Are advisors liable for losses from market downturns?

November 28, 2018 | Last updated on November 28, 2018
6 min read

While no one can predict the start of the next bear market, one thing is certain: it will arrive, and investors will suffer losses.

Clients caught off guard will likely look to you for answers. Some might even consider you liable for their losses.

“One of the best predictors of upticks in claims are market forces and downturns,” says Tom Newnham, a partner at Dolden Wallace Folick in Vancouver, and co-author of a paper on advisor liability that highlights applicable case law.

In the 1992 B.C. case Rhoads v. Prudential-Bache Securities Canada Ltd., clients suffered losses when they cashed out their investments after the October 1987 stock market crash—Black Monday, the biggest one-day market collapse ever. The clients were retired, conservative investors, and had authorized their advisors to place them in growth mutual funds as well as stocks. On appeal, the advisors argued they had no control over a market downturn, and that Black Monday was unique and unpredictable.

The court grappled with whether the client’s loss was foreseeable by “a reasonably prudent advisor doing his or her job,” says Newnham. Specifically, the court differentiated foreseeability from predictability, saying: “Damages may well be foreseeable without being predictable—accident injuries, for instance, are foreseeable as a possible consequence of a venture on the highway without being predictable at the outset of any journey.” The appeal court upheld the trial judge’s ruling that the advisors were liable.

Newnham explains the difference this way: if a client close to retirement is overexposed to equities, a loss is foreseeable; the extent of the loss isn’t predictable, but “that doesn’t save you as an advisor,” he says. His paper says the case is important in confirming that a market downturn will likely be considered a “reasonably foreseeable circumstance.”

Harold Geller, an associate at MBC Law Professional Corporation in Ottawa, notes that the 26-year-old case precedes much of today’s consumer protection regulations. “This was when financial advisors were primarily seen as salespeople,” he says.

As the advisory role expanded and advisors became viewed as professionals, standards became tougher, so the case’s finding would easily hold today, he says.

Further, Geller makes clear that such cases don’t require a fiduciary relationship.

Suitability obligations are “substantial,” he says. “In most cases, you can look at the portfolio, look at the circumstances of the client, and immediately say these things don’t fit,” he says, offering the example of an 85-year-old client in a growth portfolio with deferred sales charge funds. “Clearly, it’s not going to be suitable. I don’t have to go to a fiduciary level to prove that.”

What about the client’s responsibility?

Depending on a case’s facts, the court might find that a client contributed to their losses.

In the Alberta case Penner v. Yorkton Continental Securities Ltd., highlighted in Newnham’s paper, the court found the client 25% responsible for losses because he failed to read mailed statements from his advisor over a 10-month period. (Losses resulted from the market as well as from complicated transactions.)

“Had he read the statements, there would have been substantial losses he would have seen, [which] may have resulted in him asking some questions, and probably getting some answers much earlier,” Newnham told

The decision likely represents the highest percentage of losses for which a client would be found liable, because the court generally holds advisors to a higher standard than clients, he adds. “We’re not going to see a lot of 50-50 scenarios” where both advisor and client contribute equally to a loss, says Newnham.

Geller adds that the court assesses a client’s sophistication in the context of financial products, not with life in general, so even highly educated professionals might not be deemed sophisticated. “We start from the premise that most products are exceedingly sophisticated,” he says, which is why people hire advisors.

What advisors can do

With suitability cases being common, Newnham notes the importance of a thorough KYC form—“the launching pad” for a court’s analysis of clients and their investments. He also says regulatory changes, like enhanced KYC forms and a move toward greater fee transparency, can help prevent litigation.

“Clients [who] are better engaged and better informed become more financially literate,” he says, actively resolving issues or misunderstandings and potentially resulting in fewer claims, including those without merit.

As a bonus, such clients are more likely to recognize—and pay for—advisor value, he says.

Geller notes the advisor challenge of assessing client risk tolerance, as individual firms typically have no clear, consistent definition for risk. For example, risk can refer to volatility, loss or both, he says.

Further, clients react differently to risk, however it’s defined, based on personality and income needs. For example, in a market downturn, a client requiring income will likely sell low if they have no cash reserve—a situation advisors should foresee, says Geller.

To better meet the challenge of assessing risk tolerance, he suggests diligent KYC processes so that advisors learn about clients and implement proper planning (like establishing a cash reserve) to withstand volatility.

In its client-focused reforms, which include KYC enhancements, the CSA notes that “a proper assessment” of a client’s risk profile is often lacking. Proposed KYC enhancements include requirements to collect information about a client’s risk profile and to establish procedures to determine how subjective elements, such as risk profile, are established.

Time to revisit risk

In light of the extended market run, Geller suggests advisors revisit risk with clients, being clear that they should expect losses. For example, advisors can ask clients to consider how they’d react to a specific loss or how they’d live with a specific, lower income.

He also extends foreseeability to KYP considerations, saying advisors should recognize that, for example, highly leveraged companies are at greater risk in a downturn.

The client-focused reforms’ proposed KYP and suitability enhancements require advisors take reasonable steps to understand an investment’s risks, among other things, and consider that risk when making a suitability determination.

End-of-cycle volatility in equity markets could be particularly challenging for seniors, Newnham says, noting the MFDA’s focus on advisors’ books, especially concentrations in high-risk investments and suitability for seniors. He also suggests advisors be cautious with suitability for wealthy clients since losses in large portfolios, in absolute numbers, can be shocking for clients.

Likewise, Geller says, “Right now, any financial advisor putting their clients into risk must be very worried about the [potential] downturn, especially if they’re retirees or near-retirees.”  For senior clients challenged by the lower-for-longer interest rate environment, he suggests advisors add value through planning, such as budgeting, and exercise great caution when using growth products.

Further, seniors require planning as they make significant decisions, says Wanda Morris, chief advocacy and engagement officer at CARP in Surrey, B.C. Decisions include when to defer CPP and OAS, commute a pension, transfer savings to RRIFs or take out a home equity loan to invest.

Since these decisions often put the best interests of clients and advisors in conflict, she recommends to seniors that they use CFPs, who have a best interest duty in their code of conduct.

With all clients, advisors should document meetings and emails to support their actions and prevent misunderstandings, says Newnham. Further, advisors might want to be particularly diligent with documentation for high-maintenance clients or those who depart from their plans—withdrawing more monthly income than usual, for example.

Geller says if advisors are proactive with risk tolerance and communication, they can avoid client harm—actual or perceived.

“It’s an opportunity now, in advance of when the market plummets—because it will,” he says. “We just don’t know when.”