2005 BCSC 151 Mills v. Merrill Lynch Canada Inc.

Before: The Honourable Mr. Justice Bauman

Reasons for Judgment

Counsel for the Plaintiffs	J. S. Forstrom
Counsel for the Defendant, Merrill Lynch Canada Inc.	S. K. Gudmundseth, Q.C. and L. D. Ridgedale
Counsel for the Defendants, CIBC World Markets Inc., CIBC World Markets Inc. doing business as CIBC Wood Gundy and Robert Klenk	S. M. Winder
Date and Place of Trial/Hearing:	20-23 and 27-30 September and 1, 4, 5, 7, and 8 October 2004; and Written submissions received 21, 27, 28 and 29 October 2004
	Vancouver, B.C.

I. Overview

[1] Technology stocks had a dramatic run-up in value between 1999 and the fall of 2000.

[2] Senior staff in many technology companies made hundreds of thousands of dollars through employee share purchase and share option plans.

[3] The value of these holdings literally dwarfed the annual salaries of the affected employees.

[4] For many, it must have seemed to be all too good to be true. For many, including the plaintiffs, it was.

[5] By December 2000, the "tech bubble" had burst and all that was left for some of these employees was a stock portfolio of much diminished value and a tax liability with CCRA of nightmarish proportions.

[6] Tracy Mills and Richard Burns, wife and husband, bring action against their investment advisor, Robert Klenk, and his employers, for negligence, breach of contract and breach of fiduciary duty.

[7] The largest claim is that advanced by Ms. Mills, who was a senior manager in a Victoria based fibre optics company called SDL Optics Inc. ("SDL").

[8] In February 2001, SDL merged with JDS Uniphase ("JDS"), a very large North American technology company.

[9] When Ms. Mills approached Mr. Klenk and formally opened accounts with Merrill Lynch Canada Inc. ("Merrill Lynch"), she held in excess of $2.5 million (CAD) in SDL stock, and vested and soon to be vested options.

[10] By the time Ms. Mills severed ties with the defendants (including CIBC World Markets Inc. and Wood Gundy, collectively "Wood Gundy", who succeeded Merrill Lynch), Ms. Mills' holdings had declined in value to about $120,000 (USD) (approximately one third of the amount of tax she owed in respect of these shares).

[11] Her chief complaint against the defendants is that, in breach of Mr. Klenk's duty to competently advise her, he did not warn her of the risks associated with her extremely concentrated position in SDL and the need to diversify her holdings.

[12] Dr. Burns, a dentist, advances a smaller claim in respect of his loss of about $38,000 (USD) in trading naked call options based on Mr. Klenk's advice.

[13] Before I turn to a detailed description of the facts, it is useful to set out generally the legal backdrop.

[14] The nature and extent of the duty to advise in any particular broker-client relationship is essentially a question of fact.

[15] That relationship can be placed on a spectrum with the broker as a mere order-taker at one end, to the broker exercising virtually complete management of a discretionary account at the other.

[16] Not surprisingly, the nature and scope of the duty owed by the broker varies as one advances along the spectrum.

[17] In Rhoads v. Prudential-Bache Securities Canada Ltd. (1992), 63 B.C.L.R. (2d) 256, 11 B.C.A.C. 13 (C.A.), Justice Taylor made this point (at ¶19, 20 and 22):

What, then, is the duty of a stockbroker who chooses to offer financial, investment and taxation advice, in addition to the services of a broker or "order-taker"?

A stockbroker who merely makes sales and purchases on the instructions of clients may well have no responsibility for the wisdom of the transactions involved. The broker may if asked agree to give opinions on purchases or sales, and may make it apparent to the client, if not already well understood between them, that these constitute no more than personal opinions, and are not in the nature of considered investment advice. Where, however, as here, the firm and its employees seek to enhance their business by offering guidance to would-be investors--on "growing and managing retirement wealth" and "keeping investments safe", and to serve in "ways that no one else can" through the advice of "two financial advisors with 22 years of combined investment and taxation experience"--they must expect that their advice may be relied on as that of skilled, independent professional advisors. Stockbrokers who carry on business in this way accept responsibilities beyond those involved in bringing together buyers and sellers. They undertake the duty of providing careful, competent, considered professional advice of a sort in which clients, especially those who have no experience of their own to guide them, may well place their complete reliance.

…

In such circumstances a financial advisor must be taken to assume duties similar to those of any other professional advisor--doctor, accountant, engineer, lawyer--in the sense of being obliged to take reasonable steps to ensure that customers or clients are aware of the available options, and of the main potential benefits and risks associated with them. Considerable discretion is, of course, allowed to the professional advisor in deciding, as a matter of judgment, on the nature and scope of the advice appropriate to any case. When called on to account the advisor is not, of course, answerable as "guarantor", "custodian" or "insurer"--the terms used by counsel for the appellants in this case--but only to show that he or she reasonably applied the skill and care appropriate to the task undertaken and to the circumstances of the case.

