Conflicts of Interest

1. General introduction

In the past 20 years, Canada has seen considerable consolidation and diversification in the services that financial institutions offer. The multi-service financial institutions that have emerged since Canada relaxed the rules requiring financial service firms strictly to separate the services they provide has increased the potential for conflicts of interest. Corporate governance scandals in both the US and Canada, along with the bursting of the technology stock market bubble, have intensified focus on conflicts of interest in the financial services industry, particularly in securities firms. In this sector, a conflict of interest arises when the personal or institutional interests of a person interfere with that person’s or institution’s obligation to act in another party’s interest.

Under Canada’s federal system, two levels of government regulate financial institutions. The federal Office of the Superintendent of Financial Institutions (OSFI) regulates banks and federally incorporated trust companies, insurance companies, and credit unions. Provincially incorporated trust companies, insurance companies and credit unions are regulated at the provincial level by, for example, the Financial Services Commission of Ontario.

Securities firms also are regulated provincially. For instance, in Ontario, the Ontario Securities Commission (OSC) principally regulates and enforces the Securities Act2. Additionally, the Toronto Stock Exchange (TSX) and self-regulatory organisations (SROs), such as the Investment Dealers Association of Canada (IDA), play a significant role in regulating their members’ conduct. Market Regulation Services, an independent regulation services provider for Canadian equity markets including the TSX, regulates trading and the IDA regulates investment dealers’ activities regarding capital adequacy and conduct of business. Canada has no national securities regulator; however, most provinces tend to follow the OSC’s lead, since Ontario is Canada’s largest capital market, with Toronto at its centre.

2. Background/environment

While corporate scandals and the decline of technology stocks certainly have shaken investor confidence, Canadian reaction has been muted compared with the US rush to reform the financial industry. No Canadian regulator wields the power of an Eliot Spitzer, and there have been relatively few high-profile prosecutions involving conflicts of interest. Instead, Canada has sharpened its focus on conflict issues in the financial industry, most notably those faced by securities and multi-purpose financial services firms. This has generated new rules for managing the conflicts that analysts experience and has shifted conflicts regulation from enunciating only general principles to prescribing clear rules to achieve greater consistency.

3. Applicable law, regulation, codes and case law

All financial institutions in Canada are subject to the common law regarding fiduciary duties and the corresponding obligation to avoid conflicts of interest. In addition, even though the functional distinctions among financial institutions have blurred, each type of institution remains regulated by a separate legislative regime that includes conflicts of interest. Table 1 lists many of the laws governing each type of financial institution. For institutions provincially regulated, Ontario’s laws are presented as an example3.

Table 1: Laws governing financial institutions

4. The requirements

Fiduciary duty

Conflicts of interest issues derive from the law of fiduciary duties that has developed through case law. Generally, a person owing a fiduciary duty to another must act in utmost good faith and in the other’s best interests4.A fiduciary’s personal interest must never conflict with the interests of those to whom it owes duties, except with consent after full and fair disclosure of the potential conflict5. While some relationships attract fiduciary duties by their nature, a financial institution’s relationship with customers is not fiduciary per se. However, when the parties reasonably expect that a financial institution (or its representative) has relinquished its own self-interest and agreed to act on the customer’s behalf, courts will find a fiduciary duty6. Likewise, no fiduciary relationship exists when a securities broker acts as order-taker or information conduit; however, when a customer places trust and confidence in a broker and relies on that broker’s advice to make business decisions, the relationship takes on a fiduciary character7. Key factors in the determination are the presence of vulnerability, trust, reliance, discretion and professional standards of conduct8.

Legislation

To preserve the integrity of and public confidence in financial institutions, the following legislation addresses conflicts in situations that may not give rise to fiduciary duties.

(i) Banks, insurance companies, trust companies and credit unions Although each type of federally regulated institution is regulated separately, the conflict of interest provisions are quite similar. Generally, legislation prohibits financial institutions from entering into transactions with parties related to them9. The statutory definition of “related party” is complex, but essentially it includes persons who either have a significant interest in the institution or are related to insiders. Additionally, OSFI may designate a person or class of persons to be a “related party”10. The general prohibition excludes certain transactions with related parties, including those with nominal or immaterial value and those that OSFI specifically exempts11. Courts may set aside transactions that fail to comply with the restrictions, as well as require an accounting of profits and award compensatory damages12.

