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Courts can succeed when advisers fail in their duty

The class-action lawsuit against Manulife Financial for its role in selling Portus hedge fund products is a reminder that the courts are an effective way to get redress for investments gone bad.

Advisers and their firms are responsible for making sure the products they sell are suitable for clients, and for making a reasonable effort to scrutinize what's in an investment, how it works and how it might behave.

These cases aren't just about the adviser, though. Investors have some responsibility for understanding what they buy, especially when they have some knowledge about financial matters.

Manulife is named in a class-action suit filed on behalf of 10,000 of its clients who invested in hedge fund products offered by Portus Alternative Asset Management, which is being investigated by the Ontario Securities Commission over its sales and compliance practices. Portus has said client assets are safe, but it has also prevented clients from withdrawing money from its funds to prevent mass redemptions that would hurt fund performance.

How can you tell if you have a case against your adviser for selling a problem investment? A key issue is whether the adviser did his or her homework, which in legalese is called due diligence.

"I cannot as an adviser tell you that you should own, say, the Trimark Canadian Fund, if I have never looked at the contents of the fund," said John Hollander, an Ottawa lawyer who represents investors against advisers and their firms. "Similarly, I'm allowed to say that while I've never looked at Trimark Canadian Fund, my brokerage house highly recommends it. So I'm allowed to pass the buck up to the research department."

Hedge products are a more complex situation because they use strategies and structures that an adviser cannot be expected to inspect in detail, Mr. Hollander said. But there's still an obligation to check the nature of the fund's holdings to see if they're suitable for the client's investing objectives and risk tolerance.

Suitability is another important matter when an investor decides whether to sue an adviser. "The question is not just what did the adviser know about an investment, but what steps did the adviser take to make sure it belonged in a particular client's account?" Mr. Hollander said. "That is the broker's obligation."

The difficulty here is that suitability differs from person to person, so there's no standard. As Toronto lawyer Harold Maltz puts it: "Suitability is one of those elastic terms, like beauty."

Generally, an investment is suitable if it conforms to the client's goals, investing objectives, age and ability to tolerate the risk of losing money. Investors sometimes go along with unsuitable choices by their adviser because they don't know a lot about financial matters, which brings us to the issue of how responsible people are for what goes into their account.

"This is the million-dollar question," Mr. Maltz said. "I'll tell you, there's no easy answer."

One consideration is how savvy you are as an investor. If you have a solid investing background, a court might find that you acted on your own knowledge and didn't rely on your adviser. Inexperienced investors would be less responsible for themselves, but they wouldn't be off the hook entirely.

As far as investors are concerned, the most contentious issue with Portus is whether one of its products has a bank-backed guarantee that people will at worst get their money back after a period of years. There has been no definitive word on this question as of yet.

Mr. Maltz was intrigued by the question of adviser culpability in a situation where an investment that was sold as having a guarantee proves not to have one at all. "If the investment adviser told the client that it's guaranteed and it's not, then the adviser is toast." There would be some obligation on the part of the investor to understand the investment but, again, this would depend on the investor's knowledge of financial matters.

Legal issues aside, you need to have losses in the area of $100,000 or more to make a lawsuit against an adviser worthwhile economically. Some lawyers will work on a contingency basis, where they are paid with a percentage of any money they recover for you, but you have to keep in mind that many cases are settled for less than the actual dollar amount of your losses.

Another approach for suing an adviser or firm is to band together with other investors in a class-action or multiplaintiff suit. Think of a multiplaintiff suit as being a simpler, more informal version of a class-action suit, where a judge must certify that all participants are similar enough to have their cases decided in a single action. The Small Investor Protection Association (http://www.sipa.to) offers a service where investors with a complaint against a particular adviser or firm can find others in the same position.

One last consideration -- there are several ways to pursue a complaint against an adviser or firm, but none are as effective as using the courts.

rcarrick@globeandmail.ca

© 2007 The Globe and Mail. All rights reserved.

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