Ditching the Securities Blanket - The Travails of Revisiting the Investment Advisor-Client Fiduciary...

8/13/2019 Ditching the Securities Blanket - The Travails of Revisiting the Investment Advisor-Client Fiduciary Obligation in Canadian Law

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Ditching the Securities "Blanket": The T ravails of Revisiting the Investment Advisor -ClientFiduciary Obligation in Canadian LawBy M ark A.B. Donald' z

Introduction: South ark bellwether of the financial services industryIn a M arch 2009 episode of the television series South Park, Stan Marsh, one of the show's 10-year-old protagonists grudgingly agrees to place $100 of birthday money into a long-termsavings account at his father's request so that it can grow over the years . The bank's financialadvisor applauds the young bo y's decision and beg ins furiously typing on his com puter,announcing that he has placed the birthday cash in a `Money Market Mutual Fund' and thenreinvested the earnings into foreign currency acco unts with com pound interest. After amom entary pause, the advisor declares that the money is gone . W hen the young clientremonstrates that he had one hundred dollars, the advisor responds: Not anym ore youdon't.....poof "When South Park sees fit to attack the financial services industry, you can be sure that itsexcesses have reached critical mass in the cultural zeitgeist. This scene vividly illustrates thepervasive discontent afflicting investors both in C anada, and arou nd the w orld. In Ontario, thisdiscontent has manifested itself in a heated debate over the ov erall wisdom and proper scope of aproposed statutory fiduciary or best interest duty upon Ontario's investment advisors (IAs).The roots of this dispute can be found in socio-econo mic tum ult of the 2008-9 global econom icrecession. Hurtling to its messy zenith, the Great Recession dovetailed with profound changes inthe character of the Cana dian financial services mark et. So-c alled retail investors individualsfor whom investment has become the lynchpin of financial security w ere more prevalent thanever before, and increasingly focused on investm ent nest eggs as a mean s to secure their dreamof freedom 55 or send their children to university. This phenomeno n contrasted sharply withprevious generations that had relied upon on p ensions, government bon ds and savings accountsas the backbo ne of their financial planning.As the depth o f the crisis became clear, investor advocacy groups trained their guns on the ethicsand standards of the IAs in whom they had placed so mu ch of their faith and funds. These groupsalleged that the modern-day retail investor is often cajoled or misinformed by their IA intoinappropriate, overly-risky investm ent strategies - with often disastrous results. Leadingsecurities expert professor Janis Sarra of the U niversity of British Co lumbia echo ed this lament,writing that the Canadian securities market was designed for sophisticated investors who couldunderstand its pitfalls and m anage them accordingly a mo del rendered archaic by the rise of theamateur retail investor. To supp orters of a statutory fiduciary/best interest duty, the inequities of

1 J.D. (Queen's University), B.A. (Hons.) (Trinity College at the University of Toronto), Member of the Ontario Bar(June 2013). All comments and critiques are most welcome and can be directed to [email protected]

The author wishes to thank Mr. Ed Waltzer of Stikeman Elliott LLP, Mr. Joel Wiesenfeld, Mr. Jeffrey Spiegel ofNorton Rose Fulbright Canada LLP and other contributors for their invaluable insights on this topic. All errors andomissions are the author's sole responsibility.