Provincially regulated trust companies and credit unions are subject to similar restrictions. Generally, transactions with “restricted parties” are prohibited, with exceptions that, in some cases, require the financial institution’s board of directors’ approval13. Provincial insurance companies are prohibited from making loans to officers, directors or substantial shareholders, and from investing in corporations that are substantial shareholders, or in which substantial shareholders, officers or directors have significant interests14.

Securities dealers

The Securities Act requires disclosure of certain conflicts of interest. Any publication in which dealers recommend specific securities must state whether the dealer is acting as principal15 and whether in the last year the dealer has assumed underwriting liability or provided financial advice to the recommended securities’ issuer16. Dealers must disclose their holdings in an issuer’s securities when the dealer holds more than 10 per cent of the issuer’s outstanding securities and has agreed to act as the issuer’s agent, adviser or underwriter17. Advisers are subject to additional rules regarding conflicts of interest.

Along with requiring disclosure, the Securities Act prohibits certain activities that would lead to unacceptable conflicts of interest, such as registrants’ trading in their own or related issuers’ securities with or on behalf of customers, unless certain conditions are satisfied18. Registrants must neither act as advisers nor make recommendations regarding their own or related issuers’ securities, with certain exceptions19. Securities dealers must give clients’ orders regarding securities priority over all other orders for the same securities at the same time20. Multi-service firms are prohibited from “tied selling”, which occurs when firms require customers to invest in particular securities as a condition of supplying services or to use a service as a condition of selling particular securities21. These firms must also deliver a written disclosure statement indicating that the registrant is a separate entity from the Canadian financial institution (and other specified information).

Trading in a reporting issuer’s securities based on undisclosed material, or “inside” information, is prohibited22. A person or company accused of breaching those restrictions is relieved of liability if the accused person or company can prove that none of the issuer’s directors, officers, partners, employers or agents who made (or participated in) the decision to trade actually knew of the information and no advice was given to any of these individuals by a director, partner, officer, employer or agent of the person who actually knew of the information. This defence is not available to any individual with actual knowledge of the information23. A securities firm’s policies and procedures for preventing transmission of inside information are relevant to this defence. OSC Policy 33–601 gives general guidelines for implementing policies and procedures to contain inside information. The policy suggests that firms: (i) have written policies on educating employees, containing inside information, restricting transactions and complying; (ii) restrict access to parts of the firm that typically receive confidential information; (iii) secure confidential information through, among other things, ethical walls; and (iv) consider restricting transactions when registrants do receive inside information about an issuer24.

National Instrument 33–105 addresses the potential for conflicts of interest in the underwriting process. When the specified relationship between an issuer or selling security-holder and an underwriter could raise concerns about the underwriter’s independence, the relationship usually must be disclosed in the relevant offering documents. For prospectus offerings or distributions of special warrants, certain relationships require an independent underwriter for a specified portion of the offering. The same applies when a registrant acts as underwriter for a distribution of its own securities25. In limited circumstances, independent valuation of the securities may also be required.

Recently, the IDA has addressed the substantial potential for conflicts when securities firms providing investment banking services employ analysts. Here, analysts face a conflict between the duty to advise investor clients impartially and the institutional pressure to support corporate clients who generate investment banking revenue. The IDA’s policy No 11 requires, among other things, that:

(i)

members have written conflicts policies and procedures;

(ii)

members prominently disclose in research reports any analyst’s relationship with an issuer that might reasonably suggest a potential conflict;

(iii) members issue no reports prepared by an analyst who is, or whose affiliate is, the issuer’s officer, director, employee or adviser;

(iv)

members distributing reports to clients refrain from trading in
anticipation of a report that could be expected to affect price;

(v)

individuals involved in preparing reports on an issuer refrain from trading in the issuer’s securities within 30 days before and five days after the report is issued;

(vi)

analysts’ compensation not be based on specific investment banking transactions; and

(vii) members have policies to prevent recommendations in research reports from being influenced by their investment banking department or the issuer26.

5. Outlook

In the coming few years, conflicts issues in financial institutions will probably continue to attract increasing scrutiny, with additional reforms likely.

