National Bank Financial Ltd. v. Potter

SUPREME COURT OF NOVA SCOTIA

Citation: National Bank Financial Ltd. v. Potter, 2013 NSSC 248

Date: 2013-08-07

Docket: Hfx 174294 (Debt Action)

Hfx 206439 (Main Action)

Hfx 208293 (Barthe Action)

Hfx 246337 (National Bank/Weir Action)

Hfx 216059 (Wadden/BMO Action)

Registry: Halifax

Between:

National Bank Financial Ltd.

Plaintiff/

Defendant by Counterclaim in Hfx. No. 174294

-and-

Daniel Frederick Potter, Gramm & Company Incorporated, Starr’s Point Capital

Incorporated, 2532230 Nova Scotia Limited, 3020828 Nova Scotia Limited, Ronald D.

Richter, Solutioninc Limited, John Francis Sullivan, Linda Fay Sullivan, Calvin W.

Wadden, CraigAnthonyDunham. Douglas George Rudolph, Gerard B. McInnis, Janine

M. McInnis, LowellR.Weir, BlackwoodHoldingsIncorporated, andStaffingStrategists

International Inc.

Defendants/

Plaintiffs by Counterclaim in Hfx. No. 174294

-and-

Daniel Potter, Starr’s Point Capital Incorporated, Fiona Imrie, Gramm & Company

Incorporated, 2532230 Nova Scotia Limited, 3020828 Nova Scotia Limited, Ronald

Richter, Donald Snow, Meg Research.com Limited, 3027748 Nova Scotia Limited,

Calvin Wadden, Raymond Courtney, Bernard Schelew, Blois Colpitts, Stewart

McKelvey Stirling Scales, Bruce Clarke, 2317540 Nova Scotia Limited, Knowledge

House Inc., The Estate of the Late Michael Barthe, represented byhis Executrix Barbara

Barthe, Lutz Ristow, Derek Banks and Plastics Maritime Ltd.

Third Parties in Hfx. No. 174294

And Between:

Calvin Wadden, 3019620 Nova Scotia Limited and

Andrea Wadden

Plaintiffs in Hfx. No. 216059

Defendant in Hfx. No. 216059

-and-

BMO Nesbitt Burns

Judge:

The Honourable Justice Gregory M. Warner

Heard:

February 13^thto April 17^th, 2012, at Halifax, Nova Scotia

Final Written

Submissions:

December 21^st, 2012

Counsel:

James Hodgson, David Coles QC and Robert Blair, for NBFL and National

Bank of Canada

W. DaleDunlop, andSeanMacDonald, forCalvinWadden, AndreaWadden,

3019620 Nova Scotia Limited, the Estate of Michael Barthe, Lowell Weir,

Carol McLaughlin-Weir, Blackwood Holdings Inc., and Craig Dunham

Linda Fuerst, for BMO Nesbitt Burns

Page 2 of 139

BY THE COURT:

Paragraph

Title

1

7

A.1

A.2

A.3

A.4

B

Introduction

Brief History of KHI

16

24

Brief History of Litigation

The Trial

Submissions: NBFL and Dunlop Clients

NBFL / NBC Submissions

Craig Dunham

32

41

51

B.1

Lowell Weir, Blackwood Holdings and Carol McLaughlin-

Weir

60

Barthe Estate

71

Calvin Wadden

107

117

126

138

142

148

155

175

193

B.2

B.2.1

B.2.2

B.2.3

B.2.4

B.3

Dunlop Clients Submissions

Wadden Claim

Dunham Claim

Barthe Claim

Weir / Blackwood Claims

Supplementary Submissions - December 2012

Dunlop Clients Supplementary Submissions

NBFL’s Response to Supplemental Submissions

Analysis - Settlement Agreement

Clarke/NBFL legal relationship with the Dunlop Clients

The Starting Point

B.3.1

B.3.2

B.3.3

C.

206

C.1

Page 3 of 139

Paragraph

213

Title

C.2

C.3

Law Respecting Broker - Client Relationship

Stock Manipulation

237

247

Statutory Responses to Market Manipulation

Permissible Market Manipulation

Test for Market Manipulation

Position of the Parties

254

262

270

D.

Analysis of the liability issues of the Dunlop Clients against

Clarke and NBFL

310

371

453

573

671

708

D.1

D.2

D.3

D.4

E.

Liability to Dunham

Liability to the Weirs and Blackwood

Liability to the Barthe Estate

Liability to Wadden

Causation

F.

The Defence of Ratification

NBFL’s Third party claims against Barthe and Wadden

G.

733

747

760

Against Barthe

Against Wadden

H.

I.

Waddens’ Claims against BMO Nesbitt Burns

Assessment of Damages against NBFL

Dunham

857

858

871

876

883

I.1.

Lost Value of Shares

Consequential Losses

Punitive Damages

Analysis

Page 4 of 139

Paragraph

898

Title

I.2

Weirs / Blackwood

Analysis

902

927

I.3

I.4

I.5

Barthe Estate

932

Calvin Wadden’s Third Party Liability to NBFL

Costs

935

A.1

Introduction

[1] There are no winners in this story. The events give a black eye to the Canadian public

securities industry.

[2] Knowledge House Inc., a publicly-traded technology company, collapsed in August 2001 and

closed in September. Eighteen months earlier its share value appeared to be $110,000,000. The

events leading to the collapse epitomize the concern expressed by David Dodge, a former Governor

of the Bank of Canada, about Canada’s international reputation as the ‘Wild West’ of financial

markets.

[3] Along the way from penny stock to ‘tech darling’ to collapse, the entrepreneur behind the rise

and fall, who took control of KHI in late 1998, immediately appeared to exponentially grow its size

and sales, and, on paper, its value, by the purchase of three private technology companies in

exchange for shares of KHI. While the company had sales, it never had real income, a viable

business plan or secure financing.

[4] With the help of other insiders, including some of those who had sold their companies to KHI

for shares, a lawyer, and Bruce Clarke, a stock broker employed by NBFL, the President of KHI,

kept KHI afloat until August 2001 by manipulative and artificial trading in KHI shares, while

attempting to create a viable business and secure financing, deter existing shareholders from selling

their shares, and entice wealthy individuals and institutions to invest.

[5] The primary instrument of the artificial and manipulative trading in KHI shares was Bruce

Clarke. The failure of NBFL to supervise Bruce Clarke facilitated that trading in a manner that was

contrary to statutory and industry regulations, and NBFL’s own rules.

[6] Only NBFL/NBC, BMO Nesbitt Burns, one insider and three “outsiders” were still parties to

this litigation by the start of the trial. In this decision, claims of the three “outsiders” against NBFL

are affirmed, the claims of the insider against NBFL and BMO are denied and NBFL’s third party

claim against the insider partially affirmed.

Page 5 of 139

A.2 Brief History of KHI

[7] Knowledge House Inc. (“KHI”) was incorporated as Knowledge Publishing House Limited

in Nova Scotia in 1984. Its controlling shareholder, president and chief executive officer was Dr.

Bernard Schelew. It provided computer-based programs and software in the field of medical and

pharmaceutical education. In 1988, it was listed on the Montreal Exchange and continued thereafter

for 11 years as a publically traded penny stock with annual sales under $700,000.00.

[8] Daniel F. Potter (“Potter”), a lawyer bytraining, describedhimselfsince1991 as a “technology

information and education entrepreneur.” He founded “ITI Institute,” a post-graduate IT education

institution in 1984. From 1991 to 1998, he was chair and CEO of ITI Education Corporation, its

parent corporation. In 1998, Torstar Corporation invested 37 million dollars in ITI Education and

became the major shareholder (39%). Potter gained a reputation for success with the rapid growth

and the sale of ITI to a reputable national corporation.

[9] Potter became a director of KHI in 1985. When he ceased as CEO and chair of ITI in 1998,

he became actively involved in KHI and, by early 1999, he was the chairman, CEO and, with his

spouse, the largest shareholder. Through an aggressive acquisition program, Potter immediately

caused KHI to embark in a new direction as an internet and IT-based education services business.

[10] To add to KHI’s small pharma-education software business, KHI acquired over a six-month

period in early 1999 three rapidly growing private technology businesses:

i)

in February 1999, “Silicon Island” and “Centre for Distance Education Limited”. The

former provided a computer and telecommunication infrastructure to host online education

programs; the latter provided direct experience in distance education. As consideration for the

acquisition of these two businesses, KHI issued to the principals, Don Snow and Dr. Ken MacLeod,

1.6 million KHI shares and hired them as senior executives.

ii) in June 1999, Micronet Information Systems Limited. Micronet, founded in 1994, was

in the business of selling computer hardware and software programs. It was particularly successful

in the provision of services to schools. At the time of acquisition, it had just been the successful

bidder in a multimillion dollar, multi year tender to provide computers and IT support services to the

NovaScotia publicschoolsystem. Asconsideration fortheacquisition ofthis enterprise, KHIissued

to its principals, Calvin Wadden and Raymond Courtney, 2.2 million KHI shares and hired them as

senior executives.

iii) in July1999, Innovative Systems Limited. InnovativewasAtlanticCanada’sauthorized

reseller of Apple products and, like Micronet, had a rapidly growing business as supplier of Apple

computers and IT support services to the public through four retail outlets, and to the Nova Scotia

public school system. As consideration for the acquisition of its business, KHI issued to its

principals, Craig Dunham and Steven Wilsack, 300,000 KHI shares, and contracts to continue

running Innovative.

Page 6 of 139

[11] In rapid succession, KHI entered into partnerships with some of its major suppliers, most

notably, IBM Canada Ltd.

[12] Through the activities of the three acquisitions, KHI’s revenues grew from $813,000.00 for

the twelve months ending February 28, 1999, to 15 million dollars (on a consolidated basis) for the

ten months ending December 31, 1999, and 39 million dollars for the year 2000.

[13] In 1999, KHI lost 2.7 million dollars (23 cents per share) and in 2000, 6.5 million dollars (46

cents per share).

[14] In December 1999, KHI moved its public stock listing from the Montreal Exchange to the

Toronto Stock Exchange. From partial trading records of KHI on the ME and after December 6,

1999 on the TSE, it appears that the trading activity, inclusive of block trades arranged by KHI

insiders, crosses and other transactions that I conclude were the result of manipulation by KHI

insiders and Bruce Clarke, was as follows:

1996

1997

1998

753,000 trades in the price range of $0.09 to $0.20

2.7 million trades in the range of $0.09 cents to $1.00

2.9 million trades in the range of $0.50 to $2.00

2.1 million trades in the range of $1.80 to $4.00

January to

June 1999

July to

December

1999

Records were not before the Court except for the period

December 6 to 31, 1999, when the price rose from $4.05 to

$6.25

2000

5.2 million trades in the range of $5.50 to a peak price on

March 29, 2000 of $9.85

January to July 1.1 million trades in the range of $4.25 to $6.25

2001

from mid-

August until

the end of the

month

the price dropped to 4.5 cents per share

[15] Based on the trading price, the shareholders’ equity in KHI fell from 111.9 million dollars on

March 29, 2000, to about 2.8 million dollars when it closed its doors on September 13, 2001.

A.3 Brief History of Litigation

Page 7 of 139

[16] The history of this litigation can be read in many reported decisions, in particular National

Bank Financial Ltd v Potter, 2008 NSCA 92, and National Bank Financial Ltd v Potter, 2011 NSSC

407.

[17] In a decision of the Nova Scotia Court Appeal, upholding the refusal of NBFL’s motion for

leave to amend its pleadings to delete claims of wrongdoing against its broker, Bruce Clarke,

Cromwell JA (as he then was) briefly summarized the history as follows:

[7] The parties are involved in complex litigation concerning the collapse of Knowledge House Inc.

(KHI) in August of 2001. NBFL started a number of actions against clients and former clients for

unpaid margin debt arising from this collapse. Some of the defendants defended these claims by

alleging that they had been the victims of a conspiracy involving NBFL’s employee, Bruce Clarke,

and others to manipulate KHI share prices.

[8] NBFL responded by pleading two main allegations. First, it defended the conspiracy claims by

denying there was any conspiracy and any vicarious liability for Mr. Clarke’s actions. Second, in what

is now known as the main action, NBFL issued a statement of claim against Messrs Potter, Clarke,

Colpitts, his lawfirmand others alleging that theyconspired to manipulate the price fo KHI shares and

that the conspiracy resulted in a fraud being committed against NBFL.

[9] With respect to Mr. Clarke’s alleged involvement, NBFL alleged that he acted on his own behalf

and as the agent for an insider group of shareholders to conduct elements of the scheme, including

trading in KHI shares in his numbered company account, his RRSP and other accounts in order to

maintain the public market price of the shares, placing and carrying out orders of the other alleged

conspirators, monitoring KHI’s order book and trading activity on the TSE, maintaining buy orders

for KHI shares in the TSE order book, soliciting NBFL clients to purchase shares of KHI and

discouraging those clients from selling KHI shares.

[10] NBFL maintained in sworn testimony that, before making these allegations, it had thoroughly

investigated the matter and concluded that it “was never an issue [that]... we were going to sue Bruce

Clarke .... We believed that we had more than sufficient evidence to name every person [including Mr.

Clarke] in that claim ...” (AB 2828 - 2830).

[11] Following the issuance of NBFL’s statement of claim in the main action, several of the

respondentsstartedactionsagainstNBFLinwhichtheyincorporated byreference, NBFL’sallegations

of conspiracy. In its various defences, NBFL, among other things, denied the conspiracy.

[18] By 2008, there were more than 54 groups of parties named in 11 actions under case

management. At the commencement of trial on February13, 2012, five actions involving six groups

of parties remained.

[19] The remaining defendants in NBFL’s Debt Action (174294) are Calvin Wadden, Craig

Dunham, Lowell Weir and Weir’s corporation Blackwood Holdings Incorporated. NBFL sued for

unpaid margin debt arising from the collapse of KHI. The defendants counterclaimed against NBFL

for the actions of Bruce Clarke. NBFL third-partied, among others, Calvin Wadden and Michel

Barthe for any liability it may have in respect of the counterclaims.

Page 8 of 139

[20] The only remaining defendant in NBFL’s Main Action (206439), against KHI insiders for

conspiring to manipulate the price of KHI shares resulting in a fraud against NBFL, is Calvin

Wadden.

[21] In the Barthe Action (208293) commenced by Michael Barthe and Lutz Ristow against NBFL

for its failure to supervise Clarke and the wrongdoing of Clarke as alleged by NBFL in the Main

Action, the only remaining plaintiff is the Estate of Michael Barthe. In its pleadings, NBFL denied

liability and claimed that Barthe was part of the stock manipulation scheme. NBFL third-partied

Wadden in respect of any liability to Barthe.

[22] In the Wadden Action (216059), Calvin Wadden, Andrea Wadden and a numbered company

controlled by Calvin Wadden, sued BMO Nesbitt Burns alleging that its brokers were part of the

stock manipulation scheme, and that BMO’s handling of their accounts between March and August

2000 was negligent and in breach of its contractual obligations to the plaintiffs. BMO denied

liability.

[23] In the NBC/Weir Action (246337), National Bank of Canada sued Lowell Weir and Carol

McLaughlin-Weir on a promissory note given by the defendants to the Bank to secure a March 2003

“loan”. The Weirs claim that the money was actually an advance on NBFL’s intended settlement

of Weirs’ claims against NBFL and that NBFL represented it would complete after it had recovered

from the other responsible parties in NBFL’s litigation. The Weirs defended and counterclaimed

against NBC, based on NBC’s responsibility for NBFL and the conduct of Clarke.

A.4 The Trial

[24] The trial commenced on February 13, 2012. It ended much earlier than scheduled, on April

17, 2012. The Dunlop Clients called eight witnesses, BMO, one short witness, and NBFL/NBC, no

witnesses.

[25] The order for presentation of evidence was determined in a pretrial written decision (2011

NSSC 407).

[26] Three groups of parties remain:

i)

The Dunlop Clients (all represented by lawyer W. Dale Dunlop) - Calvin Wadden

(“Wadden”), Andrea Wadden (“Ms. Wadden”) and their numbered company 3019620 Nova Scotia

Limited, CraigDunham(“Dunham”), LowellWeir (“Weir”), BlackwoodHoldingsIncorporated(the

Weir company) (“Blackwood”), Carol McLaughlin-Weir (“McLaughlin-Weir”) and the Estate of

Michael Barthe (“Barthe”). These clients’ interests are not identical.

ii) NBFL, and its parent, National Bank of Canada (“NBC”).

