Unacceptable risk

By Mindy Paskell-Mede

Practitioners who offer financial planning services may have to compensate clients for trading losses.

Illustration by Geneviève Côté
Chartered accountants are among the many professional groups who are expanding the selection of services being offered to clients. One growing area of expertise is financial planning but, unfortunately for practitioners, it is also a fertile ground for lawsuits. The specific problem that the courts are facing is to determine whether, and to what extent, the investment losses suffered by a client were simply the result of the downside risk that is present in all such activity, or whether the financial planner's advice or behaviour was to blame.

In previous articles, we have looked at cases where the courts determined that CAs who give tax advice to clients or introduce them to potential investments have further duties to those clients regarding the creditworthiness of the investments. In the cases that follow, the defendant expressly offered financial planning services and the clients had understood that at least some degree of risk was inevitable. In both cases, however, the professional advisers were obliged to compensate their clients for trading losses. In the first case, the problem lay in the fact that the client did not fully appreciate the degree of risk and complexity in the trades. In the second case, the financial planner acted as portfolio manager and failed to maintain the composition of the portfolio as set out by both parties.

In the case of Secord v. Global Securities Corp. [2000] B.C.J. No. 2096, the British Columbia Supreme Court ruled that an investment adviser had breached his duties (contractual, in tort and fiduciary) with respect to the options account of the client's portfolio.

As is usual in such cases, where the basic issue before the court is one of credibility - principally on questions regarding the client's level of sophistication and the degree of risk accepted by her - a meticulous investigation of the facts pertaining to the case was undertaken. Although the client had already completed numerous forms prior to trading with the defendants, and although their testimony agreed on certain matters, their respective views of the client's involvement in the decisions leading to the losing transactions could not have been more opposed. The client presented herself to the court as a virtual neophyte, relying entirely and blindly on her adviser. The defendants insisted that the client had followed the trades with understanding, and had approved them in full knowledge of the risks.

The court rejected the plaintiff's attempt to show that she was so naïve as to have been unaware that stocks could go down in value. It did, however, recognize a significant gulf between her level of understanding and the knowledge required to direct trading in complex instruments. The adviser accepted that he was supposed to have acted as her "teacher," yet there were no documents showing a careful explanation of the potential risks that are unique to options trading.

The British Columbia Supreme Court determined that the client was not as inexperienced as she had attempted to demonstrate - that she had, in fact, authorized the specific trades, and that the composition of the portfolio as a whole was consistent with her investment objectives. The client, however, had never obtained sufficient sophistication to understand the options account.

The court found that, with respect to this portion of the portfolio, her reliance on the defendants was "almost total." The defendants did not adequately explain the risks to her, nor did the client truly understand the investment strategy being employed. Given the client's level of knowledge as well as her stated objectives, said the judge, options trading was "inordinately complex" and unnecessary. In other words, although the actual transactions were not themselves inconsistent with the client's objectives, it was not suitable for her to have engaged in this particular type of trading activity.

The court ruled that the defendants' duty on these facts was fiduciary. It also determined that the trading that had occurred was a breach of contractual and tort duties, but that the same damages would be awarded under each regime.

In its ruling, the court recognized that there is a spectrum of possible duties that are owed to client investors. At one end are the "mere order-takers," whose obligations would not be fiduciary but who would presumably execute instructions only in an appropriate fashion. At the other end of the spectrum are portfolio managers with trading discretion, who have the highest possible duty. The court concluded that the defendants' role in this particular case lay between these two areas, but that the duties were onerous enough to be considered fiduciary.

A debate on damages led to the conclusion that the defendants could not insist on being credited with eventual profits made from certain of the investments into which they had put the client. The court ruled that the time period in which to consider profits is the same as that given to the plaintiff in other cases for mitigation of losses, and it will vary with the marketability of the property in question. In situations where the property is highly marketable, such as shares, the date at which damages crystallize is shortly after the date of the breach.

The second ruling concerning defendants who offer financial services was the Quebec Superior Court judgment in the case of La Financière McLario v. Groupe Albatros International Inc et al., J.E.2001-478, delivered in January of last year. Although the concept of "fiduciary duty" is not part of traditional civil law, reference was in fact made to the Supreme Court of Canada case in Hodgkinson v. Simms [1994] 3 S.C.R. 377, which dealt with the standard of care, or "intensity of obligation," owed by the defendant.

The engagement in this case was clearly one concerning portfolio management - in fact, the financial planner became a director and treasurer of the plaintiff's company. There would appear to be little doubt then, in this particular case, that a fiduciary duty was owed. The initial contract determined the percentage composition of the portfolio, as well as the fees and profit-sharing to be earned by the defendant. In the lawsuit, the plaintiff complained that the composition of the portfolio was not maintained in the manner in which it had been agreed upon originally, and that the defendant had also withdrawn excessive fees. The Quebec Superior Court ruled in agreement with the plaintiffs.

The defendants argued that the owner of the plaintiff company was an experienced investor who well understood the speculative nature of the portfolio they had designed. The court ruled, however, that although he was an educated individual (a chemist), he was a careful and cautious investor without much experience in stock market trading.

The defendants were unable to persuade the court of any compelling reason as to why they had put a greater proportion of the plaintiff's portfolio into junior companies than had been originally agreed upon. Although the judge accepted that the defendants had acted in good faith, in what they believed to have been the best interests of the plaintiff, their actions could not excuse their ultimate failure to follow clear instructions set out in the initial contract between the parties. The situation was further aggravated by the defendants' continued lack of response to the request by the client to rectify the situation.

Damages assessed in this case were the amount of losses suffered in the juniors companies in which the client was over-invested, along with reimbursement of the excess fees. An appeal is pending.

Mindy Paskell-Mede, BCL, LLB, is a partner with the Montreal law firm of Nicholl Paskell-Mede, where she specializes in professional liability insurance. She is also CAmagazine's Technical Editor for Law.