For example, just recently, the OSC released a concept paper on best-execution and soft-dollar arrangements addressing the conflicts of interest securities dealers face when third parties are paid commissions for trading related goods or services27. The OSC also released a concept paper last year proposing a fundamental shift in how the retail securities industry is regulated28. The “Fair Dealing Model” recommends moving from transaction-based regulation to a model based on relationships to reflect financial service providers’ changing role. Three key principles define the Fair Dealing Model. First, a fair dealing agreement clearly allocating roles and responsibilities among the investor, representative and firm must be executed. Second, the relationship must be transparent to ensure meaningful disclosure of information regarding the representative’s compensation, the investor’s actual return and the portfolio’s risk level. Third, individual and institutional conflicts must be managed appropriately by, for instance, separating retail services from and prohibiting preferential treatment of other businesses (such as investment banking)29.

The proposed model requires investors to choose among three relationships that each raise different duties and expectations. In a “self-managed” relationship, investors make decisions, relying on the securities firm only to execute transactions. Securities firms and representatives have a duty to disclose conflicts and avoid misrepresentations. In an “advisory” relationship, investors may rely on a representative’s objective expert advice, but retain ultimate decision-making authority. Representatives must evaluate any transaction’s appropriateness in light of the customer’s investment goals and may not allow conflicts (like those created by compensation) to influence investment advice. In a “managed-for-you” relationship, the representative makes all investment decisions and owes full fiduciary duties to the investor. No conflicts are permitted in this relationship without the investor’s informed consent30.

6. Useful references

Office of the Superintendent of Financial Institutions:
http://www.osfi-bsif.gc.ca

Financial Services Commission of Ontario:
http://www.fsco.gov.on.ca

Ontario Securities Commission:
http://www.osc.gov.on.ca

Investment Dealers Association:
http://www.ida.ca

Toronto Stock Exchange:
http://www.tse.com

Market Regulation Services Inc:
http://www.rs.ca/en/home

1. General introduction

Enron’s collapse, coupled with the Xerox, WorldCom, and other scandals, shed a harsh light on flaws in the US accounting profession31. In the aftermath, some Canadian commentators suggested that Canada need not fear a similar fate given the fact that Canada’s accounting culture is principle-based whereas that in the US is rule-based32. Yet Canadian accounting firms have become strikingly similar to US firms in recent years, growing in size, offering more complex and interrelated services33 and working in multi-disciplinary practices34. Recent scandals that hit major Canadian publicly held corporations suggest these trends have created an environment susceptible to conflict35.

Increased consolidation in the accounting industry has also made it harder for the few remaining national firms to avoid conflicts. The inevitable consequence has been increased focus on enhancing regulation to prevent conflicts of interest.

Canada’s accounting profession is governed by provincial and federal legislation, as well as case law addressing accountants’ fiduciary duties to their clients. However, both the legislature and the courts have left professional accounting bodies with the task of creating and enforcing accounting standards. The Canadian Institute of Chartered Accountants (CICA) oversees the accounting profession; all provinces also have their own institutions to enforce directly the profession’s standards. For example, the Institute of Chartered Accountants of Ontario (ICAO) publishes its own Rules of Professional Conduct (the Rules) and companion Council Interpretations (the Interpretations).

The Rules prohibit conflicts of interest, without expressly defining “conflict of interest”. But the ICAO’s Interpretations do identify three kinds of potential conflict. First, professional conflicts arise when an accountant’s obligation to a client’s interest interferes with the accountant’s obligations to the profession and public. Second, legal conflicts arise from contractual obligations accountants have with clients. Third, business conflicts arise when a client’s business interests are at odds with the accountant’s own business interests.

2. Background/environment

During the first half of the twentieth century, the public accountant’s role was limited to the audit function. Auditors reviewed their clients’ financial statements to ensure that they were prepared in accordance with what became known as generally accepted accounting principles. Because the public accountant’s role was limited, conflicts of interest were not widespread36.

Developments in the past 50 years have increased the likelihood that conflicts will arise. Business has become highly sophisticated, with derivatives, securitisation and other off-balance sheet financing techniques and a host of novel financial instruments that did not exist years ago, now common. The exponential growth of global capital markets has compounded this growing complexity. Consequently, investors and other corporate stakeholders increasingly rely on accountants to interpret and verify their commercial enterprises’ financial performance. Increased reliance has increased the odds that conflicts will develop37.

