an affirmative defense with no bearing on whether a plaintiff's claim can withstand a motion to dismiss. 

In its petition (No. 23-1094), AT&T argues that the Ninth Circuit's decision "can't be reconciled with text, context, structure, or precedent," it could trigger "protracted litigation" against plan administrators merely for "entering into agreements with third parties for necessary plan services," and it could harm plan beneficiaries "who may be deprived of valuable services as administrators seek to limit their litigation exposure." Even though the case was initially decided on summary judgment and remanded in part for additional findings, AT&T states in its petition that "[t]he Ninth Circuit unequivocally held as a matter of law that even routine, arm's-length transactions for necessary services constitute 'prohibited transactions' under [§] 406" and "[t]his case involves no factual disputes or complications that could impede th[e] [Supreme] Court's review."

Meanwhile, a group of current and former employees who participated in Cornell University's two retirement plans has challenged the Second Circuit's decision in Cunningham v. Cornell University, 86 F.4th 961 (2d Cir. 2023), previously discussed here. In Cunningham, the Second Circuit joined the Third, Seventh, and Tenth Circuits in rejecting the Eighth and Ninth Circuits' reading of § 406(a)(1)(C). The four courts concluded that Congress could not have intended to prohibit fiduciaries from paying third parties to perform essential services in support of a plan. In other ways, however, the Second Circuit's decision differed. According to the Second Circuit, "[t]he fact that Congress drafted § [406] . . . to reference the § [408] exemptions supports the view that the burden of raising those exemptions lies, at least in part, with the plaintiff."

In their petition (No. 23-1007), the Cornell plan participants argue that the Third, Seventh, and Tenth Circuits improperly "narrowed § [406]'s scope through atextual requirements" and that the Second Circuit's interpretation "creates particularly unique difficulties" in terms of which of § 408's nearly two dozen exemptions a plaintiff must address at the pleading stage. According to the petitioners, the Second Circuit's decision "puts plaintiffs in the precarious position of having to plead the absence of exceptions that may (or may not) apply based on information that, absent discovery, they may (or may not) know." The petitioners also argue that the Supreme Court should take their "clean" case against Cornell and not grant cert in Bugielski, emphasizing Bugielski's "dense factual record and significant discovery" and its remand for further proceedings, at which "the district court might well still decide that AT&T falls under § [408]'s ambit, discharging it from liability." 

The third petition (No. 23-1025), which was filed by a plan that provides retirement benefits to the employees of a dental practice, focuses on a different, but related, circuit split. The district court concluded that Variable Annuity Life Insurance Company (VALIC), which administered the plan, was not a "party in interest" at all, making § 408's exemptions irrelevant. According to the district court, because the parties had no pre-existing relationship, VALIC could not have been a party in interest when it contracted with the plan. The Fifth Circuit affirmed, reasoning that the party-in-interest definition uses the present participle "providing," and a present participle expresses current action. D.L. Markham DDS, MSD, Incorporated 401(K) Plan v. Variable Annuity Life Insurance Company, 88 F.4th 602 (5th Cir. 2023). The plan argues in its petition that, "[b]y contrast, the Third, Fourth, and Seventh Circuits all agree that, while a service provider may not be a party in interest when it executes the initial contract, it is when paid fees for services pursuant to the contract." 

VALIC's deadline to respond to the plan's petition is April 17, 2024, and the Bugielski plan participants must respond to AT&T's petition by May 9, 2024. Cornell has waived its right to respond to the petition in its case, though the Supreme Court could order it to respond anyway. Ultimately, the Supreme Court could reject all three petitions, grant the three petitions and consolidate the cases, or some combination thereof.

