The first case on which Milbank, Tweed, Hadley & McCloy partner Sean Murphy was assigned right out of law school in the mid-1990s was in the somewhat unique securities litigation world created by the Investment Company Act of 1940 or simply the '40 Act.
The beginnings were auspicious, as Murphy has become a leading litigator in the area, helping to make Milbank arguably the top firm to handle investor suits against investment advisers under the even more specific Section 36, which governs fiduciary duties.
Murphy, a 14-year veteran of the firm, has worked on dozens of such cases over the past two decades. However, the rate at which those cases go to trial is small. According to Murphy, only nine have done so, and the firm has handled six of those. Of those six, Murphy has tried the only two to go to trial in the last 25 years, winning both.
Most recently, Murphy, along with partners James Cavoli and Robert Hora, in 2016's Sivolella v. AXA Equitable Life Insurance Company, 11-cv-04194 and 2017's Kasilag v. Hartford Investment Financial Services 11-cv-01083, both in the District of New Jersey, scored significant wins for clients facing hundreds of millions in potential liabilities. The decisions in those cases are likely to set new standards that Murphy said will be critical to this area of the law going forward.
Q: How are these '40 Act cases substantively different from traditional class action suits?
A: It's like a class action: they're basically seeking a return of fees from the fund, which means all shareholders. In that regard, they're similar. It's a way for the plaintiffs bar to bring a case that potentially isn't on behalf of one plaintiff, it's on behalf of a whole bunch of plaintiffs. Therefore they can seek big damages.
But it's not a class action. The statute, Section 36(b) of the 40 Act allows the plaintiff to find a single shareholder in a fund and bring a claim on behalf of all shareholders of that fund seeking a return of fees without having to go through the process of getting class certification.
There are also bells and whistles on 36(b) that make it more difficult for the plaintiff's bar in terms of succeeding namely, it's a bench trial, not a jury trial. Plaintiffs love to scare people with juries, so they don't have that. They also bear the burden of proving a breach of fiduciary duty under 36(b). So there are some hurdles built into the statute that, while in some ways it's easier to bring a claim on behalf of all shareholders, actually recovering is a little bit more difficult in some of the other traditional securities cases.
Q: Your firm has represented six of the last nine cases that went to trial under this 40 Act provision why so few?
A: Quite frankly I think it's because we've done a good job beating the plaintiffs back. I think if we'd lost a couple of these things you'd have seen a lot more of them. There's always been 36(b) litigation, and there's probably two-dozen filed in the last couple years. That's a lot for right now; two dozen of any one type of case is quite a number.
Plaintiffs are not entrepreneurial; if they can make money, they're going to file more. We've tried six cases, we've won all six of them, including the last three, two last year. That certainly limits the willingness of plaintiffs to file more of these things.
Q: What can you tell me about these two trials you most recently did?
A: The two trials last year were called manager-of-manager cases. The allegation was that the mutual fund adviser hired the sub-adviser to manage the portfolio, and only gave the sub-adviser a small portion of the fee, and kept the bulk of it for himself for not doing very much.
That was the allegation. At trial we proved that the adviser was doing a huge host of things on top of the sub-adviser. Not only overseeing the sub-adviser and participating with the sub-adviser in many aspects of the management of the portfolio, but also held on to a huge number of responsibilities, like administration, compliance, pricing, dealing with the mutual fund board, and things like that.
So that was the bulk of the theory and what we had to do to disprove it. But there are many factors that come into play in these cases, like concepts like economies of scale and fallout benefits, that are unique to this area of the law. I would say some of what we did that was nice in these cases was setup some precedent that's very helpful among those factors and will be very precedent-setting for the other almost two-dozen cases that are out there.
These were the first to go to trial of this wave of these so-called manager-of-manager cases. Everyone was looking at them to say, well, geez, we have a case that's similar or we have another case under 36(b) what's going to happen, and how do these help us? The decisions were really long, thoughtful, chock full of really helpful stuff for the industry.
Q: What among these are going to be the top things that you think will impact litigation in this area going forward?
A: One would be the ability of a manager to be compensated for the risks that it takes. When assessing an adviser's fee, one of the things the court took account of is the risk that the manager faces in managing a mutual fund. Think of regulatory risk: If you're managing a large mutual fund and you screw something up, like a pricing error and the shareholders say, "I want my money back, pay me $50 million," or the SEC comes in because somebody screwed something up and you're fined $50 million. Nobody's going to want to be in that business and make $25,000 a year if you can be tagged for a $50 million fine.
We've been arguing this for over two decades. Both cases picked up on it this time, which is the first time it's ever been done, and we think that's the correct decision of the law. It's very helpful for advisers, and I think it will be very important for the industry.
Another thing I would point to in the AXA decision, the judge was really critical of the plaintiffs' experts. I think we did a very good job cross-examining their experts and impugning their credibility. The judge really relied on the lack of credibility in finding for AXA. It really was damaging to their opinions and their credibility. The plaintiff's bar had been using these experts in every one of these cases. They came up in Hartford again. They were hired at that time in maybe eight or nine cases, and this judge really took them apart and took them to task. In those cases where they'd been the experts for plaintiffs they really have a big hill to climb. If you look at some of the newer cases that are making their way to expert discovery the plaintiffs have dropped their traditional experts. That's a big advantage for the industry, to get rid of these guys who've been perennial experts against the industry for 15 years now.
Q: Given these victories, what do you see coming in the future of this area of litigation?
A: If you look back in time, this statute has been around since 1970. These cases come in waves and then we kind of beat them back. Then they go away for awhile, and then five years later a new crop of plaintiffs pop up and file a dozen of them. That's the way it's been: they come in waves, and if you win, they go away. It's usually not the same plaintiffs. It's a new set of plaintiffs that say, "What is this great statute that allows me to sue without seeking class certification?"
I tend to think this wave is going to die out. Clearly they're facing a lot of headwinds now with the precedent we've created. We're going to have a quiet period for a couple of years before some new set of plaintiffs come along and pick it up again, and we'll be back at it. But it ebbs and flows like that as it has for the last 45 years.