Second, the increased variety of services accounting firms offer has increased the risk of conflicts. Accounting firms no longer simply monitor clients’ reporting systems as auditors; they often help design those systems. Potential conflicts obviously can arise when the designer of a reporting system is also the arbiter of its reports38. Moreover, accountants that provide lucrative business consulting services to the very firms they audit may be tempted to “soften” an audit report to avoid losing the consulting business.

Although Canada has not initiated the same degree of reform as the US – for instance, Canada has no legislation equivalent to Sarbanes-Oxley39 –in Canada the profession is working to create better accounting standards.

3. Applicable law, regulations, codes and case law

The common law regarding fiduciary obligations applies to auditors in Canada. Auditors of business corporations are regulated by both federal and provincial companies legislation, while the accounting profession mainly is self-regulated. The legislation and guidelines governing corporate auditors are shown in Table

2.

Table 2: Legislation and guidelines governing corporate auditors

4. The requirements

Jurisprudence

The courts have held that accountants owe clients fiduciary duties that cannot be contracted out of through an engagement letter or retainer. In the seminal Hodgkinson v Simms40 case, an accountant advised a client to invest in certain real estate tax shelters that, unknown to the client, the accountant had helped the developers structure for a fee. The court found that the accountant had breached his fiduciary duty to his client by failing to disclose his pecuniary interest with the developers where the client relied on the investment advice as being independent41. Moreover, in Drabinsky v KPMG42 an Ontario court stopped an accounting firm from investigating irregularities in the financial statements of a company whose senior officer had had a 20-year personal relationship with the accounting firm.

Rules of professional conduct

The CICA works closely with provincial institutes across Canada to develop uniform governance standards for the accounting profession. For example, the ICAO publishes Ontario’s Rules of Professional Conduct (the Rules), some of which cover conflicts of interest. A look at the ICAO requirements gives a sense of the basic standards at play in Canada.

Ontario’s Rules require individuals and firms practising public accounting, or a related business or practice, to identify circumstances that would cause a reasonable person to conclude that a conflict between the professional and client would be raised before accepting or continuing a retainer. If a conflict is found, the firm must neither accept nor continue with the work, unless the conflict can be managed by generally accepted management techniques whose use would not breach duties to or engagements with other clients and, after the conflict’s disclosure, all affected clients either consent or imply consent by their conduct43.

The Rules also establish steps firms must take when performing assurance engagements. Under the Rules, auditors must first identify any threats to their independence, for instance, the possibility that an auditor will benefit from a financial interest. Next, any potential threat must be evaluated to determine whether safeguards could eliminate or reduce the threat to acceptable levels. If safeguards are not adequate, the auditor must decline or end the engagement. In some situations, auditors automatically are precluded from engaging in assurance services44.

The rules also regulate the fees and benefits that may be received in the course of transactions, including commissions45. Confidentiality is also addressed. Basically, no confidential information obtained through providing services to clients may be disclosed. Likewise, clients’ confidential information may not be used for a professional’s own personal benefit. However, exceptions to the general prohibition allow confidential information to be disclosed, for example, when a firm is required to co-operate with a provincial institute46.

The ICAO’s Professional Conduct Committee investigates potential non-compliance. If the Committee lays charges of professional misconduct, a formal hearing is held before the Discipline Committee, whose decisions may be appealed to the Appeal Committee.

In practice

In the current conflict-ridden environment, accounting firms need proactively to identify and manage conflicts. To assist them, a CICA taskforce set out a process for managing conflicts of interest47. The first step in the process is to identify potential conflicts. Next, the firm must determine whether the conflict can be managed effectively, by asking:

1. Does the conflict hinder the ability to perform one’s duties?
2. What impact on the client’s ability to obtain professional services would declining the engagement cause?
3. If the conflict can be managed, will the appearance of a conflict be sufficient cause for avoiding the conflict (and engagement) entirely?
4. Is the work resulting from the engagement likely to go before a court? If so, would a court likely deem the conflict unacceptable?
5. Will available institutional mechanisms effectively manage the conflict?
6. Will the decision to avoid the conflict by resigning from the engagement present a commercially satisfactory solution for the client? Conflicts that cannot be managed must be avoided and the client must be informed that the engagement will be declined or terminated48.

