Financial advisors and their firms could be spending more time in courtrooms and in regulator hearings if regulators follow through with plans to adopt a “best interest” standard, according to some legal experts.

That’s partly because advisors would be held to a higher standard of conduct when dealing with the financial affairs of their clients. But just as important, more lawsuits may arise simply because the required standard of conduct will be more clearly defined, with new methods of enforcement to match.

Although the new test is being referred to as “best interest,” it has much in common with a fiduciary standard, which requires advisors to put the interests of clients ahead of their own. Currently, it can be difficult to establish that such a standard exists in any given relationship between advisors and their clients. With that hurdle removed, lawsuits may multiply.

“If the standard shifts, then effectively that duty is deemed to apply in all circumstances,” says James Douglas, a litigation partner with Borden Ladner Gervais LLP in Toronto. “I would expect you would see some increase of litigation in this area.”

Regulators, the financial services industry and investor advocates are involved in a heated debate over the merits of imposing this duty on advisors. Supporters argue such a standard is overdue, although advisors counter that a change will needlessly increase the burdens on advisors and that the current duty to act fairly, honestly and in good faith works well.

Thus far, no specific standard has been set, but a consultation paper from the Canadian Securities Administrators (CSA) gives the following outline for a best interest standard: “Every advisor and dealer (and each of their representatives) that provides advice to a retail client with respect to investing in, buying or selling securities or derivatives shall, when providing such advice, (a) act in the best interest of the retail client, and (b) exercise the degree of care, diligence and skill that a reasonably prudent person or company would exercise in the circumstances.”

Although this definition seems relatively simple, many of these terms have already been interpreted by courts in other contexts, likely leading to their application in ways the CSA may not anticipate. John Fabello, a litigation partner with Torys LLP in Toronto, points specifically to the phrases: “act in the best interest of the retail client, and (b) exercise the degree of care, diligence and skill that a reasonably prudent person or company would exercise in the circumstances.”

“It seems straightforward and innocuous,” he says, “but the concepts embodied in those 30 words have been developed in the case law.”

That case law has been developing since 1910, he says, and thus, there are already many judgments that set out a range of criteria to assess whether or not a fiduciary duty applies. The likely result, Fabello says, is clients will launch lawsuits arguing for the new, more uniform standard, which will be easier to establish, while advisors will argue the traditional, less uniform, tests apply.

A new rule, setting out a new standard, may also lead to more regulatory probes, says Fabello. Clients may file more complaints with regulators that advisors failed to meet the appropriate standard. “Clients will complain to [the Investment Industry Regulatory Organization of Canada], they’ll complain potentially to the securities commission, saying, ‘My advisor didn’t meet the standard’.”

Douglas also believes a new, codified best interest test could lead to more class actions against advisors and their firms. (One such action against Quebec City-based Investia Financial Services Inc. was settled in June.)

Thus, Douglas argues that a “best interest” rule as contemplated by the CSA, will make it easier to certify class actions, although he expects the increase to be gradual. The adoption of a codified best interest duty means brokers cannot opt out of the duty in a contract with the client, he says, making it far more difficult to argue that the duty did not exist on the basis of the client’s superior investing knowledge or other factors that reduce the burden on the advisor.

“It won’t really matter whether the plaintiff was sophisticated or not, acquiesced or was aware or wasn’t aware, had contributory negligence or not,” he says.

But Fabello doesn’t think there is any reason to expect more class actions against advisors if the new rule is adopted. The wording of the section is likely to make class actions difficult to certify on the basis of the new rule, he suggests: “The CSA’s paper states that advisors must exercise skill and diligence that any ‘prudent person or company would exercise in the circumstances.’ What that means in class action speak is there are individual issues. The more individual issues there are the less susceptible or appropriate class actions are.”

Then, there are those who believe a new rule will reduce the number of lawsuits against advisors because everyone will know what the rules are and how to comply with them. Harold Geller, a lawyer with Doucet McBride LLP in Ottawa, argues that a best interest standard would make the law more clear, easier to follow and leave fewer loopholes for advisors to “deny, delay and confuse.”

“More to the point, there will be less litigation because advisors will actually have to do what they say they’re doing – acting in the client’s best interest,” says Geller whose firm acted for the plaintiffs in the Investia class action.

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