Written By Cheryl Woodin, Doug Fenton, Dylan Yegendorf, and Ty Fox
In Frayce v. BMO Investor Line Inc. et al, 2023 ONSC 16 [Frayce], the Ontario Superior of Justice refused to certify a class proceeding brought by aggrieved investors to address the controversial practice of "trailing commissions" paid by mutual fund managers to discount brokers. Mutual fund trailing commissions (MFTCs) are fees paid by mutual fund managers (out of the investors' funds) to discount brokers for services in connection with mutual fund investments. The decision has important implications for class proceedings brought in connection with regulated industries, as it highlights the critical distinction between the statutory illegality of certain conduct, and whether liability can be imposed in respect of that same conduct in the pre-regulatory landscape.
In Frayce, the putative class of investors argued that the practice of paying MFTCs to discount brokers harmed investors and, importantly, contravened applicable securities law, even before the practice was prohibited in June 2022.
On the motion for certification, the core issue was whether there was "some evidence" the practice of charging MFTCs contravened Canadian securities law, before the prohibition of the practice took effect in June 2022. The plaintiffs agreed that if the answer to this issue was "no", then there would be no basis for their pleaded causes of action against the defendants, being breach of contract, negligence, unjust enrichment, knowing receipt and knowing assistance. Nor would there be any basis for the other proposed common issues and damage claims, and the plaintiffs' proposed class action would collapse and certification would be dismissed.
The Court's Analysis and Decision
The Court ultimately concluded that the plaintiffs failed to provide "some evidence of illegality". As a result, there was no basis for any of their pleaded causes of action and thus no basis for a class proceeding. The Court reached this conclusion for three principal reasons.
First and crucially, the plaintiffs could not point to any pre-2022 securities provision expressly prohibiting the impugned practice. Absent such a provision, the plaintiffs attempted to rely on general standards of practice, including the principles of "fair dealing" and "avoiding conflicts of interest", and argued that these amounted to a de facto prohibition of MFTCs. However, the Court found that this position failed because (1) by the plaintiffs' own admission, discount brokers cannot and do not provide investment "advice" and thus it was unclear as to how and where a conflict of interest could arise, (2) many of the defendants' account agreements expressly disclosed their receipt and retention of MFTCs, and (3) neither the "fair dealing" nor the "conflict-of-interest" provisions in applicable securities laws were ever used in any enforcement proceeding against any discount broker for MFTCs.
Second, the plaintiffs did not provide any expert opinion connecting the "fair dealing" or "conflict of interest" provisions to a finding of overall "illegality" of MFTCs.
Third, the plaintiffs only provided one piece of credible third-party evidence to support the view that MFTCs contravened Canadian securities laws before 2022, being a letter from an investor-advocacy organization to the Investment Industry Regulatory Organization of Canada (IIROC), stating that "the overcharging of clients is not consistent with dealing fairly honestly and in good faith with clients" and asking IIROC "enforce the law and sanction these firms, put an immediate end to the practice and provide for full restitution to investors who have been exploited."
Although this letter came close to proving "some evidence of illegality", in the Court's view it was insufficient as it was contradicted by much of the plaintiffs' other evidence adduced on the motion. For example:
- evidence that the 20-plus years of discussion and debate on the practice prior to its ban never addressed its legality per se;
- evidence that discount brokers were afforded a transition period of approximately two years to adopt new compensation models in light of the ban (which the Court held "was not an accommodation that would have been made if the existing practice had been determined to be unlawful");
- evidence of pre-2022 regulations previously proposed by IIROC that would not have prohibited MFTCs outright but would have simply prescribed limits on the practice; and
- evidence provided by the plaintiffs' own experts suggesting that the practice was not contrary to any law before 2022.
In sum, the Court found that the evidence filed on the motion strongly supported the defendants' position that "the practice of paying trailing commissions to discount brokers, although controversial and needing reform, was not illegal or unlawful until the law was changed effective June 1, 2022."
Having failed to satisfy the "some evidence of illegality" requirement for their core proposed common issue, there was no basis for the plaintiffs' pleaded causes of action, and therefore no basis for a class proceeding. The Court accordingly dismissed the plaintiffs' motion for certification.
Frayce is an important decision for class proceedings brought in regulated industries. The Court's ruling confirms that even where an impugned practice is recently prohibited or regulated, class plaintiffs must still provide sufficient evidence that the practice was illegal in its pre-prohibition landscape in order to meet the "some evidence" requirement for certification.
If you or your business require assistance in respect of issues relating to class action disputes, or related matters, please contact a member of the Bennett Jones Class Action Litigation group.