B.C. judge rejects expert in $1.3B lawsuit against TD Asset Management for bias against big banks

A B.C. Supreme Court judge says a well-known financial critic can't give expert evidence in a $1.3-billion class action lawsuit against TD Bank's asset management firm because of his alleged bias against big Canadian banks.

In a decision released this week, Justice Gordon Funt acknowledged it's "quite rare" to rule a proposed expert's evidence inadmissible.

But he concluded that Larry Bates — author of Beat the Bank: The Canadian Guide to Simply Successful Investing — has a cause, or "philosophical hostility," that renders him unable to be fair and objective in relation to an ongoing claim against TD Asset Management.

"I find that Mr. L. Bates comes to this court with an unshakeable bias against any 'big Canadian' bank," Funt said in a ruling posted Monday.

"Mr. L. Bates apparently views his proposed testimony as an expert witness as part of a game and not as a 'key element in the search for truth.'"

Use of 'closet indexing' at heart of class action

Bates filed a report in June as a proposed expert for investors suing TD Asset Management — a subsidiary of TD Bank — in relation to the company's handling of its Canadian Equity Fund, one of Canada's largest professionally managed mutual funds with more than $5 billion in assets.

The trial is currently playing out in Vancouver's downtown courthouse.

The class action case highlights the issue of so-called closet-indexing, which has been written about in academic journals and investigated by regulators.

It's a practice that allegedly sees high-charging mutual fund managers secretly make safe but unremarkable investments designed to mirror a benchmark index calculated by tracking the ongoing performance of leading companies on a particular stock exchange.

The notice of civil claim against TD Asset Management (TDAM) explains the difference between "passively" and "actively" managed funds.

Dean Turpin, the investor leading the class action, claims passively managed funds — or index funds — "are designed to closely track or replicate the performance of a specific benchmark, allowing investors to invest money knowing that they will get performance roughly equal to the performance of that benchmark."

By contrast, Turpin claims, actively managed funds are operated with the goal of outperforming the benchmark index — in this case, the S&P/TSX index tracking the performance of 250 or so companies on the Toronto Stock Exchange.

The managers of such funds "charge higher fees than index funds because of the higher expenses associated with research to select stocks and the expenses associated with increased trading activity," the claim reads.

TDAM denies that it engaged in 'closet indexing'

Turpin is suing for alleged breach of trust over the "substantial fees" he claims TD Asset Management charged for active management of its Canadian Equity Fund.

"In truth, the defendant, as manager of the Canadian Equity Fund, carried on a passive investment strategy designed to closely track or replicate, not exceed, the performance of the Canadian Equity Fund's benchmark index," Turpin claims.

"The Canadian Equity Fund's performance (before management fees) has closely tracked the benchmark and has never outperformed the benchmark once the defendant's management fees are taken into account."

According to Funt's ruling, a University of Toronto professor qualified to provide opinion evidence in the case calculated damages as a result of alleged excess fees, excess transaction fees and taxation at $1.318 billion.

TD Asset Management has denied the claims.

In a reply to Turpin's claim, the company says it manages the Canadian Equity Fund in a "diligent and prudent manner" in line with objectives set out in its offerings: "TDAM did what it said it would do," the company says.

"TDAM denies that it engaged in 'closet indexing.' There is no regulatory prescription or even academic consensus on what 'closet indexing' means," the company said. 

"Whatever it may mean, it certainly does not refer to the type of research-based asset selection the fund has employed since inception."

'Banks blatantly defy investor-protection efforts'

In the report Turpin's lawyers had hoped to introduce into evidence, Bates cited a passage from his 2018 book.

"The big Canadian banks — and by extension our entire financial industry — occupy a position of paternalistic authority that too many investors respect unquestioningly," he wrote.

"The industry brilliantly capitalizes on the combination of poor understanding of fees, deep loyalty and misplaced trust by charging Canadians the highest investment fees in the world."

Bates claimed that "closet indexing" happens because many mutual fund managers "quietly accept the reality that they can't consistently beat the market," so they track it instead.

"Closet index funds are purpose-built both to create wealth for [the industry] and, relative to easily accessible low-cost index [exchange traded funds], to destroy wealth for Canadian investors!" Bates wrote in a section of his report highlighted by the judge.

In considering whether to allow Bates's evidence, Funt also considered a series of tweets, including ones in which he complained about the "relentless 'tyranny' of high fund fees" and claimed that "banks blatantly defy investor-protection efforts."

In response to a query from CBC, Bates — who is on the board of directors of the Canadian Foundation for Advancement of Investor Rights (FAIR)— said he couldn't comment on Funt's decision or anything to do with the case.

"I am a critic of high-cost mutual funds sold by banks," he said in a statement.

"At the same time, I champion more efficient, lower-cost products and services offered by the same banks, such as low-cost index funds, online investment accounts and robo-advisors."

FAIR executive director Jean-Paul Bureaud said he couldn't comment on the specifics of the case or the decision to exclude an expert witness.

"Generally speaking, however, the issue of closet indexing is an important regulatory and investor-protection issue for obvious reasons, including undermining public confidence in our capital markets," Bureaud wrote in an email.

"In short, those that may engage in it not only cheat investors, but also undermine trust in the industry more broadly."

The trial is expected to continue into October.