Canada: From The Courts: Investor's Obligations To Mitigate With Notice Of Regulatory Proceedings (And Their Relevance)

Last Updated: February 2 2016
Article by Suzanne Kittell and Laura Paglia

Most Read Contributor in Canada, November 2017

Investor's Obligations to Mitigate with Notice of Regulatory Proceedings (and their Relevance)

The plaintiffs were amongst several investors who lost money in corporations promoted by individuals who had been the subject of proceedings by the Alberta Securities Commission (ASC). The defendants were their chartered accountant, as was the company he incorporated for consulting work. Through this company, the accountant worked as strategist and consultant to Institute for Financial Learning, Group of Companies Inc. ("IFFL"), which was also the subject of ASC proceedings. A large portion of the accountant's income over the period in question due to the fees and commissions he earned through IFFL, which fees and commissions were not disclosed to the plaintiffs. Part of the Court's determination was whether the defendants were providing "information" or "advice". It was held that a chartered accountant should have questioned the legitimacy of the investments. The fact that he chose to invest his family members as well did not address his obligations to the plaintiffs. Based on the facts, the plaintiffs were found to have placed trust, confidence and reliance on their accountant and granted him a power that entitled them to expect that he would exercise his skills in their best interest. "The non-disclosure of his commissions was held to have prevented them from knowing theirs was a commercial relationship."

The plaintiffs were found to have limited financial investment knowledge and experience. The Court found that even experienced investors would be alarmed to learn that the companies that they had invested in had assets frozen, could not trade in securities and had an upcoming securities hearing. Despite the fact that the defendants expressed repeated confidence in the investments despite the ASC proceedings, it was held that the plaintiffs, upon notice of the regulatory proceedings, should have doubted or disregarded any assurances expressed by the defendants and liquidated what they could. At a minimum, they should have sought independent advice. Instead, they continued to invest more money that constituted a failure to take obvious steps to alleviate or reduce their losses.

Three ASC proceedings were filed during the trial by the plaintiffs without objection from the defendants. The Court held ASC determinations subsequent to the plaintiffs' investments were not determinative as to what these parties knew or did not do at the time of the plaintiffs' investments. These regulatory determinations were relevant to the extent that they were known or should have been known to the parties as to what the plaintiffs did or did not do thereafter with their investments. Read the full decision here.

Investor Claim From Market Crash Denied

The investments at issue were comprised of managed funds. A key issue was asset allocation between fixed income and equities. The Court held that non-compliance with regulatory requirements, including the Know Your Client (KYC) obligation, will not on its own form a basis for liability unless the non-compliance itself also caused the loss. The investor became increasingly anxious about her portfolio as the market continued to decline in the fall of 2008. The investments were sold against advice. The Court also noted that the investor continued to invest in equities, mainly precious metals subsequent to her departure from the dealer that she considered to be conservative and low risk. No damages were awarded. Read the full decision here.

No Requirement to Check Registration Status of Trading Authorization for Single Corporate Account

A no advice Corporate Account was opened at a discount brokerage dealer. There was a profit sharing agreement as between the corporation and the unregistered individual with Trading Authorization over the corporate account ("TA"), which corporation was wholly owned by one shareholder. The corporate account sustained losses as a result of trading by the TA. The corporation and its shareholder sued the dealer and alleged that the dealer had failed in its gatekeeper obligations.

On April 20, 2011, the shareholder became aware that the account had sustained a loss of $568,198.00. The Corporation's Chief Financial Officer ("CFO") called the dealer and told the representative on the phone that the TA was a rogue trader and he wanted to revoke his trading authorization. The shareholder subsequently spoke to the TA and decided to give him a second chance, but instructed the CFO to get daily statements from him. The TA provided false reporting to the CFO.

The plaintiffs alleged that the dealer should have responded to "red flags", that should have caused it to question whether the TA was acting as an unregistered investment advisor. They alleged that the dealer should have called the shareholder and inquired about his relationship with the TA and the TA's compensation before opening the account.

The claim was denied on the basis that there was no regulatory authority that requires the broker to contact the beneficial owner of a corporation and inquire about his relationship with the person being granted trading authority or to inquire into that person's compensation arrangements.

The plaintiffs relied on IIROC's discipline in the Earl Jones matter to support a gatekeeper argument. Earl Jones was unregistered and later found to be a fraudster. The Court found that in that case the red flag was that he opened up multiple unrelated accounts over which he had sole trading authority that was different from the facts of this case in which the TA was granted trading authority over a single corporate account as an officer of the company pursuant to a signed resolution. It was further found that in the event that the dealer was held responsible for any of the plaintiff's losses, the Court would have found that they failed to mitigate their damages after April 20, 2011 when the shareholder knew that the TA had lost $568,198.00 but elected to give him a second chance. Read the full decision here.

Dealer-Advisor Relationships

Collection on Advisor Transition Loans More Difficult

A dealer terminated the contracts of 4 advisors and sought to collect on the transition loans they had received when hired. The advisors alleged material misrepresentation (that they were not told that their branch would be closing). The dealer initially obtained a summary judgment for immediate repayment of the loan of one advisor that was overturned on appeal. The Ontario Court of Appeal held that the transition loans couldn't be considered in isolation from the context in which they were made, including the advisors' hiring, the expectations of the parties, and industry practice. It also held that it could not consider the defences of one advisor without considering the evidence of the others as that may result in inconsistent verdicts on the same agreement. Read the full decision here.

Departing Advisors: Unpaid Commissions and Notices to Client

A mutual fund salesperson sued his dealer for commissions withheld after his principal/agent contract ended. The contract only provided for one specific contractual right to withhold commissions that did not apply in this circumstance. The Court found that the principal agent/relationship was for the primary purpose of avoiding payroll remittances as opposed to creating a principal/agent relationship in law that could entail greater duties on an agent advisor than on an employee advisor. In this circumstance, from the investor point of view, the dealer was a clearinghouse with the advisor developing the client relationship. The Court therefore refused to impose a fiduciary relationship on the contractual relationships between the advisor and the dealer. The advisor was therefore not in breach of any fiduciary obligation in getting notices to clients before his termination date. He was awarded the commissions withheld. The firm's counterclaim for damages resulting from the representative having taken clients with him when leaving the firm was dismissed. Read the full decision here.

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