II. Detailed Chronology

[18] Tracy Mills was aged 42 at trial. She received her Bachelor of Arts in Administration from the University of Regina in 1986. In taking that degree, she completed a number of courses in business finance and administration.

[19] In June 1996, she joined SDL, a fibre optics company in the telecommunications field, as Materials Manager.

[20] The company then had about 75 to 85 employees.

[21] When Ms. Mills left on maternity leave in May 2001, the company had approximately 800 employees.

[22] Ms. Mills' duties expanded as the company experienced its phenomenal growth. She was a senior employee. In the summer of 2000, she took over administration of the software infrastructure for the manufacturing operation of the company.

[23] Ms. Mills was not a sophisticated stock investor at any time, but she did have some exposure to the market before her contact with Mr. Klenk and Merrill Lynch.

[24] She had a very modest losing investment in Air Canada in the 1980s and successful, but relatively small, investments in at least two technology companies in the late 1990s. These investments were made after the stocks were talked up among Ms. Mills' SDL colleagues.

[25] Ms. Mills also maintained an RRSP account primarily in mutual funds.

[26] Richard Burns was aged 43 at trial. He had a successful dental practice in Sidney until October 2000, when he sold it. The practice had been listed for sale since June 2000. Dr. Burns believed that with Ms. Mills' wealth, the couple could afford for him to retire from practice.

[27] Prior to his involvement with the defendants, Dr. Burns had very little experience in the stock market, limited essentially to his RRSP investments.

[28] SDL operated two stock programs for its employees. As a senior employee, Ms. Mills was entitled to participate at a correspondingly higher level.

[29] The Employee Stock Purchase Plan ("ESPP") allowed employees to acquire shares of the company at favourable prices. The shares were paid for through payroll deductions. Distributions were made in April and October each year.

[30] The Employee Stock Option Plan ("ESOP") involved the distribution of options to purchase SDL shares at favourable prices to employees each year.

[31] The ESOP established the price for these options and their vesting date (the date when they might be exercised by the employee) in advance.

[32] Of course, the employees would benefit to the extent that the current share price of SDL stock was higher than the employee's exercise price for any vested option.

[33] The tax consequences to the employee were essentially these:

(i) under the ESPP, the difference between the employee's cost per share and the market value of that share at the date of issue represented an immediate taxable benefit and it was taken into the employee's income for that year; and

(ii) under the ESOP, the difference between the price paid by the employee to exercise an option and the market value of the share acquired at the date of exercise represented a taxable capital gain to the employee. In this case, however, payment of the tax is deferred until the sale of the shares or the employee's death.

[34] In either case, the amount of the taxable benefit was fixed at the time the employee acquired the share. If the employee elected to hold the shares and their price declined, one can appreciate the conundrum arising.

[35] The share price of SDL stock, until its merger with JDS, was highly volatile. When Ms. Mills joined the company in June 1996, the share price was $6.93 (USD). In April 1997, the price declined to $3.25 (USD).

[36] The price fluctuated between $2.50 and $6.00 (USD) until November 1998.

[37] The share price then began its climb. It was $12.50 (USD) in January 1999, $61.65 (USD) in October 1999 and $109 (USD) by the end of that year.

[38] In March 2000, the share price of SDL stock was $212 (USD). In April, however, there was a decline in the price.

[39] At this point Ms. Mills and Dr. Burns were not receiving any investment advice. They debated selling some of Ms. Mills' SDL stock because of the decline in price, and Ms. Mills eventually did so. On 17 April 2000, she sold 1,018 shares of SDL at $125 (USD) a share.

[40] Almost immediately, the share price started to rise again. By June 2000, it was at $285 (USD).

[41] Ms. Mills was upset with herself because she felt that she had sold too low. In her words, she was "kicking herself for having sold".

[42] At this point the plaintiffs realized that they needed some professional advice. They approached three potential advisors, only two of whom are relevant to the issues before me.

[43] They are Robert Klenk, then of Merrill Lynch, and Douglas Campbell of BMO/Nesbitt Burns.

[44] Ms. Mills and Dr. Burns had already been in general discussions with Douglas Campbell concerning their ability to retire at that time. Mr. Campbell had prepared a retirement profile for the couple. Based on the assumptions in that document (Exhibit 1, Tab 1 - the Pathfinder Report), Dr. Burns could then sell his practice and retire while Ms. Mills would continue in the workforce at SDL for a further five to six years.

[45] The profile was based partially on an assumed share price for SDL of $170 (USD). That became the floor price to fund the couple's retirement dreams.

[46] Ms. Mills resolved to set a test for her potential advisors. She wanted them to outline a strategy to assist her in paying the estimated $300,000 to $400,000 (CAD) she owed in taxes for the 2000 taxation year.

[47] While it is undisputed that Mr. Klenk, at least, understood that Ms. Mills was seeking advice about all of her investment assets and her overall financial position, it is important that Ms. Mills began her involvement with Mr. Klenk with this more limited enquiry.

