Ditching the Securities "Blanket": The Travails of Revisiting the Investment Advisor - Client Fiduciary Obligation in Canadian Law

By Mark A.B. Donald' z

Introduction: South Park bellwether of the financial services industry In a March 2009 episode of the television series South Park, Stan Marsh, one of the show's 10year-old protagonists grudgingly agrees to place $100 of birthday money into a long-term savings account at his father's request so that it can "grow over the years". The bank's financial advisor applauds the young boy's decision and begins furiously typing on his computer, announcing that he has placed the birthday cash in a `Money Market Mutual Fund' and then reinvested the earnings into foreign currency accounts with compound interest. After a momentary pause, the advisor declares that the money is "gone". When the young client remonstrates that he had one hundred dollars, the advisor responds: "Not anymore you don't.....poof!" When South Park sees fit to attack the financial services industry, you can be sure that its excesses have reached critical mass in the cultural zeitgeist. This scene vividly illustrates the pervasive discontent afflicting investors both in Canada, and around the world. In Ontario, this discontent has manifested itself in a heated debate over the overall wisdom and proper scope of a proposed statutory fiduciary or "best interest" duty upon Ontario's investment advisors (IAs). The roots of this dispute can be found in socio-economic tumult of the 2008-9 global economic recession. Hurtling to its messy zenith, the Great Recession dovetailed with profound changes in the character of the Canadian financial services market. So-called "retail investors" individuals for whom investment has become the lynchpin of financial security were more prevalent than ever before, and increasingly focused on investment nest eggs as a means to secure their dream of "freedom 55" or send their children to university. This phenomenon contrasted sharply with previous generations that had relied upon on pensions, government bonds and savings accounts as the backbone of their financial planning. As the depth of the crisis became clear, investor advocacy groups trained their guns on the ethics and standards of the IAs in whom they had placed so much of their faith and funds. These groups alleged that the modern-day retail investor is often cajoled or misinformed by their IA into inappropriate, overly-risky investment strategies - with often disastrous results. Leading securities expert professor Janis Sarra of the University of British Columbia echoed this lament, writing that the Canadian securities market was designed for sophisticated investors who could understand its pitfalls and manage them accordingly a model rendered archaic by the rise of the amateur retail investor. To supporters of a statutory fiduciary/best interest duty, the inequities of

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 mark.a.b.donald@gmail.com
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The author wishes to thank Mr. Ed Waltzer of Stikeman Elliott LLP, Mr. Joel Wiesenfeld, Mr. Jeffrey Spiegel of Norton Rose Fulbright Canada LLP and other contributors for their invaluable insights on this topic. All errors and omissions are the author's sole responsibility.
Z

the modem securities market were so profound that only a presumptive, statutorily-codified fiduciary relationship can protect the new generation of increasingly vulnerable clientele. In October, 2012, the Canadian Securities Administrators (CSA) responded to the growing discord by releasing a discussion paper announcing plans to investigate the issue. The organization convened a series of roundtables in June 2013 that brought proponents and detractors of the proposed new standard together. However, in November 2013, years after the first shots were fired, much remains unresolved. This ongoing inaction is a testament to the debate's startling complexity, and the vastly divergent viewpoints that it inspires. The difficulty in even defining the meaning and scope of a fiduciary/best interest standard makes in an unhelpful tool to settle a debate that engages multiple competing belief structures, differing legal philosophies, vastly different levels of education and divergent social goals. In the author's opinion, it's these diverse challenges which make the fiduciary paradigm an inappropriate mechanism through which to reform the advisor-client relationship. This paper argues therefore, that the best option is for all stakeholders to abandon the best interest/fiduciary paradigm, and instead look to more discrete, structural reforms as the key to the advisor-client puzzle.

