(A shorter version of this column appeared in the April 2009 paper edition of Investment Executive)

How often do you hear investment advisors describing their relationships with investor clients as fiduciary? The term itself has a certain ring to it, resonating of an important, close, trusting advisory relationship. But is the word being misused by the industry and, in investor loss claims, by investors? Is in fact the relationship between investment advisor and client properly characterized as fiduciary, or has the sound and import of the term led to a misperception that is not an accurate description of the legal definition of the relationship in many cases? Given the increased exposure to legal liability and damages, and likely regulatory exposure, arising from a breach of duties in a fiduciary relationship, the issue has real significance and is not just an academic exercise.

A good starting point is the industry’s own material on this issue. The Conduct and Practices Handbook (1) defines its scope as a “guideline” for the conduct of dealers and individual registrants in their dealings with investors. Notwithstanding the non-binding nature of the “guideline,” both regulators and courts, in judging registrant conduct for regulatory enforcement and civil liability purposes, have applied the rules, standards and code of ethics of the CPH as the minimum standard of conduct expected of registrants towards their investor clients, and as informing the common law duties and obligations of registrants.

The CPH characterizes the relationship between registrant and investor client as fiduciary in nature. In its lead chapter titled, “Canadian Securities Industry Registrant Code of Ethics and Standards of Conduct,” the CPH states that:

“When disputes between dealer members and clients are resolved through civil litigation, the courts will generally hold that the IA owes a fiduciary duty to the client if the IA provides investment advice and recommendations to the client, and the client relies on such advice. The existence of such a fiduciary duty imposes a higher standard of care upon the IA than would be the case if the IA merely executed the client’s orders without providing any advice. A fiduciary relationship requires the IA to act carefully, honestly, and in good faith in dealings with the client, and not to take advantage in any way of the trust the client has placed in the IA.”

This column takes a look at whether courts of law adjudicating investor loss claims are routinely finding the relationship between dealer and investment advisor, on the one hand, and investor/ clients, on the other hand, to be fiduciary in nature (regardless of the ultimate finding of the court as to whether there occurred a breach of fiduciary or trust obligations in the particular circumstances of the case).

In order to test whether this statement accurately described the way courts have characterized the IA/client relationship, I reviewed the 46 Canadian court decisions released in the period 1987 through 2007 that are summarized in the Broker/Dealer Legal Reference Case Law Database (2), in which the trial judge dealt with the issue as to whether a fiduciary or trust relationship existed between the parties. In 35 of the 46 decisions, representing 76% of the cases, the court dismissed the allegation of a fiduciary or trust relationship. In the 11 remaining cases, the court found that a fiduciary or trust relationship existed, with two of these cases concerning managed accounts. While almost all of the 46 cases dealt with investment or mutual fund dealers, two of the decisions dealt with the relationship between investors and their banks (with both decisions deciding that a fiduciary relationship had not existed) and one decision dealt with the relationship between an investor and his accountant (in which the court found that a fiduciary relationship did exist in the circumstances). Based on this review of the evidence, the statement describing the IA/client relationship as “generally” fiduciary in nature is inaccurate.

Aside from the ineluctable conclusion that the CPH has mischaracterized the usual relationship between investor/client and IA/dealer, the question is why this confusion exists. Anecdotally, IAs, particularly mutual fund IAs, themselves commonly refer to their relationships with their investor clients as fiduciary relationships. The answer lies in understanding the principal/agent relationship and the fiduciary relationship.

@page_break@The essence of the relationship between investor client and IA/dealer is that of principal and agent. The principal gives — and the agent takes — instructions, and the agent is tasked with carrying out those instructions with care, skill and diligence, and acting for the benefit of the principal in all matters connected with his agency. The duties of the agent to the principal may be set out in contractual agreements between the parties and/or may arise from the duty of care that the agent owes to the principal in the particular circumstances of the case. An agent has a narrow fiduciary duty that, for instance, precludes earning secret profits or dealing with the client as an undisclosed principal, but an investment dealer does not otherwise ordinarily owe a fiduciary duty to his client.