Page 9 of 139

iii) BMO Nesbitt Burns Inc. (“BMO”) (only in respect of the Wadden Action).

[27] While the claims in the five remaining actions were, by agreement, heard together, BMO and

the Dunlop Clients agreed, that the claims in the Wadden Action (216059) are more limited in

substance, time line and events, than the claims between the Dunlop Clients and NBFL/NBC.

[28] It was agreed by all parties that some evidence was admissible only in the Wadden Action,

some admissible only in the four actions involving NBFL and NBC, and some admissible in all five

actions. Consequently, counsel for BMO did not attend at trial for all of the evidence.

[29] The evidence admitted in the Wadden Action consists of:

i)

documentaryevidence contained in Joint Exhibit Books tendered byagreement of

BMO Nesbitt Burns and the Waddens, and identified as such, subject to the conditions of

admissibility set out in the indexes to these joint exhibits, and other exhibits tendered by agreement;

ii) the oral evidence of Ms. Wadden, Brian MacLellan Q.C. (“MacLellan”), Harold

Greenwood (“Greenwood”), Derek Banks (“Banks”), Wadden and Robert Lowe (“Lowe”); and

iii) other exhibits tendered through or referred to by these witnesses in their oral

evidence.

[30] BMO and the Waddens specifically agreed that, despite the pleadings, no claim was being

pursued bythe Waddens of involvement byBMO or anyof its employees or agents in the allegations

of wrongful manipulation of the share price of KHI shares.

[31] The evidence admitted in the four actions between Dunlop Clients and NBFL / NBC, consists

of:

i)

documentary evidence contained in Joint Exhibit Books tendered by agreement

between the Dunlop Clients and NBFL/ NBC, subject to the agreed upon conditions of admissibility

set out in the indexes, and other exhibits tendered by agreement;

ii) theoralevidenceofAndreaWadden, BrianMacLellan, HaroldGreenwood, Calvin

Wadden, Bruce Clarke, Derek Banks, Craig Dunham, Lowell Weir and Carol McLaughlin-Weir;

iii) other exhibits tendered through or referred to by these witnesses in their oral

evidence;

iv) the settlement agreement between NBFL and a securities regulator, admitted

pursuant to a decision of this Court reported as 2012 NSSC 76; and

v) excerpts from the discovery examinations of Richard Rousseau, Barbara Barthe

and Lutz Ristow as well as from the written responses to Interrogatories of Barbara Barthe and Lutz

Page 10 of 139

Ristow.

Submissions: NBFL and Dunlop Clients

B.1 NBFL/NBC Submissions

B

[32] NBFL and NBC sued on margin accounts for liquidated sums. There is no real contest that,

subject to counterclaims and set offs, debts were incurred in the amounts claimed in respect of the

marginaccounts. Dunhamowed$353,021.96; Weir owed$60,177.68; Blackwoodowed$10,403.74

and Wadden owed $1,086,072.00.

[33] The Weirs acknowledge execution of the promissory note with NBC and the receipt of

$100,000.00. NBFL presented no evidence, other than the note itself, to establish a debt. The Weir

evidence (the only evidence on the point) is that the amount was, by agreement, an advance on

NBFL’s settlement of the Weirs’ claims against NBFL (Weir and Blackwood). The money was

advanced as a loan (without interest), because NBFL was in the process of suing others from whom

it intended to seek some recovery. NBFL wanted others to share in payment of the Weirs’ losses.

The promissory note was executed at a request of NBFL to cover any bank audit inquiry about the

advance. NBFL claims payment of $100,000.00 plus prejudgment interest, less the amount of any

award (if any) of damages against NBFL.

[34] The counterclaims of the Dunlop Clients are premised on the wrongful acts of Clarke and

NBFL’s failure to supervise him. Theyallege fraud, negligence, and breach of contract. Theyallege

NBFL is liable for its own actions and non-actions, and is vicariously liable for the wrongdoing of

Clarke.

[35] For the first time in this litigation, in its post trial brief, NBFL admitted that it failed to

adequately supervise Clarke. It admitted that it was under a duty to review the activity of Clarke’s

“540" account, an account of 2317540 Nova Scotia Limited, a corporation owned and controlled by

BruceClarke, abrokeremployedat NBFL’s Halifax office. Thenumbered company(“540") opened

a margin account with NBFL that was designated by NBFL as a “pro” account because it was

controlled by one of its brokers, a designation that mandated extra supervision by NBFL

management. The effect of this admission is that, if Clarke is found to have acted unlawfully; that

is, fraudulently, negligently or in breach of his contractual obligations to the Dunlop Clients or to

anyof them in connection with the 540 account, NBFLis liable to those Dunlop Clients for Clarke’s

action both on the basis of NBFL’s own negligence and breach of contract, and on the basis of

vicarious liabilityfor the acts of Clarke who, it is not contested, was acting throughout in his capacity

as broker employed by NBFL.

[36] In a nut shell, NBFL’s submission is that the shareholders’ equity in KHI, which at one point

appeared to exceed 100 million dollars, based on the market price of its shares, disappeared in

August 2001 because KHI was not properly funded and ran out of operating capital before the e-

learning projects it was developing became marketable. The timing of its fall coincided with the

receivership of ITI. In effect, the Dunlop Clients did not lose the value of their investments in KHI

Page 11 of 139

by reason of NBFL’s margin calls in August 2001 or by reason of any wrongdoing of Clarke.

[37] Alternatively, NBFL submits that the Dunlop Clients have failed to prove that the “market

making” carried out by Clarke was unlawful or, if it was unlawful, that it caused the losses claimed

by the Dunlop Clients.

[38] Finally, NBFLsubmits that if the Court finds that Clarke’s activities at the relevant times were

unlawful and constituted illegal market making, WaddenandthelateMichael Barthe, twoofthe four

remaining Dunlop Clients, were aware of and participated in the illegal market making and are

jointly liable with NBFL for any liability of NBFL to any of the other Dunlop Clients.

[39] NBFL submits that KHI’s existence was based on Potter’s earlier success in developing and

selling another e-learning technology corporation - ITI Education Corporation, to Torstar

Corporation in 1998. KHI, which was new to the e-learning technology business, had real risks and

unlimited prospects. One of its risks was whether it could raise sufficient capital to execute its

business plan. Its gross revenues soared with the acquisition of existing technologycompanies, such

as Wadden’s Micronet, and its contract to supplye-learning technologyservices and hardware to the

Nova Scotia school system, as well as its partnership with corporations like IBM Canada and other

reputable national institutions.

[40] Early in 2001, KHI’s revenue dried up at the same time as its new e-learning programs were

taking longer to develop and KHI’s banker was reducing its line of credit. In short, KHI collapsed

because it ran out of cash. Between August 14 and 16, KHI shares were still selling in the range of

$5.10 per share. On August 16, 2001, Torstar announced that it was writing off its investment in ITI

and appointing a receiver. It had been Potter’s reputation for success in ITI that had fuelled

shareholder excitement in KHI. The Torstar announcement precipitated, says NBFL, the dramatic

fall in KHI’s share price to $4.10 on August 17 and $0.72 by August 22. It was only then that NBFL

called in the margin debt owed by many KHI shareholders to it on the security of the KHI shares.

Craig Dunham

[41] Craig Dunham and Steven Wilsack sold their Apple-based technology business, Innovative,

to KHI on July 30, 1999, in exchange for 300,000 KHI shares (150,000 each) and contracts to

continue runningInnovative for KHI. Dunham had access to these shares at the rate of 30,000 shares

per year (the rest were held in escrow).

[42] NBFL says that Dunham was an educated and experienced business man. He had experience

with brokerage accounts, although NBFL does not suggest he was an experienced investor.

[43] The agreement to sell Innovative to KHI was subject to certain adjustments. In the spring of

2000, Dunham was required to pay KHI $141,347.50 as his share of those adjustments. At the same

time he was constructing a new residence, which he expected to build with the proceeds of the sale

of KHI shares. He had no money to do either. Gerard McInnis, KHI’s controller, outlined in a

February 4, 2000 e-mail, a plan wherebyKHI would advance to Durham and his partner some of the

Page 12 of 139

shares held in escrow that “will be placed in trust with Bruce Clark[e] who will sell into the market

on an orderly basis”, with the proceeds being paid to KHI to discharge the debt owed by Dunham

and his partner. Dunham did not know Clarke at this time, but contacted him to carry out the

McInnis plan. All communication between Clarke and Dunham from February 2000 to August

2001, except one meeting and two or three phone calls, was by e-mail.

[44] In March 2000, Dunham opened a margin account with Clarke for the purpose of selling

30,000 KHI shares that KHI was advancing to Dunham’s margin account to pay KHI the

$141,347.50 that he owed KHI, with the balance of the sale proceeds to be withdrawn by Dunham.

In April 2000, KHI closed the Innovative Retail Store in New Minas that was run by Dunham.

Rather than move to Halifax, Dunham resigned from KHI. Shortly thereafter he received from KHI

another 30,000 KHI shares and in the summer of 2000 his remaining 90,000 KHI shares. These

shares were transferred by KHI into Dunham’s margin account with Clarke at NBFL.

[45] NBFL submits that Dunham understood the effect of opening a margin account and that he

was borrowing money in a margin account from NBFL for personal and other purposes.

[46] NBFL acknowledges that on three occasions Dunham gave Clarke specific instructions to sell

KHI stocks and that Clarke ignored these instructions. Following these instructions would have

produced about$52,000.00 forDunham’s account. Dunham received the records ofpurchasesmade

into his account and sales made from his account. He knew that Clarke was not following his

instructions but he made no complaint either directly to Clarke or to NBFL.

[47] NBFL submits, in short, that Dunham ratified Clarke’s failure to follow instructions. NBFL

acknowledges that Dunham askedfor advicefrom Clarke in diversifying his account, but at the same

time notes that Dunham often gave instructions to Clarke with regards to purchases of technology

stocks in respect of which he relied upon his own research.

[48] NBFL’s submissions do not directly address Dunham’s communications with Clarke to the

effect that Dunham was told he should sell KHI shares and diversify his holdings or Dunham’s

evidence that he was relying upon Clarke to give him advice about, and carryout, the diversification

of his portfolio.

[49] Finally, NBFLsubmits that Dunham failed to prove that Clarke’s failure to follow instructions

caused Dunham’s claimed losses. Other than the three specific instructions to sell, which were not

followed, Dunham received the benefit of the advances made on the margin account that he held

with NBFL.

[50] NBFL identifies and refutes Dunham’s claimed losses:

i) With respect to Dunham’s claim that he lost the value of the 120,000 KHI shares (worth

$6.95 as of June 20, 2000), NBFLargues that no specific instruction to sell all shares was ever given.

ii) With respect to Dunham’s claim for lost income at the rate of $40,000.00 per year from

Page 13 of 139

June30, 2000 (when hisresignation fromKHIbecameeffective)to December31, 2002, NBFLnotes

that Dunham did not seek alternative employment. Furthermore, there was no evidence relating his

conduct, in resigning from KHI and not working, to anything that NBFL or Clarke did or failed to

do.

iii) With regards to Dunham’s claim for recovery of the interest charged on his margin

account in the amount of $34,418.00, NBFL again notes that other than in respect of purchases that

Dunham had instructed Clarke to make from the proceeds of the sale of KHI shares (about

$52,000.00) all advances on the margin account were for Dunham’s personal benefits.

iv) With respect to Dunham’s claim for losses of $123,000.00 (which NBFL quantified as

$113,000.00) that Dunham spent developing a website called “FantasyStock,” which he says he lost

because he ran out of money he would have had if his portfolio had been diversified, NBFL notes

that Dunham spent $83,000.00 before he mortgaged his house, and only spent $30,000.00 on the

project after he mortgaged his house for $350,000.00. In effect, neither NBFL’s nor Clarke’s

wrongdoing caused this loss.

v) With respectto Dunham’sclaimforcertainlegalandprofessionalexpenses, NBFLnotes

that there was no evidence relating these fees to NBFL’s or Clarke’s activities.

vi) With regards to the claim for interest paid on credit cards and on the mortgage on his

home (about $177,000.00), NBFL says there is no factual basis connecting these interest claims to

NBFLorClarke’sconduct;rather, whatsparseevidenceexists suggeststheywereincurredin respect

of Dunham’s efforts to re-enter the computer business through his corporation, Highbury Traders.

Lowell Weir, Blackwood Holdings and Carol McLaughlin-Weir

[51] With respect to the claim by NBFL on the Promissory Note, NBC acknowledges that if the

Court determines that NBFL is liable in damages to Weir and Blackwood, then the amount owing

under the Promissory Note should be deducted from those damages.

[52] In respect of the claim by Weir, NBFL states that Weir only had two personal investments in

Knowledge House shares, 5,000 KHI shares in his LIRA account and, on February 28, 2001, 28,175

shares received on conversion of his Knowledge House Limited Partnership Unit for $145,000.00

into shares. NBFL states that Clarke and NBFL were not involved in Weir’s decision to purchase

the Limited Partnership Unit, which Weir stated he did on the advice of his lawyer Blois Colpitts

(“Colpitts”).

[53] On January 19, 2001, Weir e-mailed Clarke telling him he was not comfortable with the

investments that he, his wife and members of his family had in KHI and if the per-share price fell

below $5.00 he was to liquidate and sell all their KHI shares. NBFL submits that Weir was a

sophisticated investor who watched the price of KHI shares carefully, and whose first complaint to

Page 14 of 139

NBFL about its failure to sell when the price fell below $5.00 came after the price of KHI shares had

collapsed. In effect, Weir had ratified Clarke’s conduct in not liquidating the Weir family holdings

in KHI shares.

[54] NBFL also notes that the 28,175 KHI shares (converted from a KHI Partnership Unit) were

placed in a margin account. There were restrictions on the sale of those KHI shares and Weir used

the margin debt to buy a car for his wife and to make RRSP contributions of about $19,000.00.

[55] NBFL states that if the Court finds that NBFL is liable for Clarke’s failure to liquidate the

Weir’s 31,175 shares as instructed, the loss to Weir was$165,875.00, which should be offset against

the margin debt of $60,177.00 owed by Weir to NBFL and the $100,000.00 advance by NBC on the

Promissory Note.

[56] NBFL notes that Blackwood opened a margin account with NBFL in 1998 and began

borrowing on this margin account to purchase various securities. Blackwood held 10,000 KHI

shares in its NBFL margin account as of March 1999 but sold 2,000 in December 2000 and 1,000

in March 2001. NBFL states that if this Court finds NBFL liable for Clarke’s failure to liquidate

Blackwood’s remaining KHI shares pursuant to the January 19, 2001, e-mail (other than the 1,000

on March 28, 2001), that the loss to Blackwood was $35,000.00 less the margin debt of $10,404.00

used by Blackwood Holdings to purchase other investments.

[57] NBFL notes that Carol McLaughlin-Weir testified that she met with Clarke in May 2001 to

discuss herchildren’s account and giveinstructions to liquidateKHIshares. ShetestifiedthatClarke

advised against selling shares because KHI was going to sign another government contract and the

price would rise to $8.00 per share. As a result, she revoked her instructions to liquidate KHI shares.

On this basis, NBFL says it is not liable for Clarke’s failure to liquidate the shares pursuant to the

January 19, 2001 e-mail.

[58] Weir hadtestifiedthat on September 4, 2001, heenteredinto anagreementwith NBFLthrough

its Halifax branch manager, with respect to NBFL’s margin call against Blackwood account, to the

effect that no action would be taken on the Weir’s accounts while he was away in Europe on

business. NBFL says the evidence shows that Weir returned from Europe on September 14, 2001.

NBFL did not act on its margin call and liquidate shares in the Blackwood account until September

19, 2001, five days after Weir returned from Europe; it says that it did not breach the agreement.

[59] NBFL denied that it was vindictive and mean in the manner in which it exercised its right to

liquidate the Blackwood shares to satisfy the margin debt. NBFL further states that the Weirs had

manyopportunities to mitigate their loss and failed to do so. NBFLfurther submits that the damages

claimed by the Weirs in respect of the liquidation of Weirs’ shares in Enervision, a publically traded

company that Weir ran and had a significant investment in, was not caused by the manner in which

NBFL liquidated Blackwood’s shares pursuant to its margin call.