Good faith vs. best interest: defining the standards At its core, the debate over a fiduciary/best interest standard revolves around legal terminology. In broad terms, Ontario securities law adopts a principle-based and inherently flexible model to regulate the advisor-client relationship. The present standard requires that financial advisors deal "fairly, honestly and in good faith with their clients," 3 a benchmark that requires lAs (1) to disclose, manage or avoid conflicts of interest; (2) fulfill the "Know Your Client" requirement to provide advice tailored to the particular circumstances and risk tolerance of each investor, and (3) satisfy the "Know Your Product" obligation that lAs understand the products they are selling so that they can proffer a truly professional opinion. In contrast, a fiduciary/best interest standard demands a higher level of fidelity. Just as the name implies, this standard demands that the advisor act "in the best interests" of their client, in effect putting the client's interests wholly and completely above their own. When a fiduciary duty is found to have been breached, the legal consequences are grave: the beneficiary/client is entitled not only to be made financially whole again (i.e. a return of their investment), but also to any profits that the offending fiduciary has made as a consequence of their breach. At common law, it is possible for the advisor-client relationship to reach fiduciary status on an ad hoc, case-by-case basis - but the onus is on the aggrieved client to prove it in court. In practical terms, the client-advisor relationship exists on a sort of fiduciary spectrum: at the fiduciary end would be an account managed solely at the advisor's discretion, while at the other, non-fiduciary extreme would be an account under which the advisor has aproforma role i.e. as a "mere 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 and Dealers: Exploring the Appropriateness of Introducing a Statutory Best Interest Duty when Advice is Provided to Retail Clients at fn 23, online:< http://www.osc.gov.on.ca/en/SecuritiesLaw csa 20121025 33-403 fiduciaryduty.htm> [CSA Consultation Paper].

investors must prove that the relationship with their advisor was informed by five factors: (1) that the client's lack of knowledge or investment skill left them vulnerable; (2) that the client subsequently reposed trust in their advisor and that this trust was accepted; (3) that the client demonstrate a reliance upon the advisor's counsel and that the advisor held themselves out as having special skills and knowledge; (4) that the advisor had power or discretion over the client's account; and (5) that the advisor was bound by professional rules or codes of conduct that that suggest a fiduciary standard may be applied. 4 The power of the present common law fiduciary remedy is clear. A blanket, statutory fiduciary/best interest duty would amount to a complete reversal of risk-allocation in the advisorclient relationship by codifying the presumption of a fiduciary relationship between the parties that 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 running from 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 relationship including: (1) the clear lack of understanding that many retail investors (and purportedly, many IA themselves) have about the financial products that are being sold; (2) lAs' penchant for advertising their services in distinctly fiduciary terms, leading many clients to trust them accordingly; (3) the often glossed-over existence of third-party compensation schemes that reward lAs for recommending certain financial products over others, thereby calling into question whether lAs' obligations of honesty and good faith are being met; and (4) the lack of a cost-efficient regulatory mechanism outside of the courts to address investor grievances (critics argue that many retail clients lack the financial means to take such a dispute to court at the best of times, let alone when their investments have just taken a beating. According to one lawyer interviewed by the author, the cost of such an action for plaintiffs "regularly" exceeds $80,000 CAD). Investor advocates argue that that the product education offered by lAs as part of their good faith duty is largely incomprehensible to their retail clients, and that in any event, the salesmanship exhibited by lAs is a powerful agent for overcoming any sobering effects that informational disclosure might have. Leading corporate law scholar Donald C. Langevoort of Georgetown University for example cites studies indicating that the financial services industry is "an area, probably, where savvy salesmanship typically trumps over written consent" [relating to acceptance of risk and suitability of the marketed product]. Langevoort cites the findings of several American consumer psychologists, concluding: "We are motivated to trust those who promise us what we want, as well as those who hold out the promise of removing the anxiety associated with frightening choices." 5 As one Ontario lawyer stated in an interview to the author,
Hunt v. TO Securities 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].

investment purchases are often sealed by appealing to the better angels of retail investors' nature by asking in effect, "who are you going to trust, me or a piece ofpaper? ". Related to this problem says the pro-investor camp, is the fact that the financial services industry actively markets itself as fiduciary in character. lAs are promoted not merely as salesmen of a product, but rather as "personal wealth advisors", apparently dedicated to acting in the client's best interests, that is to say, as fiduciaries. And this advertising strategy seems to be working: the Ontario Securities Commission (OSC) has concluded that investors already perceive (incorrectly) that their financial advisors are already subject to an automatic fiduciary duty. 6 One financial adviser has written: "The financial services industry tends to encourage clients to "Trust Us" until the moment a dispute arises when they usually call in their lawyers to deal with investors who do not have similar resources," 7 while a 2012 report by the Financial Planning Standards Council found that many Canadians "operate on blind trust" when it comes to obtaining investment advice, and are misinformed about issues ranging from financial advisors' required qualifications to their ethical and legal obligations. 8 Moreover, investor advocates criticize what they call an "alphabet soup" of designations which add an air of professional credibility to the financial services industry akin to that of doctors or lawyers - two occupations that are unmistakably fiduciary in character. The Investment Industry Regulatory Organization of Canada (IIROC) echoes this criticism and has suggested that many of the official titles or designations adopted by financial advisors suggest a level of professionalism and proficiency "which may be misleading to consumers." 9

