Court refuses to allow class-action lawsuit to proceed against discount brokerage firms

Court refuses to allow class-action lawsuit to proceed against discount brokerage firms

An Ontario judge has denied a class-action lawsuit against seven Canadian discount brokerages that alleged investors had improperly been overcharged billions of dollars in fees for a service they did not receive.

Ontario Superior Court Justice Edward Belobaba dismissed an application to certify a class-action lawsuit that was filed against online trading divisions of four major Canadian banks as well as those run by HSBC Securities (Canada) Inc., Credential Qtrade Securities Inc. and Desjardins Securities Inc.

The proposed class action estimated that since 1993, discount brokers – including BMO InvestorLine Inc., Scotia Capital Inc., CIBC Investor Services Inc. and TD Waterhouse Canada Inc. – have improperly collected about $5-billion in “trailing commissions,” which are fees for providing investors advice, a service discount brokers are not legally allowed to provide.

Paul Bates, co-counsel for the plaintiff, which includes a group of do-it-yourself investors who had trading accounts at the brokerages, said Tuesday that he plans to appeal.

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“Plaintiffs’ counsel respectfully disagree with the decision of the court in this case and intend to ask the appeal court to overturn the decision on the basis that there is a good case that the discount brokers acted unfairly and illegally by receiving and retaining trailer payments,” he said in an e-mail to Tausi Insider.

(A similar class action involving four other discount brokers, including Royal Bank of Canada RY-T, is on hold pending the appeal.)

The core issue being examined by the courts was whether the collection of trailing commissions by the discount brokerages prior to 2022, when a new rule was introduced to ban the practice, contravened any applicable securities law.

During the motion for certification, Justice Belobaba said the plaintiffs failed to satisfy the legal test requiring “some evidence of illegality” and, therefore, “there is no basis for a class proceeding.”

Trailing commissions are payments a mutual fund company gives annually to an investment dealer for selling its investment products. They are intended to compensate financial advisers for providing continuing advice to investors, and are embedded in a fund’s management expense ratio, or MER. But discount brokers are prohibited from providing advice to do-it-yourself investors under regulatory rules, meaning they have collected billions in commissions without providing the intended service.

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The controversy over the fees has been debated within the investment industry for more than 20 years. The fees are often referred to as “hidden fees” by investor advocacy groups, as the commissions are paid out of the value of an investor’s investment fund.

On June 1, 2022, the Canadian Securities Administrators, an umbrella group for all provincial securities commissions, implemented a ban on all trailing commissions being paid out for DIY investing services. At the time, CSA chair Louis Morisset said the ban addressed investor protection concerns with clients buying investment fund products with trailing commissions where no suitability determination was being made.

Despite the ban, several class-action lawsuits were filed by various groups of DIY investors who had purchased mutual funds through trading platforms. Some class actions targeted Canada’s largest discount brokerages while others pointed the finger at the mutual fund arms of all six Canadian banks and independent asset manager Mackenzie Financial Corp.

However, in his most recent certification decision, Justice Belobaba wrote that the plaintiffs did not provide “a pre-2022 provision that clearly prohibited the impugned trailing commission practice and deemed it illegal or unlawful even absent the 2022 prohibition.”

“In sum, a significant amount of the evidence filed by the plaintiff strongly supports 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,” Justice Belobaba added.

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