Executive Summary: Key Legal and Evidentiary Issues

• Certification of a class action under British Columbia's Class Proceedings Act was previously denied due to insufficient evidence that a common issue of "closet indexing" actually existed.

• Expert evidence from Professor Simutin applied active share, tracking error, and R-squared metrics to identify the CIBC Funds as closet indexers, which the Court found sufficiently reliable at the certification stage.

• CIBC's competing expert, Professor Lundblad, challenged the reliability and applicability of the metrics in the Canadian equity market, but the Court declined to weigh competing expert opinions at certification.

• Allegations of fraud were expressly disclaimed by the plaintiff, with the amended pleadings focusing on breach of trust, prospectus misrepresentation, and unjust enrichment.

• Trust law obligations under the declarations of trust and s. 125 of the Securities Act were found to provide some basis in fact for common issues regarding disclosure failures and unreasonable fees.

• Prospectus disclosure requirements under s. 63 of the Securities Act and NI 81-101 supported a common issue as to whether the simplified prospectuses adequately described the Funds' investment strategies.

Background and the closet indexing allegations

William Pope, a unit holder in mutual fund trusts managed by CIBC Asset Management Inc., brought this action on behalf of a proposed class of investors who held units in the CIBC Equity Fund, Growth Fund, or Value Fund. The central allegation was that CIBC engaged in "closet indexing" — a practice where a mutual fund closely tracks a benchmark index such as the S&P/TSX Composite Index, while charging investors management fees reflecting more active management which would aim to outperform the benchmark. Mr. Pope contended that this practice caused harm to class members, who were effectively paying for active management they did not receive. This proceeding was one of four similar closet indexing cases commenced by the same class action counsel, the others being Turpin v. TD Asset Management Inc., McCorquodale v. RBC Global Asset Management Inc., and Gibbs v. HSBC Global Asset Management.

The initial certification decision and its aftermath

In October 2022, Justice Funt heard Mr. Pope's original application to certify the action as a class proceeding under the Class Proceedings Act. Justice Funt found that Mr. Pope had met all of the certification requirements under s. 4(1) except for s. 4(1)(c), which requires that the claims of the class members raise common issues. While Funt J. accepted that there was commonality between the class members, the plaintiff's expert, Professor Mikhail Simutin of the University of Toronto's Rotman School of Management, had not applied the relevant performance metrics to the specific CIBC Funds to identify them as possible closet indexers. Justice Funt granted leave for Mr. Pope to submit further evidence to fill this evidentiary gap, after which the Court would make a final determination on certification.

The expert evidence on closet indexing metrics

In his second affidavit, Professor Simutin applied three performance metrics to the CIBC Funds: active share, which measures the share of portfolio holdings that differ from the benchmark; tracking error, which measures volatility (standard deviation) of the difference in returns of the fund and the benchmark; and R-squared, which measures the proportion of variability of a fund's returns that is explained by returns of some passive portfolio holdings. Professor Simutin concluded that the Funds were "significantly and persistently" below commonly used thresholds to identify closet indexers. In response, CIBC relied on an affidavit from Professor Christian Lundblad, a professor of finance and economics at the University of North Carolina, who agreed with the basic concept of closet indexing but disagreed that the metrics alone could reliably determine whether a fund was a closet indexer. Professor Lundblad argued that the concentrated nature of the Canadian equity market provided limited opportunities for fund managers to deviate significantly from the holdings of the benchmark, and that performance similar to the benchmark on average over time, with periods of over- and under-performance, is in fact performance that one would expect from an actively managed mutual fund.

The amended pleadings and causes of action

Mr. Pope filed a proposed fresh as amended notice of civil claim (the "FANOCC"), which expressly disclaimed fraud and removed the claim of knowing receipt. The amended pleadings focused on breach of trust, prospectus misrepresentation, and unjust enrichment. The defendants did not oppose these amendments and acknowledged that the FANOCC disclosed a cause of action as required by s. 4(1)(a) of the CPA. The amended pleadings were substantially similar to the pleadings on which the Court of Appeal certified the action in Gibbs.

Trust law obligations and the standard of care

The trust law claims arose from the declarations of trust ("DOTs") under which the defendants constituted the Funds for the benefit of the unit holders. The DOTs each provide that the trustees will exercise their powers and discharge their duties honestly and in good faith, and in the best interests of the Funds, and must exercise the degree of care, diligence, and skill that a reasonably prudent person would exercise in comparable circumstances. These undertakings mirror provisions of Canadian provincial securities legislation, including s. 125 of the Securities Act, that prescribe the duties of investment fund managers. Mr. Pope alleged that the defendants breached these obligations by failing to disclose the Closet Indexing Strategy and the risk the Funds would not outperform the Benchmark after fees, and that the management fees charged by the defendants were a breach of their obligations under the DOTs and s. 125. CIBC argued that expert evidence on the professional standard of care was needed to establish a basis in fact for these common issues, but the Court found that an additional requirement for expert evidence on the standard of care in the Canadian mutual fund industry would impose too high an evidentiary burden for the purposes of certification.

Prospectus disclosure requirements

The prospectus misrepresentation claims were grounded in s. 63 of the Securities Act, which provides that a prospectus must provide "full, true and plain disclosure of all material facts relating to the securities issued or proposed to be distributed," and National Instrument 81-101, which requires disclosure of the principal investment strategies, the portfolio adviser's selection process, and risks associated with those strategies. CIBC argued that the Performance Reports and prospectuses already disclosed the performance of the Funds relative to the Benchmark. However, the Court noted that Mr. Pope's allegation was not that the defendants failed to disclose performance relative to the Benchmark, but rather that they failed to disclose a strategy to track the Benchmark and that the investment objectives set out in the prospectuses were misleading.

The ruling and outcome

Justice Elwood found that the "some basis in fact" standard was met for the closet indexing common issues as well as the liability issues grounded in trust law and prospectus misrepresentation. The Court emphasized that certification does not require evidence on a balance of probabilities and does not require the court to resolve conflicting evidence. Ultimately, Justice Elwood granted Mr. Pope leave to file the proposed FANOCC and certified the action as a class proceeding in favour of the plaintiff. No specific monetary amount was awarded or determined at this stage, as the decision concerned only the certification of the class action rather than a ruling on the merits; the substantive claims will proceed to trial for determination.