Barthe Estate

Page 15 of 139

[60] NBFL states that Barthe was a wealthy, successful and sophisticated businessman worth

hundreds of millions of dollars. He purchased a residential property and made other investments in

Guysborough County, Nova Scotia. Some of these investments were made jointly with Lutz Ristow

(“Ristow”).

[61] Barthe became interested in investing in KHI as a result of discussions with his neighbour in

Nova Scotia, Jack Sullivan (“Sullivan”), an officer of KHI, who introduced him to Potter. Barthe

conducted his own due diligence on KHI. He arranged for an analysis by an accountant who had

formerly been employed by his German corporation, and by his Nova Scotia accountant, and by his

lawyers.

[62] He was first approached by Sullivan in 1999. In May 2000, he received a proposal to make

a substantial purchase of new shares from KHI’s treasury, which proposal he did not act on. On

August 3, 2000, he entered into an agreement negotiateddirectlywithPotter andColpitts to purchase

250,000 KHI shares on the open market at $6.80 per share, for a total of 1.7 million dollars. He

received an option to purchase additional shares from Potter for $4.00 per share. At this time, he did

not have an NBFL account.

[63] He contacted Colpitts, KHI’s counsel and a Director, to ask how the agreement should be

implemented. He was advised by Colpitts to contact Clarke and open an account at NBFL. Barthe

transferred 1.7 million dollars to an account opened in his name on August 28, 2000. Clarke

executed Barthe’s instructions to purchase the shares, sent Barthe confirmation slips for each

transaction, and regular updates on his progress. Clarke was able to purchase shares for less than

the $6.80 price in the agreement. For the 1.7 million dollars, Clarke purchased 259,000 shares for

Barthe and paid himself commissions of $13,848.00.

[64] After August 30, no other transactions took place on Barthe’s NBFL account before the KHI

share price collapsed.

[65] NBFLnotes that there were no restrictions as to whom the sellers to Barthe would be, and that,

by reason of the August 3^rdagreement between Barthe and Potter, it was clear that Barthe was

agreeing to purchase KHI shares from KHI insiders.

[66] In October 2000, Barthe and Ristow decided to jointly purchase KHI shares from KHI’s

treasury. The purchase was negotiated directly with Potter and Sullivan. The terms of the private

placement, set out in the Subscription Agreement, were approved by the Toronto Stock Exchange.

Barthe confirmed an understanding that there were no assurances that the money that he and Ristow

were injecting into KHI would enable it to continue its operations. The Subscription called for four

payments of $812,500.00 directly to KHI’s Royal Bank account. The shares were being held in

escrow for six months after the payments were made. Ristow made the first two payments, the third

and the fourth payments were due from Barthe on May 15 and August 15, 2001. These payments

were not made through Barthe’s NBFL account.

[67] NBFL submits that Barthe and Ristow were offered directorships with KHI and had

Page 16 of 139

information available to them that was available to directors. Ristow was formally appointed to the

KHI board on June 29, 2001; he and Barthe were treated as if they were Directors from December

2000. They were well aware of the cash flow problems of KHI at the time of the subscription

agreement of November 15, 2000.

[68] NBFL submits that there was no evidence that Barthe would not have invested in KHI had he

knew that its share price was supported by the activities of Clarke and/or others. On the contrary,

when Barthe was advised that the stock was being supported, he did not complain. He even

expressed a willingness to help, except for the fact that he did not at that time have the financial

ability to do so.

[69] NBFL submits that not only did Barthe not complain that he had been deceived or express

concern when he was asked to support KHI’s share price, neither he nor Ristow complained that they

would not have bought KHI shares if they had known the price had been supported.

[70] NBFL argues that because at one point Barthe was offered the position as an alternative

Director in the event Ristow could not attend Director’s Meetings and because he had access to

insiders’ information that he is liable to NBFL for any wrongdoing arising from stock manipulation

by Clarke.

Calvin Wadden

[71] NBFLstates that Calvin Wadden is a well-educated, experienced businessman with extensive

employment history in banking and finance. He and Raymond Courtney (“Courtney”) founded

Micronet. Micronet purchased 100,000 KHI shares in December 1998 (later split between Wadden

and Courtney, with Wadden placing his 50,000 shares in 3019620 Nova Scotia Limited, which

opened an investment account with his best friend and broker Eric Richards at Financial Concepts

Group (“FCG”)).

[72] On June 30, 1999, Wadden and Courtney sold Micronet to KHI for 2.2 million shares (1.1

million each) and jobs as executives at KHI. The shares were held in escrow to be released over five

years. The shares were valued at that time at $2.65 each.

[73] In 1999, Wadden and Ms. Wadden invested further into KHI:

i

They purchased 111,000 additional KHI shares on the market;

ii He purchased a partnership unit for $150,000, converted in January 2001 into 28,125

KHI shares; and,

iii She purchased 62,500 shares as part of a private placement to raise operating capital for

KHI.

[74] In January 2000, the Waddens acquired 100,000 common shares from Don Snow (“Snow”),

Page 17 of 139

who was selling the bulk of his shares to Charles Keating (“Keating”), to assist in Snow monetizing

his investment into KHI, and an additional 20,000 shares on the market.

[75] Other than the shares obtained from the sale of Micronet, most of these purchases were

financed by margin debt, issued on the Wadden’s accounts at FCG. As of February 28, 2000, 80%

of the Wadden family assets were in KHI equity, offset by 1.144 million dollars in margin debt to

FCG and $300,000 in margin debt at CIBC. At this time, FCG determined it would advance no

further margin debt to the Waddens.

[76] In March 2000 Wadden’s best friend Eric Richards (“Richards”) left FCG for BMO; the

Waddens decided to move their accounts with him.

[77] In the meantime, Wadden opened a margin account through Clarke at NBFL to access cash.

In a March 7, 2000, e-mail, Wadden asked Clarke to advance $300,000.00 to CIBC to pay off a loan

secured by220,000 KHIshares and to cause those shares to be transferred to his new margin account

at NBFL. After opening this account, Wadden had made cash withdrawals of $607,500.00 by June

20 and purchased other shares on margin.

[78] NBFL notes that in Wadden’s direct evidence, at a time when KHI was entering into larger

deals and KHI’s share price was progressing from $6.00 to $7.00, Potter advised his partners that

KHI’s ‘orderly market account’ was offside and Potter asked each of the major partners to put up

100,000 shares to maintain the orderly market account onside. Wadden immediately agreed.

Wadden attended at Richard’s office to obtain the only share certificate available to him. It was for

220,000 KHI shares. He then returned to KHI’s office to give it to Potter. Potter asked him to sign

the back of it and give it to his executive secretary; he did. He acknowledged advising the executive

secretary that Potter said to send this certificate down to Clarke at NBFL.

[79] Calvin Wadden’s lawyer Brian MacLellan Q.C., who was retained by Wadden on July 17,

2000, testified that Wadden described the account to him as “mother’s account”, “box account” and

“orderly market account” and understood that he was being asked to “support the market” with his

unencumbered stock in KHI.

[80] NBFL submits that Wadden knew that the account was to be used to buy and sell KHI shares.

NBFL fails to note that Wadden was unaware that the shares were being deposited in Clarke’s 540

account. At trial, Clarke testified that the 540 account was his own account. It was not an account

of KHI nor operated by Clarke on behalf of KHI. NBFL’s submission is that it is irrelevant to

Wadden’s consent to participate in the “box account” that he did not know that the account was in

Clarke’s 540 account name, but it is important that Wadden understood (from the time of the transfer

of the CIBC held shares to his NBFL account) that shares pledged as security for an account could

not be returned unless the debt was paid off or he posted substitute security.

[81] NBFL makes the point that while in Florida with his partner Courtney, immediately after

arranging for his 220,000 KHI share certificate to be delivered to NBFL, Courtneytold Wadden that

he was not prepared to go along with Potter’s request that 100,000 of his KHI shares be placed in

Page 18 of 139

the “box account” but would agree to put $100,000.00 into the account. There is no evidence that,

after returning from Florida until May 2000, Wadden asked Potter whether the other partners had

contributed, or asked Potter for the return of the extra 120,000 shares he deposited into the account.

[82] Making the point that Wadden did not object to, or alternatively, did understand that he was

advancing 220,000 KHI shares as security for an orderly market account, NBFL notes a May 11,

2000, e-mail in which Wadden stated that he would like to take Potter and Courtneyup on their offer

to “equally support the orderly market account with Bruce and that freeing up the 120,000 [shares]

will definitely make things easier for me”.

[83] On June 7, 2000, 120,000 KHI shares were deposited to Wadden’s NBFL account from one

of Potter’s numbered company’s account. Immediately thereafter Wadden made cash withdrawals

from this NBFL margin account, which margin debt totalled 1.026 million dollars as of June 30,

2000.

[84] NBFL characterizes the relationship between Wadden and Potter as becoming strained after

June 30, 2000, when Potter failed to find a buyer for 250,000 of Wadden’s KHI shares. This relates

to Wadden’s evidence that at the time he agreed to purchase 100,000 of Snow’s shares in January

2000 (to assist in Snow monetizing his investment in KHI), Potter had promised to find him a buyer

for 250,000 of his shares. Shortly after June 30, Wadden took steps to sell KHI shares from his

account at BMO Nesbitt Burns. BMO would not allow him to do so. This led to Wadden’s retainer

of a lawyer, MacLellan, on July 17, 2000.

[85] On July 20, 2000, MacLellan sent a fax to Clarke requesting that Wadden’s 100,000 shares in

the orderlymarket account be returned. He stated that this was a follow-up to Wadden’s own request

of July 14 and July 17. Clarke was unable to return the 100,000 shares as they were held as security

for margin loans owing to NBFL by the 540 account. After Wadden resolved his disputes with

Potter in late August 2000, Ken MacLeod (“MacLeod”), another shareholder and director, caused

100,000 KHI shares to be deposited into Wadden’s account.

[86] On August 31, Wadden signed aletteracknowledging the return of all 220,000 KHIshares that

had been deposited in the 540 account. On September 5, Wadden took delivery of the 100,000 KHI

share certificate. On October 4, he deposited the certificate into an account he opened at TD

Waterhouse and immediately, on the security of that share certificate, made cash withdrawals from

that margin account to purchase other shares.

[87] NBFL suggests that there is no legal consequence to Wadden’s complaint that the 220,000

shares he deposited into the 540 account on or about March 7 were not the same 220,000 shares that

were returned to him on June 7 and August 29, 2000. It submits this claim has no relevance to

whether Wadden in fact consented on March 7 to the deposit of the 220,000 KHI shares in the

orderly market account operated by Clarke (through the 540 account).

[88] With respect to Wadden’s claim that NBFL refused his sell instructions, it submits that the

only evidence of a refusal to sell was a request to sell 3,000 shares at $6.50 made on the afternoon

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of August 11, 2000.

[89] NBFL notes that, in respect of the July 19, 2000, telephone conference call between Wadden

and Clarke from the boardroom of MacLellan’s office, MacLellan and Greenwood were present.

Wadden has no record to back up his claim that he gave Clarke instructions to sell KHI shares, and

neither MacLellan nor Greenwood has notes or confirm that Wadden instructed Clarke to sell KHI

shares during that phone call. Follow up correspondence between MacLellan and Clarke did not

refer to any instructions to sell.

[90] NBFL acknowledges that on August 11, when Wadden instructed Clarke to sell 3,000 shares

at $6.50, Clarke called Colpitts and asked if the trade could be done. On the basis of that phone call,

Clarke refused to execute the sale instructions. NBFL notes that if Clarke was in breach of his

obligation to Wadden with respect to that instruction, the proceeds would have been $19,500.00 less

commission. This loss could have been mitigated if Wadden had sold the shares after he resolved

his issues with Potter. Therewere no instructions that would have prevented him from doing so after

August 2000.

[91] In pre-trial submissions, Wadden complains that NBFL breached its obligations to him with

respect to the 28,125 KHI shares Wadden received on January 4, 2001, in exchange for his limited

partnership unit.

[92] NBFL notes that, at the trial, Wadden testified that in late December he received a call from

Potter in which Potter spoke about market pressureon KHIshareprices. Potter advisedWadden that

he was using the shares he was receiving as a result of the conversion of the limited partnership unit

as security to purchase more KHI shares. Potter asked if Wadden would do the same and Wadden

agreed.

[93] OnJanuary4, 2001, Waddene-mailedColpitts asfollows: “Pleaseforwardmysharecertificate

for the converted LP to Bruce as soon as possible. I will be depositing to my margin account and

will be able to help Bruce take 20,000 shares of KHI out of the market if we can do this today.” In

fact, the share certificate was deposited to Wadden’s NBFL account and Wadden did purchase

20,000 shares on margin.

[94] NBFL says the only evidence before the Court is that Wadden consented to the transaction.

If these market support transactions were lawful, on the basis that the purchases were made in the

expectation that the shares would increase in value, then Wadden has no claim against NBFL.

Alternatively, NBFL argues that if the Court finds that the motive behind the transactions was to

manipulate the market illegally, then this is further evidence of Wadden’s willing participation in

the manipulation and he is liable on the third party claims by NBFL with respect to any liability it

may have to Dunham, Weir, Blackwood and the Barthe estate.

[95] Finally, NBFL argues, in respect of its claim against Wadden in the Main Action, and in its

Third Party claims, that if the Court finds that the market support was an unlawful activity, Wadden

participated. NBFLsubmits that Wadden’s participation, or atleast his knowledge, as a KHIinsider,

Page 20 of 139

commenced by February 3, 2000, when he received a copy of an e-mail from KHI’s controller to

Clarke referring to shares that were going to become available “to support the market as needed or

fill any orders you have pending” following which Wadden had discussions with Clarke. As

previously noted, Wadden further deposited 220,000 shares into an account at NBFL with Clarke

on March 7, 2000, in order to help support the orderly market account. On March 9, 2000, Wadden

sent an e-mail from Florida to Clarke entitled “Trading Account”, in which it is clear that Wadden

understands his participation involved an orderly market account and efforts to find purchasers for

KHI shares.

[96] In atellinge-mail fromPotter to Wadden(copiedto Colpitts) dated November19, 2000, Potter

advised that he was hoping to close a 3.25 million-dollar treasury issue to “our German friends

[Barthe and Ristow] in the next day or two at a price of $6.50". Potter added: “If the market is

driven down in advance of this issue, it is quite likely that the investors will not close”. Potter urged

caution with respect to one of Wadden’s friend’s pressure to find a buyer for his shares.

[97] In the fall of 2000, prior to this e-mail, Wadden had been a consistent seller of KHI shares but

immediately after this e-mail he purchased 8,300 KHIshares. In December 2000 and January 2001,

Wadden and his wife purchased approximately 55,000 KHI shares on margin. As noted earlier,

Wadden agreed that the 28,125 KHIshares he received on conversion of the limited partnership unit

would be used to support the market and, in fact, purchased 20,000 KHI shares in January to take

pressure off the retail market for KHI shares.

[98] This is consistent with two e-mails from Potter to Wadden at this time. In one dated January

1, 2001, Potter advised:

... there is significant selling pressure on KHI on December 29 ... if you can be of any assistance

helping to find some buyers, that would be great. We have been and will continue to be working on

this in the coming days but I am concerned that the selling may exceed any support bids we can

engender in the next few days.

[99] Again, on January 31, 2001, Potter e-mailed Wadden: “From the look of the market it seems

we have had success in stabilizing the market and I hope that we can look forward to better days

ahead.” Wadden referred in cross-examination to “we” as including all of the founding partners,

directors, Colpitts and Clarke.

[100]

In February the founding shareholders met at Colpitts’ office and pledged to support the

market price of KHI shares. Wadden was placed in charged and paid a monthly fee for performing

that function. E-mails expand on how Wadden undertook this job. In a February 9 e-mail to Potter

he stated:

I have been speaking with Ray, Blois and Ken throughout the day and they have been in supporting

the market. Ray and I would really like to get the stock to $5.45 and try to solicit more support from

the group going forward. If we can get to $5.45-$5.50, I would like to see each of us put 5,000 shares

Page 21 of 139

into the support side and try to inch up towards $6.00 to $6.50 until we get some positive news on the

street.