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the mod em securities market were so p rofound that only a p resumptive, statutorily-codifiedfiduciary relationship can protect the new generation of increasingly vu lnerable clientele.In October, 2012, the Canadian Secu rities Adm inistrators (CSA) responded to the grow ingdiscord by releasing a discussion paper announ cing plans to investigate the issue. Theorganization convened a series of roundtables in June 2013 that brought proponen ts anddetractors of the proposed new standard together. However, in Novem ber 2013, years after thefirst shots were fired, much rem ains unresolved.This ongo ing inaction is a testament to the deb ate's startling com plexity, and the vastly divergentviewpoints that it inspires. The difficulty in even defining the m eaning and scop e of afiduciary/best interest standard m akes in an u nhelpful tool to settle a debate that engages m ultiplecom peting belief structures, differing legal philosophies, vastly different levels of education anddivergent social goals. In the author's opinion, it's these diverse challenges which make thefiduciary paradigm an inappropriate mechan ism through w hich to reform the advisor-clientrelationship. This paper argu es therefore, that the best option is for all stakeholders to aband onthe best interest/fiduciary paradigm, and instead look to m ore discrete, structural reforms as thekey to the advisor-client puzzle.Go od faith vs. best interest: defining the standard sAt its core, the debate over a fiduciary/best interest standard revo lves around legal terminology .In broad terms, O ntario securities law adopts a principle-based and inherently flexible model toregulate the advisor-client relationship. The present standard requires that financial advisors dealfairly, honestly and in good faith with their clients, 3 a benchm ark that requires lAs (1) todisclose, manag e or avoid conflicts of interest; (2) fulfill the Kno w Your Client requirement toprovide adv ice tailored to the particular circumstances and risk tolerance of each investor, and(3) satisfy the Know Y our Product obligation that lAs understand the products they are sellingso that they can p roffer a truly professional opinion.In contrast, a fiduciary/best interest standard dem ands a h igher level of fidelity. Just as the nam eimplies, this standard demands that the advisor act in the best interests of their client, in effectputting the client's interests wholly and com pletely above their own. Wh en a fiduciary duty isfound to have been breached, the legal consequen ces are grave: the beneficiary/client is entitlednot only to be m ade financially whole again (i.e. a return of their investment), but also to anyprofits that the offending fiduciary has m ade as a consequen ce of their breach.At com mo n law, it is possible for the advisor-client relationship to reach fiduciary status on anad hoc, case-by-case basis - but the o nus is on the aggrieved client to prove it in cou rt. Inpractical terms, the client-advisor relationship exists on a sort of fiduciary spectrum : at thefiduciary end wo uld be an accou nt manag ed solely at the advisor's discretion, while at the other,non-fiduciary extreme wou ld be an account under which the advisor has aproforma role i.e. as amere order-taker for the client. In order to reside on the fiduciary end of the spectrum, jilted

Canadian Securities Administrators, Consultation Paper 33-403: The Standard of Conduct for Advisors andDealers: Exploring the Appropriateness of Introducing a Statutory Best Interest Duty when Advice is Provided toRetail Clients at fn 23, online:< http://www.osc.gov.on.ca/en/SecuritiesLaw csa 20121025 33-403 fiduciary-duty.htm> [CSA Consultation Paper].

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investors must prove that the relationship w ith their advisor was informed by five factors: (1)that the client's lack of kno wledge o r investment skill left them vulnerable; (2) that the clientsubsequently reposed trust in their advisor and that this trust was accepted; (3) that the clientdemo nstrate a reliance upon the adv isor's counsel and that the advisor held them selves out ashaving special skills and know ledge; (4) that the advisor had p ower o r discretion ov er the client'saccount; and (5) that the advisor was bound by professional rules or codes of condu ct that thatsuggest a fiduciary standard m ay be app lied. 4The pow er of the present common law fiduciary remedy is clear. A blanket, statutoryfiduciary/best interest duty would amou nt to a com plete reversal of risk-allocation in the advisor-client relationship by co difying the presum ption of a fiduciary relationship between the partiesthat the advisor would then be forced to rebut.

A broken system?To many in the investor advocacy lobby, the concept of a spectrum of relationships runningfrom the trusted fiduciary advisor to the non-fiduciary mere order-taker is not so clear cut.They decry the present principle-based good faith duty of care as lacking teeth and moreover,call the common law's present ad hoc approach to IA's fiduciary obligations inherently unfair.Investor advocates cite what they view as a cavalcade of inequities that beset the relationshipincluding: (1) the clear lack of und erstanding that many retail investors (and purpo rtedly, manyIA themselves) have about the financial products that are being sold; (2) lAs' penchant foradvertising their services in distinctly fiduciary terms, leading m any clients to trust themaccordingly; (3) the often glossed-over existence of third-party compensation schem es thatreward lAs for recommending certain financial products over others, thereby calling intoquestion whether lAs' obligations of honesty and good faith are being met; and (4) the lack of acost-efficient regulatory mech anism o utside of the courts to address investor grievances (criticsargue that m any retail clients lack the financial means to take such a dispute to court at the bestof times, let alone w hen their investments have just taken a beating. According to o ne lawyerinterviewed by the author, the cost of such an action for plaintiffs regularly exceeds $80,000CAD).Investor advocates argue that that the product education offered by lAs as p art of their good faithduty is largely incomp rehensible to their retail clients, and that in any event, the salesmanshipexhibited by lAs is a pow erful agent for overcoming any sobering effects that informationaldisclosure might have. Leading corporate law scholar Don ald C. Langevoort of GeorgetownUniversity for example cites studies indicating that the financial services industry is an area,probably, where savvy salesmanship typically trumps over written consent [relating toacceptance of risk and suitability of the m arketed product]. Langev oort cites the findings ofseveral Am erican consum er psychologists, concluding: W e are motivated to trust those whoprom ise us what we want, as well as those who hold out the promise of remo ving the anxietyassociated with frightening ch oices. 5 As one O ntario lawyer stated in an interview to the author,

