No fiduciary standard needed in Canada

By David Di Paolo, Kara Beitel | May 12, 2011 | Last updated on May 12, 2011
4 min read

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In the wake of numerous instances of financial fraud in North America, there has been increased focus on the duties and obligations owed by investment professionals to their clients. In the U.S. and elsewhere, regulators are proposing changes that would impose a fiduciary standard on those entrusted with managing investor funds.

In Canada, however, regulators have been reluctant to move to a fiduciary standard, in part because some of the new standards being proposed in other countries have been in place in Canada for some time — and in part because they do not believe imposing a fiduciary standard is necessary.

That said, while a fiduciary standard applicable to all registered individuals is not on the table in Canada, the OSC, IIROC and the MFDA are moving ahead with regulatory reforms that will change advisors’ relationships with their clients, bringing them closer to a fiduciary standard.

The fiduciary

The legal concept of a fiduciary is exemplified by agent-principal and trustee-beneficiary relationships. The agent or trustee has absolute obligation to act for the sole benefit of the principal or beneficiary. A high standard is imposed on the fiduciary because he often has discretion over the interests of the beneficiary; thus, the beneficiary is reliant upon the fiduciary.

Part of the impetus to move to a fiduciary standard in the U.S. was existing legislation that applied a fiduciary standard to financial advisors but not broker-dealers. Because financial advisors and broker-dealers can both provide personalized investment advice or recommendations about securities to retail investors, different standards for each were confusing and could lead to regulatory arbitrage.

The fiduciary standard in the United States is comprised of:

  • A duty of loyalty, which prohibits advisors from putting their interests first by requiring conflicts of interest be avoided or disclosed
  • A duty of care, requiring advisors to determine that they are not basing recommendations on materially inaccurate or incomplete information, and to seek best execution of the clients’ securities transactions.

Over the years, Canadian courts have considered relationships outside of the agent-principal and trustee-beneficiary categories and developed a principled approach to identifying situations in which a fiduciary duty is owed. Having considered the relationship between financial professionals and clients, the courts have clearly stated the relationship is not presumptively fiduciary.

A financial professional owes clients a duty of care. However, a fiduciary relationship, and all the attending obligations, may or may not exist, depending on the circumstances of the specific relationship. The Ontario Court (General Division) provided useful guidance on fiduciary duties in the context of the broker-client relationship (Varcoe v. Sterling, 1992). This description has been cited and approved by the Supreme Court of Canada in describing the principles of fiduciaries in the context of independent professional advisory relationships.

In addition to civil standards, there have been regulatory requirements for a number of years — at least in Ontario — that a registered individual deal fairly, honestly and in good faith with his or her clients. Self-regulatory organizations (SROs) such as IIROC and the MFDA have included similar requirements in their rules.

IIROC Rule 29.1 requires that investment professionals observe high standards of ethics and conduct in the transaction of their business; not engage in any business conduct or practice which is unbecoming or detrimental to the public interest; and be of such character and business repute as is consistent with the standards of the rule. The MFDA has the same requirements, but also states explicitly that investment professionals under its jurisdiction must deal fairly, honestly and in good faith with their clients.

The duties imposed on investment professionals by the civil courts, the OSC and SROs provide important protections for investors. Canadian securities regulatory agencies have proposed strengthening and enhancing regulations to further protect investors.

In September 2009, amendments to National Instrument 31-103 came into effect that contain provisions relating to “know your client” and suitability obligations, as well as conflict of interest management, identification and disclosure. Moreover, IIROC and the MFDA have proposed, and in the case of the MFDA passed, amendments to their rules pursuant to the Client Relationship Model (CRM) project. Neither the amendments to NI 31-103 nor the CRM proposals impose a fiduciary duty on IIROC and MFDA members, but they do codify and in some cases add to the obligations these investment professionals owe to their clients.

A fiduciary standard in Canada?

The existing duties and obligations imposed on investment professionals, together with the rules developed through the CRM project, provide investors with significant safeguards in their financial dealings with registered investment professionals. They are similar to the protections that would be afforded under the uniform fiduciary standard being proposed in the United States.

In many instances, the advice of investment professionals, while no doubt valued, is not relied upon or even followed by the client. Many individuals conduct their own research and analysis and take an active role in determining which investments to hold in their portfolio. In cases where a client is made aware of and is knowledgeable of the risks of a particular holding or strategy, investment professionals, who are not acting in the capacity of a true fiduciary, should not be held to the higher standard applicable to fiduciaries.

In civil actions, the imposition of a fiduciary standard may deprive the investment professional of certain defences, including that the client is at least partially responsible for her own losses, or that the losses are attributable to market events rather than negligence.

Moreover, the damages that flow from a finding of breach of fiduciary duty can be higher than those flowing from a finding of negligence, in some cases significantly so. A blanket imposition of a fiduciary standard would ignore the realities of many advisor-client relationships. In this regard, Canadian regulators have taken the correct approach to enhancing investor protection.

  • David Di Paolo and Kara Beitel are partners at Borden Ladner Gervais LLP (BLG) specializing in securities litigation.

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    David Di Paolo, Kara Beitel