Third, when a conflict is deemed manageable, the firm needs to develop an effective management approach, which involves examining the institutional techniques available to the firm. These may include ethical walls, cones of silence, employee confidentiality agreements, engagement code names and restricted access to files. The fourth step is to review the overall plan for effectiveness. If the firm finds the conflict management plan will work in practice, the firm may proceed.

Following these steps does not necessarily mean the accounting firm will be safe from scrutiny. Courts have been reluctant to find that institutional mechanisms do avoid conflicts of interest because so many are established ad hoc instead of on an ongoing basis49.

Because courts particularly scrutinise ethical walls, the taskforce has recommended, among other suggestions: (a) having someone specific monitor activities within ethical walls to ensure the firm is acting appropriately; (b) physically separating departments; (c) providing ongoing educational programmes; (d) monitoring the monitors; and (e) clearly establishing disciplinary procedures to address situations where walls are breached50. In this way, accounting firms are not simply erecting institutional mechanisms when needed, but are instead establishing systems reasonably likely to protect confidentiality and avoid conflicts.

5. Outlook

Trust and confidence in the public markets and the accounting profession has decreased and must be rebuilt. In Canada, the corporate sector, governments and stakeholders like CICA and ICAO have made positive changes to raise ethical standards. However, businesses continue to become more sophisticated and reliant on the accounting profession and no sign that the accounting profession will reduce the range of services offered has been seen. And courts seem to be adopting stricter approaches to conflicts. The various stakeholders will be wise to continue implementing policies and standards for avoiding conflicts and restoring confidence.

Although Canada should be wary of adopting the US’s strict rules-based approach, a number of US initiatives may provide guidance for preventing conflicts. For example, the US now requires companies to report on their internal management systems’ effectiveness, which helps ensure that internal management systems actually work. Several stakeholders in Canada recommend that auditors in Canada adopt similar reporting measures for their conflict management mechanisms51.

6. Useful references

The Canadian Institute of Chartered Accountants, http://www.cica.ca

Institute of Chartered Accountants of Ontario, http://www.icao.on.ca

The Society of Management Accountants of Ontario,

http://www.cmacanada.org/ontario/index.asp

Canadian Public Accountability Board, http://www.cpab-ccrc.ca/

1. General introduction – Summary

Lawyers in Canada owe their clients a fiduciary duty that requires them always to put their clients’ interests first and avoid situations that might interfere with their ability zealously to represent their clients. In this way, Canada has long recognised a lawyer’s uncompromised duty of loyalty as essential to the integrity of and public confidence in the administration of justice. Fundamentally, this duty requires lawyers to be committed to their client’s cause, be candid with their clients and avoid conflicts of interest that might divide or divert their loyalty.

Canada’s legal profession is self-governing, with guidelines and codes of professional conduct developed by the Canadian Bar Association (CBA) and Federation of Law Societies at the national level and adopted, expanded or adjusted and enforced by provincial and territorial law societies at the local level. Although the provincial and territorial law societies handle complaints about misconduct and discipline lawyers, Canadian courts have always played a substantial role in interpreting and defining the rules governing lawyers and their relationship with clients, disqualifying lawyers and firms from matters where loyalty to clients could be compromised, and awarding damages where duties are breached.

For over a decade, the Supreme Court of Canada’s decision in MacDonald Estate v Martin52 defined what constitutes a disqualifying conflict of interest warranting a lawyer’s removal from a matter. Emphasising that room for doubting a lawyer’s dedication to a client’s cause must never exist, the court adopted a test somewhere between the UK’s relatively relaxed “probability of mischief” and US’s stricter “possibility of mischief” tests, with the mischief being the risk that the lawyer would disclose or use against a client confidential information from a client.

In 2002, the Supreme Court spoke again – loudly if not so clearly – dropping a bombshell that has particularly shaken large national firms. In R v Neil53, the Supreme Court expanded the duty of loyalty beyond situations where lawyers hold relevant confidential information such that lawyers would be disqualified from acting against a client even where they have no confidential information from the client relevant to the matter, unless the client has consented. Many feared that the decision could preclude firms from accepting new retainers from clients whose business interests conflict with those of current or even former clients. Large firms responded by delivering firm-wide memoranda and educational seminars for their lawyers, rethinking or augmenting their conflicts checking procedures, and reviewing file opening and closing procedures and policies. The case left many wondering what would now constitute a client and an adverse interest, whether lawyers may represent two clients with conflicting interests who consent to protective screening measures and other safeguards, and when and how clients’ consent would be needed. Considerable uncertainty still surrounds Neil’s implications and only time will tell how far-reaching its effects will be.

