IDA's court win underlines Supreme Court landmark case
by Brent Mudry
October 26, 2002
In a significant court decision for Canada's investment community, an Ontario supreme court judge has dismissed the heavily publicized bid by a disgruntled client of Mark Valentine's Thomson Kernaghan to add the Investment Dealers Association of Canada as a defendant in a $5.75-million lawsuit against the now-defunct brokerage. In a speedy decision released Thursday afternoon, hours after the IDA argued its case, Madam Justice Ruth Mesbur of the Ontario Superior Court of Justice dismissed Chris Morgis's July 23 application to amend his Kernaghan suit to include the regulator.
Despite heavy and uncritical publicity in the Toronto media, the quixotic quest of Mr. Morgis against the IDA appeared doomed from the start, as it flew in the face of the Supreme Court of Canada's November, 2001, Hobart decision and as TK clients who lost money after Mr. Morgis's complaint were the real losers of the regulator's alleged inaction.
In Hobart, the high court upheld the precedent-setting February, 2000, decision of the Court of Appeal for British Columbia to dismiss a $180-million class action suit launched by investors in Eron Mortgage against Robert Hobart, B.C.'s Registrar of Mortgage Brokers, for failing to shut down the fraudulent Ponzi scheme earlier. The Hobart case, Canada's landmark case for regulators' liability, ruled that the regulator does not hold a legal duty of care to the investing public.
Reaction to Thursday's decision was mixed. "We are pleased -- we are free to regulate effectively in the public interest without concern that we are subject to legal action from individual investors," Jeff Kehoe, IDA enforcement litigation director, told Stockwatch.
Mr. Morgis, who lost about $2-million in his Kernaghan accounts, is disappointed with the court ruling. "At the end of the day there is nobody left to be accountable for this TK train wreck." Although Mr. Morgis disagrees with all of the judge's substantive findings, he concedes that "we knew going in we had an uphill battle."
The Toronto investor made a detailed complaint about Kernaghan to the IDA in March, 2001, about 14 months before the brokerage was shut down, and similar complaints to the Toronto police and the Ontario Securities Commission. His lawyer, Erica Baron of McCarthy Tetrault, declined to comment on the court loss.
On the bright side, Mr. Morgis did get a thumbs up from the judge to add four former Thomson Kernaghan officials to his suit. The new defendants are former brokerage president Lee Simpson, vice-president and retail manager David Grand, past compliance head Ron Kelterborn and compliance officer Lance Longmore. No one appeared in court for the Kernaghan quartet or raised any objection to their being added to the suit.
(Mr. Kelterborn, now with BMO Nesbitt Burns, is one of 10 members of an IDA compliance subcommittee dealing with advertising and sales literature. Derek Hatfield, a round-the-world sailor and former senior RCMP officer, joined Thomson Kernaghan as compliance head in July, 2001, three months after Mr. Morgis complained to regulators, and is not named as a defendant.)
Mr. Morgis is also keen to add former Thomson Kernaghan head Mr. Valentine, who regulators claim fostered a culture of non-compliance, as a defendant once legal service is achieved. Mr. Valentine, the co-namesake of Operation Bermuda Short, was held in jail after his arrest in Frankfurt on Aug. 14, shipped to Miami late last week and released on $530,000 (U.S.) personal bail on Monday, with strict house-arrest terms including a night-time curfew, an electronic monitoring anklet and an order not to leave the United States.
Mr. Morgis's case has been well publicized in the Toronto media, starting with the Financial Post in May, 2001, just after he launched his complaints and his $5.75-million lawsuit. The media, however, made little effort at examining Thomson Kernaghan until regulators abruptly suspended Mr. Valentine and shut the brokerage down after internal complaints leaked out a year later.
Mr. Morgis's July 23 application to name the IDA as a defendant was reported widely, with headline coverage by the Post on July 26, the Toronto Star on Aug. 3 and Aug. 20, and even CBC-TV's The National newscast on Aug. 23, introduced by Wendy Mesley. None of the stories, however, asked whether a regulator can be sued, or made any mention of the precedent-setting Hobart case.