Hunt v. TO S ecurities Inc., 2003 CarswellOnt 3141, 66 OR (3d) 481 at para 40 (Ont CA).Donald C. Langevoort, Psychological Perspectives on the Fiduciary Business, 91 Boston University Law Review 995

at 997, online: < http://www.bu.edu/law/ceritral/id/organizations/iournals/bulr/documents/LANGEVOORT.Pdf >[Perspectives].


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investment purchases are o ften sealed by app ealing to the better angels of retail investors' natureby asking in effect, who are you going to trust, me or a piece ofpaper? .Related to this problem says the pro-investor cam p, is the fact that the financial services industryactively markets itself as fiduciary in character. lAs are prom oted not m erely as salesmen of aproduct, but rather as personal wealth advisors , apparently dedicated to acting in the client'sbest interests, that is to say, as fiduciaries. And this adv ertising strategy seems to be working: theOntario Securities Comm ission (OS C) has concluded that investors already perceive(incorrectly) that their financial advisors are already sub ject to an autom atic fiduciary duty. Onefinancial adviser has written: The financial services industry tends to encourage clients toTrust Us until the mom ent a dispute arises when they usually call in their lawyers to deal withinvestors who do not have similar resources, 7 while a 2012 report by the Financial PlanningStandards Council found that man y Canadians operate on blind trust when it comes toobtaining investment advice, and are m isinformed about issues ranging from financial advisors'required qua lifications to their ethical and legal obligations. 8

Mo reover, investor advocates criticize what they call an alphabet soup of designations whichadd an air of professional credibility to the financial services industry akin to that of d octors orlawyers - two o ccupations that are unmistakably fiduciary in character. The Investment IndustryRegulatory Organ ization of Canad a (IIROC) echoes this criticism and has suggested that manyof the o fficial titles or de signations adopted by financial advisors suggest a level ofprofessionalism and proficiency which may be misleading to consumers. 9

The fiduciary obligation in practice: horribly indeterminateTo critics of a statutory fiduciary/best interest standard ho wever, the m easure is a blunt anddangerous respo nse to the com plex reality of the advisor-client relationship. They charge thatproponen ts of a fiduciary/best interest standard are guilty of focusing too closely on the emo tiveplight of certain unfortunate retail investors without considering what the term fiduciary

6 Ontario Securities Commission Investor Advisory Panel, News Release, "Draft Statement of Priorities OSC letter"27 April 2011), online: .Ken Kivenko, Advisor Risk, Canadian Money Saver (June 2011), online:.

It's Regulated, Right? - Research Reveals Canadians in the Dark Regarding Qualifications, Ethical Obligations ofFinancial Planners and Advisors, Canada Newswire, (21 February 2012), online:

regarding-gualifications-ethicaI-obliations-of-financial-planners-and-advisors>.Canadian Foundation for Advancement of Investor Rights (FAIR), Open Letter RE: Misleading Use of Business

Titles and Financial Designations, 26 April, 2013), online: .

