In the wake of several big securities scandals in the U.S., there is greater scrutiny of the actions of advisors by their clients. And regulators have been cracking down on advisors with increasing frequency.
According to leading Canadian liability lawyers who work closely with dealers and advisors, that means there is far more rigour around the role of the advisor. Ellen Bessner, a partner at Gowling Lafleur Henderson LLP<\/b> in Toronto, Jim Douglas, a partner at Borden Ladner Gervais LLP<\/b> in Toronto, Michael Nicholas, a partner at McCarthy T\u00e9trault LLP; <\/b> and John Fabello of Torys LLP<\/b>, all agree: The onus is now on advisors to prove they have done right by clients \u2014 and that is getting harder to do.
In many ways, the problems have stayed the same over the years. There have been a few rule changes, but nothing radical. Rather, the climate has shifted in the wake of what Bessner calls the \u201cbig busts\u201d \u2014 Enron Corp. and WorldCom Inc. come to mind \u2014 and the ensuing distrust that ushered in a new level of scrutiny from clients and the tightening of regulatory control.
What are the regulators cracking down on? What amber flags are they raising? According to Bessner, the issues are \u201crepetitive\u201d and the problems all too familiar: know your client and suitability. Obligations that begin with the client\u2019s goals and the KYC form can lead to allegations that the advisor did not know the client and subsequently failed to select suitable investments. And in this new climate, it is not enough to know the investments are suitable; proof is needed.
Indeed, says Nicholas, the advisor\u2019s best defence is diligence and thorough knowledge of the client \u2014 that is well documented. There needs to be a \u201cculture of compliance\u201d in the industry, he says. The courts realize that \u201crisk is in the game\u201d but still may favour the client if there is no documentation supporting an advisor\u2019s decision.
Douglas suggests advisors approach the issue of suitability and due diligence with prospective clients with one question: \u201cHow much of this money are you prepared to lose?\u201d
Douglas asserts that if the answer is \u201cNone,\u201d then those clients should not be in the stock market. It is the concept of knowing the client\u2019s appetite for risk that should guide the advisor. Then the advisor can tailor the investments accordingly. But there should be a clear understanding between the parties at the very beginning that losses are a very real possibility.
Douglas is one of the most respected voices on broker liability. He, too, sees brokers working in a shifting environment \u2014 an environment sped up by the \u201ctech wreck\u201d of 2000-01. Since then, he says, the courts have taken the investor\u2019s side more often than not.
\u201cThe courts have swallowed the industry regulatory standards and made them apply to the advisors,\u201d Douglas says. This has increased the onus on advisors. Court decisions have increasingly allowed negligence to be a cause for action in broker liability cases.
\u201cThis has made the whole process uncertain,\u201d he says.
He also laments the ongoing duty regarding suitability. It would be better if the duty of suitability were transactional. That would make the question: \u201cWas the investment suitable at the time?\u201d
Instead, advisors have to comply with the more stringent duty to ensure each investment is and remains suitable. This onus allows for more lawsuits to be brought by disgruntled investors, creating more court decisions, which create more confusion.
Before too much despair sets in, there are possible solutions. Douglas does see a way out of this morass. \u201cRight now the Investment Dealers Association of Canada<\/b>\u2019s arbitration tribunal system applies only to actions that are less than $100,000. This is much too low.\u201d The IDA should increase the limit to $5 million, he suggests: \u201cThis would effectively capture 90% of the cases.\u201d
What is the advantage of a tribunal? Why is it a better option than the courts?
\u201cWell, first you have to remember that judges are only human,\u201d Douglas says, dispelling a widely held belief. \u201cThey see a small investor stacked up against a rich financial institution\u2026 \u201d
Another reason to favour a tribunal is the expertise tribunal members would bring to the process. Douglas believes that improving the arbitration process will bring some much needed predictability to the area of broker liability.
@page_break@On this, McCarthy Tetrault\u2019s Nicholas doesn\u2019t necessarily agree with Douglas. \u201cI am not sure that arbitration is the panacea people believe it to be,\u201d he says with a shrug.
