The Seventh Circuit aptly assessed the Mertens dicta, noting that the majority opinion:

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1 A New Twist on Nonfiduciary Liability Journal of Pension Benefits Winter 1999 Tess J. Ferrera Details Is knowing-participation cause of action available under ERISA? The author looks at a recent case that seems to conflict with conventional wisdom and Supreme Court precedent. Since the Supreme Court's ruling in Mertens v. Hewitt Associates [508 US 248 (1993)], the conventional wisdom has been that ERISA does not provide a cause of action against a nonfiduciary, non-party-ininterest who knowingly participates in a fiduciary's breach of fiduciary duties. Although in Mertens the Court was not squarely presented with the question, it nonetheless stated its views on whether a knowing-participation cause of action was available under ERISA, albeit in dicta. Writing for the majority, Justice Scalia stated: while ERISA contains various provisions that can be read as imposing obligations upon nonfiduciaries..., no provision explicitly requires them to avoid participation (knowing or unknowing) in a fiduciary's breach of fiduciary duty. It is unlikely, moreover, that this was an oversight, since ERISA does explicitly impose "knowing participation" liability on cofiduciaries. That limitation appears all the more deliberate in light of the fact that "knowing participation" liability on the part of both cotrustees and third persons was well established under the common law of trusts. In Russell we emphasized our unwillingness to infer causes of action in the ERISA context, since that statute's carefully crafted and detailed enforcement scheme provides "strong evidence that Congress did not intend to authorize other remedies that it simply" forgot to incorporate expressly. [Id, at (internal citations omitted, emphasis added)] The Court's dicta was strong enough that three courts of appeals subsequently held that Mertens precluded a knowing participation cause of action against nonfiduciaries who allegedly participated in a breach of fiduciary duty. [See Reich v Compton, 57 F 3d 270 (3d Cir 1995); Reich v Rowe, 20 F 3d 25 (1st Cir 1994); and Reich v Continental Cas Co, 33 F 3d 754 (7th Cir 1994)] The Seventh Circuit aptly assessed the Mertens dicta, noting that the majority opinion: goes out of its way to throw cold water on the idea of an implied liability of nonfiduciaries for knowing participation in fiduciary misconduct. The discussion is dictum, but it is considered dictum...it would be reckless to think the Court likely to adopt a contrary view in the near future. In such a case the dictum provides the best, though not an infallible, guide to what the law is, and it will ordinarily be the duty of a lower court to be guided by it. [Continental Cas Co, 33 F 3d at 757]

2 With some exceptions, the Mertens dicta has generally been followed by the lower courts, and since Mertens there has been a general understanding that a knowing-participation cause of action against a nonfiduciary is unavailable under ERISA. In LeBlanc v. Cahill [153 F 3d 134 (4th Cir 1998)], however, the Fourth Circuit may have disposed of this notion, at least when the fiduciary breach involves a prohibited transaction. Can LeBlanc be squared with Mertens? The LeBlanc Decision The Sheet Metal Workers National Pension Fund, its administrator, and the union president brought suit against Edward I. Williams, the Fund's former investment manager, and other former Fund fiduciaries and service providers. The Fund also sued a number of nonfiduciaries who were not partiesin-interest to the Fund within the meaning of ERISA Section 3(14). Collectively, these nonfiduciary defendants will be referred to as the Larken defendants. The Larken defendants included Larken Inc., a corporation engaged in operating and managing hotel properties, its owners Lawrence and Kenneth Cahill, Larken Properties, Inc. (LPI), a corporation engaged in real estate ventures, and LPI's principal shareholders and officers, who included the Cahill brothers, James Beck, and Charles Underbrink. Larken Inc. owned many of the hotels that it managed. Most were Holiday Inns. In 1986, Beck and Underbrink agreed to serve as investment bankers for Larken Inc. and eventually arranged for a $60,750,000 mortgage to refinance about $40,000,000 worth of debt on 17 hotels owned by Larken Inc. The new mortgage was due and payable in From about 1988 through mid-1989, efforts were made to offer the 17 Larken properties and 5 other leveraged hotels to 100 potential investors, but very few expressed an interest. The 22 properties were thereafter placed in a limited partnership that was formed by Larken, the Cahills, Beck, and Underbrink and in which LPI served as the general partner. In 1989, James Beck offered Williams, the Fund's investment manager, the opportunity for the Fund to invest in the limited partnership. The Fund's due diligence team asked Arthur Andersen & Company to evaluate the Fund's exposure if it invested in the limited partnership. In spite of Arthur Andersen's conclusion that it was a bad investment, Williams advised the Fund to invest $15 million in the limited partnership. It was later discovered that James Beck had told Williams that if the Fund invested in the limited partnership, the Larken defendants would involve him in managing some of the properties and pay him an additional fee for providing due diligence reports to other pension funds that were interested in investing in the limited partnership. When the limited partnership defaulted on the interest payments on the note held by the Fund, the Fund filed a lawsuit against, among others, Williams. The complaint alleged that Williams, a Fund fiduciary and party-in-interest, had engaged in transactions prohibited by ERISA Sections 406(b)(2) and 406(b)(3). Section 406(b)(2) of ERISA prohibits a fiduciary from sitting on both sides of a transaction involving a plan and a party adverse to a plan, and ERISA Section 406(b)(3) prohibits a fiduciary from accepting a kickback or other consideration in a transaction