[48] On 17 May 2000, Ms. Mills sent identical e-mails to Mr. Klenk and Mr. Campbell, including "Additional Information for Recommended Financial Plan for Tax Strategy 2000".

[49] She invited proposals by 26 May 2000.

[50] I will now turn to those proposals, but it should be remembered that at the centre of the plaintiffs' problem, and their essential complaint, is the fact that Ms. Mills' portfolio remained largely concentrated in SDL stock and that she did not diversify while the stock was at its higher values.

[51] On 24 May 2000, Douglas Campbell responded by letter to the plaintiffs. He did not offer much concrete advice as he recommended a session with a tax accountant.

[52] He did say this, however, concerning changes in the capital gains tax regime:

Because the Options were made available at fair market value to you at the time, the gain is taxed at the same rate as a capital gain. Therefore, because the capital gain tax is less than the income tax, there is an advantage to selling the options before selling the shares from the ESPP. Presently the capital gains tax works out to about 34% compared to 52% for straight income tax.

There is considerable innuendo that the next budget may reduce the capital gain tax to 50% from 66% of the gain, meaning a .52(50) - 26% tax on the capital gain. Incidentally the Pathfinder analysis which we did showed the tax rate on the options at 50%, so we can correct it to 34% to reflect the current condition.

[53] And he ended with this advice about the need to diversify:

As discussed in our previous meeting, I believe that a detailed investment strategy needs to be designed, to implement a higher degree of diversification in the portfolio (from an asset allocation and security perspective) which you are presently lacking. I look forward to working with both of you in the future, and hope that this has been of some use to you.

[54] On 25 May 2000, Mr. Klenk responded. His covering e-mail, with the subject heading "Tax Planning", includes the following:

Any assumptions have been noted and the plan is designed around a neutral bias on the stock itself. Again, if you have any questions or notice any discrepancies please let me know. It is concise but will provide a good foundation to build on.

[55] Mr. Klenk's proposal is titled: "Tax-Planning and Funding Overview 2000 Tax Year-Tracy Mills".

[56] I highlight that to give context again to the proposal. The parties were concentrating on an aspect of Ms. Mills' financial picture - the planning necessary to fund her year 2000 tax bill.

[57] Mr. Klenk states the "Objective" of the proposal so:

Objective

To fund tax installments and ESPP tax liability without selling securities at the market price during this year. By minimizing any additional sales of SDL, we can delay incurring any additional capital gains until the following tax year.

To accomplish this, we will sell call options on SDL to generate enough cash to pay tax installments in September and December. The benefit to an outright sale is the time premium in the option that is substantial due to the potential return of SDL and the recent volatility of the market.

[58] Under "Assumptions" he states:

Assumptions

Concentration in SDL stock is not a factor in the discussion above and therefore the stock is assumed to remain static throughout the year. …

[59] Under "Risk Management":

Risk Management

The company and market specific risk of concentration in SDL is an issue that has not been covered and should be dealt with concurrently as it may be accomplished as a secondary issue while funding the tax liability. Contingency planning should also be addressed should SDL make a significant move either up or down.

[60] Under "Conclusion":

Conclusion

Above I have noted a few available strategies designed to maximize your after-tax return while funding your tax liabilities as they come due. As mentioned, they are for illustration purpose only.

Before determining the appropriate tax strategy, you may wish to consider determining a risk management strategy for such a concentrated equity position. For example, a strategy that would cap the downside potential and participate in the upside within parameters set by you to diversify and reduce risk.…

[61] In the context of the plaintiffs' essential complaint, I note that at this point the plaintiffs:

• had been told by Mr. Campbell that Ms. Mills needed a higher degree of diversification in her portfolio; and

• had been told by Mr. Klenk that Ms. Mills' concentration in SDL was an issue that "should be dealt with concurrently";

• but that in Mr. Klenk's proposal, "concentration is not a factor" because the objective was "to fund tax installments and ESPP tax liability without selling securities at the market price during this year".

[62] As to why Mr. Klenk made the assumptions he did, Ms. Mills in her evidence said that while she read the stated objective in Mr. Klenk's proposal, it was not her objective.

[63] Curiously, she also said that she did not tell Mr. Klenk that.

[64] On cross-examination, Ms. Mills was referred to the portion of Mr. Klenk's proposal dealing with minimizing sales of SDL shares in 2000 and she was asked (Transcript: 22 September 2004, p. 19, lines 5-42):

Q And was it not your objective -- was it your objective, rather, to defer selling more SDL because if you did it would be subject potentially to a higher tax rate?

A No.

Q Did you tell him that that was not your objective?

A No, I didn't, no.

Q Then under the heading "Assumptions":

Concentration in SDL stock is not a factor in the discussion above and therefore the stock is assumed to remain static throughout the year.

Do you see that?

A Yes.

Q And did you understand when he said that the stock is assumed to remain static throughout the year that for the purpose of his analysis he was assuming a stable price in the stock?

A I don't know if I thought about it.

