Dismissing its suggestion to the contrary in Mertens v. Hewitt Associates, the U.S. Supreme Court has held that there is a right of action under ERISA against a non-fiduciary party in interest for a violation of the prohibited transaction rules. Harris Trust & Savings Bank v. Salomon Smith Barney, Inc., 530 U.S. __, 120 S. Ct. 2180, 2000 WL 742912 (2000).

The effect of this decision will be to provide a basis under ERISA for lawsuits against non-fiduciaries for participating in any ERISA fiduciary breach, not just violations of the prohibited transaction rules. This will have significant implications for any organization that provides services or even sells investment products to ERISA plans. Such an organization could potentially be liable even if it has little or no control over the plan decision to enter into the transaction.

The Ameritech Pension Trust had purchased motel properties from Salomon Smith Barney, a party in interest to the plan by reason of its provision of broker-dealer services, for nearly $21 million. The purchase was directed by an independent investment manager. Upon discovering that the motel interests were nearly worthless, the plan fiduciaries sued Salomon Smith Barney as a fiduciary, and in the alternative under section 502(a)(3) of ERISA as a non-fiduciary party in interest engaging in a per se prohibited transaction under section 406(a), requesting recission of the transaction, restitution of the purchase price with interest, and disgorgement of profits.

The district court dismissed the fiduciary breach claim, leaving only the claim under section 502(a)(3) against Salomon Smith Barney in its role as a non-fiduciary party in interest. On appeal, the Seventh Circuit Court of Appeals held that there was no cause of action against a non-fiduciary party in interest for participating in a prohibited transaction, reasoning that only a fiduciary could violate the ERISA prohibited transaction rules. This created a conflict with five of the other circuits, leading the Supreme Court to accept certiorari. The Supreme Court reversed.

The focus of the Supreme Court’s analysis is on the scope of section 502(a)(3), which is in Part 5 of Title I of ERISA. Part 5 contains ERISA’s remedial provisions, and section 502(a) describes various rights of action that can be brought by plan participants, beneficiaries and fiduciaries, as well as the Secretary of Labor. Section 502(a)(3) permits civil actions by a participant, beneficiary or fiduciary (A) to enjoin any act or practice that violates ERISA or the terms of the plan, or (B) "to obtain any other appropriate equitable relief (i) to redress such violations or (ii) to enforce any provisions of [ERISA] or the terms of the plan."

According to the Court, section 502(a)(3) "admits no limit…on the universe of possible defendants," in contrast to other ERISA provisions such as section 409(a) (the provision describing the personal liability that may be imposed on fiduciaries) and section 502(l) (imposing civil penalties for fiduciary breaches on fiduciaries and "other persons"). Section 502(a), by contrast, focuses on who may be the plaintiffs. While the Court said it was inclined to interpret ERISA provisions narrowly, it cited section 502(l) to demonstrate that the scope of section 502(a)(3) is in fact broader than one might assume.

The argument the Court needed to address through its cite to section 502(l) was that section 502(a)(3) imposes no separate duties on plan fiduciaries. The lower court had found that ERISA duties arise only under such provisions as section 406(a), which is part of the fiduciary rules of Part 4, and not under the remedial provisions of Part 5. The Court disagreed, finding that defendant status may arise from duties imposed by section 502(a)(3) itself rather than "under one of ERISA’s substantive provisions." The proof is that section 502(l) provides for civil penalties to be imposed on recoveries against an "other person" who "knowing[ly] participat[es]" in "any…violation of…part 4…by a fiduciary," referring to section 502(a)(5), which is the equivalent of section 502(a)(3) for lawsuits by the Secretary of Labor rather than private parties. Because section 502(l) plainly implies that section 502(a)(5) suits by the Secretary of Labor may be brought against "other persons" who are not fiduciaries, the same would hold true for section 502(a)(3) suits by private plaintiffs.