3 involving a plan. The complaint also alleged that the Larken defendants were liable to the Fund under ERISA Section 502(a)(3) for knowingly participating in the prohibited transactions that Williams had committed. Specifically, the complaint alleged that the Larken defendants participated in Williams's selfdealing by promising Williams that they would help him start a business in which he would receive a fee for advising other plans to invest in the limited partnership, if Williams himself would invest plan assets in the limited partnership. The district court dismissed the ERISA claims against the Larken defendants, holding that Mertens foreclosed a knowing-participation cause of action against them. The Fourth Circuit reversed. It held that Mertens did not preclude an action against the Larken defendants as nonfiduciary non-parties-ininterest because: (1) any discussion in Mertens about a knowing-participation cause of action was nonbinding dicta; (2) Mertens did not really address the question of knowing participation in the context of prohibited transactions; and (3) Mertens acknowledge that ERISA allows actions against nonfiduciary parties-ininterest who participate in a prohibited transaction, and therefore, the court said, by analogy, ERISA permits actions against non-parties-in-interest who participate in prohibited transactions. In support for its conclusion that the Larken defendants could be sued under ERISA for knowingly participating in a prohibited transaction, the court cited numerous post-mertens federal appellate decisions holding that a party-in-interest to a plan within the meaning of ERISA Section 3(14) who participates in a prohibited transaction may be liable for equitable relief under ERISA Section 502(a)(3) or (5). [See Herman v SC Nat'l Bank, 140 F 3d 1413, (11th Cir 1998); Reich v Stangl, 73 F 3d 1027, (10th Cir) cert denied, 117 S Ct 48 (1996); Landweher v Dupree, 72 F 3d 726, (9th Cir 1995); Compton, 57 F 3d at ; and Rowe, 20 F 3d at 31 n 7] As explained below, the Fourth Circuit's reliance on these cases is misplaced. ERISA Recognizes a Cause of Action Against Parties-In-Interest ERISA Section 406(a) creates per se prohibitions against certain transactions involving a plan and specified related parties, unless a statutory or administrative exemption is available. The specified related parties-ininterest who may not participate in a Section 406(a) transaction involving a plan are defined by ERISA Section 3(14) and include about 21 categories of persons, such as fiduciaries, service providers, and employers who sponsor plans. The transactions prohibited between a plan and a party-in-interest by Section 406 (a) include the sale, exchange, or lease of any property or the making of a loan to a party-ininterest. [See ERISA 406(a)(1)(A), (B)] Section 406(a) also prohibits the furnishing of goods or services between a plan and a party-in-interest and the transfer to or use of plan assets for the benefit of a party-ininterest. [See ERISA 406(a)(1)(C), (D)] There are statutory and administrative exemptions that, if applicable, permit the plan to engage in an otherwise prohibited transaction. [See ERISA 408(a), (b)] If no exemption applies, however, the enumerated transactions in Section 406(a) are prohibited.

