Questionable Ruling Certifies Class Action Against Investment Advisors – Hoping for Appeal
On February 17, 2012, the Ontario Superior Court of Justice certified a class action brought against two investment advisors and their registered dealer (the “Dealer”) in the case of French and Karas et al v. Smith and Stephenson et al, 2012 ONSC 1150 (“French"). This is a terrible decision for securities dealers, mutual fund dealers and advisors because a class action was certified, notwithstanding that a strategy alleged to be applied to an entire client base must be assessed for individual suitability to determine if the advisor was negligent.
The class is comprised of the clients of two mutual fund advisors, David Karas (“Karas") and James Stephenson (“Stephenson"). The claim alleges that Karas and Stephenson inappropriately applied a "one size-fits all" investment strategy for their clients and had no regard for client suitability or objectives. The plaintiffs allege that Karas and Stephenson engaged in a leveraging scheme whereby they encouraged and facilitated clients to take on debt for the purpose of purchasing mutual funds. As a result, the plaintiffs allege, Karas and Stephenson enjoyed additional compensation through increased trading volume while their clients bore the cost and risk associated with investing with debt. The plaintiffs further claim damages against the Dealer for failing in its compliance responsibilities by allowing this leveraging to occur.
In support of their claim that the defendants have breached the duties owed to their clients, the plaintiffs pointed to a Mutual Fund Dealer Association (“MFDA") Member Regulatory Notice which provides that leveraging is not suitable for all investors and that individual consideration must be given with respect to the client's know your client (“KYC") form.
To approve of the certification, the Court concluded that the proposed class members share sufficiently similar claims, which all relate to the duty of care owed by the defendants to their clients. However, the Court held that the actual damages suffered by each claimant will require an individual assessment based on a number of factors, including the date of purchase, the applicable interest rate on loans, tax implications and mitigation. As a result, the quantum of damages was not certified as a common issue.
We are hopeful that this decision will be appealed as it is our view that the decision incorrectly applied the law. Both the standard of care and whether or not there was a breach of the duty must be assessed on a case-by-case basis. A class cannot be certified when suitability is at the heart of the claim, notwithstanding that one strategy may have been applied across the board. Whether that strategy was suitable must be determined based on the sophistication and risk tolerance of EACH plaintiff. How can this be determined in a class action proceeding? It can’t.