An elderly investor whose financial advisors did not meet the “know your client” (KYC) suitability requirements is 20% liable for the catastrophic losses in his portfolio, according to a recent ruling from the British Columbia Court of Appeal.

The investor – a former executive of Principal Group, a trust company that collapsed in the late 1980s – also is not entitled to include the substantial initial gains he made on the high-risk, options trading strategy he entered into when he was 82.

However, the advisors involved and their firm, Canaccord Genuity Capital Corp., were found to be 80% liable for the investor’s losses, with the trial court noting that the KYC requirement is “the cardinal rule of the brokerage business.”

The fallout from Marlin Investments Inc. v. Moldovan is both good news and bad news for investment advisors, according to lawyers involved in the case.

“What this decision does is say, ‘Beware, investors. Keep a close eye on investment advisors’,” says Scott Stanley, lawyer with Murphy Battista LLP in Vancouver; he represented the investor, Kenneth Marlin.

The lawyer for the advisors and their firms disagrees. “We now have clarity that where there is an investment strategy or a course of trading over time,” says David Mitchell, lawyer with Miller Thomson LLP in Vancouver, “a plaintiff cannot come to the court and sue for losses on the basis that the entire course of trading was unsuitable but yet choose to keep any profits from that unsuitable trading.”

Marlin had invested in a sophisticated options trading strategy that led to significant losses for many investors in 2008. Marlin and other investors sued, alleging improper screening for the high-risk strategy.

The trial judge found the advisors to be negligent, and their company to be responsible as well. No contributory negligence by Marlin was found in that trial, although the gains on the investment were excluded from the calculation of the award. Marlin appealed, on the basis that all his gains should be included in the calculation of the award.

Both courts reviewed the details about Marlin’s account-opening process. In addition to Marlin’s age and his bankruptcy associated with the collapse of Principal Group, Marlin had very poor vision as a result of treatment for cancer. He used a large magnifying glass and was unable to read a computer screen. He also had numerous health issues. In addition, Marlin was taking care of his wife, who was unwell.

There was a pronounced discrepancy between Marlin’s financial reality and the account forms, which indicated a net worth and income that were substantially greater than Marlin’s actual situation. (He was living on government subsidies and pensions.)

The forms also stated that Marlin had “extensive” experience with options, commodities/futures, venture situations and margin trading – all of which, Marlin said at trial, were untrue. The trial court decision also notes: “Two copies of the same form had different entries for ‘Investment Objectives’: on that [form] in Canaccord’s file ‘100%’ is typed in under ‘Speculative High risk’.”

Although the forms completed when an account is opened are one method of collecting information for a KYC assessment, according to Justice Elaine Adair’s written decision, they are not the only method. She found that Marlin would not have been accepted as a client if a proper assessment had been done.

Who filled in the forms was key. Adair’s decision continued: “I find that it was [advisor Traian] Moldovan who made the decision to check the boxes indicating ‘extensive’ knowledge of the commodities and futures markets and options, because unless those boxes were checked, the accounts would not be opened. He probably did not know the level of [the client’s] experience with option trading, and made an assumption.”

Adair found that Marlin lost more than $310,000 in the options strategy but deducted almost $100,000 from this amount due to gains made during the initial period of the investment.

But while the B.C. Court of Appeal agreed with Adair, that court differed on the issue of contributory negligence by Marlin, finding Marlin to be 20% at fault: “Although [Marlin] may not have been responsible for the erroneous information on the account forms, he chose to participate in the options program and to continue participating in it despite his inexperience with options trading, his limited financial resources and his ailing health. Mr. Marlin’s failure to take reasonable care of himself contributed to his losses.”

“It was an odd appeal, in that the plaintiff won at trial, then appealed over a secondary issue,” Mitchell says. “Ultimately, both the trial judge and a unanimous Court of Appeal panel rejected the plaintiff’s argument that it could nominate a ‘claim period’ in order to maximize [Marlin’s] claim.

“The plaintiff sought to keep all the gains made in the previous three years and sue only for the losses in the last three months.”

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