Q Did -- now having had this read to you, do you understand what it means?

A Yes.

Q Okay. And presumably you understood what it meant at the time that you read it back in May of 2000; right?

A I presume so.

Q And when he says:

Concentration in SDL stock is not a factor in the discussion ...

Is it fair to say that you understood that you were concentrated in SDL stock?

A Yes, I knew my holdings were all SDL, pretty much all of them. Except for the RRSPs. But the majority was.

[65] Mr. Klenk was referred to notes he made, which are found at Exhibit 3, Tab 132. He said that he made these notes in May 2000, before sending his proposal to Ms. Mills. The notes are headed "2000 Tax Plan" and they state this under the heading "Assumptions": "- do not want to reduce company specific risk in your concentrated position in SDL."

[66] Mr. Klenk testified that the assumptions stated in the notes "came from my talks with Ms. Mills and my assessment of her position."

[67] On the whole of the evidence, I conclude that this was so.

[68] I will digress briefly to discuss the credibility of the parties. Neither of the principal parties questioned the credibility, in the sense of the truthfulness, of the opposing principal witnesses. Neither do I.

[69] The plaintiffs and Mr. Klenk were all forthright witnesses. The differences between them reflect memory lapses and the like. In resolving questions of fact, I have relied on the preponderance of probabilities given the circumstances surrounding each question of fact and on contemporary documentary evidence.

[70] Returning to the particular issue here, it is most reasonable to conclude that Mr. Klenk's assumptions were based on his discussions with Ms. Mills. Briefly, this is so because he recorded the assumptions in notes made before the proposal, he stated them expressly in the proposal without objection from Ms. Mills, and the position was entirely consistent with Ms. Mills' mindset at the time - she had just lost a lot of money by selling over 1,000 shares of SDL in April before its price started to climb dramatically and she was very positive as to the company's prospects.

[71] Standing pat with the SDL shares, in fact, turned out to be a highly profitable decision for Ms. Mills in the summer of 2000. She did not, in the result, formally open her accounts with Merrill Lynch until September 2000. On 1 June 2000, SDL shares were trading at $249.69 (USD); on 1 September 2000, they were trading at $401.13 (USD).

[72] During the summer, the plaintiffs had a number of telephone discussions with Mr. Klenk.

[73] These conversations included discussions concerning Mr. Klenk's options strategy for Ms. Mills, which involved the sale of covered call options in SDL shares. Essentially, a covered call option involves the sale of the right to purchase a certain number of shares at a set price in the future (the strike price). The seller recovers a premium and in consideration of that, gives up the upside potential in the stock price. It is called a covered option, because the seller of the call owns the underlying shares.

[74] The evidence before me is to the effect that this is the most conservative options trading strategy. Options trading is an area that can include a number of very risky strategies.

[75] The purpose of selling covered calls is to generate revenue while maintaining one's position in the underlying stock.

[76] In July 2000, Mr. Klenk met with the plaintiffs in their home in Sidney. I accept that the parties discussed calls and puts in options trading and that Mr. Klenk spoke of an options strategy which "gave away the upside and protected the downside."

[77] As to the "downside", I also accept that the plaintiffs discussed Mr. Campbell's Pathfinder Report and the floor price that he established for SDL shares at $170 (USD) as that required to fund the plaintiffs' very early retirement.

[78] During this period, indeed at all relevant times, I am satisfied that the plaintiffs fully understood the essential risk that they faced by remaining concentrated so completely in SDL stock. Ms. Mills, in particular, was warned of this by both Mr. Campbell and Mr. Klenk in May 2000. But more importantly, it was, I find, self evident to Ms. Mills.

[79] Ms. Mills knew that she was concentrated and she knew that she risked a decline in the stock value. She had watched the stock closely since her employment started in 1996; indeed, it was a topic of much conversation among her fellow employees at SDL. Ms. Mills witnessed the stock's startling volatility. By the summer of 2000, she was watching the stock on the Nasdaq Exchange weekly and at times, daily.

[80] At this point, Ms. Mills was very positive about the company's prospects. She had witnessed its dramatic growth from the ground floor. Her Excel spreadsheets provided to Mr. Klenk and Mr. Campbell in May 2000 contemplated significant future growth in SDL share value.

[81] At the same time, it is fair to observe that Mr. Klenk was as well positive about the company and its prospects. SDL was by then a substantial manufacturing company in a cutting edge field - telecommunications and fibre optics.

[82] It was in this context that Mr. Klenk testified, and I accept, that he discussed the risk of concentration with Ms. Mills many times and the sale of SDL stock to protect the downside. It was Mr. Klenk's assessment that Ms. Mills was confident holding the stock.

[83] In early September 2000, Ms. Mills met with Mr. Klenk and signed various account opening forms with Merrill Lynch. At this point, Ms. Mills had 1,035 shares in her ESPP account and 2,050 shares represented by vested options.

