The Court of Appeal for Ontario (the Court) recently considered whether a group of clients of an investment advisory firm had a reasonable cause of action for breach of fiduciary duty. The Court reversed the Divisional Court and certification decisions, which held that the plaintiff's claim failed to plead material facts establishing the existence of an ad hoc fiduciary duty owed by the investment advisor. Boal v. International Capital Management Inc., 2023 ONCA 840 provides important guidance on pleading breach of fiduciary duty, in addition to when advisors will owe a fiduciary duty to their clients and the obligations imposed on advisors when such a duty arises.
Background
John Sanchez and Javier Sanchez were registered mutual fund salespersons and investment advisors who provided advice through their investment management company, International Capital Management Inc. (ICM). ICM was a registered mutual fund dealer and both Sanchez brothers and ICM were regulated by the Mutual Fund Dealers Association (MFDA).1 The MFDA Rules at all times required the Sanchez brothers and ICM to "deal fairly, honestly, and in good faith with their clients, disclose any conflict or potential conflict of interest, and address conflicts of interest by the exercise of responsible business judgment influenced only by the best interests of the clients."
In 2001, John Sanchez began providing investment advice to the representative plaintiff in this proceeding, Rebecca Boal (Boal). In 2014, Sanchez presented Boal with the opportunity to invest in promissory notes of a company called Invoice Payment Systems Corp. (IPS). ICM was the exclusive agent for the notes. In presenting the opportunity to Boal, Sanchez allegedly failed to disclose that his family directly and indirectly owned 75% of IPS's shares, and that the notes were a high-risk investment. Boal proceeded to purchase a note for CA$101,224.26.
In 2018, the Sanchez brothers and ICM entered into a settlement agreement with the MFDA, which terminated ICM's membership in the MFDA and banned the Sanchez brothers from the mutual fund business. As part of the settlement, the defendants admitted that between 2006 and 2016, they sold or facilitated the sale of at least CA$25,800,000 of investments in a non-arm's length company (IPS) to at least 170 ICM clients. As a result of the sales, the Sanchez brothers netted approximately CA$3,000,000 in commissions.
The class proceeding and certification motion
As the representative plaintiff in a class proceeding brought on behalf of 170 ICM clients who purchased IPS notes, Boal sued ICM and the Sanchez brothers for breach of fiduciary duty (among other claims). However, the certification motion failed on the basis that the claim did not disclose a reasonable cause of action for breach of fiduciary duty on a class-wide basis. It was also determined that there was a lack of common issues and that a class action was not the preferable procedure.
On appeal, the Divisional Court agreed with the certification judge, principally because the fiduciary duty claim was based solely on the MFDA Rules, which were insufficient on their own to establish an ad hoc fiduciary relationship. An ad hoc fiduciary duty was required to be plead because the relationship between an investment advisor and their clients is not a recognized category of fiduciary relationship but a fiduciary relationship can exist in particular circumstances.
Court of Appeal decision
Upon further appeal to the Court of Appeal, the Boal class action was certified. The Court held that the claim disclosed a class-wide reasonable cause of action for breach of fiduciary duty, as required for certification under s. 5(1)(a) of Ontario's Class Proceedings Act, 1992.
The Court of Appeal's holding turned on a view of the facts pleaded in the claim which was different from that in the courts below. Unlike the courts below, the Court of Appeal determined that the claim for breach of fiduciary duty did not rely solely on the fact that the class was comprised of former clients of ICM and the Sanchez brothers, who were subject to the MFDA Rules and By-Laws. Rather, this was but one fact which supported the claim that a fiduciary relationship existed between the proposed class and their financial advisors.
Boal pled that the investment relationships between the proposed class and the defendants were impressed with the hallmarks of a fiduciary relationship: vulnerability, trust, reliance and an undertaking by the defendants to act in their clients' best interests. The defendants allegedly prepared and monitored comprehensive financial plans for the class members and undertook to make investment recommendations in their best interests. Further, ICM and the Sanchez brothers exercised discretion by recommending and soliciting investment in the IPS notes, while rendering their clients vulnerable to that exercise of discretion by holding all of the information relevant to the IPS notes and selectively disclosing it to their clients. The class members' investments in the IPS notes undoubtedly affected their legal and practical interests.
ICM and the Sanchez brothers promoted and sold the IPS notes to their clients, while being in conflict with their own interests. This was contrary to the proposed class members' right, enshrined in the MFDA Rules, "to expect that their professional advisors would act in their best interests, to the exclusion of all other interests, because the contrary had not been disclosed to them."
Ultimately, the Court of Appeal held that it was not "plain and obvious" that the class-wide fiduciary duty claim had no reasonable prospect of success. The common issues and preferable procedure certification criteria were remitted to the court below for redetermination.
Conclusion
In order to determine whether a financial advisor is a fiduciary of their client, five factors must be weighed and balanced:
- The degree to which the client is vulnerable, which can include a consideration of the client's age, lack of education, and/or experience in the market;
- The degree of trust and confidence which exists in the advisor-client relationship;
- The degree to which the advisor's judgment and advice has historically been relied upon, and whether that reliance is reasonable;
- The extent of the advisor's discretion over the client's account; and
- The advisor's duties, as established by applicable regulatory rules and standards of professional conduct.
Boal v. International Capital Management Inc. serves as a reminder that the onus on a plaintiff to establish a reasonable cause of action is not an onerous one. A well-pled claim against an investment advisor for breach of fiduciary duty will likely survive a certification motion. Investment advisors should be mindful of the low pleadings bar to satisfy the test for certification as they consider their defence strategy when named in a class action. They should also consider the factors used to determine if a fiduciary duty exists as they develop their internal policies and procedures and attempt to clarify the nature of their client relationships.
Footnote
1. The Mutual Fund Dealers Association of Canada and the Investment Industry Regulatory Organization of Canada amalgamated to continue as the New Self-Regulatory Organization of Canada (New SRO), effective January 1, 2023. On June 1, 2023 the New SRO changed its name to the Canadian Investment Regulatory Organization (CIRO)
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