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actually means at law, or the extreme con sequences that may result from applying itinappropriately.Anti-statutory observers criticize the investor rights lobby for its apparent tendency to see theapplication of a statutory fiduciary/best interest duty as zero-sum proposition and therefore, tosee blanket application of the duty as the best, and perhaps only w ay to achieve m ore robustinvestor protection. In this way charge som e in the securities defence bar, investor advocates arein fact stifling constructive debate by ad vocating for an extreme response to a problem thatdem ands nuance. A s the CSA opined in its October 2012 report, a statutory best interest standardneed not mean an un qualified commo n law-style commo n law fiduciary duty on all advisors inrespect of each and every facet of the relationship, but rather, can be qu alified to accom mod atethe particular circumstances and business m odel of the financial advice industry.' This approachaccepts the possibility that certain discrete fiduciary obligations can be created between advisorand client to create a qualified fiduciary duty w ithout taking the fateful step of codifying an all-encompassing fiduciary relationship.Experience show s that targeted structural reforms can accomp lish many of goals cham pioned byinvestor advocates without resorting to a b lanket fiduciary/best interest duty. In the UnitedKingdo m for exam ple, the regulatory watchdog Financial Services Authority (FSA ) hasintroduced what is widely seen to be a qualified best interest standard that creates tiered levelsof advice, each requiring different levels of disclosure depending on whether the IA is advisingupon o r recomm ending a restricted or proprietary range of prod ucts. In addition, both Au straliaand the U.K. have banned third party commissions-based lAs - mainstay features of theCanadian financial services market which h ave been criticized by investor advocates in thiscountry as inimical to the IA's duty to act honestly and in good faith. Closer to home, IIROCand the Mutual Fund D ealers Association of Canada (MD FA) have recently strengthened theirown reg ulatory standards with the Client Relationship Model, which calls for more robustdisclosure.Reform efforts like these illustrate how law and p olicymakers can ad opt a graduated appro ach toregulation of the financial services industry that avoids the m uddled and often acrimoniousdebates surrounding impo sition of a blanket, comm on law-style fiduciary duty. In contrast. manygroups at the forefront of the investor advocacy m ovem ent appear to view a fiduciary/bestinterest standard as best em ployed, or perhap s only available, in a blanket, all-encompassingman ner. Indeed, the transcript of the CSA 's June 2013 roun dtable reveals that man y investoradvocates have identifiable concerns, but a tenden cy to talk about a statutory fiduciary duty as asingular, inflexible legal mo nolith.The ultimate problem with a blanket approach to fiduciary/best interest duties is one of consum erpsychology. In rejecting the application of an all-encom passing fiduciary approach, one m ustappreciate that the term fiduciary is as pow erful as it is imprecise. Black s Law Dictionarydefines a fiduciary as: [O]ne who owes another the duties of good faith, trust, confidence, andcandour ... one who m ust exercise a high standard of care in managing ano ther's mon ey orCSA Consultation Paper, Supra note 1.CSA Consultation Paper Supra note 1

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property. W hile this definition appears intuitively satisfying at first glance, its application is,according to Langevoort, horribly indeterminate. 2 Legendary A merican Jurist FelixFrankfurter conceded the challenges of applying the fiduciary title when he opined But to saythat a man is a fiduciary only begins the inquiry. 3The practical consequence of this uncertainty means that the term 'fiduciary' can be arguablyapplied to virtually any relationship with a little imagination - imagination that lAs fear will runwild when a retail investor has just seen their child's college fund wiped out. It is unlikely thatthe unsophisticated retail investor can be expected to understand the avo wed co mplexity of theterm fiduciary and all the conceptual legal baggage it imports, let alone differentiate it inpractice from the standards already in p lace. With this in mind, the fact that retail investorsreportedly believe that financial advisors are fiduciaries belies the fact that they, along with thelegal profession itself, struggle to defme what the term fiduciary actually means.