[84] By 6 October 2000, she had an additional 1,022 shares in her ESPP account. In addition, she held unvested options. On that date, SDL shares were trading at $300.94 (USD). The approximate value of her current and soon to be acquired shares in September 2000 was $2.5 million (CAD).

[85] As to the fact of discussions between Mr. Klenk and Ms. Mills about the possibility of diversification, we have Ms. Mills' note of an 11 October 2000 telephone conversation with Mr. Klenk: "Diversify - Lucent, down $10 today - good buy" and "Sell stock - pay liabilities …". And Ms. Mills' agenda for a meeting with Mr. Klenk dated 21 October 2000 includes: "4. Risk Acceptance - Diversification."

[86] Mr. Klenk executed the first covered call transaction for Ms. Mills in October 2000. It was a relatively small deal. While Mr. Klenk had hoped to generate up to $80,000 (USD) per year for Ms. Mills with the covered call options strategy, in fact he only made about half that amount over the course of the parties' relationship, which effectively lasted just over a year.

[87] The share price of SDL stock had peaked in the summer of 2000 at over $400 (USD). In early September 2000, it ranged between $340 and $390 (USD) per share.

[88] In October 2000, however, the share price began a virtually consistent decline to $300, thence to $246 (USD) on 1 November 2000. On 30 November 2000, the share price plunged to $181.75 (USD). It recovered into the mid $200 (USD) range in early to mid December 2000.

[89] In mid February 2001, the merger with JDS was completed and thereafter Ms. Mills held shares in that company.

[90] By March 2001, the value of Ms. Mills' JDS shares was about equivalent to her tax liability in respect of them. By the end of November 2001, when Ms. Mills and Dr. Burns had stopped using the services of Mr. Klenk, the value of Ms. Mills' portfolio was $120,000 (USD), which was about one-third of the tax which she owed on the shares.

[91] Ms. Mills, I find, must have well understood the course of the declining value of her SDL/JDS shares. Her monthly statements from Merrill Lynch contained a summary cover page which clearly indicated the declining values of her portfolio.

[92] I turn to juxtapose Ms. Mills' dealings with Mr. Klenk in this period.

[93] On 1 December 2000, Ms. Mills had a further telephone conversation with Mr. Klenk and her notes of it are at Exhibit 1, Tab 24.

[94] These notes indicate clearly that Ms. Mills and Mr. Klenk discussed the pros and cons of selling SDL stock. Changes anticipated in the capital gains tax regime were discussed. Mr. Klenk is recorded as thinking "we've seen the worst of it", a reference, I take it, to the decline in value of the stock.

[95] On 19 December 2000, the two had a further telephone conference.

[96] A sale of some of the SDL stock was again discussed, prompted no doubt by Ms. Mills' need to pay for an original Robert Bateman painting which the couple purchased for approximately $180,000.

[97] Ms. Mills and Mr. Klenk discussed their plans going forward. I note these entries in Ms. Mills' notes:

Keep stock for this year (don't tax loss sell) ...

Continue Option calls through next yr to raise cash.

and immediately below that last note:

Risk - Stock absolutely tanks and forced to sell a bunch for tax bill come April. Meet in Jan. to discuss.

[98] On 11 January 2001, Ms. Mills sold 500 SDL shares to pay for the Bateman painting.

[99] In February 2001, as I indicated earlier, the merger with JDS completed and Ms. Mills received 3.8 JDS shares for each SDL share.

[100] On 9 April 2001, Ms. Mills was facing a large tax bill for the 2000 taxation year. She had a telephone conference with her accountant and her notes of the conversation, or made around the time of the conference, are at Exhibit 1, Tab 44. They indicate a consideration of various alternatives to pay off the substantial tax liability. I highlight these notes:

Pay off purely on Options = + 4 years.

Risk - Stock goes to Ø …

Benefit - keep stock.

Accelerate Payment - If stocks rise - cash in some to pay off and retire debt.

[101] Again, this makes clear to me that throughout the period Ms. Mills was carefully monitoring her own financial position; she was alive to her concentration in SDL/JDS stock and the risk associated with that ("stock goes to Ø"), but that she also saw the potential benefit of holding the stock in the hope of a rise in value.

[102] In April 2001, Ms. Mills instructed Mr. Klenk to sell 4,916 of her JDS shares (they were trading in the $20 (USD) range).

[103] For some reason, Mr. Klenk only sold 2,000 of these shares. When he told Ms. Mills this fact, he indicated that he would honour the price on the shares which he did not sell and he would make it up to her in the future. Ms. Mills testified that she accepted that.

[104] Ms. Mills and a number of her colleagues at SDL filed Notices of Objection with CCRA in respect of the tax treatment of their ESPP and ESOP shares. Ms. Mills eventually paid her 2000 tax liability through a loan advanced by her aunt. That loan remains outstanding.

[105] In June 2001, Ms. Mills and Dr. Burns had a very emotional conversation concerning their financial position. It was realized that Dr. Burns would have to remain in practice. Dr. Burns testified that after this conversation he went for a long bike ride and on that ride he called Mr. Klenk on his cell phone.