It was at this point in its analysis that the Court distinguished Mertens. In Mertens, the court had read "other persons" in section 502(l) to be limited to co-fiduciaries, so that there was no need to read it to extend to non-fiduciaries. In Harris Trust, the Court described this statement as a suggestion made in dictum, merely flagging the issue without discussion. Now, the Court is saying that the term "other person," as used in section 502(l), is clearly distinguished from a fiduciary.

The next step was to address the argument that this reading of ERISA was too broad, extending ERISA liability to innocent parties who may have no connection to the alleged fiduciary breach. In response, the Court cited the "limiting principle explicit in § 502(a)(3): that the retrospective relief sought be ’appropriate equitable relief.’" Slip op. at 10. This concept was explained by analogy to the common law of trusts.

Under the common law of trusts, where a third person receives trust property as the result of a breach of trust, the trustee or beneficiaries may maintain an action for restitution of the property (if still held) or disgorgement of proceeds (if disposed of) from that third person, who has taken the property subject to the trust, unless the person purchased the property for value and without notice of the fiduciary’s breach of duty. The Court continued:

This analysis relies on analogy to common law. Salomon argued that such an analogy made no sense because section 406(a) prohibited transactions were unknown at common law, but the Court rejected this argument as an unsupported suggestion.

A more general argument made by Salomon was that ERISA should not be construed to require parties dealing with plans to monitor ERISA compliance. The Court deferred this issue as one relevant to the determination of what a transferee should (or should not) be expected to know when engaging in a transaction with a fiduciary. This discussion included citations to the recordkeeping requirements of PTE 75-1, although it is unclear what that was supposed to demonstrate. The Court seemed to emphasize that these recordkeeping requirements were imposed on the plan, thereby not imposing additional requirements on counterparties to plan transactions. The Court failed to note that subsequent exemptions have imposed the recordkeeping requirements on the counterparties themselves rather than the plan.

Salomon also argued that its position was supported by legislative history rejecting language that would have imposed a duty on non-fiduciary parties to section 406(a) prohibited transactions, but the Court refused to look beyond the text of the statute where it said that the statute itself provides a clear answer.

The Court therefore concluded that an action for restitution against a transferee of "tainted plan assets" constitutes an action for "appropriate equitable relief" under section 502(a)(3). The case was remanded for further proceedings.

After Mertens, many ERISA practitioners thought that the concept of non-fiduciary liability under ERISA was finished. The case had seemingly rejected the notion that a non-fiduciary could be held liable for knowingly participating in a fiduciary breach, a theory developed in the lower courts based on the common law of trusts. Subsequent decisions accepted this holding for section 404 liability cases, but developed the concept of holding non-fiduciaries liable for knowing participation in a prohibited transaction under section 406. It was never clear to us why section 406 should be any different from section 404 in this regard.

Mertens, it turns out, should be read narrowly. That opinion in fact began by acknowledging that the dispute was limited to the forms of relief available for the alleged violation, which was odd, said the Court, given that it was unclear whether a "remediable wrong" had even been alleged. In light of Harris Trust, it is now clear that Mertens should be read as limited to the issue of whether damages are available as a remedy in an action brought under section 502(a)(3) (the answer being no), and not as speaking more generally as to which parties may be subject to "appropriate equitable relief" under that provision.

In light of this history, it can be argued that the Harris Trust holding also should be read narrowly. The case deals solely with non-fiduciary liability for a party in interest who participates in a transaction prohibited by section 406(a), an area in which a good case can be made for non-fiduciary liability – the party in interest status reflects the prohibited nature of the party’s dealings with the plan, and that party also would be subject to excise tax liability for the same transaction. The case does not address non-fiduciary liability for transactions prohibited by section 406(b), a subject raised in circuit court opinions. In addition, it does not address non-fiduciary liability for transactions that violate the section 404 fiduciary duties. Consequently, the Harris Trust holding itself stands only for the proposition that a party in interest may be liable as a non-fiduciary in connection with a section 406(a) violation. Nevertheless, the Court’s expansive interpretation of "other person" as used in section 502(l) can easily be extended to persons other than parties in interest, particularly given the Court’s view that section 502(a)(3) can impose duties outside of ERISA’s "substantive provisions."