[101]

On February 13, Wadden sent an e-mail to Steven Wilsack (Craig Dunham’s partner),

in which he tells Wilsack that he told “the whole table” that Wilsack was not in fact selling but rather

buying and it helped him to convince others to support the KHI share price and put the stock in the

$6.00 plus range. He added: “I can honestly say I is the reason the damn stock ain’t at $4.00. I am

working for the shareholders.”

[102]

In February Wadden took a trading course and subscribed to a stock watch program and

was spending a considerable amount of time in front of his computer “tracking and trading stocks”.

Wadden’s market support activities included more than KHI. It showed a clear knowledge and

understanding by Wadden that he was trying to assist insiders in more than one companyto keep the

market price of publicly traded stocks elevated.

[103]

NBFL makes the point that after March 2, 2001, Clarke’s 540 account did not trade in

KHI shares. NBFL does not mention that the obvious reason for this was that Clarke had run out

of margin in that account to continue the efforts that had persisted since at least early March 2000,

when Wadden had deposited his 220,000 KHI share certificate and Potter had placed $100,000.00

cash into the 540 account.

[104]

involved.

NBFL argues that if providing market support was unlawful, clearly Wadden was

B.2 Dunlop Clients Submissions

[105]

The Dunlop Clients submit that the KHI share price collapsed from above $5.00 to nil

in less than two months, not because of a cataclysmic event threatening KHI. KHI had just

announced an anticipated, substantial contract with the Province of Nova Scotia.

[106]

Onthecontrary, KHIcollapsedbecauseNBFLandBMOwereincreasingtheirpurchases

of KHI shares, while other brokers were reducing their ownership. Weir was rebuffed by NBFL

when he noticed this and asked Clarke that shares owned by him and his family be sold if the price

touched $5.00.

[107]

When the shares fell below $5.00, counsel submits that margin calls byNBFL occurred.

These margin calls occurred before the collapse of KHI price and the margin call was the cause of

the collapse.

[108]

A second cause of the losses to the Dunlop Clients was Clarke’s misdeed respecting the

trading in KHI shares, including through his 540 account, which NBFL failed to stop. Counsel

argues that the evidence shows that Clarke used the 540 account to borrow millions of dollars from

NBFL on margin, using money and shares provided by KHI insiders to support the KHI share price.

This is the substance of NBFL’s allegations in the action it commenced known as the Main Action.

Page 22 of 139

When the various non-NBFL parties attempted to have NBFL’s Main Action dismissed or,

alternatively, the other actions in which NBFLpleaded that Clarke was innocent of anywrongdoing,

NBFLadvanced its ownresearch andinvestigations to supportits allegationagainst Clarkeandother

alleged KHI’s insiders of misdeeds respecting the trading in KHI’s shares.

[109]

In this respect, counsel refers the court to affidavits filed in NBFL’s pretrial motions, the

Brian Awad Memoranda, and the tendered discoveryevidence of Mr. Rousseau, an Executive Vice-

President at NBFL in charge of its network of brokers.

[110] The Court notes that some of the “evidence” relied upon by counsel in his submissions

was not tendered at trial and is not before the Court as evidence.

[111]

Dunlop submits that NBFL’s pretrial machinations and shifting theories of the

misconduct of Clarke and others negate NBFL’s pretrial submissions to the effect that there was no

wrongdoingbyanyone, includingNBFL. Hecontrasts this withhis clients’consistentallegation that

Clarke acted wrongly in several respects, which he summarized in his post-trial submissions in nine

categories: (1) conflict of interest; (2) breach of confidence; (3) failure to inform or warn; (4)

unsuitability; (5) over concentration in one stock; (6) improper financial dealings with clients to the

detriment of others; (7) misrepresentation; (8) failure to follow and execute sale orders; and (9)

unauthorized trading.

[112]

Counsel submits that NBFL itself was negligent in failing to properly supervise Clarke

and, in addition, is vicariously liable for Clarke’s wrongdoing. All of Clarke’s nine misdeeds are

relevant to Dunham’s claim; all but the fifth (over concentration in one stock) are relevant to the

Weirs’ claim; all but the fourth, fifth and ninth apply to the Waddens’ claims; and that four of those

misdeeds, the first, third, sixth and seventh, apply to the Barthe claims.

[113]

Counsel relies upon the IDAC settlement agreement with NBFL for the truth of its

contents, and the evidence of Clarke, to prove Clarke’s wrongdoing and NBFL’s negligence and

breach of contract in not supervising him.

[114]

Dunlop notes that, at the end of the plaintiffs’ case, despite filing a lengthy list of

proposed witnesses, NBFL called no witnesses. The Dunlop Clients submit that the Court should

draw an adverse inference against NBFL because they called no evidence and because of Clarke’s

evidence with respect to his handling of the 540 account, his dealings with KHI insiders and with

NBFL’s management, as well as the nine specific claims of wrongdoing by Clarke. In this regard,

counsel refers the Court to the Law of Evidence, 3^rdEdition, by Alan Bryant et al, para 6.449,

Falkenham Backhoe Services v Nova Scotia, 2008 NSCA 38, para 48; Constitution Insurance v

Coombe, 1993 5461 (ONSC), in which, at para 15, the Court cites Chief Justice Gale in

Northern Wood Preserves v Hall Corporation Shipping (1973), 2 OR (2d) 335.

[115]

In all of their claims, the Dunlop Clients plead negligence and breach of contract. In the

Dunham claim, counsel claims also that NBFL breached its fiduciary duty. Rousseau’s discovery

evidence established NBFL’s heightened duty to supervise Clarke and the 540 account. NBFL

Page 23 of 139

produced no evidence that it supervised Clarke.

[116] The Court has already noted that, after Dunlop’s post-trial submissions were made, and

for the first time, NBFL acknowledges, in its post-trial submission, that it failed to supervise Clarke

in respect of the 540 account. NBFL did continue to claim that Clarke did nothing wrong.

B.2.1

The Wadden Claim

[117]

Dunlop submits that the wisdom of Wadden’s sale of his interest in Micronet for shares

in KHI is not in issue. As of March 7, 2000, 440,000 of Wadden’s freely tradable KHI shares were

“lodged with NBFL” and had a market value of about three million dollars.

[118]

How 220,000 ended up in Clarke’s 540 account is important. Wadden says that he

agreed to assign these shares, at the request of Potter, as security for a KHI account that was “off

side” and needed for a short term support. The existence of the KHI account at NBFL was not a

secret. Wadden knew nothing of the 540 account that his shares actually went into.

[119]

While admitting that Clarke in fact used Wadden’s shares as securityto buyand sell KHI

shares through the 540 account, Wadden relies first on NBFL’s position that Clarke did nothing

wrong with the 540 account. Alternatively, if Clarke acted wrongly, that Wadden, whose credibility

was not impeached, had no personal contact with Wadden about how his 220,000 KHI shares were

to be used; did not know that these shares were being used to support Clarke’s 540 account; refused

to sign a document drafted by Clarke acknowledging a loan of shares to Clarke and hired a lawyer

to get the share certificates for these shares back. All of this establishes that Wadden did not

voluntarily loan his shares to a broker’s private account.

[120]

Counsel argues that Clarke acknowledged taking instructions from Colpitts and

sometimes from Potter on whether to execute sell instructions from Wadden. When Wadden put

NBFL on notice of Clarke’s wrongful use of his KHI shares, NBFL accepted absurd explanations

from Clarke rather than check the conduct of Clarke in respect of his 540 account.

[121] Counsel argues that only then did Wadden “capitulate” and get some of his KHI shares

released. What counsel meant by “capitulation” is not explained in his submission.

[122]

Wadden claims the value of 440,000 shares lodged with NBFL in March 2000, when

their market value was $6.80 per share, or $2,992,000.00. Because NBFL argued that neither it nor

Clarke did anything wrong, it cannot be argued that the market value for KHI shares was not the

price on the TSX of $6.80 per share.

[123]

Absent any evidence that Wadden should not have been allowed to trade freely in these

440,000 shares, but was, in fact, prevented from doing so, and absent evidence that the TSX stock

price for KHI shares was not their real market value, the Court should not speculate that the market

would not have absorbed the 440,000 KHI shares for less than $6.80 per share.

Page 24 of 139

[124] Counsel cites Hodgkinson v Simms [1994], 3 SCR 377 for the proposed remedy for

Wadden’s capital losses.

[125]

Between Clarke’s wrongful taking of instructions from Colpitts to prevent thesale of the

220,000 KHIshares in Wadden’s margin account and the wrongful taking of the 220,000 KHIshares

in the 540 account, counsel argues that Wadden is entitled to an award for damages equal to the

value of the TSX public stock price for those shares in March 2000.

B.2.2

The Dunham Claim

[126]

Craig Dunham’s claim against NBFL is for negligence and breach of contract as well as

breach of a fiduciary duty. The claim is based both on NBFL’s own breaches of duty, and

vicariously for Clarke’s wrongdoing.

[127] Dunham claims that Clarke, and therefore NBFL, breached a fiduciary duty to Dunham.

On the totality of the evidence, it is clear that Dunham placed himself totally in Clarke’s hand in a

manner described in Varcoe v Sterling, 1992 Carswell Ont 1156 (ONSC) at paras 86 and 90.

[128]

Clarke knew that Dunham was a novice investor who relied totally on Clarke’s skill and

knowledge to guide him and to diversify his account. Instead, Clarke acted contrary to Dunham’s

bests interests in an intentional manner such that Dunham not only lost the value of the 150,000 KHI

shares placed in the care of Clarke but incurred significant consequential losses.

[129] Counsel argues that nothingin Clarke’s conduct could reasonablyhave warned Dunham

that Clarke was in a conflict of interest position and acting deceitfully toward him.

[130] Counsel cites Kerr v Baranow, 2011 SCC 10, at paras 70 and 71, respecting the

flexibility given to courts to grant equitable remedies. Dunham submits that Clarke ruined his life.

[131]

Dunham claims that the market value of his KHI shares, as they came in Clarke’s “orbit

of influence” was $800,000.00. But for Clarke’s deceit and failure to disclose his interest in the 540

account as well as his relationship and activities on behalf of KHI’s insiders, Dunham would not

have placed his remaining KHI shares with Clarke and would have been able to liquidate them.

[132]

Counsel argues that, in a 2005 decision removing NBFL’s then counsel in this litigation,

Justice Scanlan had admonished NBFL to settle with the truly innocent investors. Counsel

characterized Dunham as, without doubt, one of the clearly innocent investors with whom NBFL

should havesettled. Dunham’ssubmissionwasmadebeforecounselwasawareofNBFL’spost-trial

acknowledgment that it had failed to properlysupervise Clarke and his 540 account. Counsel argues

that NBFL should be liable for substantial punitive damages as described in Whiten v Pilot

Insurance, 2002 SCC 18, for the manner in which it strenuously contested Dunham’s claim for

several years, during which time Dunham lost his home, his credit, his business and his business

reputation.

Page 25 of 139

[133]

NBFL knew it had no defence to Dunham’s claim, even while it advanced conflicting

pleadings and claims, including claims first that Clarke and others had conspired to cause the loss

to NBFL and its client and, on the other hand, that neither NBFL nor Clarke had done anything

wrong.

[134]

Counsel stresses that NBFL’s tactics and stratagems protracted the litigation, not unlike

the treatment of the Blackburns in Blackburn v Midland Walwyn, 2003 Carswell Ont 684. In that

case, the Court tripled the costs award. Counsel notes that unlike the Blackburn case, the NBFL

managers in this case have not been otherwise punished.

[135]

NBFL’s reduction in its margin rates for KHIshares were affected suddenlyand without

regard to the consequences on its clients, including those like Dunham. This irresponsible conduct

merits denunciation.

[136]

Failure to honour its contractual duty of good faith is distinct from breach of contract,

(Whiten, para 79), and forms an additional basis for punitive damages. Counsel refers to para 112

to 125 in Whiten for the measure of punitive damages.

[137] Applying these principles, counsel submits a substantial award of punitive damages is

warranted because NBFL was so oppressive and affected so many over so extensive a period.

B.2.3

The Barthe Claim

[138] The late Michael “Ben” Barthe, made two investments in KHI after Clarke commenced

his machinations with the KHI stock in March of 2000.

[139] First, Clarke contracted to purchase KHI shares for Barthe, who was referred to Clarke

by a KHI insider Colpitts. Counsel submits that Clarke had a concomitant duty when he contracted

to act for Barthe in the purchase of shares to disclose his involvement in the 540 account as well as

his work for KHI’s insiders in maintaining the KHI share price. He did not disclose these to Barthe.

[140]

NBFL’s defence that Barthe was not induced by Clarke to buy KHI stock and that the

purchase of KHIshares was not an unsuitable investment for Barthe, is not an answer to the “but for”

test. Counsel submits that if Clarke had told Barthe what he knew, Barthe would not have purchased

the KHI shares. Compounding Clarke’s non-disclosure was Clarke’s continued manipulation of the

market price of the KHI shares, while Barthe purchased shares.

[141] Barthe invested $3,315,000.00 in KHI shares. He lost the value of his shares, except a

minimal recovery, and the interest on those shares.

B.2.4

The Weir/Blackwood Claims

[142] Lowell Weir gave explicit instructions to Clarke to sell all KHI shares held by him, his

company and his family in January 2001 in the event that the KHI share price dipped below $5.00.

Page 26 of 139

It did and Clarke did not sell his shares.

[143] When Weir received a share certificate for 28,125 KHI shares on the redemption of his

KHI limited partnership unit, these instructions required Clarke to liquidate those shares.

[144]

Theloss to BlackwoodbyClarke’s failureto sell at$5.00its KHIshares was$42,000.00.

The loss to Weir himself was $26,250.00 for the shares he held as of January 2001 and $157,500.00

for the 28,125 shares received into his NBFL account shortly afterwards. Weir claimed these sums

plus interest.

[145]

The claim by Weir and Blackwood is based upon Weir’s clear instruction to sell, which

instruction was not carried out. Weir says it was not complied with because of Clarke’s illegal

trading both through the 540 account and otherwise. NBFL was negligent and in breach of its

contract with Weir to failing to properly supervise Clarke.

[146]

Weir claims that when KHI collapsed and NBFL knew, or should have become aware,

of Clarke’s illegal activities, Weir and Blackwood should have had their claims for losses quickly

resolved. Instead, it has taken over 10 years.

[147]

Weir’scredible evidencewith respectto his communicationswiththeheadofficeofKHI

was uncontradicted by any evidence at trial. It was to the effect that NBFL’s head office agreed to

compensate him once NBFL had recovered from those others that it had sued for their part in the

wrongdoing, that the$100,000.00 wasanadvanceonaneventualsettlementofWeir’sclaimsagainst

NBFL, (which advance was documented as a loan for audit purposes only), and NBFL employees

made subsequent threats to teach him a lesson, and generally acted in bad faith. All these things

merit punitive damages against NBFL. The effect upon Weir and his family from the liquidation of

his margin account with NBFL, and that of Blackwood, which included the forced sale of his shares

in Helical (formerly Enervision), created collateral damages in the form of the loss to him of his

interest in Helical and his business reputation. These merit punitive damages.

B.3 Supplementary Submissions - December 2012

[148]

At trial, the Dunlop Clients sought to have the Court receive undisclosed evidence that

he considered relevant and important to the proceeding. NBFL objected vehemently to any

disclosure of the subject matter of the evidence Dunlop proposed to tender. Counsel advised that

NBFL would seek a mistrial if the subject matter was disclosed. The request by Dunlop was made

both before the Dunlop Clients had closed their case and at the end of the hearing of all parties’

evidence.

[149]

Specifically Dunlop requested that his clients be entitled to reopen the case if the

evidence he was prevented from introducing at the trial could, at a later date, be introduced. The

Court advised that it would entertain a motion to receivenew evidence within a reasonable time after

Page 27 of 139

the close of the evidence, if that occurred before the court had rendered a decision.

[150] OnDecember4, 2012, aSettlement Agreemententeredintoin June2005betweenNBFL

and its Halifax manager Eric Hicks on the one part and the Nova Scotia Security Commission, the

Investment Dealers Association of Canada, and Market Regulation Services Inc., respecting the

conduct of NBFL and Hicks in relation to its dealings with the subject matter of this litigation, and

which, by order of the Commission, had been kept secret until approved by the Commission, was

approved by the Nova Scotia Securities Commission and made public.