4 A Section 406(a) prohibited transaction requires the presence of at least three elements: (1) a fiduciary that causes the plan to engage in the transaction; (2) a transaction that is one of the enumerated transactions in Section 406(a); and (3) a transaction that involves a "party-in-interest" within the meaning of ERISA. If there is no party-in-interest involved in a transaction enumerated in Section 406(a), the transaction may be imprudent and the fiduciary liable under ERISA Section 404, but there will not be a prohibited transaction within the meaning of ERISA Section 406(a). [Brock v Gerace, 635 F Supp 563 (D NJ 1986)] Accordingly, there would be no party-in-interest liability. Unlike Section 406(a), ERISA Section 406(b) does not mention or discuss prohibited transactions between the plan and a party-in-interest. Section 406(b) forbids a fiduciary from using plan assets in his or her own self-interest, representing both sides of a transaction when one side is adverse to the plan, and accepting kickbacks or other consideration from a party in a transaction involving a plan. ERISA Section 406(b) proscribes certain acts and practices of self-dealing by a plan fiduciary. It does not address nonfiduciary misconduct or impose obligations on nonfiduciaries. Unlike ERISA Section 406(b), the provisions of Section 406(a) "can be read to [impose] obligations against nonfiduciaries..." [Mertens, 508 at ] ERISA Section 406(a) specifically refers to transactions in which parties-in-interest may not participate. [Id, at 254, n 4] Under this reasoning, federal courts of appeals have unanimously held that ERISA Section 502(a)(3) authorizes a cause of action against a party-in-interest who participates in a prohibited transaction. [See, e.g., SC Nat'l Bank, 140 F 3d 1413 (11th Cir 1998); Stangl, 73 F 3d 1027, (10th Cir); Dupree, 72 F 3d 726 (9th Cir 1995); Compton, 57 F 3d 270 (3d Cir 1995); and Rowe, 20 F 3d 25 (1st Cir 1994)] In reaching this conclusion, courts have recognized that the language of Section 502(a)(3) "expressly grants equitable power to redress violations of ERISA and that transactions prohibited under Section 406 constitute violations for which equitable relief may be obtained." [See Stangl, 73 F 3d at 1030] As the Ninth Circuit has said, "Courts may find it difficult or impossible to undo such illegal transactions unless they have jurisdiction over all parties who allegedly participated in them." [Nieto v Ecker, 845 F 2d 868, 874 (9th Cir 1988)] Moreover, the Supreme Court in Mertens recognized, albeit also in dicta, that ERISA Section 502(a)(3) authorizes a cause of action against a party-in-interest who participates in a prohibited transaction, at least for the purpose of obtaining equitable relief. [Mertens, 508 US at 254, n 4] In subsequent cases the Supreme Court has "declined to retreat from that dicta." [LeBlanc, 153 at 152 (citing Lockheed Corp v Spink, 517 US 882, 889 n 3, 116 S Ct 1783 (1996)] Accordingly, whereas there is well-established case law under ERISA for actions against parties-ininterest who participate in a transaction prohibited by ERISA Section 406(a), the same is not true for acts proscribed under ERISA Section 406(b) because, simply put, Section 406(b) does not govern or proscribe nonfiduciary behavior.

5 The LeBlanc Court and ERISA Section 406(A) and (B) The LeBlanc court held that the distinctions between ERISA Section 406(a) and (b) were "without a difference." [LeBlanc, 73 F 3d at 153] It stated that: Nothing in the Supreme Court's dicta in Mertens or Lockheed suggests that allowing equitable relief to be obtained from nonfiduciary parties in interest who participated in a transaction prohibited under ERISA 406(a)(1) would be any different if the transaction were prohibited under ERISA 406(b)(2) or 406(b)(3). The key requirement for liability is that the subsection at issue expressly prohibits a transaction involving a nonfiduciary third party. [Id, at 153 (emphasis added)] In making this statement the Fourth Circuit reveals its faulty and unsound reasoning in finding a cause of action against non-parties-in-interest under a party-in-interest theory of liability. First, as discussed above, Section 406(b) governs only fiduciary acts; it does not impose obligations on nonfiduciaries. Second, a key requirement for nonfiduciary liability under Section 406(a) is not the presence of just any third party. The third party must be a party-in-interest within the meaning of ERISA Section 3(14), or there is no prohibited transaction and accordingly no nonfiduciary liability. Third, there is cause to pause in making the leap to non-party-in-interest liability under Mertens and Lockheed. In Mertens, the Supreme Court stated again that it is unwilling "to infer causes of action in the ERISA context, since that statute's carefully crafted and detailed enforcement scheme provides strong evidence that Congress did not intend to authorize other remedies that it simply forgot to incorporate expressly.'" [Mertens, 508 US at 254 (quoting Massachusetts Mut Life Ins Co v Russell, 473 US 134, (1985)] In finding that ERISA authorizes a cause of action against nonfiduciary, non-parties-in-interest, LeBlanc seems to have created a new cause of action under ERISA, and one that the Supreme Court strongly questioned in Mertens. Lockheed should also have given the Fourth Circuit pause. In that case, the Supreme Court chastised the Ninth Circuit for failing to evaluate whether a fiduciary had caused the plan to engage in the alleged transaction prohibited under ERISA Section 406(a)(1)(D). The court noted: In order to sustain an alleged transgression of 406(a), a plaintiff must show that a fiduciary caused the plan to engage in the allegedly unlawful transaction. Unless the plaintiff can make that showing, there can be no violation of 406(a)(1) to warrant relief under the enforcement provisions. (Citations omitted). The Court of Appeals erred by not asking whether fiduciary status existed in this case before it found a violation of 406(a)(1)(D). [Lockheed, 116 S Ct 1783 at ] In LeBlanc, the Fourth Circuit never explains how or why a theory supporting liability against a nonfiduciary party-in-interest who participates in a prohibited transaction can rationally be used to extend liability to nonparties-in-interest. LeBlanc's sole support for its finding that a non-party-ininterest may be liable for allegedly participating in a prohibited transaction is dicta in Compton. [LeBlanc, 73 F 3d at 153 (citing Compton, 57 F 3d at )]