As Justice Winkler stated in his Reasons in the Bre-X class (3) action, “…the notion that a broker-client relationship is inherently fiduciary has been soundly rejected in Canadian law.” As stated by Justice Keenan in the Varcoe v. Sterling Dean Witter Reynolds (Canada) Inc. (4) decision, “the relationship of broker and client is not per se a fiduciary relationship.”

In order to elevate the relationship that existed between the IA/dealer and the investor/client to a fiduciary relationship, the court must find, based on a factual analysis, a sufficient degree of vulnerability, trust, confidence, dependency and reliance by the investor client on the IA/dealer. An IA/client relationship found, in the circumstances, to be fiduciary in nature, is usually characterized by the exercise of discretion and power over the operation of the account by the IA in circumstances where the investor client was clearly dependent and reliant on the IA and vulnerable to the exercise of that discretion and power.

The seminal case of Ryder v. Osler Wills Bickle, (5) decided in 1985, predates our survey, but is frequently cited by courts deciding investor loss cases where there has been an allegation of a fiduciary relationship and corresponding breaches of fiduciary duties. In that case, the investor client was found to have been an unsophisticated investor who placed complete trust and confidence in the IA. She was elderly, a widow, entirely reliant and dependent on the IA, and vulnerable to her. The account, although opened as a non-discretionary account, was operated as a discretionary account, and traded in a speculative and disastrous manner.

At the other end of the spectrum is the oft cited case of Varcoe v. Sterling (6), where the investor client’s allegation of a fiduciary relationship was not accepted by the trial judge, given the sophisticated investment background of the client, his control over his accounts, and his lack of the degree of trust, confidence and reliance on the IA necessary for a finding of a fiduciary relationship.

Clearly, a fiduciary relationship exists in a managed account situation where the portfolio manager exercises discretion and control over the conduct of the investment account within defined limits; and, just as clearly, a fiduciary relationship does not exist in a discount brokerage account situation, where the dealer does not provide any investment advice, there is no designated IA for the client and his/her accounts, and the investor/client has total control and direction in respect of the conduct of the account.

It is common in investor loss litigation for investor/client plaintiffs to allege that a fiduciary relationship existed between the dealer and IA, on the one hand, and the investor/client, on the other hand, and that the registrants engaged in misconduct that constituted a breach of their fiduciary obligations to the client. These allegations are usually accompanied by claims for negligence and breach of contract. It appears clear from our survey that courts find that a fiduciary relationship existed only in a minority of cases and that the characterization of the CPH of the relationship between investor/client and IA/dealer is in error and the CPH ought to be corrected.

The lesson for investor clients seeking compensation for investor losses through legal proceedings is to focus their allegations on the actual relationship that existed between the particular investor/ client and the IA/dealer, thereby to limit claims founded on the allegation of a fiduciary relationship to those where the relationship arguably merits such an allegation. The lesson for IAs, enamored of the term “fiduciary” to describe their relationships with clients, is to change their vocabulary, or risk a court accepting that characterization, with the possible consequent adverse effect on the court’s determination of compensatory and other damages, and the degree, if at all, that the client’s conduct will be taken into account by the court on liability and damages issues.

Joel Wiesenfeld is a partner at Torys LLP. The views expressed in this article are strictly personal.

(1) CSI Global Education Inc. (2008)

(2) Joel Wiesenfeld, CD-ROM: Broker/Dealer Legal Reference Case Law Database, 2009 rel. (Toronto: Carswell, 2008)

(3) (1999), 46 B.L.R. (2d) 247 (Ont. S.C.J.)

(4) (1992), 7 O.R. (3d) 204 (Ont. Gen. Div.); aff’d 10 OR (3d) 574 (C.A.); (1992), 10 OR (3d) xv, 145 N.R. 390, 60 OAC 74 (S.C.C.).

(5) (1985), 49 O.R. (2d) 609 (Ont. H.C.J.)

(6) Varcoe v. Sterling, supra