Nicholas explains the events leading up to the changes in advisor regulations this way: \u201cWhereas before, the advisor could rely on the underwriter to investigate the product, that is no longer possible.\u201d
The regulations are clear about the duties to which advisors must adhere, and the courts have clearly stated that there is a standard of care, as well. The result is that financial institutions now are proceeding to implement changes that will allow them \u201cto weed out the acceptable from the unacceptable,\u201d Nicholas says.
This is in addition to friction arising from unsatisfied clients armed with three main causes of actions: a breach of contract; negligence; and, depending on the facts, a breach of fiduciary duty.
In 2004, the Ontario Securities Commission released a concept paper entitled Fair Dealing Model, <\/i> containing three categories of investor\/advisor relationships: the self-managed, the advisory and the managed-for-you account. While it remains a concept paper only, the case law agrees with the categorization, says Nicholas. The duties in the first and third categories are clear, but the advisory category, which has a standard of care attached, seemingly can bleed into the fiduciary. The courts are still sorting this out.
\u201cIt now all turns on the facts of the case to see what the duty is,\u201d Nicholas says.
Torys\u2019 Fabello, however, thinks that arbitration offers one strong advantage over the courts: privacy. This is something of supreme importance to financial services institutions.
In Fabello\u2019s reckoning, though, the arbitration decisions are fairly similar to those of the courts. He does not see the situation as uncertain as some may believe. Certainly, there has been some disrepute attached to the industry, and events such as the collapse of Portus Alternative Asset Management Inc. and of Norshield Financial Group have not been helpful, but the situation has improved since the trigger-happy days following the tech wreck.
The \u201cclarification of the regulations\u201d has imposed more onerous duties on advisors, which are being enforced by the courts, Fabello says. Advisors\u2019 jobs have gotten harder as a result. But new advisors are entering the field well equipped to meet the challenge.
And while there is some merit to the argument that the courts have tended to favour the client, the amount of \u201csilly\u201d litigation is decreasing. But litigation, legitimate or otherwise, persists.
This concept is something that Fabello tries to pass on to the advisors at his educational seminars. \u201cIn the battle of memory\u201d \u2014 absent documentation supporting one side \u2014 he tells advisors, \u201cthe client almost always wins.\u201d
Certainly, answers may lie in education and institutional change. While neither would seem to be a particularly fast route to surer ground, they could be reason for optimism. While the self-regulating duty was clarified in a Mutual Fund Dealers Association<\/b> notice, and the courts can flesh it out, advisors can protect themselves through education and diligence.
But advisor and manager education hasn\u2019t necessarily kept pace with the stepped-up scrutiny and the added duties placed on managers.
\u201cThe industry educators are more focused on client education than advisor education,\u201d says Gowling\u2019s Bessner. \u201cAdvisors and branch managers are often ill-prepared to fulfill their obligations.\u201d
Bessner, whose own workload has increased, admits she feels sorry for those advisors and branch managers who are ill-prepared for the high level of scrutiny by regulators. Even simple activities such as maintaining a paper trail can be arduous for men and women pressured to increase the size of their books of business.
And the record-keeping checks are not limited to the advisor; now regulators will look into the paper trail between advisor and manager, and between manager and compliance officer, as well. This regulatory intensity is an attempt to ensure problems are investigated early and thoroughly.
Bessner\u2019s response is a course designed to give branch managers and advisors the \u201ctips and tools\u201d necessary to perform their jobs in a manner that aims to reduce their risk when regulators investigate and clients commence complaint proceedings.
Bessner works to educate dealers and advisors about their new roles and the increasingly difficult task of being in full compliance with the evolving regulatory environment.
Another lesson Fabello bequeaths: \u201cIn the battle of risk explanation, the client wins.\u201d Basically, keep a record.
Sounds simple enough, but it isn\u2019t. Another hardship \u2014 also part of the \u201csea change,\u201d according to Fabello \u2014 is the positive obligation to report questionable investments.
Is this another way of saying there is a self-regulating duty?
\u201cNo,\u201d Fabello responds. It not enough to avoid bad investments. Now, if something appears off-kilter, you cannot ignore it and hope it works itself out, although that may happen. Rather, you have to report it to the regulators. Repeat: amber flags are to be reported.
In Fabello\u2019s mind, this gate-keeping function is probably the biggest change in the industry. It would cause any advisor waking from a blissful 10-year coma to question his or her sanity. IE<\/b>
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