The fiduciary obligation in practice: horribly indeterminate To critics of a statutory fiduciary/best interest standard however, the measure is a blunt and dangerous response to the complex reality of the advisor-client relationship. They charge that proponents of a fiduciary/best interest standard are guilty of focusing too closely on the emotive plight of certain unfortunate retail investors without considering what the term "fiduciary"

Ontario Securities Commission Investor Advisory Panel, News Release, "Draft Statement of Priorities OSC letter" (27 April 2011), online: <http://www.osc.gov.on.ca/docurnents/en/Securities-CategorylComments/corn 20110427 11-765 ananda.pdf>. Ken Kivenko, Advisor Risk, Canadian Money Saver (June 2011), online: <http://www.canadianfundwatch.com/files/advisor-risk.pdf >. "It's Regulated, Right?" - Research Reveals Canadians in the Dark Regarding Qualifications, Ethical Obligations of Financial 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: <http://faircanada.ca/wpcontent/uploads/2011/01/130426-Letter-to-CSA-re-Misleading-TitIes-and-Designations.pdf >. 4

actually means at law, or the extreme consequences that may result from applying it inappropriately. Anti-statutory observers criticize the investor rights lobby for its apparent tendency to see the application of a statutory fiduciary/best interest duty as zero-sum proposition and therefore, to see blanket application of the duty as the best, and perhaps only way to achieve more robust investor protection. In this way charge some in the securities defence bar, investor advocates are in fact stifling constructive debate by advocating for an extreme response to a problem that demands nuance. As the CSA opined in its October 2012 report, a statutory best interest standard need not mean an unqualified common law-style common law fiduciary duty on all advisors in respect of each and every facet of the relationship, but rather, can be qualified to accommodate the particular circumstances and business model of the financial advice industry.' 0 This approach accepts the possibility that certain discrete fiduciary obligations can be created between advisor and client to create a qualified fiduciary duty without taking the fateful step of codifying an allencompassing fiduciary relationship. Experience shows that targeted structural reforms can accomplish many of goals championed by investor advocates without resorting to a blanket fiduciary/best interest duty. In the United Kingdom for example, the regulatory watchdog Financial Services Authority (FSA) has introduced what is widely seen to be a qualified best interest standard that creates "tiered" levels of advice, each requiring different levels of disclosure depending on whether the IA is advising upon or recommending a restricted or proprietary range of products. In addition, both Australia and the U.K. have banned third party commissions-based lAs - mainstay features of the Canadian financial services market which have been criticized by investor advocates in this country as inimical to the IA's duty to act honestly and in good faith." Closer to home, IIROC and the Mutual Fund Dealers Association of Canada (MDFA) have recently strengthened their own regulatory standards with the Client Relationship Model, which calls for more robust disclosure. Reform efforts like these illustrate how law and policymakers can adopt a graduated approach to regulation of the financial services industry that avoids the muddled and often acrimonious debates surrounding imposition of a blanket, common law-style fiduciary duty. In contrast. many groups at the forefront of the investor advocacy movement appear to view a fiduciary/best interest standard as best employed, or perhaps only available, in a blanket, all-encompassing manner. Indeed, the transcript of the CSA's June 2013 roundtable reveals that many investor advocates have identifiable concerns, but a tendency to talk about a statutory fiduciary duty as a singular, inflexible legal monolith. The ultimate problem with a blanket approach to fiduciary/best interest duties is one of consumer psychology. In rejecting the application of an all-encompassing fiduciary approach, one must appreciate that the term "fiduciary" is as powerful as it is imprecise. Black's Law Dictionary defines a "fiduciary" as: "[O]ne who owes another the duties of good faith, trust, confidence, and candour ... one who must exercise a high standard of care in managing another's money or
CSA Consultation Paper, Supra note 1. "CSA Consultation Paper, Supra note 1.

property." While this definition appears intuitively satisfying at first glance, its application is, according to Langevoort, "horribly indeterminate." 2 Legendary American Jurist Felix Frankfurter conceded the challenges of applying the fiduciary title when he opined "But to say that a man is a fiduciary only begins the inquiry." 3 The practical consequence of this uncertainty means that the term 'fiduciary' can be arguably applied to virtually any relationship with a little imagination - imagination that lAs fear will run wild when a retail investor has just seen their child's college fund wiped out. It is unlikely that the unsophisticated retail investor can be expected to understand the avowed complexity of the term "fiduciary" and all the conceptual legal baggage it imports, let alone differentiate it in practice from the standards already in place. With this in mind, the fact that retail investors reportedly believe that financial advisors are fiduciaries belies the fact that they, along with the legal profession itself, struggle to defme what the term "fiduciary" actually means.