The Hobart case, predictably, was the No. 1 precedent cited by both the IDA's counsel Gary Luftspring of Goodman and Carr, and the judge in her decision.
"In three very recent cases, the Supreme Court of Canada and the Ontario Court of Appeal have refused to recognize any duty of care owed by a supervising regulatory body to individual members of the public harmed by members of the regulated association or profession," states Mr. Luftspring in his factum, dated Sept. 4. The three cases cited are Hobart, Edwards v. Law Society of Upper Canada and Rogers v. Faught. A fourth citation was later added: the Ontario appeal court's Sept. 11 Hughes v. Sunbeam Corp. decision.
"The plaintiffs base a duty of care on the allegation that the 'IDA is responsible for regulating investment dealers ... to protect the investing public.' This is the very proposition rejected by the Supreme Court of Canada and the Ontario Court of Appeal," states Mr. Luftspring in his written arguments.
The lawyer argued that the IDA defendants (the IDA and senior executives Terry Salman, Kym Anthony and Joe Oliver) do not owe a private duty of care to individual members of the investing public for alleged negligence in failing to properly oversee the conduct of IDA members for two reasons. First, he argued there is no relationship of "sufficient proximity" between Mr. Morgis and the IDA defendants to create a prima facie duty of care in tort law. Second, he argued that even if a prima facie duty were established, this duty is negated by overriding policy consideration.
In her decision, Judge Mesbur echoed and accepted these key arguments. "In my view, this case falls squarely within the line of cases relied upon by the IDA defendants," stated the judge.
Judge Mesbur strongly rejected the proximity argument of Ms. Baron, Mr. Morgis's lawyer.
"The plaintiff suggests that since he complained to the IDA, this creates the necessary 'proximity' -- i.e. the IDA should have known that he would suffer harm if they fulfilled their role diligently. I disagree. In my view the IDA's obligation is to protect investors generally (underlined) and the public in general. It does not extend to any particular investor notwithstanding a complaint about a member," stated Judge Mesbur.
Plaintiff counsel Ms. Baron argued unsuccessfully that the Hobart case should not apply, as it only covers statutory regulators, which are recognized by legislation, and she described the IDA as a kind of "club," an unincorporated voluntary association of Canadian securities dealers.
Judge Mesbur cided with the response arguments of Mr. Luftspring, who documented the recognition of the IDA by the Ontario Securities Commission, which is a statutory regulator. The judge notes that in 1994, the OSC recognized the IDA's role as a self-regulatory organization, representing its members and regulating the operations and standards of practice of its members with a view to promoting the protection of investors and the public interest.
Judge Mesbur also noted that even if Mr. Morgis succeeded on the proximity issue, she would have found that residual policy considerations would defeat his claim.
"The IDA regulates the investment industry for the benefit of the entire public. It does not undertake to protect individual investors from economic loss resulting from the acts of one of its members. Imposing that duty of care on the IDA would create an insurance scheme for dissatisfied investors who have paid the IDA nothing," stated the judge.
Mr. Morgis was quite critical of the IDA's arguments and the judge's decision. "I am disappointed that the fourth leg of the chair cannot recognize there is a need for accountability," he told Stockwatch, saying his Thomson Kernaghan complaints to the police, the OSC, the IDA and now the courts have all failed. "The first three (the police, the OSC and the IDA) failed investors miserably ... so I am embarrassed for all Canadians. I suggest caveat emptor for investors."
"It is like having a pedophile or a rapist on the loose and you are the police and you do nothing to protect the public," says Mr. Morgis.
Mr. Morgis says he has been in touch with dozens of disgruntled Thomson Kernaghan investors, including many who lost heavily after he made his complaints to the regulators. "A 65-year-old widow lost $600,000 after my complaint." Mr. Morgis also says that levels of sophistication are not important, as he knows of one lawyer, at the Bay Street firm Gardiner Roberts, who lost $300,000 in Thomson Kernaghan hedge funds after his complaints.
While it is not known if any of these Thomson Kernaghan clients had seen or paid heed to spring, 2001, initial media coverage of the complaints of Mr. Morgis, he now offers a pretty candid appraisal of the failed brokerage. "This place was a Wild West place to begin with."
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