6 In Compton, the Third Circuit, in the context of discussing party-in-interest liability, stated that Section 406(a)(1)(D) extends the scope of liability under ERISA beyond fiduciaries and parties-in-interest. [Compton, 73 F 3d at 287] Section 406(a)(1)(D) of ERISA prohibits a fiduciary from transferring to or using plan assets by or for the benefit of a party-in-interest. [Id, at 287] If in Compton the Third Circuit meant to say that a non-party-in-interest could be liable under Section 406(a)(1)(D), then the dicta in Compton is simply wrong and the Fourth Circuit's reliance on that dicta lacks support. The Third Circuit's dicta, however, can be read less expansively. Maybe the Third Circuit only meant to say that liability under Section 406(a) (1)(D) may trigger against a party-in-interest if the party-in-interest benefits from the transfer of plan assets even though the recipient of the plan assets is a third party. If the Third Circuit's dicta is narrowly construed, then it is consistent with Section 406(a), which prohibits direct or indirect transfers of plan assets if the transfer is for the benefit of a party-in-interest. And, accordingly, Compton would provide no support for the Fourth Circuit's position in LeBlanc. So What is the Remedy? In their complaint, plaintiffs seek to restore to the Fund all losses the Fund experienced as a result of the investment. [LeBlanc, 153 F 3d at 153]. In LeBlanc, the Fourth Circuit indicates that such relief can be considered a form of equitable relief, and thus available against the Larken defendants if judgment issues against them under ERISA Section 502(a)(3). [Id] In Mertens, the Supreme Court characterized this type of relief as "the classic form of legal relief" and decided such relief was unavailable under ERISA Section 502(a)(3). [Mertens, 508 U.S. at 255] Accordingly, unless plaintiffs can demonstrate that the Larken defendants were unjustly enriched as a result of Williams's prohibited transactions, relief against the Larken defendants may be a problem or at least become an issue on appeal. Conclusion The common law of trusts recognizes a cause of action against third parties for participating in a fiduciary's breach of fiduciary duty that also allows joint and several liability against a nonfiduciary for all direct and consequential damages suffered by the plan. [4 A Scott & W Fratcher, Law of Trusts 326, p 291 (4th ed 1988); Mertens 508 US at 262] The common law of trusts would have given the Fourth Circuit a sound legal basis for finding the Larken defendants liable as nonfiduciaries and nonparties-in-interest. Mertens appears to have foreclosed this option. In Mertens, however, the Supreme Court noted that under traditional trust law, only the formal trustee had fiduciary duties. [Id] In contrast, ERISA expands "the universe of persons subject to fiduciary duties -- and to damages." [Id] Thus, the Supreme Court may have decided that the common-law theory of liability was unnecessary in ERISA, because a third party might be deemed a fiduciary by virtue of his or her control or authority over the plan or its assets and accordingly be subject to liability under ERISA as a fiduciary.

7 If the Larken defendants' actions in persuading Williams to invest in the limited partnership made them fiduciaries to the Fund, then the LeBlanc plaintiffs might have a fiduciary-breach liability against the Larken defendants. After all, a person need not have exclusive, complete, or final decision-making authority to be a fiduciary within the meaning of ERISA. [Firestone Tire & Rubber Co v Bruch, 489 US 101 (1989); see ERISA 3(21)(A)] Of course, plaintiffs would have to prove that the Larken defendants were fiduciaries. A theory of fiduciary liability would have been more consistent with current law and not stretched beyond recognition the theory of party-in-interest liability. The LeBlanc opinion presents an interesting twist on nonfiduciary liability. Its survival will depend to some extent on whether other circuits pick up where LeBlanc leaves off. Given the faulty reasoning in the case, it can only be hoped that LeBlanc will not be followed. This article appeared in the Winter 1999 issue of Journal of Pension Benefits and is reproduced with permission from the Journal of Pension Benefits Schiff Hardin LLP This publication has been prepared for the general information of clients and friends of the firm. It is not intended to provide legal advice with respect to any specific matter. Under rules applicable to the professional conduct of attorneys in various jurisdictions, it may be considered attorney advertising material. Prior results do not guarantee a similar outcome. For more information visit our Web site at