Discount brokers can’t be sued over pre-ban trailers, court rules

The practice of mutual funds paying trailer commissions to discount brokers for advice they were prohibited from providing was finally outlawed last year. But investors cannot sue to recover fees they paid before the ban took effect, an Ontario court has ruled.

The Ontario Superior Court of Justice dismissed a proposed class action suit on behalf of investors against many of the major discount brokerages: BMO Investor Line Inc., CIBC Investor Services Inc., Desjardins Securities Inc., HSBC Securities (Canada) Inc., QTrade Securities Inc., Scotia Capital Inc. and TD Waterhouse Canada Inc. The suit alleged that, while the practice of paying trailing commissions to discount brokers wasn’t banned until 2022, it represented a violation of securities law long before that.

According to the court, the plaintiffs in the proposed suit argued that “the receipt of trailing commissions by discount brokers was illegal and exposed the discount brokers to damage claims long before the formal prohibition.”

The defendant brokerage firms argued that, while a debate over the fairness of trailers may have dragged on for more than 20 years, “there is no evidence that the receipt of trailing commissions by discount brokers was illegal or unlawful” before the prohibition adopted by the Canadian Securities Administrators (CSA) in 2022.

Ultimately, the court sided with the brokers.

The plaintiffs argued that general regulatory provisions calling on dealers to avoid conflicts of interest should be considered an implied restriction on funds paying trailers to discount firms, but the court disagreed.

The court also found that the plaintiffs were unable to produce evidence of independent reports or studies that concluded the payment of trailers to discounters could be considered illegal.

“The only item in the plaintiffs’ evidence that arguably comes close to satisfying the ‘some evidence’ requirement about overall illegality is a Nov. 9, 2016 letter to IIROC from Kenmar Associates, an investor-advocacy organization,” the court noted. “[T]his letter provides some evidence that at least one stakeholder was of the view that applicable securities laws were being contravened well before the imposition of the 2022 prohibition.”

However, the court said this was not enough to hang an entire class-action suit on.

“In deciding whether the ‘some evidence’ requirement is satisfied, the court is obliged to consider the entirety of the plaintiffs’ evidence. It cannot pick one item that appears to favour the plaintiffs’ submission and ignore the many other items (also in the plaintiffs’ evidence) that undermine this submission,” it said.

Instead, the court said, “the evidence shows that the 20-plus years of discussion and debate was not about legality per se but whether, as a matter of policy, trailing commissions should be abolished entirely.”

The court also noted the CSA wouldn’t have allowed a two-year transition period for something it considered to be illegal.

“In sum, a significant amount of the evidence filed by the plaintiff strongly supports the defendants’ position that the practice of paying trailing commissions to discount brokers, although controversial and needing reform, was not illegal or unlawful until the law was changed effective June 1, 2022,” the court said.

As a result, the case was not certified as a class action, as there was no basis for a lawsuit.

Class-action lawsuits targeting mutual fund managers for paying trailers to discount brokers have previously been certified.

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.