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Increased duties for investment fund managers in Canada

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Marie-Noël Rochon
Monica-Ann Jarry (student)

In its recent decision in Wright v. Horizons ETFS Management (Canada), the Ontario Court of Appeal confirms the trend towards increased duties for investment fund managers in Canada.

Background

In Wright v. Horizons ETFS Management (Canada) Inc., 2020 ONCA 337, the Ontario Court of Appeal reversed a first instance order refusing to certify a class action. The proposed class action was brought forth on behalf of investors in a proprietary derivative-based exchange-traded fund (“ETF” or “Fund”) developed and managed by Horizons ETFS Management (Canada) Inc. (“Horizons”). The Fund was meant to provide inverse exposure to stock market volatility. The prospectus described the Fund as “highly speculative” and “involving a high degree of risk”. Units of the Fund were distributed to retail investors. On February 5, 2018, the Fund lost nearly 90% of its value overnight and, on April 10, 2018, Horizons closed the Fund.

Wright alleges that Horizons was negligent in designing, developing, offering, and promoting the Fund, which was allegedly “doomed to fail”. Wright also alleges that Horizons failed to explain the real nature and extent of the risks of investing in the Fund, to monitor the Fund’s investment strategy and to diligently perform its duties as manager of the Fund. Moreover, Wright alleges that Horizons made misrepresentations in the prospectus within the meaning of s. 130 of the Securities Act, R.S.O. 1990, c. S.5. (“OSA”).

Justice Perell of the Ontario Superior Court of Justice denied Wright’s motion for certification and dismissed the action. Justice Perell held that it was obvious there was no reasonable cause of action in negligence against Horizons.

Justice Perell rejected that Wright’s claim fell within any of the previously recognized categories of duties of care for pure economic loss (including, for example, negligent supply of a “shoddy good” or negligent performance of a service). As such, he considered whether it was appropriate to recognize a novel duty of care.

Ultimately, Justice Perell determined that it was not appropriate to recognize a novel duty of care in these circumstances. While he was prepared to accept that there was a legally “proximate” relationship between Horizons and the Fund’s investors, he found that any resulting duty of care was limited by the narrow scope of Horizons’ undertaking. In his view, Horizons had not agreed to guarantee returns or to actively manage the Fund. Rather, Horizons had simply undertaken to put on the market an ETF product that operated as described in the accompanying disclosure documents (which the Fund did). Justice Perell also held that there were policy reasons that militated against extending a duty of care for pure economic loss in the manner proposed by Wright.

Justice Perell accepted that there should be a statutory cause of action for misrepresentations in the selling of ETFs, which now represent a substantial and growing share of the investment marketplace. The novel issue was whether a claim for misrepresentations arising out of the sale of ETFs could be brought under s. 130 of the OSA (primary market misrepresentations), or whether a claim only arose under s. 138.3 of the OSA (secondary market misrepresentations). He concluded that Wright and the class members did not have a cause of action pursuant to s. 130 of the OSA.

The Ontario Court of Appeal

The Court of Appeal allowed the appeal in part on the basis that the statement of claim disclosed reasonable causes of action and remanded the case back to Justice Perell for a decision on the remaining certification factors.

Writing for a unanimous panel of the Court of Appeal, Thorburn J.A. held that both causes of action were viable. Regarding the negligence claim, the Court of Appeal reached the conclusion that Wright had reasonable chances of demonstrating that the claim fell within a recognized duty of care under the category of negligent performance of a service and that the situation at hand was analogous to Cannon v. Funds for Canada Foundation,[1] a case involving a failed tax avoidance program. Moreover, the Court found that Horizons, as the fund manager, also had a legally proximate relationship with the investors and undertook towards them to act honestly, in good faith and in the best interests of the Fund and to exercise the degree of care and diligence that a prudent person should exercise in the circumstances.

The Court of Appeal disagreed with Justice Perell’s conclusion that all units should be treated as secondary market purchases, such that only s. 138 OSA would apply. The Court of Appeal noted that investors did not know, when purchasing a unit, whether they were receiving a new unit (“Creation Unit”) or a unit previously in circulation on a stock exchange. The fact that Creation Units were comingled with other units purchased on the secondary market should not disentitle holders of Creation Units from invoking their rights under s. 130 OSA. Wright had not pled the material facts necessary to establish that he has a cause of action under s. 130 OSA, but the Court of Appeal granted leave to amend the statement of claim to address this issue.

The Court of Appeal’s decision does not certify the class. Wright will still need to satisfy the remaining certification criteria in order to have the action certified as a class action and to prove his claims at trial.

A Trend Towards Increased Duties for Fund Managers

In Asselin v. Desjardins Cabinet de services financiers inc.[2], the Quebec Court of Appeal discusses at length the extra contractual and contractual liability regime and how it should be treated before Quebec courts in matters of authorization (certification) of securities class actions.

Regarding Desjardins Gestion Internationale d’Actifs inc. (“DGIA”), Asselin alleges that it should be liable for having been negligent in designing and managing investment products. The Quebec Court of Appeal authorized (certified) the class action under both the Quebec Code of Civil Procedure and under the Quebec’s Securities Act (c. V-1.1) (“QSA”), based on Asselin’s allegations of faults on the part of the DGIA, of a prejudice (loss of return, loss related to deprivation of capital, disturbance and inconvenience) and of a causal link between the prejudice and the faults.

The tort of negligence does not exist under Quebec civil law. Instead, one must refer to the articles which are the basis of extra-contractual and contractual liability, respectively articles 1457 and 1458 of the Civil Code of Québec. A representative plaintiff has to include in her pleadings allegations of fault, damages and causal link. The civil remedy regimes for misrepresentations under the OSA and the QSA are very similar. The similarities between the two regimes were highlighted in the Quebec Court of Appeal’s ruling in Theratechnologies inc. v. 121851 Canada Inc.[3]

Under both Ontario and Quebec law regimes, the trend is towards an expansion of duties for investment funds managers. The Wright and Asselin decisions, rendered respectively by the Ontario and Quebec Courts of Appeal, suggest that fund managers may be held liable for failure to properly design funds (including ETF) and to fully disclose all associated risks.

[1] 2012 ONSC 399, 13 C.P.C. (7th) 250.

[2] 2017 QCCA 1673; application for leave granted, 2019 CanLII 58133 (SCC), judgment pending.

[3] 2013 QCCA 1256, para. 68; confirmed on that ground by the Supreme Court of Canada: Theratechnologies Inc. v. 121851 Canada Inc., (2015) 2 RCS 106, para 32.