The underlying problem: The myth of the "no risk" market Discerning the difference between a blanket fiduciary duty and a qualified best interest standard is clearly a difficult task, leading many investor advocates to question why the higher fiduciary/best interest duty was not codified yesterday. According to many opponents of a blanket fiduciary standard however, the problem is that modern-day retail investors have a developed a skewed understanding of personal investment that makes imposition of a blanket duty especially dangerous. Previous generations of Canadians saw financial products like savings bonds, Guaranteed Investment Certificates (GICs) and their low-return bank savings accounts as the pillars of financial security, but as retail investment has become more prevalent, many in the financial services industry assert that investors have not accepted the subsequent increase in risk that accompanies that decision to abandon low-return investment strategies and enter the stock market. Opponents of a blanket fiduciary duty are therefore concerned that such a statutory creation is particularly ill-advised and dangerous for lAs in an era when their clients have come to believe that in the word of one practitioner interviewed by the author, even "low risk" in the securities market has come to mean "no risk." Statistics support the idea that retail investors are too quick to apply the fiduciary tag in the face of financial difficulties, and that that the modern day investor-client relationship is not as beset by careless fiduciaries as investor advocates suggest. In 2009, leading securities lawyer Joel Wiesenfeld analyzed the 47 cases then-contained in Carswell' s Broker/Dealer Legal Reference Case Law Database spanning the years 1987-2007. He found that in 35 of the 46 (with three cases involving non-client/advisor relationships) - a full 76% - the courts declined to find a fiduciary duty on the basis of the indicia of trust, vulnerability and reliance. 14 The evidence therefore suggests that on the facts, advisors are only rarely found to be fiduciaries by the courts,

12
' 3

Donald C. Langevoort, Brokers as Fiduciaries, 71 University of Pittsburgh Law Review 439 at 446 [Brokers]. SEC v. Chenery Corp., 318 U.S. 80,85(1943). 14 Joe1 Wiesenfeld, Beware of the Lure of the "Fiduciary" Label, Investment Executive, April 2009.

and certainly not to an extent that would demand a wholesale change to the law of fiduciary obligation via a blanket duty.

Education and disclosure: the antithetical goals of a blanket fiduciary standard Moreover, the practical implementation of a blanket statutory standard comes with far-reaching, adverse consequences. Foremost is whether or not such a standard is even practicably workable in the case of many unsophisticated retail investors. Speaking in September, 2013 on the issue of financial stewardship, John G. Taft, CEO of RBC Wealth Management - U.S., asserted that investment advisors should be viewed as fiduciaries, and that the integral component of this duty was advisor's responsibility to disclose the specifics of the products they are selling and educate the client as to the risks. At the CSA's June 2013 roundtable, one participant called the present disclosure regime "incomprehensible", and unsuitable for present market conditions given that the average person can't even do comparative pricing when they shop for paper towels." By way of example, one securities law practitioner interviewed by the author criticized the OSC's use of the Flesch-Kincaid grade level, a system which purports to measure and ascribe the grade-school level of reading required for comprehension and thereby ensure readability. According to this interviewee however, the system is flawed in that only OSC policy document 81-101 "Mutual Fund Prospectus Disclosure" purports to set a benchmark of grade 6 reader comprehension. Moreover argues this detractor, the notion that complex securities products can be distilled into grade six language is fundamentally flawed. And this is exactly the problem. These two oft-repeated prescriptions - increased disclosure and increased education of clients by lAs - may be desirable in the abstract, but their benefits in cases where the investor/client makes the ultimate decision are arguably illusory. The financial services industry is avowedly complex and influenced by an infinite number of social economic and political factors. With this in mind, and given the aforementioned state of contemporary consumer psychology on the issue, it is questionable whether as a group, retail investors can be "educated" to such an extent that their decisions are informed to a standard that satisfies their conception of what a fiduciary standard entails. When combined, this unprecedented complexity along with investors' apparently unrealistic expectations threatens to make sound financial planning advice less attainable to ordinary retail investors. The most adverse mooted consequence of a blanket statutory standard say critics would be a situation wherein low-asset retail investors find themselves "shut out" of the market by lAs who refuse to take-on a generation of retail clients conditioned to viewing poorly performing investments as the inevitable result of advisor mismanagement. American lawmakers expressed have already their concern to the U.S. Securities and Exchange Commission that a fiduciary standard would "severely limit access to low cost investment advice.'