[106] Dr. Burns says that he and Mr. Klenk discussed the basic question "How did we get into this situation?" He testified that Mr. Klenk said: "In hindsight, we should have sold … it happened too fast."

[107] Dr. Burns says that at this point Mr. Klenk remained bullish on JDS. That stock was then trading in the $10 to $12 (USD) range, which it did until a further drop below $10 in December 2001.

[108] In October and November 2001, Ms. Mills and Mr. Klenk had a disagreement over the sale of a covered call. As I take it, Mr. Klenk acknowledged that he made a mistake in the transaction. By this point, however, Ms. Mills had lost confidence in Mr. Klenk and she instructed him to stop trading options in her account on 16 November 2001.

[109] On 12 November 2001, Dr. Burns (who had suffered some losses in his options trading) sent a letter of complaint to Mr. Klenk's supervisor, Gary P. Mayzes.

[110] It is an interesting letter, as much for what it does not say. Dr. Burns complained of the sale of two put options in January 2001, on his account, which resulted in losses to him.

[111] Dr. Burns also complained of the failure of Mr. Klenk to sell the 1,916 shares in Ms. Mills' account in April 2001 and the botched sale of the call option in November 2001.

[112] Importantly, however, Dr. Burns made no complaint alleging Mr. Klenk's failing to advise the couple of the dangers of concentration in SDL stock and the need to diversify if their retirement plans were to be preserved.

[113] Merrill Lynch responded to Dr. Burns' complaint in March 2002. They gave it no weight. Dr. Burns and Ms. Mills severed all ties with Merrill Lynch (by then replaced by Wood Gundy) in March 2002.

[114] I will backtrack to discuss Dr. Burns' relationship with Mr. Klenk.

[115] Dr. Burns opened his accounts with Merrill Lynch in December 2000. He transferred about $350,000 from the sale of his dental practice and $60,000 in RRSPs into his accounts.

[116] Among the documents prepared by Mr. Klenk in opening Dr. Burns' accounts is one titled "Compass Investor Profile" wherein Dr. Burns answered various questions concerning his financial position and his plans. Dr. Burns checked the box "I think higher risk investing may be appropriate, but only for a portion of my portfolio."

[117] He answered the question: "Should your investment decline, how easily could you replace this loss from other sources?" With: "Easily, with some planning involved."

[118] Dr. Burns indicated that he needed a return of $3,000 per month from his portfolio.

[119] Among the documents signed by Dr. Burns was a "Special Statement for Uncovered Option Writers".

[120] That document is replete with pretty dire warnings, including:

There are special risks associated with uncovered option writing which expose the investor to potentially significant losses. Therefore, this type of strategy may not be suitable for all clients approved for options transactions.

1. The potential loss of uncovered call option writing is unlimited. The writer of an uncovered call is in an extremely risky position, and must understand that he/she can incur large losses if the value of the underlying instruments increases above the exercise price.

…

NOTE: It is expected that you will read the document entitled "Risk Disclosure Statement for Futures and Options" which was provided to you at the time you opened your option account. Additional copies are available from your Financial Consultant. In particular your attention is directed to the sections entitled "Options" and "Additional Risks Common to Futures and Options."

[121] Dr. Burns also signed the form acknowledging receipt of Merrill Lynch's Disclosure Statement for Exchange Traded Options, but he did not, in evidence, actually recall receiving it.

[122] I have related above the general trend in the trading in Dr. Burns' account. The bulk of his losses occurred with the first trade in January 2001 (the subject of his complaint to Merrill Lynch in November 2001), but Dr. Burns continued making trades in risky uncovered options until November 2001.

[123] Dr. Burns testified that he never really understood the risks which he faced. But he acknowledged in cross-examination by Mr. Gudmundseth, that he discussed each transaction with Mr. Klenk and that Mr. Klenk explained the "whys" of each trade to him.

[124] Dr. Burns further appreciated that success could not be guaranteed by Mr. Klenk.

[125] Interestingly, on his examination for discovery, Dr. Burns was referred to his complaint letter of November 2001 and he gave these answers, which he accepted as true at trial (Transcript: 7 September 2004, pp. 110-111, lines 20-25 and 1-8):

Q Well, I know that. But I'm trying to understand what was in your mind at the time. So it's entirely possible it was in your mind that if they cut you a cheque, you'd stay with Mr. Klenk, and away you'd go. Is that what was in your mind at the time?

A It may have been in my mind at the time.

Q Well, I don't want you to speculate, I'd just like to know if that's what you were thinking. Because you keep bringing up the fact about waiting for that response. And to me that means, if it were positive -- if it were favourable, you would have stayed with Mr. Klenk. Is that a fair assumption?

A I may have. I wanted to see what they were going to say, yes.