Cases decided since Neil suggest that Canadian lawyers will be wise to avoid not only circumstances creating true conflicts, but also those that might create even the appearance of conflict. What is more, the ramifications and consequences of breach have been quite severe in some cases.

2. Background/environment

The Canadian Bar Association published its first Code of Professional Conduct (the Code) in 1920 and substantially revised it in 1987. Comprehensive amendments to the Code and its commentary were adopted in 2004. Rules of professional conduct similar, and in some cases identical, to the Code exist in all Canadian provinces and territories. Although not bound by these standards, Canadian courts do give them deference and are guided by their principles. However, the courts also recognise their inherent jurisdiction over the administration of justice and lawyers’ conduct in legal proceedings as officers of the court54.

The landscape in which these principles operate has changed considerably over the years. Particularly in large urban centres like Toronto, the legal profession in recent years has witnessed far more lawyers changing firms at later stages in their careers alongside the rapid growth of national and inter-national mega-firms through merger in the past ten or so years. Multi-disciplinary practices that combine lawyers with other professionals (who may not be held to the same high standards regarding confidentiality and conflicts) remain a continuing source of debate in Canada, pitting economic reality and client demands against the public interest in a legal profession that is independent and retains high standards for safeguarding confidentiality and avoiding conflicts of interest.

3. Applicable law, regulation, codes and case law

The CBA Code specifically addresses conflicts of interest between a lawyer’s clients55 and between a lawyer and a client56. More broadly, the Code requires lawyers to discharge all duties owed to clients, the court, the legal profession and the public with integrity57 and hold in strict confidence all information about the client’s business and affairs obtained through the lawyer-client relationship, unless authorised or required to disclose information58. The provincial and territorial law societies have published very similar parallel rules of conduct with supporting commentary59, and professional liability insurers provide commentary and further guidance60. In addition, a wealth of jurisprudence has interpreted and developed the law in this area.

4. The requirements

In Canada, lawyers are in a fiduciary relationship with their clients and their duty of loyalty to their clients requires them to avoid conflicts of interest, defined to cover anything likely adversely to affect the lawyer’s judgment on behalf of or loyalty to a current, prospective or even former client. As fiduciaries, lawyers can face liability absent any ill-will or bad faith and their duties to their clients extend beyond the scope and life of a retainer61.

Their duty of undivided loyalty to a client’s cause prevents lawyers from acting for more than one side of a dispute. Additionally, lawyers should neither accept nor continue to act in matters where two or more clients’ interests may conflict, nor should they put themselves in a position where their own interests might conflict with clients’ interests62. In general, lawyers may not act against clients from whom they have obtained relevant confidential information in the same or a related or new matter, unless the client consents.

Nevertheless, Canadian lawyers may represent multiple parties and accept joint retainers in certain kinds of cases63 where the parties’ interests are aligned and appear non-contentious and both parties consent. However, because parties’ interests may diverge during the course of representation, acting for multiple parties is always risky; lawyers should do so cautiously and only after fully considering the potential conflicts that might arise. Generally, lawyers accepting joint retainers in Canada need both parties’ consent (preferably in writing) after fully disclosing the conflicts that could surface and what the lawyer would need to do if a conflict materialises.

Because lawyers within a law firm or partnership are assumed to have access to confidential information about each other’s clients, conflict of interest issues often arise when lawyers move from one firm to another. Although most firms establish and scrupulously follow their own procedures for revealing actual and potential conflicts when hiring laterals, situations still arise where a new hire’s continued representation of a client raises a potential conflict with the firm’s representation of a client or prospect. When considering whether to disqualify lawyers or firms in these circumstances, Canadian courts balance three competing interests: the interest in maintaining the profession’s high standards and the justice system’s integrity; the policy that litigants should be deprived of their choice of counsel only with good cause; and the need for mobility in the legal profession.