The groundwork for future litigation is laid by the Court’s discussion of the limitations on section 502(a)(3) liability. To be subject to section 502(a)(3) liability, the party in interest must have "actual or constructive knowledge" of the circumstances that rendered the transaction unlawful, i.e., that the plan fiduciary satisfied the elements of a section 406(a) transaction. This may be difficult to demonstrate, and the Court left the issue of how to allocate the burden of proof for the lower court on remand. Furthermore, only "equitable" relief can be requested. The Court said that restitution relief is equitable in nature, but lower courts have struggled with the issue of what is restitution relief as opposed to what is damages relief – because damages are not equitable in nature, as held by Mertens.

An important issue raised by the defendants, and acknowledged by the Court, is to what extent non-fiduciary parties in interest may now have an obligation (or more of an obligation) to monitor ERISA compliance when they engage in transactions with plans. The Court’s citation to the recordkeeping obligations of a plan under a class exemption does not even begin to answer the question. Many parties currently protect themselves by obtaining representations from the responsible plan fiduciary that the transaction does not violate ERISA, which in most circumstances may meet the "actual or constructive knowledge" standard described by the Court absent clear indications that the representation was made recklessly or in bad faith. Because of the risk that non-fiduciary liability may now extend to non-parties in interest, it may become incumbent for any party dealing with a plan, not just parties in interest, to obtain such representations and assurances. Parties may thus start to look for additional assurances, or additional consideration for the increased risk of dealing with a plan, in the post-Harris Trust era.

A possible consequence of the Court’s holding is an impact on ERISA preemption cases. A recent case held that a suit against a law firm for charging excessive attorneys’ fees to a plan was preempted by ERISA, because ERISA provides a separate cause of action against non-fiduciaries who engage in prohibited transactions. Rutledge v. Seyfarth, Shaw, Fairweather & Geraldson, 24 EBC 1149 (9th Cir. 2000). While this seemed to be an overly broad reading of the ERISA preemption provision prior to the Harris Trust opinion, because excessive attorneys’ fees is generally an issue to be dealt with under state law, that may no longer be the case post-Harris Trust. It can be awkward to apply ERISA remedies to such situations, because in order to claim that the non-fiduciary knowingly participated in the violation, the fiduciary bringing the action would have to acknowledge that it knowingly violated its fiduciary duties by paying those fees. (The Court did not view this as a problem, because the common law "sees no incongruity" in a rule that permits the culpable fiduciary to seek restitution from a counterparty-transferee.) Since courts have interpreted ERISA not to permit recovery of punitive or other extra-contractual damages, parties may actually be better off suing under state law.

One of the interesting aspects of the Court’s opinion is the reliance on the common law of trusts. Many courts have relied on trust law in interpreting ERISA, and in fact the general concept of non-fiduciary liability for knowing participation in a fiduciary breach was originally developed by the courts based on trust law concepts. The unfortunate part was the Court’s offhand rejection of the argument that common law principles may not be appropriate when dealing with the ERISA prohibited transaction rules. The prohibited transaction rules are considerably more strict than common law, and come with their own comprehensive set of remedies – damages, excise taxes and civil penalties. The rules are complicated and often serve as traps for the unwary. Courts should exercise care before expanding upon the strict penalties that already apply to parties engaging in prohibited transactions, particularly the section 406(a) prohibited transaction rules that impose per se liability.

For these reasons, it is difficult to know how to read the Court’s opinion. The fact that it was unanimous raises even more questions, since the absence of a dissent or concurrence denies insights that could have been helpful in trying to understand the limits of the Court’s holding. Consequently, while important questions as to the scope of non-fiduciary liability under ERISA have been resolved, and it is clear that the door is open to lawsuits against non-fiduciaries, more questions remain for future court opinions.