Court resurrects fiduciary duty claim against investment advisors

Investment advisors should take extra care when addressing conflicts after the Court of Appeal for Ontario revived a proposed class action that alleges a breach of fiduciary duty between financial advisors and a group of their clients. 

In 2021, an Ontario Superior Court of Justice judge declined to certify a class action against mutual fund dealer International Capital Management Inc. (ICM) and several associated parties after finding that a class-wide fiduciary duty could not be established solely on the basis of Mutual Fund Dealers Association of Canada (MFDA) rules requiring members to address conflicts in the best interests of their clients.  

A 2-1 majority of Ontario’s Divisional Court upheld the original ruling, but a Dec. 20, 2023 decision from the Court of Appeal for Ontario gave new life to the claim, finding it was not “plain and obvious” that the claim for breach of fiduciary duty would fail on a class-wide basis.  

The fiduciary claim remains unproven, with the case now returning to the Superior Court for a fresh certification hearing.  

Nonetheless, the Appeal Court decision should be a “wake-up call” to advisors, said Nancy Mehrad, founder of Registrant Law in Toronto. The decision challenges conventional wisdom about when an advisor/client relationship could be considered a fiduciary one.  

“It’s a good reminder to mutual fund dealers or any other advisor that you have to take these [conflict] rules seriously,” Mehrad said. “Just because you’re in non-managed or non-discretionary accounts doesn’t mean you’re shielded from fiduciary duty obligations.”  

The roots of the case lie in the sale of promissory notes by brothers John and Javier Sanchez, who were principals at ICM.  

According to court rulings, the representative plaintiff alleges they and other clients who were offered the promissory notes were not told that the investments were high risk, that the Sanchez brothers and their family members owned 75% of the shares in the company issuing the promissory notes, and that the advisors were collecting commissions. 

The lawsuit was launched following a 2018 MFDA settlement concerning ICM, which saw the Sanchez brothers permanently banned from the industry. According to the settlement, the brothers and their associated companies collected around $3 million in commissions on almost $26 million in promissory note sales between 2006 and 2016.  

The class action hit a roadblock in 2021, when a certification judge found the pleadings were insufficient to support a claim for a breach of fiduciary duty. A year later, a 2-1 majority of the Divisional Court agreed with the certification judge, concluding the fiduciary claim fell short because it rested “essentially and in its entirety” on the MFDA rules regarding conflicts.   

However, at the Appeal Court, a three-judge panel unanimously ruled that the MFDA rules were “but one fact” supporting the fiduciary duty claim. Taken as a whole, they found the pleaded facts included allegations that the plaintiff investors were specifically selected for the promissory note opportunity by their advisors, had long-standing relationships with them and were vulnerable due to the information imbalance in the relationship.  

“The certification judge erred in principle in failing to consider those other facts in conjunction with the Sanchez Defendants’ breaches of professional rules,” the Appeal Court judges wrote. 

Establishing whether a financial advisor owes a fiduciary duty to a client is not straightforward, said Kate Findlay, partner with Aird & Berlis LLP in Toronto, adding that a duty can arise on an ad-hoc basis. Depending on the circumstances, the fiduciary nature of a relationship could even vary by transaction, she said.  

The Appeal Court decision restated the factors a judge will consider when determining whether a fiduciary obligation exists: 

• The vulnerability of the client 
• The degree of trust and confidence placed by the client in the advisor 
• The history of reliance on the advisor’s judgement and advice 
• The level of discretion the advisor has over the client’s account 
• Professional rules of codes of conduct establishing the standards to which the advisor will be held  

“The more of these factors exist, the greater the risk an ad-hoc duty may arise,” Findlay said.  

Regardless of the relationship’s nature, “clear disclosure of any interest relationship is the best protection against litigation, including potential class proceedings,” she added. 

John Fabello, partner with Torys LLP in Toronto, said the Appeal Court ruling is significant as it’s one of the first since the client-focused reforms took effect.  

Fabello was among those advocating against the inclusion of a best-interest standard in the CFRs, arguing that the courts were already effectively calibrating the legal standard for a fiduciary relationship between clients and advisors.  

“We were encouraging the regulators to leave that to the court, for fear that if the best-interest standard was included in the regulations, it would find its way into the judge-made law and arguably upset that balance the courts had struck,” Fabello said. “Now, here is an example of that best-interest standard being considered and impacting the legal duty. It remains to be seen if it’s a good result for the law that’s applied by judges, but it is certainly impacting it.”