[151]

On December 5, 2012, Dunlop wrote to the Court requesting that I grant his request to

reopen the case if the evidence that was referred to as the “big secret” became public before I

rendered my decision. He asked that the court reconvene so the NBFL / Hicks settlement agreement

couldbetenderedasevidenceandsubmissionsbeadvancedasto theconsequencesoftheagreement.

[152]

On December 6, Hodgson, counsel for NBFL, replied in part:

For purposes of the Record, NBFL objects to the admissibility into evidence of the Agreement.

However, this is an issue which has already been fully argued and upon which your Lordship has

already ruled. Accordingly, (unless your Lordship has reconsidered his Decision) NBFL accepts that

the Agreement will be entered into evidence as an Exhibit.

All counsel are in your Lordship’s hands. However, given the time of the year, I am wondering if it

might be more expeditious for Mr. Dunlop to simply provide written argument for “the consequences”

of the Settlement Agreement ... and for NBFL to provide its written Submissions ...

[153]

Hodgson’s reference to my decision, was my decision respecting the admissibility of a

Settlement Agreement between NBFL and IDAC, arising from failure by NBFL to supervise other

branch operations during the time frame of the alleged wrongdoing by Clarke, which decision is

reported as 2012 NSSC 76. On December 6, Dunlop replied to Hodgson’s letter thanking him “. .

. for agreeing that the Settlement Agreements be entered as exhibits for your consideration . . . [and]

I am in agreement with Mr. Hodgson’s suggestion that we deal with the matter by way of written

argument rather than try to schedule a court appearance.”

[154]

On the same day, the Court wrote to counsel, in part as follows: “. . . based on counsel’s

agreement on procedure, Iam prepared to accept written submissions as to the “consequences” (your

words) or use that may be made of the settlement agreement.” I set time lines for written

submissions. Dunlop’s submissions were received on December 14, and NBFL’s on December 21,

2012.

B.3.1

Dunlop Clients Supplementary Submissions

[155]

In June 2005, NBFL and its Halifax manager Eric Hicks, entered into a Settlement

Agreement with the Nova Scotia Securities Commission Staff, the Investment Dealers Association

of Canada (“IDAC”) and Market Regulations Services Inc. (“MRS”), with an attached Statement

of Allegations. The Agreement dealt with the subject matter of this litigation and the prior publicly-

available settlement agreement between the Commission and Clarke. The Agreement provided that

Page 28 of 139

it was to remain confidential until approved by the Commission.

[156] The NBFL/Hicks/NSSC/IDAC/MRS Settlement Agreement was approved by the

Commission and became public on December 4, 2012. The Dunlop Clients tendered the Settlement

Agreement, the decision of the Nova Scotia Securities Commission (“Commission”) dated

December 4, 2012, approving the Settlement Agreement signed June 2005, together with the Nova

Scotia Securities Commission decision dated April 17, 2012, amended September 30, 2012, and two

decisions of the Nova Scotia Court of Appeal respecting the Settlement Agreement - the Court’s

decisions of January 31, 2012 (2012 NSCA 12) and September 21, 2012, (2012 NSCA 99).

[157]

These decisions discuss the process bywhich the Settlement Agreement was kept secret

for seven years. They explain why the Dunlop Clients were unaware of the Settlement Agreement

and agreed facts in the Statement of Allegations until shortly before the joint trial of these

proceedings was commenced. The decisions also explain why the Dunlop Clients were prevented

from introducing evidence in this litigation of the Settlement Agreement and the agreed Statement

of Allegations until after the trial was completed and initial post-trial submissions in this proceeding

were made.

[158]

They explain why it is appropriate that this Court, not having yet rendered a decision,

entertains the request to admit into evidence, and consider, if admitted, the purpose, and how the

Settlement Agreement approved by the Commission on December 4, 2012, should impact this

proceeding.

[159]

In substance, the Agreement provides that NBFL and Hicks agree that the Settlement

Agreement was entered into on the basis of the facts contained in the Statement of Allegations of

NSSC Staff attached to the Settlement Agreement. The parties to the Agreement agree that the facts

and conclusions are for the purpose of the Settlement Agreement only. The agreement on the facts

and conclusions in the Statement of Allegations is “without prejudice to [NBFL] in any other

proceedings of any kind, including . . . any civil or other proceedings”. The Agreement sets out, as

mitigating factors, NBFL’s full co-operation with the investigation, and the fact that “NBFL has

conducted a thorough and rigorous examination of its internal procedures and policies resulting in

significant changes to its compliance regime in order to enhance its ability to supervise and to detect

compliance violations by its employees in their trading activities.” Finally, “this Settlement

Agreement and its terms are to be treated as confidential until approved bythe Commission and only

thereafter if, for any reason whatsoever, [it] is not approved by the Commission.”

[160]

The agreed Statement of Allegations attached to the Settlement Agreement contains 34

paragraphs that mimic in substance evidence heard orally in this litigation. The December 4, 2012,

decision of the Commission summarizes the factual basis admitted to by NBFL as its violations of

the Securities Act. The Commission summarized the facts as follows:

3. ... relates to the Respondents’ actions, or lack thereof, in connection with certain activities of Bruce

Elliot Clarke, a former employee of NBFL. Mr. Hicks was Mr. Clarke’s immediate supervisor at

NBFL. Mr. Clarke entered into a settlement agreement with the Commission in 2004 relating to his

actions involving Knowledge House Inc. which were a violation of Nova Scotia securities laws and

Page 29 of 139

contrary to the public interest.

...

11.

2001.

The violations of the Act admitted to by NBFL and Mr. Hicks occurred between 1999 and

...

17.

It is clear that the violations specified in the Statement of Allegations attached to the Settlement

Agreement were serious violations. The violations demonstrated, among other, a lack of attention to

internal policies, a failure to detect a pattern of manipulative trading, a failure to establish and

implement proper internal control procedures, a failure to ensure that the NBFL branch office

confirmed with prudent business practices and failure to properly supervise certain staff members.

The Respondents have admitted the factsset out in the Statement of Allegations, and acknowledge that

during the relevant period they violated Nova Scotia securities laws, and engaged in conduct contrary

to the public interest as set out in the Statement of Allegations.

[161]

The Statement of Allegations relates to the activities of Clarke, commencing in 1999,

as an investor advisor for a number of KHI insiders and entering into an arrangement to act jointly

to maintain themarket priceof KHIshares. Clarke carriedthis out through several means, including,

in particular, trading in the 540 account, with cash and share transfers from KHI insiders and margin

debt from NBFL. Deposits of money and shares from KHI insiders into the 540 account, enabled

Clarke to buy significant quantities of KHI shares on margin in a manner described in para 33 of the

agreed Statement of Allegations, resulting in a pattern of manipulative trading that NBFL failed to

detect and prevent.

[162]

In their December Supplementary Submissions, the Dunlop Clients appear to accept as

given that the Settlement Agreement constitutes acknowledgment of facts in the Statement of

Allegations for this litigation, despite para 4 of the Agreement.

[163] Counsel focuses on the non-disclosure by NBFL of the existence of the Settlement

Agreement, and the effect on this litigation.

[164]

Counsel argues that the Settlement Agreement made in June 2005 was improperly

concealed for seven years, contrary to the Securities Act, as determined by the Commission in 2012.

The Civil Procedure Rules, both the old (1972) and the new (2009), require parties to fully disclose

the existence of all relevant documents, and to disclose the contents of all relevant documents for

which privilege is not expressly and specifically claimed. NBFL never disclosed the existence of

the Settlement Agreement, nor claimed non-disclosure of their contents on the basis of privilege.

[165] Demand for disclosure was made by the Dunlop Clients on NBFL. NBFL should have

acknowledged its existence and claimed privilege.

[166] The Escrow Agreement that NBFL relied upon to not disclose the existence of the

Settlement Agreement had no legal validity, as determined by the Commission, a Supreme Court

Justice, and the Nova Scotia Court of Appeal. Any bona fide but mistaken belief that NBFL could

Page 30 of 139

legally not disclose the existence of the Agreement ended with those decisions.

[167] NBFL’srefusalto disclosetheexistenceoftheAgreement,andtheadmissions contained

intheAgreement, includingtheexpress acknowledgementofClarke’s manipulativetradinginKHI’s

shares and NBFL’s failure to supervise him properlywith regards to the activities in his 540 account,

both of which is central to this litigation, have had an obvious impact on the claims, and ability of

the claimants to pursue a remedy, against NBFL for more than 10 years.

[168]

Having hidden the existence of the Settlement Agreement since 2005, NBFL was able

to argue conflicting theories as to the wrongdoing of itself, of Clarke and of other parties, for which

NBFL had already accepted responsibility. In a decision not to strike NBFL pleadings by Justice

Scanlan [2005 NSJ No. 13], Justice Scanlan had written: “Until a Court determines whether there

was stock manipulation, NBFL will not know what its rights or liabilities may be . . . NBFL says

at this point, and perhaps not until the Court decides what occurred, does NBFLhave full knowledge

of the factual situation so as to enable it to assert its rights with certainty.”

[169]

Similarly, in another decision by Justice Scanlan [2005 NSJ No. 186], Justice Scanlan

admonished NBFL, whom he noted was blinded by the regulatoryinvestigation, “. . . to not sacrifice

‘innocent investors’ or use their financial might to crush litigants into submission in a situation in

which it may result in an injustice.”

[170]

Counsel cites several later motions in this litigation where NBFL took a position about

the facts contrary to its admissions in the Settlement Agreement with the Commission, IDAC and

MRS. All of these Court decisions show a reliance upon NBFL’s representation that it did not know

the facts and should be permitted to continue with conflicting pleadings with respect to the facts

surrounding Clarke, the 540 account, and the use of that account to manipulate KHI shares.

[171]

Counsel argues that the concealment of the Settlement Agreement was highlyimproper.

It seeks several remedies arising from the concealment, including striking of NBFL’s pleadings,

solicitor - client costs to all parties, and exemplary and punitive damages.

[172]

Counsel submits that NBFL has been cited for its bad faith in these proceedings

previously. This is not its first misconduct. Counsel cites Church of Scientology of Toronto v

Maritime Broadcasting (1979), 33 NSR (2d) 500 (NSCA), in comparing NBFL’s conduct to

contempt.

[173]

Counsel submits that NBFL’s conduct since 2005 amounts to a concerted effort to shield

evidence of its wrongdoing from the Court and the Dunlop Clients. For remedies, he refers to

Homer Estate v Eurocopter SA, 2003 BCCA 229, cited in Grewal v Nijjer, 2011 BCCA 505, Aecon

Buildings v Brampton, 2010 ONCA 898 and Ameron International v Sable Off shore Energy Ltd et

al, 2011 NSCA 121.

[174] Counsel argues that NBFL’s wrongful non-disclosure of the existence of the Settlement

Agreement put all parties through seven years of unnecessarylitigation, manyparties of whom were

Page 31 of 139

not deep pocketed litigant and were those to whom Justice Scanlan referred to in his 2005 decisions.

B.3.2

NBFL’s Response to Supplemental Submissions

[175]

Counsel for NBFL notes that at the opening of the trial Dunlop raised the issue of the

existence of a secret document and his proposed motion to have the document entered as evidence

in this proceeding. NBFLvigorouslyobjectedto identificationof the document or its contents at that

time. The Court indicated that it would hear any motion that counsel may bring in order to avoid

the threat of a mistrial (raised by NBFL). At the close of the Dunlop Clients’ case, Dunlop again

sought to introduce evidence respecting the secret document if it became available at a later date.

NBFL’s counsel consented to Dunlop being permitted to reopen the case so that the issue of whether

any additional documents could be admitted into evidence and, if so, on what basis or for what

purpose.

[176]

The secret document they were speaking about is the Settlement Agreement between

NBFL and Eric Hicks, of one part, and the Commission Staff, IDAC and MRS, of the other part.

The document became public when approved by the Commission on December 4, 2012.

[177]

NBFL objects to the admission of the Settlement Agreement and Commission’s Orders

approving it. It does so on the basis that the Settlement Agreement states that NBFL’s agreement

to the facts is without prejudice to it in any civil or other proceedings.

[178]

NBFL states in its December 2012 brief that it assumes that this Court’s decision during

the trial to admit into evidence another Settlement Agreement between NBFL and IDAC (2012

NSSC 76) will dispose this Court to enter into evidence this Settlement Agreement and Commission

Orders. On that basis, counsel makes the following additional submissions:

1.

TheSettlement Agreementdoesnot containanyadmission thatClarkemanipulated KHI

stock. Dunlop’s December 2012 submission did not deal with the contents of the Settlement

Agreement; rather, it constituted an unwarranted attack on NBFL and its counsel for not revealing

the existence of the Settlement Agreement and claims for new relief.

2.

Respecting the admissions made by NBFL, it submits that in order to find that Clarke

manipulated the KHI share price, the Court must find both that Clarke’s trading in the 540 account

caused KHI share price to be artificial; that is, different from what would have been based on supply

and demand and, additionally, that Clarke intended to cause KHI share price to be artificial.

[179]

NBFL states that it did not admit in the Settlement Agreement that Clarke manipulated

the share price or that Clarke’s trading in the 540 account caused KHI share price to be artificial or

that Clarke intended to cause KHI share price to be artificial. NBFL submits that para 33 of the

Statement of Allegations attached to the Settlement Agreement reflect what Clarke admitted, which

it describes as making purchasers for the insider group and their accounts and through the 540

account, in order to maintain KHI share price within a certain range. What NBFL admitted was that

it failed to detect the purchases Clarke made for the insider group in their own accounts and in the

Page 32 of 139

540 account to maintain the KHI share price within a certain range. NBFL admitted nothing more.

[180]

NBFL simply admitted that it failed to ensure that the Halifax Branch conformed with

prudent business practices and serve its clients adequate as well as failed to properly supervise

Clarke and detect Clarke’s involvement with the KHI’s insiders and the 540 account.

[181]

NBFL submits that the admissions in the Settlement Agreement do not establish that

NBFL came to a definitive conclusion as to whether Clarke’s trading cause KHI’s share price to be

manipulated or that he intended that to occur. Specifically NBFL did not know, nor was it indicated

in Clarke’s Settlement Agreement, that Clarke intended to cause KHI’s share price to be artificial.

NBFL submits that it would require expert analysis of Clarke’s trading to establish Clarke’s intent.

[182] NBFLstatesthatDunlop’sreferenceinits briefto aPricewaterhouseCoopersReportand

its contents was inappropriate. It was not in evidence in these proceedings. [I agree.]

[183] NBFL’sadmissionsintheSettlementAgreement should not impactthis Court’sdecision

for five reasons:

a)

b)

c)

The evidence, which is set out in NBFL’s post-trial brief, does not support that Clarke’s

540 account trading resulted in an artificial price.

The evidence, the best evidence being Clarke’s eight days of oral evidence at trial, does

not support that Clarke intended to cause the price to be artificial.

What NBFL admitted to in the Settlement Agreement about the 540 account (the

accumulation of KHI shares and the deposits of cash and shares into that account from

insiders) was clearly apparent from the documents in evidence at trial. Besides the

testimony of Clarke and Wadden, others who conducted transactions with the 540

account, including Potter, Courtney and MacLeod, were known to the Dunlop Clients

and could have been called by the Dunlop Clients to testify.

d)

e)

NBFL’s admissions regarding the failure to supervise the 540 account activity were

already admitted in NBFL’s post-trial brief.

The Dunlop Clients submitted in their post-trial brief that NBFL’s failure to supervise

the activity in the 540 account was apparently before the trial and in the trial evidence.

[184]

NBFL submits that it did not conduct the trial so as to leave the Dunlop Clients to

believe it would contest what they say was obvious. Its witness list did not include Hicks, Roby or

any other witnesses who could testify as to the supervision by NBFL of the 540 account;

furthermore, its pre-trial brief did not address the issue and, at trial, it called no evidence respecting

the issue.

[185]

NBFL admits in the Settlement Agreement that it failed to monitor Clarke’s

Page 33 of 139

communications using his personal e-mail address. This was not one of the nine alleged breaches

of NBFL’s duty to the Dunlop Clients, enumerated by Dunlop in his post-trial brief. The fact of

Clarke’s use of his personal e-mail was in evidence at trial. NBFL’s e-mail policyand excerpts from

its compliance manual were in evidence and admitted. In effect, the Settlement Agreement adds

nothing to this issue. Furthermore, there is no evidence that the failure to monitor Clarke’s use of

his personal e-mail address caused the Dunlop Clients any loss.

