Litigation proves effectiveness of class actions to protect investors

By LegalMatters Staff • Financial institutions that fail to fairly and openly serve investment clients could face penalties or lawsuits, says Toronto class-action lawyer Margaret Waddell.

Waddell, a partner with Waddell Phillips Professional Corporation, points to several recent events where banking conglomerates have been made to answer for the way they deal with their investing customers.

She says two class action cases from earlier this year – one which was decided on a summary judgment motion and the other that was granted certification ­– involve issues about fees improperly charged to clients.

The cases demonstrate the need for, and effectiveness of class-action lawsuits to protect consumers from practices that serve the interests of the banks but not their customers, Waddell tells LegalMattersCanada.ca.

‘Publicize issues’

“What makes class-action lawsuits so essential is that they publicize issues and improve consumer awareness, hopefully correcting the behaviour of the institutions and reminding them of their obligations to their clients,” she says. “This is the type of issue where class actions can shed a light on what is happening, and that may lead to change, not just at the one or two banks named in the class proceedings, but in the entire industry.”

Waddell highlights three instances that indicate an “increasing awareness of self-dealing among banks and financial institutions.”

“It’s a new area of financial consumer protection where small investors are now questioning those brokers who put their institution’s financial interests ahead of their clients,” she says. 

Waddell says the circumstances involved in an order by the U.S. Securities and Exchange Commission (SEC) in April is an example of “self-dealing.”

In the case, one financial institution agreed to pay US$3.9 million after allegations that it failed to disclose potential conflicts of interest when it recommended and sold more expensive mutual fund share classes to some charitable organization and retail retirement account clients who were eligible for less expensive options.

Increasing awareness

“There has been increasing awareness of self-dealing among banks and financial institutions for several years now. It’s been under review by the securities commission in Canada and the SEC and there is starting to be some litigation flowing out of that,” Waddell says. “Because of that scrutiny, it’s becoming more publicized. 

“We haven’t yet seen litigation in Canada on the issue regarding the sale of more expensive share classes but it certainly would not surprise me if class actions were launched,” she adds.

In MacDonald et al v. BMO Trust Company et al, Ontario Superior Court dealt with the issue of hidden foreign exchange fees in a class action brought about against the financial institution by registered account holders.

• What class-action lawsuits in past pandemics can teach us
• Class-actions can be effective in workplace harassment cases

The account holders argued the bank committed a breach of trust by acting as a trustee of their registered accounts while charging and profiting from hidden foreign exchange fees between 2001 and 2011.

While the account holders were told of the total exchange rate, they were not advised of the bank’s mark-up fee, the court heard.

‘A breach of trust’

In his summary judgment decision, Justice Edward P. Belobaba writes “the core finding is that the defendants’ failure to disclose the amount of the markup fee charged on the foreign exchange conversions and the unauthorized self-payment is a breach of trust and fiduciary duty.” 

“The bank was essentially paying itself and doing it at the expense of its investor customers who hold registered retirement accounts or other registered accounts,” Waddell says. “That’s offside because, with the registered accounts the bank is a trustee, which means it has fiduciary obligations to its account holders and can’t be profiting at the expense of the holders of those accounts unless it’s completely transparent and it is for actual work that has been done.”

She says she expects the “bank would say it’s all completely transparent and if you read the fine print in the documents you know exactly what’s going on” but that isn’t entirely correct.

“They said they may charge fees but never said how much. It was never clear what the account holders would be charged for the foreign exchange fee and the bank just chose to charge the fee without getting authorization or approval for it,” Waddell says. “When you are operating registered retirement plans, banks have higher obligations to be transparent and to not profit from their position unfairly.”

Trailing fees

She says the case bears similarities to the issue of mutual fund “trailing fees” that prompted the certification of a class-action lawsuit in January. 

In Stenzler v. TD Asset Management Inc., the court was told a retired dentist held units of various mutual funds and discovered he was paying “trailing commissions to discount brokers for ‘service and advice’ even though no advice of any kind was being provided by them.”

According to the certification decision, during the past 10 years, “the payment of trailing commissions to discount brokers has been a topic of concern in the mutual fund industry.” The motion judge noted that the Canadian Securities Administrators concluded in 2018 that there was “no justifiable rationale” for paying discount brokers an ongoing trailing commission for the sale of a mutual fund.

Series of cases

“In the case of trailing commissions, the asset manager would pay brokerages a fee for giving investment advice and that is fine when you are dealing with a full–service broker, even if it is the broker that is part of the same bank organization. But the institution was also paying the fee to its in-house low–cost brokers who don’t provide investment advice. It is kind of a double-dip,” Waddell says. “There’s been a series of cases on trailing fee commissions that have been launched.”

She says each case illustrates the importance of both regulations and litigation when it comes to protecting the average consumer.

“This is something that needs to be vigilantly monitored because most of us are not highly sophisticated investors and when we retain and pay a broker, we expect them to be looking out for us, not the profits of the bank,” Waddell says.