The recent decision of the Court of Appeal for Ontario (Court of Appeal) in Wright v. Horizons ETFs Management (Canada) Inc. (Horizons) opens the door for a new common law duty of care for investment fund managers.
The decision does not certify the proposed class action or make any determination of its merits but allows the action to proceed to a further certification hearing. In making its decision, the Court of Appeal was required to presume that the plaintiff’s allegations were true and did not consider any evidence. Horizons has stated that it will seek leave to appeal the decision to the Supreme Court of Canada.
The proposed class plaintiff commenced an action against Horizons, a manager of exchange traded funds (ETFs), in respect of losses sustained on February 5, 2018, by the BetaPro S&P VIX Short-Term Futures Daily Inverse ETF (HVI), resulting from unprecedented volatility in the pricing of the S&P 500 VIX futures. HVI was originally established on December 16, 2011, and was designed to track one times the inverse (opposite) of the daily performance of the S&P 500 VIX Short Term Futures Index. HVI was terminated on June 12, 2018.
HVI was structured as a commodity pool for purposes of Canadian securities laws and, accordingly, granted greater freedom in its use of specified derivatives and leverage strategies than conventional mutual funds. HVI was not designed to be an active investment product. The prospectus disclosed a number of detailed risk factors associated with an investment in HVI, including that it was a speculative investment tracking a highly volatile index that could incur substantial one-day losses, including the loss of an investor’s entire investment.
The plaintiff’s primary claim was that Horizons was negligent for developing, promoting and selling an improvident investment fund that was unsuitable for retail investors and for failing to actively manage HVI in a rapidly declining market, despite being a passive investment product.
The Honourable Justice Perell of the Ontario Superior Court of Justice dismissed the plaintiff’s motion for certification and the action on the basis that it was plain and obvious that there was no cause of action in negligence against the creator of an investment fund for designing and promoting a product that was too risky for the retail investment market, and no cause of action in negligence against the manager of a passively managed index-linked ETF for failing to step in to protect investors from losses.
Justice Perell applied the analytical framework set out by the Supreme Court of Canada in Deloitte & Touche v. Livent (Receiver of) (Livent) to determine that while there was a relationship of proximity between the plaintiff and Horizons, the plaintiff’s claims were not within the scope of Horizons’ undertaking as an ETF provider, which was to offer an investment fund that operated in accordance with its prospectus disclosure.
COURT OF APPEAL DECISION
On June 1, 2020, the Court of Appeal overturned the dismissal of the action and remanded the case back to Justice Perell for decision on the other certification factors. The Court of Appeal found that Horizons could have a duty of care with respect to the design of HVI, despite it being structured and sold as a passive index-tracking investment product.
Like Justice Perell, the Court of Appeal applied the Livent analytical framework in considering whether a duty of care exists. The Court of Appeal first held that the claim could be a recognized duty of care under the category of “negligent performance of a service.”
The Court of Appeal then held that, even if it is not negligent performance of a service, the conditions exist for creating a novel duty of care for investment fund managers. Taking a relationship of proximity between the plaintiff and Horizons as given, the Court of Appeal disagreed with Justice Perell as to the scope of Horizons’ undertaking. The Court of Appeal held that Horizons’ undertaking cannot be limited to offering an investment fund that operated in accordance with its prospectus disclosure, but must also include a dimension of suitability, even though that analysis requires specific knowledge of each individual investors’ financial circumstance and risk tolerance. On this basis, the Court of Appeal would not foreclose that Horizons could have a duty of care as alleged by the plaintiff.
The potential implications of the decision for the Canadian investment fund industry are far-reaching. The decision raises such questions as:
- Do investment fund managers have a duty to make suitability determinations for investors with whom they have no direct relationship or contact?
- Do investment fund managers of passive index-tracking investment funds have a positive duty to take action in response to declining or volatile markets?
- Can investment fund managers be held liable for investor losses, even if they comply entirely with all securities laws and offer securities under receipted final prospectuses that provide full, true and plain disclosure, including fulsome disclosure of the risks of investing?
- What regulatory body should make the final determination as to whether an investment product that complies with securities regulation and disclosure requirements is nevertheless considered unsuitable for certain investors, and should therefore not be publicly offered?
- Will the scope of the registration regime currently governing investment fund managers need to be expanded to include the suitability or assessment requirements previously imposed only upon advisors that met minimum proficiency requirements?
The answers to these questions could significantly alter the asset management landscape, including the willingness or unwillingness of certain asset managers to assume the risks associated with launching retail product in Canada, and could also result in a significant reduction in the number of investment fund products that become available to the marketplace, or lead to the winding-up or amendment of the terms of existing investment funds that are already included as critical components of Canadian investors’ portfolios.
For further information, please contact:
Kevin Rusli 416-863-4020
Christopher Yeretsian 416-863-2410
Seumas Woods 416-863-3876
Ryan Morris 416-863-2176
or any other member of our Investment Products & Asset Management and Litigation & Dispute Resolution groups.
* Blake, Cassels & Graydon LLP acted for Horizons ETFs Management (Canada) Inc.
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