Dealers are responsible for unauthorized off-book transactions but consumers must remain diligent

Key Learnings

• Investment advisors must conduct all securities trading through their investment firm.
• Firms are often responsible for investment recommendations their advisors make outside of the firm (off-book transactions) even if the firm was not aware of the investment.
• Consumers should make efforts to know that their investment firm is aware of, and approves of, the investment being made.

Ms. G sold her home in 2015. She had no investment experience. She had recently been introduced to a financial advisor by a mutual friend. Ms. G decided to invest the proceeds of the sale of her home with the advisor’s firm.

Advisor presents an investment opportunity

Several months later, the advisor approached Ms. G at a social gathering. The advisor mentioned an opportunity to invest in a new company. Ms. G recognized the company’s products and, when she next saw the advisor, asked if the investment opportunity was still available.

Ms. G met with company representatives several times. She was impressed with the products and sales materials they presented. On the recommendation of her advisor, she sold some of the securities she held with her investment firm so that she could invest $100,000 in the company.

Investment in the company considered an outside business activity

Ms. G didn’t sign any documents regarding her investment in the company. She did not receive any documents or statements related to the company from her investment firm. Ms. G understood that investing in the company was different than the type of investments she had previously made through the firm. She also knew her advisor had personally invested in the company.

Subsequent investments in the company

Later, Ms. G joined the company as its book keeper and helped open its first bank account. As a representative listed on company invoices, Ms. G often used the email address provided to her by the company to carry out business on their behalf. Six months after her initial investment, she loaned the company $50,000 to help with operational costs. Ms. G then made two additional loans to the company in late 2016 totalling over $50,000 to help with rent and materials. The advisor gave Ms. G advice on how she should structure her loans. Ms. G was concerned but felt she had to loan the company money or risk losing her initial investment.

Despite Ms. G’s additional loans, the company ran out of funding and ceased operations. As a result, Ms. G lost her entire investment of over $200,000. Ms. G sought reimbursement of her investments plus interest for a total of $250,000 from the firm.

The firm’s response to Ms. G’s complaint

The advisor’s firm was unaware Ms. G had made any investment in the company. However, the firm reasoned that Ms. G would not have made her initial investment without the recommendation of their financial advisor. They offered to compensate Ms. G her initial $100,000 investment plus interest. The firm didn’t expect Ms. G. to understand that the advisor had to have their approval prior to engaging in an outside business activity. They also relied on the fact that Ms. G said she was aware that any investments made in the company after her initial investment did not involve the investment firm.

What did OBSI do?

OBSI agreed with the firm. Ms. G would not have made the initial $100,000 investment in the company without their advisor’s involvement. The firm should, therefore, be responsible for that loss.

We also determined that given her involvement in the company, the firm was not responsible for the subsequent investments she gave the company. Ms. G was a signatory to the company bank account and had access to company emails. Ms. G had never received or signed any documentation from the firm linking the firm to her investments. OBSI concluded that, while she had no investment experience and acted on the advice of the advisor, by the time Ms. G loaned money to the company, she knew or ought to have known her investment firm had nothing to do with these subsequent investments.

OBSI’s recommendation

Both Ms. G and the advisor acknowledged that he initially approached her about investing in the company. Ms. G made the initial investment based on the advisor’s recommendation. Ms. G made the subsequent investments in the off-book company with knowledge gained through her role within the company.

OBSI reached out to the investment firm and requested that they reinstate their initial offer to compensate the client $100,000 plus interest for her initial investment.

(2017)