The underlying problem: The myth of the no risk marketDiscerning the d ifference between a b lanket fiduciary duty and a qualified best interest standardis clearly a difficult task, leading m any investor advo cates to question why the higherfiduciary/best interest duty was n ot codified yesterday. According to m any opp onents of ablanket fiduciary standard however, the problem is that modern-day retail investors have adeveloped a skew ed understanding of personal investment that makes imp osition of a blanketduty especially dangerous.Previous generations of Canadians saw financial products like savings bond s, GuaranteedInvestment Certificates (GICs) and their low-return ban k savings accou nts as the pillars offinancial security, but as retail investment h as becom e mo re prevalent, many in the financialservices industry assert that investors have not accep ted the subsequent increase in risk thataccomp anies that decision to abando n low-return investment strategies and enter the stockmarket. Opp onents of a blanket fiduciary duty are therefore concerned that such a statutorycreation is particularly ill-advised and dangerous for lAs in an era when their clients have com eto believe that in the word of one practitioner interviewed by the author, even low risk in thesecurities market has come to mean no risk.Statistics support the idea that retail investors are too q uick to ap ply the fiduciary tag in the faceof financial difficulties, and that that the m odern d ay investor-client relationship is no t as besetby careless fiduciaries as investor advocates sugg est. In 2009, leading securities lawyer JoelWiesenfeld analyzed the 47 cases then-contained in Carswell' s Broker/Dealer L egal R eferenceCase Law Database spanning the years 1987-2007. He foun d that in 35 of the 46 (with threecases involving non-client/advisor relationships) - a full 76% - the courts declined to find afiduciary duty on the basis of the indicia of trust, vulnerability and reliance. 4 The evidencetherefore suggests that on the facts, advisors are only rarely found to be fiduciaries by the courts,

12 Donald C. Langevoort, Brokers as Fiduciaries, 71 University of Pittsburgh Law Review 439 at 446 [Brokers].SEC v. Ch enery Corp., 318 U.S. 80,85 1943).

14 Joe1 Wiesenfeld, Beware of the Lure of the "Fiduciary" Label, Investment E xecutive, April 2009.


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and certainly not to an extent that would dem and a wh olesale change to the law of fiduciaryobligation via a blanket duty.

Educa tion and disclosure: the antithetical goals of a blanket fiduciary standardMo reover, the practical implemen tation of a blanket statutory standard com es with far-reaching,adverse consequences. Forem ost is whether or not such a standard is even practicably workablein the case of many unsophisticated retail investors. Speaking in Sep tember, 2013 on the issue offinancial stewardship, John G. Taft, CEO of RB C W ealth Managem ent - U.S., asserted thatinvestment advisors should be view ed as fiduciaries, and that the integral componen t of this dutywas adv isor's responsibility to disclose the specifics of the products they are selling and educatethe client as to the risks. At the CSA 's June 2013 roundtable, one participant called the presentdisclosure regime incomp rehensible , and unsuitable for present market conditions given thatthe average person can't even do com parative pricing wh en they shop for paper towels.By w ay of exam ple, one securities law practitioner interviewed by the au thor criticized theOSC 's use of the Flesch-Kincaid grade level, a system w hich purports to measure and ascribe thegrade-school level of reading required for com prehension and thereby ensure readability.According to this interviewee however, the system is flawed in that only OSC policy docum ent81-101 Mutual Fund Prospectus Disclosure purports to set a benchmark of grade 6 readercomp rehension. Mo reover argues this detractor, the notion that complex securities products canbe distilled into grade six language is fundam entally flawed.And this is exactly the problem. These tw o oft-repeated prescriptions - increased disclosure andincreased education of clients by lAs - ma y be d esirable in the abstract, but their benefits in caseswhere the investor/client makes the u ltimate decision are arguably illusory. The financialservices industry is avowedly com plex and influenced by an infinite number of social economicand political factors. With this in mind, and given the aforementioned state of contemp oraryconsumer psychology on the issue, it is questionable whether as a group, retail investors can beeducated to such an extent that their decisions are informed to a standard that satisfies theirconception of w hat a fiduciary standard entails.W hen com bined, this unprecedented complexity along with investors' apparently unrealisticexpectations threatens to make so und financial planning ad vice less attainable to ordinary retailinvestors. The most adverse m ooted consequen ce of a blanket statutory standard say criticswould be a situation wherein low-asset retail investors find themselves shut out of the marketby lAs w ho refuse to take-on a gen eration of retail clients conditioned to viewing po orlyperforming investmen ts as the inevitable result of advisor mismanagem ent. American lawm akersexpressed have already their concern to the U.S. Securities and Exchan ge Com mission that afiduciary standard would severely limit access to low cost investment advice.'