Court Remands Residential Treatment Center Claims to Third Party Administrator with Strict Guidelines

The U.S. District Court for the District of Utah recently issued summary judgment to the plaintiffs in Anne A. v. United HealthCare Insurance Co., No. 20-cv-00814 (D. Utah Mar. 26, 2024), finding the defendants' denial of coverage for residential treatment was arbitrary and capricious because they disregarded the opinions of the claimant's medical providers and failed to sufficiently explain their coverage decisions. In reaching its decision, the court applied the standards articulated by the Tenth Circuit last May in D.K. v. United Behavioral Health, 67 F.4th 1224 (10th Cir. 2023), cert. denied, 2024 U.S. LEXIS 748. The case is noteworthy in that the court remanded the claim back to the plan administrator with strict guidelines that the court itself acknowledged "turn[ed] the remand procedure into an exercise in futility."

The case arose out of a denial of coverage for an adolescent's 20-month admission to the Chrysalis Therapeutic Boarding School, a residential treatment center (RTC) in Montana. The claims at issue were denied on medical necessity grounds based on application of the Optum Level of Care Guidelines for mental health residential treatment. According to the initial denials, the claimant (Kate) could be treated in a less-intensive level of care. The plaintiffs appealed the denial of claims by submitting to the defendants a 40-page appeal letter and roughly 1,700 pages of exhibits, which included the claimant's medical records from Chrysalis, her admission application, a psychological evaluation and assessment, a form completed by the claimant's psychiatrist three months prior to the Chrysalis admission about claimant's condition (which her mother used to support a family medical leave request at her place of employment), and a letter from the claimant's psychiatrist expressing his opinion that the claimant needed residential treatment and could not be treated on an outpatient basis. The denials were upheld on the first and second appeals and following an external review.

The plaintiffs filed their lawsuit alleging the coverage denials were arbitrary and capricious because defendants failed to engage in the meaningful dialogue required by ERISA's claims procedures when responding to the claimant's medical records and treating physician's opinions throughout the prelitigation appeals process and because the denial letters were "vague, conclusory, and threadbare" and inadequately explained the denial decisions with reference to the claimant's medical records. The court agreed on both points.

First, the court faulted the defendants for failing to specifically address the medical opinions of claimant's treating providers in their denial letters. "Post-hoc rationales claiming Defendants denied benefits based on a careful review of Kate's medical records cannot save their coverage decision when none of the letters addressed the reliable evidence Plaintiffs provided that contradicted Defendants' conclusions."

Second, the court further held that the denials were arbitrary and capricious because they failed to provide sufficient reasoning "supported by citations to Kate's medical records." Although the defendants stated they reviewed Kate's records, "they didn't truly provide 'any analysis, let alone a reasoned analysis[,]' because their denials consisted of conclusory assertions, contradicted by parts of the record, with no reasoning as to what information was relied on, which pieces of Kate's medical records Defendants found persuasive, or what parts of Kate's medical history were in fact reviewed" (quoting D.K.).

The court remanded the claims to the defendants for a full and fair review, but precluded the defendants from relying on "any of the post-hoc reasons for denying the benefits that they raised for the first time before this court" and limiting their review "to only to the rationales for denying benefits that they stated in their denial letters." According to the court, "[i]f Defendants were now free on remand to read the opinions of medical necessity from Kate's providers, sort through her medical records that Plaintiffs repeatedly provided in the prelitigation appeals process, and find new evidence therein to justify their decision to deny benefits, it would deny the prelitigation meaningful dialogue in which Defendants were obliged to engage." The court stopped short of awarding benefits to the plaintiffs, opting for what appears to be a remand in name only, stating that clarification is needed from the Tenth Circuit on when a court may award benefits. 

The court gave short shrift to the plaintiffs' claim alleging violation of the Mental Health Parity and Addiction Equity Act (MHPAEA), deciding the claim was "premature." While D.K. is binding only in the Tenth Circuit, this case illustrates the considerable level of detail and analysis courts in Colorado, Kansas, New Mexico, Oklahoma, Utah, and Wyoming may require in denial letters to pass an arbitrary and capricious standard of review.

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