[186]

NBFL states that it entered the Settlement Agreement with the regulators in good faith.

It was a term of the Agreement that it was held in escrow and was not to be put before the

Commission until the final disposition of all regulatory proceedings relating to KHI trading

activities.

[187]

Itis not unprecedentedforCommission proceedings to beconfidential. Theproceedings

againstWaddenandMacLeod, includingtheallegationthattheyandothersmanipulatedKHI’sshare

price, were kept confidential, on the motion of their counsel Dunlop, from May 19, 2006 to October

15, 2010. It was only disclosed with Wadden and MacLeod’s consent. NBFL argues that the

Commission determined that the Escrow Agreement was invalid in April 2012, but, even then, ruled

that it remains protectedbysettlementprivilegeuntil approval bytheCommission. TheCommission

dismissed allegations of impropriety against NBFL and the Staff at that time. Its decision was

upheld by the Nova Scotia Court of Appeal.

[188]

Dunlop’srequest foranorderforimmediatedisclosureoftheSettlement Agreement, and

its contents, both in November 2011 and September 2012, was not granted bythe Nova Scotia Court

of Appeal.

[189]

NBFL objects to Dunlop’s accusation that it and its counsel acted in bad faith. Counsel

states that the allegations involve issues that are beyond the purview of these proceedings. Limited

to the purposes of these proceedings, NBFL says that it was not a foregone conclusion that the

Settlement Agreement would be approved and, if it had not been, it would have remained

confidential forever.

[190]

Counsel cites Justice Hood’s consideration of the use that could be made of the Clarke

Settlement Agreement in Barthe v NBFL, 2009 NSSC 305. Possibly in retaliation for Dunlop’s

allegation against NBFL and its counsel for acting in bad faith (and in contempt of Court), NBFL

resurrected its concern, raised earlier in these proceedings (by it and others), that Dunlop may have

been in a conflict of interest with respect to the relations of his client’s inter se. These conflicts were

conceded and written consents were obtained to Dunlop acting for them.

[191] NBFL also calls out Dunlop for referring in his December 2012 brief to the contents of

privileged settlement conferences in these proceedings with Justice Moir.

[192]

Finally, NBFLtakesissue with Dunlop’sinferencethatNBFLandtheCommission were

in cahoots. It states that the “sharing of information” by NBFL was pursuant to investigation orders

of the Commission, which compelled NBFL to provide the information.

Page 34 of 139

B.3.3

Analysis - Settlement Agreement

[193]

In summary, both the Dunlop Clients’ brief andtheNBFLbrief respecting the admission

and use that should be made of the Settlement Agreement with attached admissions of facts made

by NBFL in that Agreement, focussed on allegations by each of the other’s bad faith.

[194]

TheSettlementAgreement,includingtheattachedStatementofAllegations is admissible

for the same reasons as set out in this Court’s decision of February 17, 2012 (2012 NSSC 76)

respecting the IDAC/NBFL Settlement Agreement.

[195] However, the Court agrees with many of NBFL’s submissions in its December 2012

brief respecting what admissions were made and not made, and what use should be made of them.

[196]

As noted in para 183, NBFL submits that its admissions in the Settlement Agreement

should not impact this Court’s decision for five reasons. I agree with the third, fourth and fifth

reasons; that is, the accumulation of KHI shares and the deposits of cash and shares into the 540

account from KHI insiders is clear and apparent from the documents and other evidence at trial.

NBFL in its post-trial brief admitted its failure to supervise the 540 account activity. Its failure to

supervise the activity in the 540 account was apparent in the trial evidence.

[197]

NBFL submits that its admissions in the Settlement Agreement should not impact this

Court’s decision because the evidence at trial does not support that Clarke’s 540 account trading

resulted in an artificial price or that Clarke intended to cause the price to be artificial.

[198]

Ido not relyon NBFL’s admissions in theSettlement Agreement, andin particular, paras

12, 27 and 33 of the Statement of Allegations, to conclude that the admissions contained in that

Settlement Agreement, with respect to Clarke are true. Commencing in late 1999, certain KHI

insiders entered into an arrangement to act jointlyto maintain the price of KHIshares. Clarke agreed

to assist those insiders in carrying out this arrangement and Clarke made a large number of purchases

of KHI shares on margin through the 540 account. The purpose of the trades was to maintain the

price of KHI shares within a certain range with the collateral effect of maintaining the value of those

shares upon which the amount of margin debt in the accounts of the shareholders was based.

Additionally, during the relevant period (from at least March 2000 to July2001), Clarke entered into

a large number of transactions, almost exclusively purchases, for the insiders, both through the 540

account and through the accounts of the insiders, for the purpose of facilitating that arrangement.

This arrangement had the effect of supporting the market price for KHI shares on behalf of KHI

insiders. This pattern of trading by Clarke and the insiders for whom he acted was a pattern of

manipulativetrading, contrarytosecurities regulations andthedutyClarkeowedto thoseclientswho

invested in KHI shares.

[199]

It is an unreasonable interpretation of the Settlement Agreement and the Statement of

Allegations, to which NBFL agreed as part of that settlement, to suggest that the arrangement

between Clarke and certain KHI insiders was not to act jointly to maintain the price of KHI shares

within a certain range. Further, the records of transactions by Clarke, which constituted large

Page 35 of 139

numbers of purchases of KHI shares in the 540 account, and on behalf of KHI insiders, reveal both

the intent and effect: facilitating the maintenance of the share price within a certain range in a

secretive manner that breached securities laws, exchange rules, and NBFL’s own corporate policy,

and the common-law relating to contracts, torts and equity. The trial evidence of Clarke, a

knowledgeable, experienced professional, whose disbelieved plea of ignorance and innocent intent,

is drowned out by his actions as revealed in the documents and trading records tendered at trial.

[200]

The volume of transactions carried out by Clarke, both in the 540 account and on behalf

of KHI insiders, was substantial. Most of the transactions in the 540 account were purchases and

the few sales were for the purpose of facilitating KHI insiders in finding new wealthy investors, and

maintaining the share price above a minimal level, while KHI attempted to create a viable business.

[201]

The description of Clarke’s conduct in the Statement of Allegations at paras 12, 27 and

33 use the word “manipulative” only once; however, the totality of the admission, which adds

nothing new to (nor distracts from) the trial evidence upon which I rely, is that Clarke, acting jointly

with KHI insiders, traded in significant numbers of KHI shares, both in his own 540 account and as

the agent and broker for KHI insiders for the purpose of secretly facilitating market support, to the

detriment of those who relied on the open regulated public market. They include those to whom

Clarke and NBFL owed a duty of care in contract, tort and equity.

[202]

The activities of Clarke in trading KHI shares, viewed in hindsight on the basis of the

documentary evidence tendered at trial, do not require expert interpretation to draw the obvious

inference of fact. Without Clarke’s 540 account trades, and the other trades he facilitated for KHI

insiders in their efforts to buy time, while creating a viable business and seeking new investors, had

an effect upon the market price for KHI shares that was not known to the public and to Clarke’s

clients. Clarke’s trading activities were not authorized by the laws and regulations governing

investment dealers, and NBFL’s own policies and procedures. The market support resulting from

the joint activities of Clarke and insiders was of such magnitude that it clearly created an artificial

price for KHI shares that would not have existed, but for Clarke’s activities. How much that

artificial price deviated from what otherwise would have been the price - the true market price, was

not the subject of any evidence in these proceedings. In the circumstances, it is unlikelythat it could

have been calculated with any precision.

[203]

While there is no presumption that a person intends the natural consequences of his acts,

the trier of fact may infer a state of mind, such as intention, from engaging in conduct the natural

consequences of which, taken in context of all the evidence, is the certain result. The intent of Clarke

is obvious from his actions. His statements of ignorance and innocent intent were not credible, and

belie his obvious intent - to use the shares and moneygiven to him to purchase on margin KHIshares

in the 540 account, and to facilitate trades among insiders, for the purpose of propping up the KHI

share price secretly; in short, to conduct and facilitate manipulative trading in KHI shares.

[204]

The Court does not relyupon the Statement of Allegations in the Settlement Agreement.

The admissions in the Settlement Agreement are obvious through assessment of the other trial

evidence.

Page 36 of 139

[205] The existence of the Settlement Agreement and circumstances by which it was kept

secret may be factors relevant to the assessment of punitive damages.

C.

Clarke’s/NBFL’s legal relationship with the Dunlop Clients

The starting point

C.1

[206]

The Dunlop Clients’ claims against NBFL are based on the relationship between each

of them and Clarke - Clarke’s alleged wrongful acts (for which NBFL is vicariously liable), and

NBFL’s failure to properly supervised Clarke and his 540 account.

[207]

NBFL does not dispute, and no evidence was tendered to rebut, the evidence that

throughout the time relevant to this litigation Clarke acted as a stock broker, employed by and under

the control of NBFL at its Halifax branch.

[208]

If Clarke breached any of his legal obligations to the Dunlop Clients, it is not disputed

by NBFL, and there is no evidence to contradict the conclusion, that NBFL is vicariously liable for

Clarke’s breaches of his legal duties to the Dunlop Clients.

[209]

Separatefromvicarious liability, NBFL admits in its post-trialbrief, andtheCourt heard

no evidence to the contrary, that it failed to properly supervise Clarke with respect to his dealings

in the 540 account. NBFL’s original pleadings in the Main Action that Clarke was on “a frolic of

his own”, thereby negating vicarious liability, was not pursued by NBFL in the evidence or its

submissions.

[210] NBFL maintains that the Dunlop Clients failed to establish that Clarke acted in breach

of his duties to them.

[211] The starting point for the assessment of Clarke’s liability to each of the four Dunlop

Clients is an analysis of the legal relationship between Clarke and each of them.

[212]

The relationships between Clarke and each of the four Dunlop Clients are not identical.

The Law Respecting Broker - Client Relationship

C.2

[213]

The relationship between an investment advisors and their clients is one of agent and

principal, but the precise nature of the duties owed by an investment advisor to his or her principal

depends on the circumstances. Most investment advisor-client relationships fall in the middle of a

spectrum between the investment advisor as a mere “order taker” and the investment advisor as a

fiduciary (Kent v May (2001), 298 AR 71 (QB) at paras 51 to 53, aff’d (2002), 317 AR 281 (CA)).

A fiduciary relationship is not presumed and must be established based on evidence (Elderkin v

Merrill Lynch, Royal Securities Ltd, (1977), 22 NSR (2d) 218, 1977 CarswellNS 184 at 34;

Hodgkinson v Simms, [1994] 3 SCR 377, 1994 CarswellBC 438 at paras 44, 135).

Page 37 of 139

[214]

At a minimum, investment advisors must follow their client’s instructions, subject to

refusal for illegality (LaFlamme v Prudential-Bache Commodities Canada Ltd., [2000] 1 SCR 638

at 646), abide by the terms of any applicable contractual agreement, and not permit a conflict of

interest to arise. Any extension of the investment advisor’s duties beyond these bare minimums is

a question of fact (Reed v McDermid St. Lawrence Ltd. (1990), 52 BCLR (2d) 265, 1990

CarswellBC 291 at para 14 (CA)).

[215]

Whilenoteveryinvestment advisor-client relationship willriseto the level of afiduciary

one, it is helpful to consider the test for finding a fiduciary relationship in order to place the

relationships in question on the relevant spectrum. In Hunt v TD Securities Inc. (2002), 229 DLR

(4^th) 609; 2003 Carswell 3141 at para 40 (ONCA), leave to appeal to the SCC refused 2004

CarswellOnt 1610, the OntarioCourt of Appeal interpreted the Supreme Court of Canada’s decision

in Hodgkinson as disclosing five factors to consider when determining whether a fiduciary

relationship exists:

i) Vulnerability - the degree of vulnerability of the client that exists due to such things as

age or lack of language skills, investment knowledge, education or experience in the stock market.

ii) Trust - the degree of trust and confidence that a client reposes in the advisor and the

extent to which the advisor accepts that trust.

iii) Reliance- whetherthere is a long historyofrelyingontheadvisor’sjudgment andadvice

and whether the advisor holds him or herself out as having special skills and knowledge upon which

the client can rely.

iv) Discretion - the extent to which the advisor has power or discretion over the client’s

account.

v) Professional Rules or Codes of Conduct - help to establish the duties of the advisor and

the standards to which the advisor and the standards to which the advisor will be held.

[216]

The fifth factor is a useful starting point, since Professional Rules or Codes of Conduct

may inform the relevant standard of care (Morin v Blais, [1977] 1 SCR 570; 875121 Ontario Ltd v

Nesbitt Burns Inc. (1999), 50 BLR (2d) 137, 1999 CarswellOnt 3247 at para 86 (Ont Supr Ct J)).

For this reason, I reference the relevant sections of National Instrument 31-103, Registration

Requirements and Exemptions (NI 31-103).

[217]

Even where the Hunt factors do not support a full fiduciary relationship, an investment

advisor must still know the client (NI 31-103, s. 13.2), an obligation of paramount importance that

is met in part, by the client completing a New Client Application form or “Know Your Client”

(“KYC”) form. These forms provide the investment advisor with some indication of the client’s

investment knowledge, experience, risk tolerance and objectives (Abrams v Sprott Securities Ltd

(2001), 13 BLR (3d) 78; 2001 CarswellOnt 547 at para 29; Parent v Leach, 2008 CarswellOnt 3217

at para 89; Varco v Sterling (1992), 7 OR (3d) 204, 1992 CarswellOnt 1156 at para 101 (Ont Sup

Page 38 of 139

Ct J); Merit Investment Corp v Mogil, 1989 CarswellOnt 2708 at para 43 (Ont SC (H Ct J)).

[218] An investment advisor (and his/her firm) also has an obligation to identify and mitigate

any existing or potential conflicts of interest (NI 31-103, s. 13.4).

[219]

As previously mentioned, applying the factors outlined in Hunt and Hodgkinson, and

translating them into an applicable standard of care, is a fact-based exercise that is not amendable

to a rigid formulaic approach. The Court must look at the cumulative effect of all factors together.

For example, a client’s history of not following the investment advisor’s advice may not be an

indicator of expertise or a lack of vulnerability that overrides other factors that suggest vulnerability

(Gale at para 4). Conversely, use of margin investing or other more sophisticated investment

approaches, while potentially indicative of expertise in some cases, may not be in other cases where

a client shows a long history of reliance on her investment advisor (Osborne v Harper, 2005 BCSC

1202). In each case, the Court must balance the various factors to ascertain the applicable duties

owed by an investment advisor to his client.

[220] The authors, Joseph Groia and Pamela Hardie, in Securities Litigation and

Enforcement. Toronto: Thomson Carswell, 2007. [Grioa], at pp. 168 to 169, write:

The relationship of broker to a client is based primarily in contract as principal and agent. This

relationship changes as trust, confidence and reliance are placed by the client in the broker, such that

it may also give rise to a higher duty of care or a fiduciary duty.

In Kent v May, the Court described that relationship as follows:

Essentially, therefore, one should consider the relationship to be a spectrum. At one

end is a relationship of full trust and advice. The broker effectively makes all the

decisions because of the great reliance and trust reposed in him or her by the client

...

This is exacerbated where the account is discretionary, such that the broker has

authority to make trades with the client’s consent or even knowledge ... Obviously

there is a fiduciary relationship at this end of the spectrum ... At the other end is a

relationship where the broker is merely an “order-taker” for the client, the client

does not rely on any advice from the broker, and the broker has no discretion ...

Relationships at this end of the spectrum lack the elements of a fiduciary

relationship ... Most cases fall somewhere in the middle.

[221]

The authors John A. Campion and Diana W. Dimmer in Professional Liability in

Canada, 4^thed. Toronto: Carswell, 1994 (looseleaf to 2011) c. 10; c. VII [Campion], at p. 10-1,

describe the relationship as follows:

Providers of financial advice are providing financial planning information and other investment

services in exchange for consideration, be it a flat fee or a commission. While this has the appearance

of a commercial relationship, it is a relationship which demands a high level of trust in the advisor and

the delivery of confidential and personal information. [The footnote at this point reads: Even in the

barest “order taker” styled stockbroker/client relationship, the “Know Your Client” rule requires the

broker to have a large body of private information on the client at his or her disposal.] This fact alone

Page 39 of 139

dictates a stringent code of conduct which governs all persons who provide financial advice. The

opportunity for self-dealing and breaches of trust are legion and the courts have been vigilant in the

protection of investors.

