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Article

Broker Liability for Losses Resulting from Breach of Duty of Care to Clients

Date

March 5, 2007


Newman v. T.D. Securities Inc., 2007 CanLII 463

Ontario Superior Court of Justice, January 16, 2007

Court Docket No. 04-CV-28596

The plaintiffs suffered investment losses of approximately $2 million, primarily as a result of significant holdings in Nortel – the plaintiffs brought a claim against their investment advisor and his brokerage firm to recover such losses – the plaintiffs alleged that the investment advisor breached his duty of care by failing to recommend the sale of Nortel shares, and also by recommending the purchase of shares in other high technology companies – the court held that the investment advisor recommended the sale of Nortel shares on several occasions and thereby met the requisite standard of care – however, the investment advisor breached the standard of care by recommending the purchase of additional shares in high technology companies at a time when the plaintiffs’ stock portfolio was not allocated in accordance with its stated objectives – the plaintiffs were contributorily negligent and 50% responsible for such losses.

The plaintiffs transferred investments of approximately $1.2 million into a brokerage account at T.D. Securities Inc. The value of the account rose above $3 million, but then decreased again to approximately $1 million. Most of the rise and fall in value was attributable to the plaintiffs’ shareholdings in Nortel Networks Inc. ("Nortel"), for whom one of the plaintiffs worked.

The plaintiffs sought to recover their investment losses from their investment advisor and his brokerage firm. The plaintiffs alleged that the investment advisor breached his duty of care by failing to recommend the sale of a specific number of Nortel shares, and by failing to provide a workable tax plan to avoid capital gains taxes related thereto. The plaintiffs also alleged that the investment advisor breached his duty of care by recommending the purchase of shares in other high technology companies. At the time of the latter recommendation, their portfolio’s allocation of income-generating securities was lower than 20%, which was their stated investment objective. The plaintiffs alleged that the investment advisor ought to have recommended the purchase of income-generating securities such as bonds or preferred shares instead of shares in other high technology companies.

Issues: Whether (i) the investment advisor met the requisite standard of care in advising the plaintiffs; (ii) the plaintiffs were contributorily negligent and partially responsible for any loss; and (ii) the measure of damages suffered by the plaintiffs.

Held: The investment advisor met the standard of care with regard to his advice on the Nortel shares. However, the investment advisor did not meet the standard of care by advising the plaintiffs to invest certain proceeds in other high technology companies. The plaintiffs’ damages were reduced by 50% in order to reflect their contributory negligence.

The court must consider five factors in order to determine the extent of an investment advisor’s duty of care: the client’s degree of vulnerability; the degree of trust and confidence placed in the investment advisor by the client; the client’s history of reliance upon the investment advisor; the investment advisor’s discretion over the client’s account; and the applicable professional rules and code of conduct.

Based upon these factors, the court will place the broker-client relationship somewhere along a spectrum. On one end of the spectrum is a fiduciary relationship of full trust and advice; on the other end is a relationship where the broker merely takes orders from, and provides no advice to, the client and the broker has no discretion to trade without the client’s consent or knowledge.

In this case, the relationship was closer to that of an order taker than to that of a fiduciary. The plaintiffs were both well-educated; their degree of reliance upon and confidence in the investment advisor was in the lower range; the investment advisor did not have trading discretion over the account; and as the broker-client relationship lasted only four years, the court found that there was not a long-term relationship.

In these circumstances, the duty of the investment advisor is to give "appropriate financial advice" and to abide by the relevant professional rules and code of conduct. If a client disregards such advice, it would be prudent (but not necessary) for the advisor to record such fact in writing.

On the evidence before it, the court held that the investment advisor had recommended the sale of some of the plaintiffs’ Nortel shares and to diversify the portfolio on several occasions. The plaintiffs refused to follow this advice. The plaintiffs’ submission that the investment advisor ought to have provided them with an appropriate tax plan to minimize capital gains was unfounded. An investment advisor does not owe a duty to give income tax advice, and the plaintiffs had been advised to consult with their own tax expert. Accordingly, the plaintiffs were responsible for the losses that resulted from their shareholdings in Nortel.

On the other hand, the investment advisor failed to meet the requisite standard of care with regard to his recommendation that the plaintiffs purchase shares in several other high technology companies. In these circumstances, the investment advisor owed a duty to the plaintiffs to recommend investments suitable for their portfolio, and to apply an appropriate degree of skill and knowledge to such recommendation. At the time of the recommendations, approximately 87% of the plaintiffs’ portfolio already comprised high technology stocks, which exceeded the plaintiffs’ stated objective of 80%. The portfolio also failed meet the stated objective of 20% for income-generating securities. Moreover, the Nortel stock alone comprised 73% of the entire portfolio.

In the circumstances, prudent financial advice would have consisted of a discussion and recommendation of the purchase of income-generating securities such as preferred shares or bonds. The purchase of additional shares in high technology companies was not suitable advice.

However, the plaintiffs were contributorily negligent and partially responsible for the loss. The degree of contributory negligence is a question of fact. In this case, one of the plaintiffs worked in the high technology field, was comfortable with high technology investments, and had approved of the investments. Further, the plaintiffs failed to sell shares of Nortel in accordance with the investment advisor’s advice, which would have reduced their general holdings in high technology companies. Accordingly, the court held that the plaintiffs were 50% responsible for the loss.

The court held that the investment advisor was not responsible for investment losses suffered after a reasonable period of time elapsed subsequent to the termination of the broker-client relationship. Such period of time is generally decided on the basis of factors such as the ease of sale of the investments, the clients’ degree of sophistication and experience, the degree of trust placed in the broker, and whether the broker had discretion over trading. In this case, a period of four months subsequent to the termination of the relationship was appropriate.

The plaintiffs also claimed damages for an opportunity cost of 5% per annum on their losses, which is the rate of return that would have been produced by income-generating securities. To reflect this opportunity cost, the court awarded prejudgment interest at the rate of 5%, which was higher than the applicable prejudgment rate of interest of 2.3%.

Before: Smith J.

Expertise