In MacDonald Estate v Martin, the Supreme Court disqualified a firm where a lateral obtained confidential information about the opposing party through past employment with the party’s solicitor. The court ruled that once a client shows that a previous relationship existed sufficiently related to the matter at hand, the court should infer that confidential information was imparted unless the lawyer satisfies the court that no information that could be relevant in fact passed64. So, MacDonald requires courts to consider whether the lawyer (or firm) holds confidential information from a past lawyer-client relationship relevant to the present matter and whether that information could be used to prejudice the client. The court left open whether institutional mechanisms such as ethical (or Chinese) walls could adequately ensure against disclosure of confidential information, specifically consigning the study and development of standards for these mechanisms to the CBA and law societies. Interestingly, the 2004 amendments to the CBA Code include in the commentary to the conflicts chapter guidelines for institutional screening mechanisms65. The guidelines describe how screens should be set up and maintained to ensure no confidential information passes inappropriately, and advise firms to inform affected clients of the measures adopted. Firms apply these guidelines not only to situations involving laterals, but also those involving multiple retainers on the same issues and Neil-type conflicts.

In R v Neil, the Supreme Court of Canada broadened the reach of the rules prohibiting lawyers from acting against clients, establishing the somewhat controversial “bright line” test as follows:

“… it is the firm, not the individual lawyer that owes a fiduciary duty to its clients, and a bright line is required. The bright line is provided by the general rule that a lawyer may not represent one client whose interests are directly adverse to the immediate interests of another current client – even if the two mandates are unrelated – unless both clients consent after receiving full disclosure (and preferably independent legal advice), and the lawyer reasonably believes that he or she is able to represent each client without adversely affecting the other.”66

In a few sentences, this statement dramatically expanded the lawyer’s duty of loyalty to encompass what formerly were regarded as “business” rather than true “legal” conflicts.

Regarding consent, although Neil intimates that in very rare circumstances consent may be implied, as in the case of large institutional clients like chartered banks that could be seen as professional litigants, generally a client’s express consent is needed. But sometimes consent may not be enough to shield a lawyer from disqualification as a court may question the consent’s scope and timing. To pass muster, consent must not only be informed following full disclosure, but also contemplate the very ill the consent is later called upon to cure.

Shortly after Neil, an Ontario court disqualified a firm from acting against a former client who had consented to the firm’s representing a second client with potentially adverse interests. What is more, the client signed the consent after full disclosure of the potential for conflict and securing independent legal advice about the consent at the firm’s suggestion. Even so, the court disqualified the firm from representing the second client in litigation involving a “direct and violent” attack on the client who had consented. The court observed that, when signed, the consent in no way contemplated or explored the degree and nature of adversity that later emerged between the clients67.In its decision, the court invoked the “public interest in the confidence of every litigant that their legal advisers will not later attack them in matters closely related to their confidential retainers”68.

Perhaps worse still are situations where lawyers put themselves in a position where their own interests might distract lawyers from focussing on a client’s interests. When this happens, the danger is not so much that the client’s confidential information will be disclosed as that the lawyer may fail to disclose to the client information the client would need or want to know. The British Columbia Court of Appeal underscored this point in stunning fashion in 3462940 Inc v Strother, awarding damages that may exceed C$32 million against a lawyer who crossed the “bright line”69.

In Strother, a tax lawyer advised his first client to abandon a line of business because of a change in the relevant tax law. Later, while the lawyer was still generally advising that client, the client’s former employee pitched a potential work-around that might permit the line of business the first client had abandoned to be pursued. Without revealing this possibility to the first client, the lawyer accepted from the former employee a retainer to seek a tax ruling that would render the line of business legal again. To make matters worse, the lawyer accepted as payment an interest in the business the former employee later started up. In ruling against the lawyer, the court observed that once the lawyer placed himself in a position where his duty to one client would require him to reveal confidences of another client, he was obliged to withdraw from representing both clients. The court added that even though lawyers may freely act for clients who are competitors, lawyers themselves may not be their clients’ competitor.