[126] I will end the chronology by summarizing a number of my findings of fact:

(i) Although Mr. Klenk was engaged to give general financial advice to Ms. Mills, the relationship began, at Ms. Mills' direction, with a concentration on strategies to fund her 2000 tax year liability;

(ii) Ms. Mills and Dr. Burns fully understood the danger of Ms. Mills' concentrated position in SDL/JDS, but they were confident of its prospects and held on to the shares with their eyes open to the risk of a declining share price; they accepted the risk of a fall in the share price;

(iii) indeed, Mr. Klenk was confident as well, but that was a view shared by many in the investment industry at the time and it was not an unreasonable one;

(iv) while the plaintiffs wanted to retire early and they made that known to Mr. Klenk, they were not typical retirees who should never risk concentration in one stock; the parties expected Ms. Mills to continue work for a number of years and Dr. Burns always had, and knew he had, the fallback of his profession;

(v) the plaintiffs knew that their early retirement was premised on a stock price of $170 (USD) for SDL, but they both watched the price fall well below that without apparent concern;

(vi) while the plaintiffs had limited investment knowledge, as Mr. Klenk understood, they were intelligent individuals who diligently attended to their own affairs by asking questions, keeping notes and seeking accounting and other advice; they understood that there were risks in investing in companies listed on the stock market and that there are different levels of risk with respect to different stocks; Dr. Burns in particular understood that there was a relationship between risk and returns and that with higher returns came higher risks;

(vii) while Mr. Klenk acknowledged that establishing a floor price for SDL was something that should have been done, but was not, the plaintiffs understood that as well and did not need to be warned about it, and indeed, they already had the floor price established by Mr. Campbell;

(viii) while Mr. Klenk advised Ms. Mills to roll forward with the options strategy at various points, Ms. Mills was alive to the alternative of selling her stock in SDL and chose not to do so, except for the sales which I noted in the chronology; and

(ix) while Dr. Burns was trading in the much more risky uncovered options, he was warned of the risks and accepted them in an effort to generate more monthly income from his portfolio. In fact, the bulk of Dr. Burns' capital was invested in a managed fund, Frontiers.

III. Legal Principles

[127] While the plaintiffs focus their claims in negligence, breach of contract and breach of fiduciary duties, they acknowledge that, in the circumstances, there is no significant distinction between these causes of action. Because of the view I take, it is not necessary to resolve the question of whether Mr. Klenk was a fiduciary to the plaintiffs.

[128] This action is founded on the broker's duty to advise. I have already discussed the decision in Rhoads in this context:

… the advisor is not, of course, answerable as "guarantor", "custodian" or "insurer" … but only to show that he or she reasonably applied the skill and care appropriate to the task undertaken and the circumstances of the case.

[129] To put the duty in a different way, brokers are under no duty to offer only successful financial advice. Brokers will inevitably make wrong predictions and it is difficult, in hindsight, to question honest investment advice - see Kent v. May (2001), 298 A.R. 71, [2001] A.J. No. 552 at ¶67 and 81 (Alta.Q.B.).

[130] Because it is particularly relevant to the plaintiffs' claims and the thrust of the expert evidence to which I will refer, I note the submission that the rules governing brokers set by the Investment Dealers Association inform the broker-client relationship and assist in establishing the legal standard of care for brokers. Cited in this regard are: Varcoe v. Sterling (1992), 7 O.R. (3d) 204, [1992] O.J. No. 60 (Gen.Div.), affirmed 10 O.R. (3d) 574, [1992] O.J. No. 1501 (C.A.) and Refco Futures (Canada) Ltd. v. SYB Holdings Corp. et al. (2001), 16 B.L.R. (3d) 243, 2001 BCSC 1037.

IV. Conclusions

[131] In his submissions, Mr. Winder, for Wood Gundy, says that the resolution of the plaintiffs' claims turns primarily on the answer to this relatively simple question: "Did Ms. Mills and Dr. Burns make an informed choice to accept the risks of pursuing options trading and remaining concentrated in SDL/JDS?" I agree that the answer to that question is at the heart of this case.

[132] For the reasons that I have intimated in my treatment of the facts, I answer this question in the affirmative.

[133] Generally, the plaintiffs were driven throughout, or at least until it was too late, by a strong belief in the security of SDL/JDS as an investment and a realization that they lost a lot of money by giving up on it in respect of the 1,018 shares in April 2000.

[134] The plaintiffs knew the risk of their concentration in SDL, they were given the opportunity both on their own and through Mr. Klenk to reconsider that position at various points and I find that they effectively resolved to stay the course and run the risk.

[135] In the summer of 2001, Mr. Klenk provided an article to the plaintiffs. It dealt with the stock market since the terrorist attacks of September 2001. Dr. Burns sent an e-mail back to Mr. Klenk "Re: Great Article" dated 2 October 2001. Dr. Burns said in part:

If we accept that greed kept us in the market too long, don't we run the risk of greed keeping us eyeing only companies with the potential for huge run-ups in the so-called ""V"" recovery, versus some with just potential 30% ho-hum returns? Shouldn't we be selecting some of each, in a few different ""scenario groupings""?

