Ex-dealing rep’s faulty advice leads to tax liability for senior spouses

MFDA settlement agreement says client threatened to sue after learning about six-figure fund investment's tax implications

Ex-dealing rep’s faulty advice leads to tax liability for senior spouses

The Mutual Fund Dealers Association of Canada (MFDA) has ordered a former dealing representative to pay $31,000, including a $26,000 fine and $5,000 in costs, for incorrectly advising two senior clients about the tax liability associated with an investment he recommended.

In a settlement agreement, the MFDA said Kenneth George Russell was advising two senior clients who were spouses in June 2016. During that time, the husband approached Russell saying that he and his wife wanted to get higher rates of return on their investments, while preserving the principal of their investment and obtaining returns that would be tax-deferred into the future.

Russell recommended a fund that he said would preserve 100% of their principal investment and provide distributions for 20 years. He said the clients would receive at least 5% of their principal investment amount per year, on top of any returns the fund generated in excess of 5%, and any taxes payable by the clients on distributions from the fund would be deferred until after the 20-year distribution period.

Based on Russell’s recommendation, the two clients decided to invest $600,000 in the fund, which they held in their individual TFSAs and their joint non-registered account.

But his advice was wrong: any portion of distributions investors receive from the fund that exceeds the 5% yearly return on capital is taxable in the year those amounts are received. The husband found that out in May or June 2017, when he received a tax slip saying some distributions he got from the fund in 2016 were taxable. He complained to Russell, who said he’d look into it.

According to his employer branch’s policies and MFDA rules, Russell should have informed his employer about the investor complaint within two days after receiving it. However, he didn’t inform his branch of the complaint.

The husband didn’t receive any taxable distributions in 2017. But in May or June of 2019, he got another tax slip saying some distributions he got from the fund were taxable. He complained to Russell that he had incurred a tax liability of around $1,900, and said he was considering a lawsuit against Russell and his employer branch because of it.

Russell didn’t report that complaint immediately to his employer. Instead, he wrote a cheque to pay the two clients back directly for the tax liability they had incurred in connection with distributions they had gotten from the fund in 2018.

According to his employer firm’s policies, all monetary and non-monetary benefits provided to clients must flow through the member firm, and approved persons are not permitted to write cheques directly to clients.

The MFDA said Russell also fell short of his regulatory duties in June 2016 when he completed a new account application form for the wife based on information provided by her husband, without communicating with the wife about it.

Russell eventually informed his employer about the husband’s complaint on December 30, 2019. After discovering his violations, the firm terminated him on February 10, 2020.

Apart from the fine and costs, the MFDA also said Russell must “complete an ethics or professional conduct course or another course acceptable to Staff” before he can be accepted back as an approved person.