In a recent report, ICI Mutual summarizes developments in 36(b) litigation since the Supreme Court’s Jones v. Harris decision. According to the report, plaintiffs have filed 26 Section 36(b) cases against 23 different advisers (or their affiliates), with the vast majority of cases pertaining to fund groups in the top 100 by AUM. Eight of those cases have been initiated in the last year alone. The report divides the cases into three major categories:
- Manager-of-manager cases where the primary adviser delegates most portfolio management responsibilities to sub-advisers. In these cases, the plaintiffs contend that the portion of the management fee retained by the primary adviser is “excessive.”
- Sub-advisory cases where the adviser being sued acts as an adviser for proprietary funds and as sub-adviser for funds sponsored by others. In these cases, plaintiffs contend that the fees the adviser charges to proprietary funds are excessive when compared to the fees that the adviser receives when acting as a sub-adviser.
- Other. Plaintiffs in these cases rely on different theories of adviser liability.
The report also provides the status of the cases that are currently pending. As of June 30, 2016, the status of the cases is as follows:
- Five are in early litigation, including three with pending motions to dismiss. (One motion to dismiss has been granted in this group, though the plaintiff retains the opportunity to refile.)
- 12 are in or are approaching discovery.
- Four (all manager-of-managers cases) are in late stages of litigation, including one that has gone to trial and is awaiting the judge’s decision.
- Five have reached final resolution.
According to the report, the following features of Section 36(b) may explain why the plaintiffs’ bar continues to pursue these cases:
- Fewer barriers to entry than either securities fraud cases or traditional derivative suits
- Advisers’ challenges in obtaining early dismissals
- Litigation costs that are significantly lower for plaintiffs than the defendant advisers
- Mixed results at the summary judgment stage
- Risks of going to trial that encourage parties to settle
- Typically private settlements that are generally not subject to judicial review.
The report predicts that the next 12 – 18 months will be significant with respect to litigation in this area because of a probable decision on the merits by a district court judge for the first time since Jones, a second lawsuit that will likely proceed to trial, and a decision on a pending motion to dismiss. According to the report, the developments over the next year or so “may influence (1) how litigants and courts address and resolve those post-Jones lawsuits that currently remain in the earlier stages of the litigation process, and (2) whether, and to what extent, the plaintiffs’ bar continues to initiate similar section 36(b) lawsuits against other fund advisers.”
While the report acknowledges that fund directors are rarely defendants in these cases and that there is little directors can do to stop cases against their funds’ adviser (or affiliate), it states that scrutiny of directors and their processes can be “intense.” The report suggests that directors focus on “three fundamental principles—preparation, process, and documentation” to “assist directors in managing “front-end” risk in section 36(b) litigation, so as to increase the likelihood that such litigation, if brought, will be resolved in a manner that reflects favorably on the care and attention that independent directors devote to the section 15(c) process.” In addition, ICI Mutual reminds directors that they may be called as non-party witnesses and recommends that they discuss with their counsel whether they can be indemnified for the costs incurred related to their testimony in these cases and that directors review the terms of their insurance policies to determine whether insurance will cover costs incurred by directors as non-party witnesses.