When things go sour in the markets, it’s not just investments that take a hit. Advisors may become the target of angry clients — rightly or wrongly — with some clients deciding that the advisor should compensate them for losses. The result can be disputes that escalate into legal challenges, ranging from mediated settlements to full-bore litigation. And more and more often, advisors are losing.

“It’s possible that we are now on the edge of a wave of new litigation similar to what we saw after technology stocks crashed seven years ago,” says John Fabello, a lawyer with Torys LLPin Toronto who defends cases involving clients who sue their financial advisors.

“These things tend to go in cycles,” agrees David Lipton, a mediator specializing in resolving such conflicts in Toronto. “The current credit crisis may mark the start of a new cycle of conflict.”

Fabello notes that numerous client/advisor conflicts originating from the tech crisis at the start of the decade have been resolved only over the past year. He recommends that mutual fund and investment dealers hoping to win future legal challenges look closely at the outcomes in these disputes: “The cases placing the onus on the dealers are predominant. Only in rare cases, [in which] clients are very savvy, very sophisticated investors, have courts recently found in favour of the brokers.”

That assessment draws a strong endorsement from Julie Martine Loranger, a securities lawyer with Gowling Lafleur Henderson LLP in Montreal. “The courts have been imposing what amounts to almost a gatekeeper duty [on brokers and dealers],” says Loranger, who, like Fabello, acts as defence counsel to brokers and dealers.

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“The advisors are clearly seen as professional,” she says, “and although the duty to advise will vary with the degree of the client’s sophistication, the era of the invincible advisor is now over.” While financial advisors rarely lost court cases in the past, she adds, “Now it’s completely the opposite.”

Not surprising, the lawyers used to viewing these cases through plaintiffs’ eyes see things somewhat differently. John Hollander, a lawyer with Doucet McBride LLP in Ottawa who represents plaintiffs in client/advisor disputes, suggests there continues to be an “ebb and flow” in the trend among court outcomes.

“Starting five years ago, there was certainly a strong trend toward broker responsibility,” Hollander says. “But that has changed somewhat in the past two or three years. The trend recently is toward courts insisting on the duty of clients to take responsibility for decisions in which they had a clear role.”

As an example, Hollander points to a curiously bifurcated decision from the Ontario Superior Court of Justice in January 2007. In Newman v. TD Securities Inc. , Hollander, who represented William Newman, a retired electrical engineer who had worked at Nortel Networks Corp., and his wife Helen, a medi-cal doctor, failed to persuade Justice Robert Smith that TD was culpable when the Newmans’ large Nortel holdings led to a loss at the end of the tech boom.

“The Newmans and [TD advisor Chris] Martin did not have a fiduciary relationship and while Martin was more than an order taker, the relationship was closer to that of an order taker than that of a fiduciary,” Smith concluded.

The judge also noted that New-man, who had realized an 80% gain on holdings that reached $1.2 million at one point, was adequately warned about the risks of holding large numbers of Nortel shares. “When the client has specific knowledge,” Hollander says, “this will trump the broker’s advice.”

But advisors should not take too much comfort from the decision. Despite Martin’s warning about being overweighted and the court’s ruling that there was no fiduciary relationship, Smith faulted TD for not rebalancing the remainder of the portfolio away from tech stocks — even though the Newmans expressed insistent enthusiasm for tech stocks at the time.

In the Newman decision, which Hollander, Loranger and Fabello all describe as notable for its insistence on the broker’s responsibility despite the client’s sophistication, Smith found: “Martin did not meet the required standard of care by failing to discuss and recommend the purchase of income-generating investments, such as bonds or preferred shares. Martin recommended the purchase of additional high technology shares in A.T.I., C-MAC, Qualcomm and Certicom, when the Newmans’ account held a large proportion of Nortel stock, and when the accounts did not have 20% of their value invested in income-generating investment in accordance with the clients’ stated objectives.”

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Fabello sees the case as driving home “the point that the trend in the courts is to enhance the duty owed by the broker.” He also points to a decision this past March from the Quebec Superior Court in Loevinsohn v. Services Investors Ltée. As with Newman, Loevinsohn involved a sophisticated inves-tor — in this case, the plaintiff had a PhD in economics — who complained about financial advice regarding her $4.6-million portfolio.

And, once again, Fabello says, the court found that the advisor failed to protect the client through use of an asset-allocation model appropriate to the client’s age and income. “You could have argued that she was a brilliant, sophisticated economist,” says Fabello. “Nevertheless, the court emphasized the advisor’s duty.”

Clearly, these cases show that advisors need to step very carefully when advising clients, especially those with large stock holdings. Fabello recommends that dealers advise brokers to take very careful notes of the advice they offer to clients, and that dealers make direct contact with clients as soon as complaints emerge.

For Lipton, who acted as an expert witness for TD in Newman, the ability of financial advisors to defend such cases hinges on their success in knowing their clients, documenting their relationships with their clients and on getting asset-allocation mixes right, keeping in mind that demographic patterns indicate that many clients will live longer than previous generations and increasingly run the risk of outliving their assets.

“If you’re going to live longer, you’re going to need to have a higher rate of return for longer,” Lipton says. “And that will likely involve taking more risks.” IE