5. Outlook

Neil and its progeny suggest that Canadian courts will continue to examine closely conflicts of interest and disqualify lawyers and award damages when lawyers and firms appear to breach their duty of loyalty by acting against their clients’ interests. Though the standards lawyers must meet may well change only slightly, firms – especially large multi-jurisdictional ones – will likely stand to lose lucrative new retainers and face both loss of good will and potentially large damage awards if they do not rigorously and continuously look for potential conflicts and address them promptly and adequately. With the CBA and provincial law societies addressing the gap Neil and MacDonald left regarding ethical walls and other screening measures, firms will probably continue re-evaluating their policies and procedures in this regard. In response to the courts’ past perceived “cracking down” on conflicts, some litigators left their large firms to create litigation boutiques; another crop of litigation boutiques may well bloom in Toronto and other Canadian cities in the next few years if the current trend persists.

6. Useful references

Surveillance and enforcement institutions

Canadian Bar Association, http://www.cba.org

Provincial Law Societies

Alberta, http://www.www.lawsocietyalberta.com

British Columbia, http://www.lawsociety.bc.ca

Manitoba, http://www.lawsociety.mb.ca

New Brunswick, http://www.lawsociety-barreau.nb.ca

Newfoundland and Labrador, http://www.lawsociety.nf.ca

Northwest Territories, http://www.lawsociety.nt.ca

69 [2005] BCCA 35 (BCCA).

Nova Scotia, http://www.nsbs.ns.ca
Nunavut, http://www.lawsociety.nt.ca
Ontario, http://www.lsuc.on.ca
Prince Edward Island, http://www.cdnq.org
Quebec, http://www.barreau.qc.ca and http://www.cdnq.org
Saskatchewan, http://www.lawsociety.sk.ca
Yukon, http://www.cdnq.org

Other references

Federation of Law Societies of Canada, http://www.flsc.ca Canadian Bar Association, Code of Professional Conduct, http://www.cba.org?CBA/Epiigram/february2002/codeeng.pdf Canadian Bar Association, CBA Code of Conduct Resolutions, http://www.cba.org?CBA/Epiigram/february2002/resolutions.pdf Gavin MacKenzie (ed), Lawyers and Ethics: Professional Responsibility and Discipline, loose-leaf (Toronto: Thomson Canada Limited, 2001)

FOOTNOTES

1 The authors gratefully acknowledge the invaluable research assistance of David Hudson, John Park, Sandra Sbrocchi and Greg Walters, students-at-law, in preparing this chapter, and the helpful comments of Dan MacDonald and Kimberly Poster, all of McMillan Binch Mendelsohn.

2 RSO 1990, c S-5. 

3 The other common law provinces’ laws may differ in detail and Quebec’s civil law regime differs significantly from the rest of Canada. Since Ontario is Canada’s major capital market, its regulatory practises influence other provinces. 

4 Mark Vincent Ellis, Fiduciary Duties in Canada (Toronto: Thomson Carswell, 2004) at 1–3.

5 Standard Investments Ltd v CIBC (1985),52OR (2d) 473 (CA) at p 499–500; Ellis, above note 3, at 1–5.

6 Hodgkinson v Simms [1994] 3 SCR 377 at para 33 (hereinafter Hodgkinson).

7 Varcoe v Sterling, Dean Witter Reynolds (Canada) Inc and Dean Witter Reynolds Inc (1992),7OR (3d) 204 (Gen Div) at 234–236; cited in Hodgkinson at para 44.

8 Hunt v TD Securities Inc cob as TD Evergreen et al (2003),66OR (3d) 481 (CA) at para 40.

9 Bank Act, s 489(1); Trust and Loan Companies Act, s 477(1); Insurance Companies Act, s 521(1); Co-operative Credit Association Act, s 413(1).

10 Bank Act, s 486; Trust and Loan Companies Act, s 474; Insurance Companies Act, s 518; Cooperative Credit Associations Act, s 410.

11 Bank Act, ss 490–499; Trust and Loan Companies Act, ss 478–488; Insurance Companies Act, ss 522–533; Cooperative Credit Associations Act, ss 414–424.

12 Bank Act, s 506; Trust and Loan Companies Act, s 494; Insurance Companies Act, s 539; Cooperative Credit Associations Act, s 430.

13 Loan and Trust Companies Act, ss 140–145, Credit Union and Caisses Populaires Act, s 207 and regulations, ss 84–86.

14 Insurance Act, s 436.

15 Securities Act, ss 39–40.

16 Securities Act, s 41.

17 Investment Dealers Association of Canada, Rule Book, by-law 29.29(2), online: Investment Dealers Association of Canada, http://www.ida.ca