recent developments in legal liability for financial advisors a presentation by dolden wallace...

Recent Developments in Legal Liability for Financial Advisors

A presentation by Dolden Wallace Folick LLP on behalf of AXIS/Magnes Group

Scope of presentation

• Regulatory framework

• Tort obligations (negligence)

• Contractual obligations

• Fiduciary obligations

• Damage issues

Insurance Law Expertise… It’s our policy.

Statutory framework for financial advisors

• Regulatory framework

• Tort obligations (negligence)


Administrative framework for financial advisors

• These guidelines used by Judges as standard of care

• “know your client” rule

• “know the product” rule


Who?

• 2008 merger of Investment Dealers Assoc. and Market Regulation Services

• Result: Dealer Member Rules

Investment Industry Regulatory Organization


Who?

• Creation of “Conduct of Practice Handbook”

• Issuance of “National Instruments”

Gale v. Scotia McLeodNewfoundland – 2008

Canadian Securities Institute


Who?

• Creation of “Annotated Rule Book”

• “Know Your Client” rule

Mutual Fund Dealers Association of Canada


Difference between a financial advisor and an

investment advisor?

Financial planners and advisors have wider duties than investment advisors

Young v. RBC Dominion Securities

Ontario – 2008


Liability in contract for financial advisors

• Implied term you keep your client fully informed

• Problem with a discretionary account

Davidson v. Noram CapitalOntario - 2005

• Problem of a non-discretionary account

• “order taker” v. “portfolio manager”


Liability in tort for financial advisors

• Problem of “pure economic loss”

• Exception to rule for professional services


Rules developed in Young v. RBC Dominion

• Exercise reasonable skill and care

• Concurrent liability in tort and contract

• Beyond this duty liability depends upon the facts

• Standard of care higher if inexperienced client

• As you move from “order taker” to “advisor” the standard of care increases


• The advice given can increase the duty

• If the investment is not suitable for the client the duty to warn increases

• Have to warn about the risk of borrowing money to invest

• Non-compliance with administrative guidelines gives rise to liability if it caused the loss


• Cardinal rule is “know your client” – designed to ensure the investment decisions are suitable

• What is suitable is a function of client’s age, income, net worth, investment knowledge and risk tolerance

• After the investment is made the advisor has to monitor the ongoing suitability of the investment


• The “suitability” rule is known as “know your product” rule

• You cannot leave the “know your product” rule to the client to figure out

• When you recommend a product you have to disclose the “pros” and “cons”

• A “market downturn” is something the advisor should anticipate

• Mature adults can make “foolish decisions” after you warn themInsurance Law Expertise… It’s our

policy.

Content of the “Know Your Client” Rule

• The advice to invest must be consistent with the client’s objectives

• Ongoing need to monitor the suitability of the earlier investments as the client’s needs change

• If the client’s suggestions don’t make sense the duty to warn increases


Content of the “Know Your Client” Rule

• If the client is unsophisticated and the instructions are not consistent you have to refuse to do the purchase

• If the client is sophisticated you warn the client but can proceed with the purchase

• The duty to warn varies as the client’s appetite for risk increases or decreases over time


Factors to consider on the “know your client” rule:

• What the money is being invested for – the client’s objectives

• The client’s available other wealth

• Whether the client can realistically reach his or her financial goal


Factors to consider on the “know your client” rule:

• Client’s ability to survive if the investment does poorly

• Client’s ability to deviate from the plan

• The “time horizon” of the client’s goals

• The client’s personal income tax situation


When is a financial advisor liable for breach of fiduciary duty?

• Does the client trust the financial advisor?

• Does the financial advisor say he or she has expertise?

• Does the financial advisor have discretion how the money is invested?

• Guidance from the Professional Rules or Codes of Conduct

Four criteria the judges examine:


Why would youcare whether there is liability for

breach of fiduciary duty?• Affirmative duty to disclose material

facts

Turcotte v. Global SecuritiesB.C. 2000

• The investment monies are trust fund (if stolen or advisor insolvent)


CSA Consultation Paper – Raising the Standards?

• Canadian Securities Administrators issued “Consultation Paper 33-403”, Oct. 25, 2012

• Proposes imposing statutory “best interest” standard to improve investor protection

• Comments closed, Feb. 22, 2013

Example of “Best Interest” Standard

Every adviser and dealer (and each of their representatives) that provides advice to a retail client with respect to investing in, buying or selling securities or derivatives shall, when providing such advice,(a) act in the best interests of the retail client and(b) exercise the degree of care, diligence and skill that a reasonably prudent person or company would exercise in the circumstances.

Concerns with Current Standards

• Current standards too “commercial” – buyer beware

• Informational asymmetry between advisers and clients

• “Expectation gap” – clients think advisers always acting in client’s best interests

• Suitable investments not always in best interests

• Current conflict rules possibly weak

Possible benefits of “best interest” standard

• Principle-based approach alleviates need for prescriptive rules

• Align standards with investor expectations

• Reduce uncertainty as to applicable standard

• Strengthen investors’ legal remedy for breach of fiduciary duty

Potential downsides of “best interest” standard

• May impose greater cost on advice• Reduce access to advisory services• Uncertain impact on capital raising,

compensation• Industry may need guidance on

application of principles in specific circumstances

Industry Responses

• Extensive responses – posted by OSC• Industry – ranges from guarded to

critical• Proposal vague and unnecessary• Resists “one size fits all” standard

• Consumer groups – generally supportive

Implications for advisors/planners

• Canadian standards may align more closely with UK, EU

• Underwriting focus shifts – more emphasis on insured’s training than target market

• Clearer standards could simplify claims handling – but also period of uncertainty

Why would advisors and planners care

whether there is liability for breach of fiduciary duty?

• Measure of damages greater – “expectation losses”

Schwarzkopf v. McLaughlinB.C. 2008


Is a “downturn” in the financial markets reasonably

foreseeable?

Rhoads v. Prudential Bache B.C. 1992


Contributory Negligence by the client

• What is it: client’s failure to act with reasonable care

• Client failure to make inquiries: 875121 Ontario Ltd. v. Nesbitt Burns

• Client’s failure to limit losses in a downward market: 595698 Ontario v. Midland Walwyn

• Client’s failiure to read his or her own mail: Penner v. Yorkton Securities


Ratification by the clients

• What is it? Turning a “blind eye” to what is happening

• Client has a choice when an error is made: silence means acceptance


Does the client have a duty to mitigate the loss?

• Contract, tort and fiduciary duty: same rule applies – must mitigate the loss

• How quickly does the client have to act to minimize the loss?

Secord v. Global SecuritiesB.C. 2003


Damages

Client must demonstrate what an alternative investment would have achieved

Young v. RBC Dominion Ontario 2008

Hawkenson v. RogersB.C. 2006


Damages

Client must reduce damages by any profits earned from the other investments

Secord v. Global Securities B.C. 2003


DOLDEN WALLACE FOLICK LLP

Insurance Lawyers


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Toronto

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recent developments in legal liability for financial advisors a presentation by dolden wallace...

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