[222]

At page 10-2, Campion cites Robinson v Funded Investments Inc. (2006), 2006

CarswellOnt 4477, for the observation “. . . every brokerage case is fact specific due to the unique

relationship that the broker has with each client.” They describe the three general types of services

provided by stockbrokers.

[223]

When stockbrokers act as simple order takers, a function necessary as the Canadian

securities industry is a closed system, the transaction “. . . creates a simple principal-agent

relationship. The scope of any fiduciary duty is restricted to the actual transaction or series of

transactions.”

[224]

When a stockbroker performs the additional role of investment advisor, he / she “. . .

assumes a much larger role in suggesting investments to the client. In this situation, a fiduciary

relationship mayor maynot exist, depending on the residual discretion vested in the client to control

his or her own portfolio and the level of trust placed on the advisor. In all cases, this is a question

of fact. In addition to fiduciary duties, an investment advisor is also potentially liable for negligent

misrepresentation.”

[225]

The third type of function exists when the stockbroker acts “. . . as a manager of an

investor’s account where the manager exercises a discretion which is independent of the investor’s

direction. This form of financial advice invariably attracts fiduciary obligations . . .”

[226]

Several causes of actions against brokers are recognized. The most common is: breach

of fiduciary duty, negligence (including negligent misrepresentation) and breach of contract.

Because of the nature of the professional relationship, principles of agency law, which impose an

ongoing duty on the part of the broker to act “scrupulously, fairly, openlyand honestly”, are relevant

and important. (See Campion, p. 10-2)

[227]

There are other possible causes of action. A frequent one, where the allegation involves

market manipulation, is fraud or fraudulent misrepresentation and conspiracy. Fraud is not only a

relevant cause of action, when the action of the defendants is directed to the plaintiff, but has

developed in the United States since the 1940s even absent the ability of a plaintiff to prove actual

reliance on a misrepresentation to him or her, through the theory of “fraud on the market”. It is this

cause of action, arising out of s. 10(b) of the Securities Exchange Act of 1934 that founded class

actions by plaintiffs with regards to unpublished market making or stock manipulation, where the

plaintiffs had no direct connections to the defendants. Fraud on the market was not pleaded by any

of the Dunlop Clients.

[228]

Becausefraud, in the form of illegal market manipulation, was pleaded byNBFLagainst

Wadden and Barthe, and by some of the Dunlop Clients against Clarke, and because much of the

evidence before the Court centred on the machinations by Clarke directly and through the 540

account, which had the effect of manipulating (in this case attempting to maintain) an artificially

Page 40 of 139

high market price for the shares of KHI, the Court spent some time reviewingthe caselaw respecting

stock manipulation.

[229]

For this, the Court has also reviewed several additional texts, including: Nicholls,

Christopher C. Corporate Finance and Canadian Law. Toronto: Carswell, 2000, pp. 97 - 99;

Petraglia, Philip and Lazar Sarna. Corporate Securities Law in Canada. Markham: Butterworths,

2005, ch. XVII; Soderquist, Larry D. and Theresa A. Gabaldon. Securities Law, 2^nded. New

York: Thomson West, 2004, Borden Ladner Gervais LLP. Securities Law and Practice, 3^rded.

Toronto: Thomson Carswell, 2009 (loose leaf) ch. 21 and 23; Loss, Louis and Joel Seligman,

Fundamentals of Securities Regulation, 4^thed. New York: Aspen, 2004 ch. 9, 10 and 11; and Poser,

Norman S. “Stock Manipulation and Corporate Control Transactions”, (1986, 40 U.Miami.L.Rev,

671); Biron, Caroline and Oliver C. Bouton. “Recent Developments in Broker’s Liability in

Canada”, in Todd L. Archibald andRandall ScottEchlin, EDS.,AnnualReview of Civil Litigation

2011. Toronto: Thomson Carswell, 2011, pp. 303-344; and Powell, John L., Roger Stewart and

R. Jackson. Jackson & Powell on Professional Liability, 6^thed. London: Sweet & Maxwell, 2007

& 4^thsupp. to 6^thed., October 2010. c. 15.

[230] ThreeofthefourgroupsofDunlopClients (Dunham, Weir andWadden)expresslyplead

breach of fiduciary duty, negligence and breach of contract by Clarke and NBFL.

[231]

In addition, Wadden expressly pleads that Clarke, on his own or possibly with third

parties including Potter and Colpitts, unlawfully manipulated the KHI share price. Weir adopts and

incorporates Wadden’s claim that Clarke, alone or with others, manipulated the KHI share price.

[232]

Barthe, in his action, pleads breach of contract by NBFL and Clarke, as well as

negligence by NBFL in failing to supervise Clarke, who, Barthe alleges, was involved in a stock

manipulation scheme with Potter. He relied upon and incorporated NBFL’s pleadings of a

conspiracy to manipulate KHI’s share price against Clarke and Potter in the Main Action.

[233]

The Dunlop Clients: Dunham, Weir and Wadden allege that Clarke failed to follow

instructions to sell KHIshares. All three allege that Clarkeheld various conflicts of interest between

his duty to them as clients, with actions and interests of himself, of the 540 account and of KHI

insiders such as Potter. Dunham and Wadden allege that Clarke disclosed confidential information

to others, including Potter and Colpitts, and sacrificed the interests of Dunham and Wadden for

himself and others.

[234]

Dunham alleges that Clarke breached such fundamental duties as a failure to diversify

Dunham’s account in light of Dunham’s instructions and his obvious naivety with respect to

investing. Wadden alleges that Clarke counselled him to purchase KHI shares when he knew or

ought to have known that the price was being artificially maintained.

[235] All of the Dunlop Clients allege that NBFLfailed to monitor or supervise Clarke and his

various dealings in KHI shares, including through the 540 account.

Page 41 of 139

[236]

All of the Dunlop Clients say that NBFL is vicariously liable for the wrongdoing of

Clarke, their employee.

C.3 Stock Manipulation

Market manipulation “is probably as old as the securities markets” (Louis Loss, Joel

[237]

Seligman & Troy Paredes, Fundamentals of Securities Regulation, 6th Ed, Vol 2 (New York:

Wolters Kluwer Law & Business, 2011) at 1485.

[238]

Despite this history, comprehensively defining the outer boundaries of what constitutes

“market manipulation” has proven difficult (Norman S Poser, “Stock Market Manipulation and

Corporate Control Transactions” (1986) 40:3 University of Miami Law Review 672). In Santa Fe

Industries, Inc. et al v Green et al, 430 US 462 at 477 (1977), the Supreme Court of the United

States remarked, in obiter, that in the securities context, manipulation is “virtually a term of art.”

[239]

This definitional imprecision has led some to argue that the concept of market

manipulation should be abandoned, particularlysince it often turns on the subjective intention of the

allegedmanipulator(Fischel&Ross, “Should theLawProhibit Manipulation in FinancialMarkets?”

(1991) 105 Harv L Rev 503 at 506-507). The response of legislators, however, has not been to

abandon prohibitions against market manipulation, but instead to pass and amend laws to address

the impact of rapid “technological advances in the securities industry” (Mark Borrelli, “Market

Making in the Electronic Age” (2000-2001) 32 Loy U Chic LJ 815 at 907) and emergent fraudulent

schemes resulting from a combination of human ingenuity, greed, and questionable ethics.

[240]

The reason for these ongoing legislative efforts is twofold. The primary purpose of

securities legislation is to protect investors, but it also serves to maintain efficient capital markets

and public confidence in these markets (Pezim v British Columbia (Superintendent of Brokers),

[1994] 2 SCR 557). The rationale behind these protections is that they enhance “the pool of capital

available to entrepreneurs” (Kerr v Danier Leather Inc., 2007 SCC 44 at para 32) thereby providing

an essential prerequisite for our capitalist system.

[241]

Before reviewing the existing law, it is helpful to have an understanding of the types of

manipulativeschemesthat arefrequentlyemployed, suchaswashsales(andrelatedmatchedorders),

dissemination of false information, scalping, false market signals from high volume trading, and

parkingor warehousing stocks (Mark R. Gillen, Securities Regulation in Canada, 3rd Ed (Toronto:

Thomson Carswell, 2007); Alan R Bromberg & Lewis D Lowenfels, Securities Fraud &

Commodities Fraud, Vol. 3 (New York: McGraw-Hill Inc., 1991)). More than one are evident in

this litigation.

[242]

A wash sale “is a trade in which there is no change in the beneficial ownership of the

security(i.e., the buyer is also the seller or the buyer and seller are acting jointly)” (Gillen, Securities

Regulation at 423). A matched order is a transaction where one party enters an order for a security

knowing that another party, acting in concert, will simultaneously enter a corresponding offsetting

order for substantially the same size and price (Bromberg, Securities Fraud at 7:58).

Page 42 of 139

[243]

Dissemination of false information, positive or negative, sometimes in the former case

referred to as touting, is self-explanatory. Scalping “involves the purchase of a particular security

just prior to touting the security in some form of investment commentary or news media” (Gillen,

Securities Regulation at 425).

[244]

False market signals occur when one or more persons, “who control a large portion of

the securities of an issuer” sell a large volume of the security in order to profit from the artificially

depressed price (Gillen, Securities Regulation at 425). Relatedly, warehousing and parking

involves, respectively, transactions where the recipient ultimately intends to sell a security back to

the original seller at the same price, and transactions where a broker-dealer temporarily transfers

securities to a customer’s account.

[245] These manipulative schemes can often be combined. A classic manipulative scheme is

described in as follows:

The group [of manipulators] first secures an option to purchase at a price higher than the then market

quotation a large block of a stock which possesses actual or potential market appeal and an easily

controllable floating supply. It is the task of the pool manager and operator to raise the market price

above the option price, and, if the supply on the market remains constant, this can be accomplished

only by increasing the demand. The most effective manner of inducing others to purchase is to have

a favorable ticker tape record which indicates to prospective purchasers that others consider the

security to be underpriced. The manager opens a number of accounts with various brokers and,

fortified by a knowledge of the condition of the market obtained from the book of a specialist, enters

both buying and selling orders with a preponderance of the former so that the price is made to rise

slowly upon an increasing volume of transactions. In the cruder form of operation many of these

transactions will be washed sales in which the operator is both buyer and seller of the same stock; in

others known as matched orders he enters orders to sell with the knowledge that some confederate is

concomitantly entering orders to purchase the same amount of stock at the same price. As the price

slowly rises, a complex publicity apparatus is set into motion to aid the stimulation of demand: The

directors of the corporation whose stock is being manipulated, who maybe members of the pool, issue

favorable, but not wholly true, statements concerning the corporation's prospects; brokers, likewise

interested in the operations, advise customers through market letters and customers' men to purchase

the stock; subsidized tipster sheets and financial columnists in the daily papers tell glowingly of the

corporation's future; "chisellers," "touts," and "wire-pluggers" are employed to disseminate false

rumors of increased earnings or impending merger. As the market price passes the option price, the

operator exercises his option and, increasing his sales over purchases, carefully unloads upon the

public the optioned stock as well as that acquired in the process of marking up the price. But the

operator does not necessarily rest with this gain. If he is able to distribute his holdings, he may sell

short, and the stock, priced at an uneconomically high level and bereft of the pool's support, declines

precipitately. As it approaches its normal quotation the pool covers its short position, thereby profiting

both from the rise which it has engineered and the inevitable reaction ( “Market Manipulation and the

Securities Exchange Act” (1937) 46 Yale LJ 624 at 626-628).

[246]

Manipulative schemes also frequently depend on the nature of the market for a given

security. For example, “[m]arket manipulation [that depends on volume signals] is more likely to

work where there is a relativelylow volume of tradingin the security” (Gillen, Securities Regulation

at 426). This is because sophisticated investors, who can adequately research the fundamentals of

a company, are less likely to invest in thinly traded stocks, leaving relatively unsophisticated

investors, who depend on price and volume as proxies for research, as the main market participants

Page 43 of 139

(Gillen, Securities Regulation at 426).

Statutory Responses to Market Manipulation

[247]

In Canada, responses to market manipulation can be found in the Criminal Code, RSC

1985, c C-46, provincial securities statutes, such as the Securities Act, RSNS 1989, c 418, and self-

regulatory rules, such as the Investment Industry Regulatory Organization of Canada’s National

Instrument 23-101 – Trading Rules.

[248] Section 383 of the Criminal Code of Canada prohibits certain types of transactions that

are intended to manipulate the price of a stock:

Fraudulent manipulation of stock exchange transactions

Every one who, through the facility of a stock exchange, curb market or other market, with intent to

create a false or misleading appearance of active public trading in a security or with intent to create

a false or misleading appearance with respect to the market price of a security,

(a) effects a transaction in the security that involves no change in the beneficial ownership thereof,

(b) enters an order for the purchase of the security, knowing that an order of substantiallythe same size

at substantially the same time and at substantially the same price for the sale of the security has been

or will be entered by or for the same or different persons, or

(c) enters an order for the sale of the security, knowing that an order of substantially the same size at

substantiallythe same time and at substantiallythe same price for the purchase of the securityhas been

or will be entered by or for the same or different persons,

is guilty of an indictable offence and liable to imprisonment for a term not exceeding ten years.

[249]

and fraud:

Section 3.1(1) of National Instrument 23-101 – Trading Rules addresses manipulation

A person or company shall not, directly or indirectly, engage or participate in any act, practice or

course of conduct relating to securities or derivatives of securities that the person or company knows

or reasonably ought to know

(a) results in or contributes to a misleading appearance of trading activity in, or an artificial price

for, a security or derivative of a security; or

(b) perpetrates a fraud on any person or company.

[250]

In 2006, the Securities Act was amended to include the following in s 132A:

A person or company shall not, directly or indirectly, engage or participate in any act, practice or

course of conduct relating to securities or derivatives of securities that the person or company knows

or reasonably ought to know

(a) results in or contributes to a misleading appearance of trading activity in, or an artificial price

for, a security or derivative of a security; or

Page 44 of 139

(b) perpetrates a fraud on any person or company.

[251]

Given the paucity of Canadian jurisprudence on what constitutes market manipulation,

it is also helpful to consider the comparatively rich US jurisprudence on this subject. In doing so,

one must be cautious to recognize that in the US, the basis for civil claims alleging damages from

market manipulation is frequently statutory. This means that the US jurisprudence is not

immediately portable to Canada, but it does not mean that it is irrelevant.

[252]

TheUS SecuritiesExchangeActof 1934, 15USC §78a, containsanumberofprovisions

that prohibit market manipulation of securities prices on securities exchanges and in the over-the-

counter market. In particular, s. 9(a)(2) makes it unlawful to use the mails, other means of interstate

commerce, or a national securities exchange:

To effect, alone or with 1 or more other persons, a series of transactions in any security other than a

government security, any security not so registered, or in connection with any security-based swap or

security-based swap agreement with respect to such security creating actual or apparent active trading

in such security, or raising or depressing the price of such security, for the purpose of inducing the

purchase or sale of such security by others.

[253]

The prohibitions on market manipulation contained in the Exchange Act are also

buttressed by Rule 10b-5, Employment of manipulative and deceptive devices, which was

promulgated by the Securities Exchange Commission pursuant to the Exchange Act. That Rule is

often central to US jurisprudence on market manipulation and reads:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality

of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in

order to make the statements made, in the light of the circumstances under which they were made, not

misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud

or deceit upon any person,

in connection with the purchase or sale of any security.

Permissible Market Manipulation

[254] Despite these prohibitions against market manipulation, there are certain manipulative

activities that are nonetheless permitted if they are found to be for the purpose of “stabilization”.

[255]

A common example of permissible “stabilization” occurs in new offerings of securities

that are alreadytraded on an exchange (Larry D. Soderquist and Theresa A. Gabaldon, Securities

Law, 2nd Ed (New York: Thomson, 2004) at 181). During such transactions, underwriters, who sell

securities to investors on behalf of the issuers, face a risk that the market price will drop to such a

degree that it erases the “underwriting spread” and creates a loss for the underwriters. Since

Page 45 of 139

underwriters provide an essential service to the functioning of capital markets, the securities

regulators permit underwriters to “stabilize” the market in the security being issued in order to

artificially maintain its price until the offering is completed (Soderquist, Securities Law).

