The Court of Appeal establishes a common law duty of care between investment fund managers and investors

The Ontario Court of Appeal’s decision in Wright v. Horizons ETFS Management (Canada) Inc., 2020 ONCA 337 may generate a significant impact in the investment fund community, after establishing a novel common law duty of care between investment fund managers and investors, for negligence under pure economic loss.

The defendant, Horizons ETFS Management (Canada) Inc. (“Horizons”) created and managed a complex derivatives-based exchange traded fund (“ETF”), which was purchased through stock exchanges and was available to retail investors, one of whom was the plaintiff, Wright. The Fund was meant to provide inverse exposure to stock market volatility. The Fund was described in the prospectus as “highly speculative” and “involv[ing] a high degree of risk”. After two years of growth, the value of the Fund dropped suddenly and dramatically; the Fund lost almost 90% of its value overnight. Investors lost nearly $40 million and the Fund never recovered. Wright commenced a proposed class action alleging that Horizons was negligent and liable for:

  1. Designing, developing, offering, and promoting a financial product that was not adequately tested before launching, excessively risky, complex and doomed to fail, and;
  2. Making misrepresentations in its prospectus within the meaning of s. 130 of the Securities Act.

The certification judge denied Wright’s motion, holding that the statement of claim did not disclose a reasonable cause of action, because it was plain and obvious that Horizons did not owe the class a duty of care. Wright appealed.

The Court of Appeal granted the appeal in part, holding that the certification judge erred in concluding that the claim disclosed no reasonable cause of action. Wright had a reasonable prospect of demonstrating that the claim fell within a recognized duty of care under the category of negligent performance of service as Horizons had undertaken to create and sell an ETF that was suitable for some investors and, on pleading as drafted, it was not.

In deciding whether there was a reasonable cause of action in negligence, the Court first assessed whether the claim could fit within an existing duty of care. Wright proposed that this claim was analogous to cases for negligent performance of service. The Court agreed, and relied on a previous case that established a reasonable cause of action against the creditors of a tax avoidance program, when the participants alleged that the program was negligently designed and did not operate as advertised. The Court found a relationship of proximity between Horizons and the proposed class because as a funds manager, it had a duty to investors to act honestly, in good faith and in the best interest of the Fund. Horizons failed to disclose the nature and extent of the risks to the investors; and therefore, the risk of injury was reasonably foreseeable.

The Court has now remanded this case to the lower Court to determine whether other certification criteria are met, before the merits of the case are assessed. Nevertheless, this case serves as a prudent reminder to fund managers to reassess the appropriate market for their products, and to make the requisite disclosures to identify potential risk exposure for investors. The legal and investor community will wait to see whether this case catalyzes other unhappy investors to come forward to try and recoup their losses from adverse investments.