Solving the impasse: moving beyond the fiduciary construct Perhaps the fundamental stumbling block in the discussion over a fiduciary standard is that it is more aptly seen as a policy question, as opposed to the strict application of common law principles. Scholar Leonard Rotman has written: "The fiduciary concept is primarily a public 7

policy tool designed to regulate important social and economic relationships that arise from human interdependency in contemporary society. This explanation clarifies exactly why the fiduciary debate over lAs is so fierce - it engages issues and challenges that run the gamut, including professional regulation, economic efficiency, consumer psychology, legal philosophy and societal demographics. Ultimately, the debate over a blanket statutory fiduciary/best interest standard represents a clash of two diametrically opposed philosophies: general acknowledgement that sound financial advice is vital to a society's economic health on the one hand, but also a widespread acceptance that profit motive, however large or small is an acceptable lodestar for financial services industry. Despite the fact that lAs might promote themselves as possessing a veneer of professional status, there is little doubt that their expertise is fundamentally different to that of other fiduciary professions. Unlike in the financial advisor-client context, the scope of a doctor-patient or solicitor-client relationship is confined to a specific expertise upon which the beneficiary of the fiduciary duty is completely reliant. Few Canadians can expect to perform a successful surgery or win a legal case by spending a few hours googling, getting advice from acquaintances at a party or simply listening to their intuition. In the stock market however, these insights can make even an untrained investor wildly successful, illustrating that while lAs can provide clear 'value added' to their clients, there is no escaping the inherent risk of the market, and with it the understanding that lAs are, at their basic core salespeople, and not fiduciaries. Langevoort gives a particularly prescient rationale from the American perspective: "The punch line is simple. You can't really expect to "fiduciarize" a business that is all about selling unless you are prepared to reorient its structure entirely, which economically and politically - we are still far from willing or able to do with the securities industry." 5 He ultimately concludes that "regulating at the margins" is the better solution. 16 Perhaps the best approach would be to abandon the idea that a full, common law-style fiduciary duty or even a limited "best interests" standard is an appropriate conceptual starting point for reforming the advisor-client relationship in Canada. Ed Waitzer, Partner at Stikeman Elliott LLP and former head of the Ontario Securities Commission posits that the Chilean Multfundo model, for example, might be provide a more practical alternative to the seemingly endless debates over the scope and advisability of a statutory fiduciary duty. Under Multfundo system, the investment options available to investors are limited by government authorities to a series of five funds, A to E, with each targeted towards a specific age group/risk preference based on the fund's allocation of equities and foreign assets. Investors are able to select their own investment managers, but are restrained from assuming certain risk/return preferences depending on their proximity to retirement, and are barred from investment patterns that exceed the government-mandated risk levels.

Conclusion Not entirely unexpectedly, the South Park shines as beacon of truth. The swift demise of Stan Marsh's modest birthday haul reminds us that new social dynamics and economic realities clearly demand a re-evaluation of how our financial services industry works. However, the
' Perspectives, Supra note 3 at 996. 16 Brokers, Supra note 9 at 449.

inherently ideological and emotive debate over a statutory fiduciary/best interest duty, blanket or otherwise, is ultimately counterproductive in the author's opinion. While obviously wellintentioned, many supporters of a blanket statutory fiduciary/best interest standard apparently view this equitable legal construct as a sort of panacea. This position ignores the significant practical legal perils that such a statutory creation would create, and puts investor advocates on an unhelpful, and arguably unavoidable collision course with lAs and the securities defence bar. The better way forward would be for all parties to consider the power of targeted, systemic regulatory changes to the financial services industry, and accept that wholesale revolution to the client-advisor relationship is not a precondition to developing a fairer and more efficient financial services industry. Such an approach could have profound, positive results, while avoiding the theoretical debates that make a fiduciary/best interest solution so elusive.