Solving the impasse: moving beyond the fiduciary constructPerhaps the fund amen tal stumbling block in the d iscussion over a fiduciary standard is that it ismore ap tly seen as a policy question, as opposed to the strict application of comm on lawprinciples. Scholar Leonard Rotm an has written: The fiduciary concept is primarily a public

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policy tool designed to regu late important social and econo mic relationships that arise fromhuman interdependency in contemporary society. This explanation clarifies exactly why thefiduciary debate over lAs is so fierce - it engages issues and challenges that run the gamu t,including professional regulation, econom ic efficiency, consum er psychology, legal philosophyand societal dem ographics. Ultimately, the debate ov er a b lanket statutory fiduciary/best intereststandard represents a clash of two diametrically opposed philosophies: general acknowledgem entthat sound financial advice is vital to a society's econom ic health on the one han d, but also awidespread acceptance that profit motive, how ever large or small is an acceptable lodestar forfinancial services industry.Desp ite the fact that lAs might prom ote themselves as possessing a veneer of professional status,there is little doubt that their expertise is fundamentally different to that of other fiduciaryprofessions. Unlike in the financial advisor-client context, the scope of a doctor-patient orsolicitor-client relationship is confined to a specific expertise upon which the beneficiary of thefiduciary duty is completely reliant. Few C anadians can expect to perform a successful surgeryor win a legal case by spending a few hou rs googling, getting advice from acq uaintances at aparty or simp ly listening to their intuition. In the stock m arket howev er, these insights can m akeeven an untrained investor wildly successful, illustrating that while lAs can provide clear 'valueadded' to their clients, there is no escaping the inherent risk of the m arket, and with it theunderstanding that lAs are, at their basic core salespeople, and not fiduciaries. Langevoort givesa particularly prescient rationale from the Am erican perspective: The punch line is simple. Youcan't really expect to fiduciarize a business that is all about selling unless you are prepared toreorient its structure entirely, which economically and politically - we are still far from willingor able to do with the securities industry. 5 He ultimately concludes that regulating at themargins is the better solution. 1 6Perhaps the best approach wo uld be to abandon the idea that a full, comm on law-style fiduciaryduty or even a limited best interests standard is an appropriate conceptual starting point forreforming the adv isor-client relationship in Can ada. Ed W aitzer, Partner at Stikeman Elliott LLPand form er head of the Ontario Securities Com mission posits that the Chilean Multfundo model,for exam ple, might be provide a m ore practical alternative to the seemingly en dless debates overthe scope and advisability of a statutory fiduciary duty. U nder Multfundo system, the investmentoptions available to investors are limited by gov ernment au thorities to a series of five funds, A toE, with each targeted towards a specific age group/risk preference based on the fund's allocationof equities and foreign assets. Investors are able to select their own investment m anagers, but arerestrained from assuming certain risk/return preferences depending on their proximity toretirement, and are barred from investm ent patterns that exceed the governm ent-mand ated risklevels.

ConclusionNot entirely unexpec tedly, the South Park shines as beacon of truth. The swift dem ise of StanMarsh's modest birthday haul reminds us that new social dynamics and economic realitiesclearly demand a re-evaluation of how o ur financial services industry works. However, thePerspectives, Supra note 3 at 996.

16 Brokers, Supra note 9 at 449.


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inherently ideological and emo tive debate over a statutory fiduciary/best interest duty, blanket orotherwise, is ultimately counterproductive in the author's opinion. Wh ile obviously well-intentioned, m any sup porters of a b lanket statutory fiduciary/best interest standard apparentlyview this equitable legal construct as a sort of panacea. Th is position ignores the significantpractical legal perils that such a statutory creation w ould create, and pu ts investor advocates onan unhelpful, and arguably u navoidable collision course with lAs and the securities defence bar.The better way forward w ould be for all parties to consider the pow er of targeted, systemicregulatory changes to the financial services industry, and accept that wh olesale revolution to theclient-advisor relationship is not a precondition to developing a fairer and m ore efficientfinancial services industry. Such an approach co uld have profound, po sitive results, whileavoiding the theoretical debates that make a fiduciary/best interest solution so elusive.

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