Just a few late night ruminations, talk to you soon,

Richard

[Emphasis added.]

[136] The sentiment expressed here was, I conclude, accurate. While, to be charitable, I would not call it greed, clearly the hope of exceedingly large gains based on their experience in 1999 to midway in 2000, is what motivated the plaintiffs to knowingly take the risks they did.

[137] I wish to address specific points made by the plaintiffs in their written submissions.

[138] At paragraph 75, Mr. Forstrom submits:

The failure of Mr. Klenk giving rise to liability is obvious, and undeniable. He failed to offer any advice to Mills to deal with the unsuitable concentration problem in her portfolio. Quite the reverse, he recommended an options trading strategy to her which perpetuated the concentration in her account.

[139] I have found as a fact that Mr. Klenk discussed diversification with Ms. Mills on many occasions. I have found that Mr. Klenk recommended an options trading strategy because Ms. Mills wanted to hold onto her stock.

[140] At paragraph 80, Mr. Forstrom writes:

Mills had previously sold SDLI shares in April, and certainly understood she would have to sell the rest at some point to fund her retirement. In fact, she was seeking Klenk's advice on when and how to do this. Obviously, like any investor, she wished to maximize the value of her available investment assets, but not at the risk of her primary financial goals. The Plaintiffs submit that there is no reasonable basis upon which the Court could conclude that Mills was unwilling to sell her SDLI shares when she hired Klenk, or that she would not, in fact, have done so had Klenk advised her that this was the appropriate thing to do. Mills denies ever saying this, and Klenk has no clear recollection that she did. He says he now believes she must have done so, because this is the only way to rationalize the advice he gave her. The Plaintiffs submit that the more probable explanation is that this is something he assumed, or simply failed to consider.

[141] In fact, Ms. Mills was upset with herself for selling the stock in April 2000. It was a bad experience for her. That experience coloured her approach to the question of selling stock, which she discussed with Mr. Klenk on a number of occasions. In fact, Ms. Mills was prepared to risk her financial goals by hanging onto the SDL stock. She watched its price decline with her eyes open.

[142] At paragraph 83, it is said:

… The issue of "informed consent" applies to the formulation of Klenk's advice regardless of whose idea the options trading strategy was. In the absence of appropriate cautionary advice, the Plaintiffs decision to accept Klenk's recommendations cannot be considered to be properly informed.

[143] I have found that there was cautionary advice given by Mr. Klenk as I have detailed above. In any event, the risk was obvious and not overlooked by Ms. Mills in her careful and diligent approach to her financial affairs. The options trading strategy was recommended based on Ms. Mills' advice that she wanted to remain in SDL.

[144] At paragraph 142, it is submitted:

Obviously, Mills understood that her portfolio was completely concentrated in securities of SDLI when she opened her account. Knowledge of this fact does not mean she understood the risk. As Mr. Horgan testified under cross-examination, the fact of concentration is easily understood by any investor, but the risks which accompany concentration (company specific risk, sector risk, market risk, other systemic risks) are more subtle and complex, and would not ordinarily be understood by an unsophisticated investor. While anyone can understand that the value of a completely concentrated portfolio will rise and fall in accordance with the underlying share price, an inexperienced investor is unlikely to appreciate that, regardless of how positive the outlook for the stock, a completely concentrated portfolio is inherently high risk, and inappropriate for an investor who is dependant upon their investment capital for income. The Plaintiffs simply lacked the knowledge or experience to evaluate such risks. They relied on Klenk's advice, and justifiably assumed that whatever he recommended would be suitable to their circumstances.

[145] I have found as a fact that the plaintiffs, in particular Ms. Mills, understood the inherently high risk of staying concentrated in SDL. Ms. Mills was on the ground floor closely following a very volatile stock over a lengthy period. Quite simply, the plaintiffs did not lack the knowledge or experience to evaluate such risks.

[146] In conclusion, I can find no breach of the duty of care by Mr. Klenk and the defendants.

[147] The plaintiffs made comprehensive submissions on alleged breaches of regulatory provisions by the defendants, particularly in the opening of the plaintiffs' accounts. I need not deal with these submissions because even if made out, those breaches were not causative of the plaintiffs' losses.

[148] In this regard, the decision in Parks v. Midland Walwyn Capital Inc., [1995] O.J. No. 2073 (Ont. Gen. Div.) is apposite (at ¶48):

48 Non-compliance with regulations, either as set forth in the Registered Representative's Manual, or in the compliance manual, do not, in and of themselves, give rise to liability on the part of Midland. To approach the analysis of Midland's position from this perspective would be to overlook the responsibility that Mr. Parks must assume for his decisions with respect to his investment strategies. I do not suggest that compliance may be loosely regarded. In this case, the non-compliance, which has been admitted to, is not the cause of Mr. Parks' losses.

[149] Their loss, in the context of Ms. Mills, arose because of th

Citation:	*Mills v. Merrill Lynch Canada Inc.,*
	2005 BCSC 151