[256] Another permissible type of manipulation is trading by market-makers. The Ontario

Securities Commission (OSC) has defined a market-maker:

as a person, normally approved by the stock exchange on which the shares are listed, who buys and

sells shares of an issuer as principle or for his own account on a continuous basis with a view to

creating or maintaining an orderly market for the shares. Their function is to take the other side of a

transaction when none is apparent, that is, to buy a stock when someone wishes to sell and there are

no apparent buyers and vice versa. The market-maker also attempts to prevent undue variations in the

price of a stock by selling into a rising market or buying in a declining market. These are called

stabilizing trades because they attenuate the buying or selling pressure. Destabilizing trades, on the

other hand, work the opposite way, that is they are buys in rising market and sales in a declining

market which tend to exacerbate the pressure. The purpose of a market-maker is to provide liquidity

and to maintain an orderly market.

[257]

When a market-maker is simply taking the other side in a transaction, their trades will

not be manipulative per se, but when their trades “prevent undue variations in the price of a stock,”

they are in effect manipulating the market. According to the OSC, selling in a rising market and

buying in a declining market are both permissible forms of stabilization.

[258]

The SEC takes a more narrow approach, defining stabilization as “the buying of a

security for the limited purpose of preventing or retarding a decline in its open market price in order

to facilitate its distribution to the public” (SEC, Exchange Act Release No. 2,446 Mar 18, 1940).

Nonetheless, the SEC permits market-makers to enter sell-side orders to provide liquidity and to

maintain an orderlymarket, presumablyon the basis that such transactions areneither stabilizing nor

destabilizing.

[259] It is fair to see that major securities regulators “view stabilization as a necessary evil”

(Soderquist, Securities Law at 183).

[260]

The specific rules that apply to market-makers depend on the exchange where the

security is traded. For example, the Toronto Stock Exchange (TSX), on which KHI traded, requires

all market-makers to be designated upon application by a Participating Organization, usually an

investment bank. The Participating Organization then designates one of its employees to be the

formal market-maker, who is then subject to the TSX rules concerning market-making.

[261] Where over-the-counter trades are concerned, some securities legislation requires an

application to the provincial regulator to become a market-maker. For example, in Ontario, s. 155

of the Securities Act, RRO 1990, Regulation 1015 reads:

A registered dealer, other than a security issuer, mutual fund dealer or scholarship plan dealer, may

apply to the Director for approval to act as a market-maker in a COATS security of a class that trades

in Ontario.

Test for Market Manipulation

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[262] The test for what constitutes market manipulation depends on the statutory framework and

context in which a case arises. For example, market manipulation in the context of a criminal charge

is obviously tied closely to the wording of the criminal statute. Market manipulation allegations in

the context of a provincial regulator’s “public interest power” is more relaxed and linked to the

provincial legislation. Market manipulation in the context of a civil action depends on whether it

is an action pursuant to the common law or a statutory action where available. In any event, the

jurisprudence discloses some common elements of what constitutes market manipulation.

[263] Market manipulation requires a manipulative or deceptive scheme (Anderson v British

Columbia (Securities Commission), 2004 BCCA 7, leave to appeal to the SCC denied [2004] SCCA

81, [Anderson]; Santa Fe Industries, Inc. et al v Green et al, 430 US 462 (1977)).

[264] There must be an intention on the part of the person(s) employing the scheme to defraud, that

is, there is a mens rea requirement of scienter (R v Jay, [1966] 1 CCC 70 (Ont CA); Ernst & Ernst

v Hochfelder et al, 425 US 185, (1975)). In the context of an anti-manipulation provision that is

similar to s 132A of the Securities Act, the British Columbia Court of Appeal held that subjective

knowledge of the relevant facts is required when proving market manipulation - recklessness is not

sufficient (Anderson at para 28).

[265] In Anderson, the Court also imported into the market manipulation context the test for fraud

outlined by McLachlin J (as she then was) in R v Theroux, [1993] 2 SCR 5 at 20:

… the actus reus of the offence of fraud will be established by proof of:

1.

2.

the prohibited act, be it an act of deceit, a falsehood or some other fraudulent means; and

deprivation caused by the prohibited act, which may consist in actual loss or the placing of

the victim's pecuniary interests at risk.

Correspondingly, the mens rea of fraud is established by proof of:

1.

2.

subjective knowledge of the prohibited act; and

subjective knowledge that the prohibited act could have as a consequence the deprivation of

another (which deprivation may consist in knowledge that the victim's pecuniary interests are put at

risk).

[266] The BC approach has been followed in Ontario (Al-Tar Energy Corp, Re (2010), 33 OSCB

5535, 2010 CarswellOnt 3966). Given the similarity between s 132A of the Securities Act and the

BC and Ontario legislation, it also makes sense to follow this approach in Nova Scotia.

[267] A manipulative purpose may be inferred from circumstantial evidence, but caution must be

exercised not to review individual trades in isolation (Sears Canada Inc., Re, 2006 CarswellOnt

6994 (OSC) at para 28; Federal Corp., 25 SEC 227 at 230 (1947); MacLean v Huddleston, 459 US

375 at 390 to 391 (1983).

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[268] Circumstantial evidence might take a variety of forms such as purchasing blocks in

successivelyhigher prices, deliberate activityto dryup overhanging supply, agreements to withhold

large amounts of the security from the market, concomitantly timed disclosures (accurate or

otherwise), “guaranteeing purchasers against loss, or arranging for the issuer to declare a dividend

at a critical juncture in the manipulation (Loss, Fundamentals of Securities at 1500).

[269] While creation of an “article price” for a security may be evidence of manipulation (Sears

Canada at para 127), and a crucial requirement for the establishment of damages in a civil action,

a successful scheme is not an element for the offence of market manipulation (Rex v de Berenger,

(1814), 3 Maule & S 67, 105 Eng Rep 536 at 537). As Lord Ellenborough explained in de Berenger:

…the crime lies in the act of conspiracy and combination to effect that purpose, and would have been

complete although it had not been pursued to its consequences, or the parties had not been able to

carry it into effect.

The creation of "a misleading appearance of trading activity" alone is sufficient "because it misleads

other buyers and sellers (Sears Canada at para 127).

Position of the Parties

[270] While much evidence was tendered in this case regarding Clarke’s activities, neither the

Dunlop Clients nor NBFL provided much assistance in their post-trial submissions on the law

concerning market manipulation. The Dunlop Clients cited material that was disclosed by NBFL,

but not entered into evidence, as “proof” of the manipulation. This material is irrelevant since it was

not entered into evidence. The Dunlop Clients provided no submissions on the boundaries of market

manipulation or how the evidence that was tendered meets the test for market manipulation. NBFL

provided submissions on some of the case law concerning market manipulation, but its submissions

were highly selective.

[271] NBFLsubmits that expert evidence is required to establish the industrystandards that NBFL

is alleged to have breach through their admitted lack of supervision and/or vicarious liability for

Clarke’s actions. NBFL further submits that expert evidence is required to establish that Clarke’s

actions were not consistent with that of an ordinary market-maker. In the alternative, NBFL argues

that the Dunlop Clients have failed to establish that Clarke’s actions resulted in an “artificial price”

and that he intended to create an “artificial price.”

[272] NBFL cites Connolly v Walwyn Stodgell Cochran Murray Ltd (1993), 121 NSR (2d) 278

[Connolly], 820823 OntarioLtd vKagan, 2003 CarswellOnt 1446 (Ont Sup Ct J), and Cole v Merrill

Lynch Canada Inc, 2005 CarswellOnt 9962 (Ont Sup Ct J) for the proposition that expert evidence

is necessary to establish the industry standards that the Dunlop Clients say NBFL breached.

[273] Connolly stands for the proposition that a plaintiff must identify the particular standard that

he alleges the defendant breached. The Court of Appeal in that case remarks that no expert evidence

was adduced to establish unsuitability, but this is not the same as saying that expert evidence must

be adduced in all cases; in any event, the Court of Appeal’s remarks is obiter because the Court also

found that the plaintiff in that case failed to plead unsuitability.

Page 48 of 139

[274] In Kagan, the Ontario Superior Court of Justice held that the Court should be vigilant about

admitting unnecessaryexpert evidence, but went on to find that expert evidence of investing account

management was likely not within the knowledge of the trier of fact and was therefore helpful,

though not determinative, in determining the standard of care.

[275] In Cole, the Court followed Kagan and held that investment advisor handbooks and internal

bank policies were evidence of the standard of care, but that expert evidence was necessary to

properlyapplythosestandards, especiallywhenthebank’sinternalrulesweresomewhatflexibleand

therefore open to interpretation.

[276] Recently, in Johansson v General Motors of Canada Ltd, 2011 NSSC 352, the Court

reviewed the onus on the plaintiff, in an action for negligence, to establish the specific standard of

care that she says was breached. The Court cited favourably a decision of the Ontario Court of

Appeal, Krawchuk v Scherbak, 2011 ONCA 352. There, the Court held, at para 125:

External indicators of reasonable conduct, such as custom, industry practice, and statutory or

regulatory standard, may inform the standard. Where a debate arises as to how a reasonable agent

would have conducted himself or herself, recourse should generally be made to expert evidence.

[277] At para 36, the Court also accepted the two exceptions, outlined in Krawchuk, to the

requirement that the plaintiff must adduce expert evidence of how to applythe standard of care when

there are ambiguities in what constitutes "reasonable conduct":

Failure to produce this type of evidence is not always fatal to a plaintiff's claim. In Krawchuk, the

Ontario Court of Appeal outlined two exceptions to the general rule that expert evidence is required

in the articulation of a professional's standard of care. The first exception is where the matters are non

technical and therefore within the ordinary knowledge of the trier of fact (Krawchuk at para. 133).

The second exception is where the defendant's conduct is so egregious that it would be obvious to an

ordinary person that the "conduct has fallen short of the standard of care, even without knowing

precisely the parameters of that standard" (Krawchuk at para. 135).

[278] TheNovaScotia Court Appeal, in overturningthedefendants’non-suitmotioninJohansson,

2012 NSCA 120, dealt with the type of evidence of industry practices and regulatory benchmarks

that are required of a plaintiff, and those circumstances where expert evidence is and is not required

to establish the standard of care and the application of that standard to the facts.

[279] The trial court had held that expert evidence was required unless the issues were non-

technical or the defendants’ conduct was egregious. The Court of Appeal effectively held that

evidence of industry practices and regulatory benchmarks, in addition to expert evidence, may be

persuasive and probative, but not necessary. The analysis runs from paras 90 to 124 of that decision.

Particularly relevant statements include, at para 105:

. . . it is for the jury to balance those factors and weigh the evidence related to the application of the

standard of care. It is for the jury to decide whether in the circumstances of a particular case evidence

of industry practice or regulatory benchmarks, on the one hand, or evidence surrounding the defect,

on the other, should tip the scale. It is not for the judge to wade into the factual waters with a finding

that a particular factor, such as industry practice, . . . will outweigh the others.

Page 49 of 139

[280] At paragraph 110:

. . . a plaintiff may lead evidence that the defendant failed to comply with industry practice, and that

evidence may assist to establish a prima facie case. Or the defendant may lead evidence of

compliance with industry practice. Either way, the evidence is to be weighed, with other evidence,

by the jury at the conclusion of the trial. But evidence of industry practice does not necessarily trump

other evidence and settle the negligence issue in the jury room. . . .

[281] At paragraph 111, in commenting on the fact that there was no evidence of how the

defendant performed against the regulatory benchmark, Fichaud, J.A. noted that the case was not a

private prosecution for an offence under the legislation, but rather a negligence action where the trier

of fact is to assess the reasonableness of the defendant’s conduct.

[282] At paragraph 115, Fichaud, J.A., recognized that the standard of care for each professional

is defined by reference to his or her profession and that evidence related to the standards of the

defendant’s particular professions “is in order”. But, he goes on to cite Ryan v Victoria, [1999] 1

SCR 201 (SCC), to note that expert evidence of industry standards would be relevant but is not

legally mandatory in certain circumstances. It is a matter of whether the issue so technical that the

trier of fact cannot reasonably determine the standard of care or the application of it to the facts

without expert evidence.

[283] It is true that the Dunlop Clients have not tendered expert evidence on how to apply the

standard of care expected of Clarke and NBFL. In my view, on the basis of Krawchuk, this failure

is not fatal to the Dunlop Clients’ claims. I am satisfied that the conduct is “so egregious” that

expert evidence is not essential for determination of whether the market manipulation in this case

was a breach of what is expected of a reasonable investment advisor or order taker.

[284] NBFLcitesCycommInternational Inc., Re, 1993CarswellOnt 922(OSC)fortheproposition

that expert evidence is necessary to establish market manipulation. In Cycomm, the OSC held that

disagreement between two experts “highlighted the difficulty in characterizing the trades in

question as manipulative or market-making” [emphasis added]. The OSC did not find that expert

evidence was obligatory in all cases.

[285] In Canada, expert evidence is not required as a matter of course. To the contrary, expert

evidence is only admissible where it is necessary R v Mohan, [1994] 2 SCR 9.

What is required is that the opinion be necessary in the sense that it provide information "which is

likely to be outside the experience and knowledge of a judge or jury": as quoted by Dickson J. in R.

v. Abbey, supra. As stated by Dickson J., the evidence must be necessary to enable the trier of fact to

appreciate the matters in issue due to their technical nature. In Kelliher (Village) v. Smith, [1931]

S.C.R. 672, at p. 684, this court, quoting from Beven on Negligence (4th ed. 1928), p. 141, stated that

in order for expert evidence to be admissible, "[t]he subject-matter of the inquiry must be such that

ordinary people are unlikely to form a correct judgment about it, if unassisted by persons with special

knowledge." More recently, in Lavallee, supra, the above passages from Kelliher and Abbey were

applied to admit expert evidence as to the state of mind of a "battered" woman. The judgment stressed

that this was an area that is not understood by the average person.

Page 50 of 139

[286] “In many cases, the proffered [expert] opinion evidence will fall somewhere between the

essential and the unhelpful” R v Abbey (2009), 97 OR (3d) 330 (CA), leaveto appeal to SCC refused,

(2010 CarswellOnt 4827). While expert evidence may have fallen toward the essential end of the

spectrum in Cycomm, I am not satisfied that the same can be said in this case. In Cycomm, the sole

evidence of manipulation was the trading pattern in question. In this case, there is a substantial

amount of non-technical evidence of manipulation. The allegation of market manipulation against

Clarke does not depend solely on his trading pattern. I am satisfied that I can, as the trier-of-fact,

appreciate the matters in issue without recourse to expert evidence.

[287] In the US, “expensive securities-fraud actions will ordinarily have at their disposal experts

of the highest caliber to test each other,” (Patrick J Coughlin, Eric Alan Issacson & Joseph D Daley,

“What’s Brewingin Dura v Broudo: The Plaintiff’s Attorneys Review the Supreme Court’s Opinion

and Its Import for Securities-Fraud Litigation” (2004) 37 Loy U Chi LJ 1 at 40) but the rule is that

such experts may be employed not that they must be employed (United States v Bilzerian, 926 F.2d

1285 at 1294 (2nd Cir. 1991); Blackie v Barrack, 524 F.2d 891 at 909 (9^thCir. 1975); Huddleston

v Herman &MacLean, 640 F.2d 534 (5th Cir. 1981), aff’d in part and rev’d in part on other grounds,

459 US 375 (1983)). In the US, like in Canada, triers-of-fact, whether juries or judges, are

empowered and trusted to make complex evaluations of fact (US Fin Sec Litig, 609 F.2d 411 at 429-

430 (9th Cir. 1979); Morgan v District of Columbia, 824 F.2d 1049 at 1062 (DC Cir 1987); SRI Int’l

v Matsushita Elec Corp, 775 F.2d 1107 at 1130 (Fed Cir 1985); Cotton v Witco Chem Corp, 651 F2d

274 at 276 (5th Cir 1981)).

[288] NBFL also cites Cycomm for the proposition that companies may act as their own market-

makers. In Cycomm, the security at issue traded on the Alberta Securities Exchange (ASE). The

OSC noted that the ASE had no rules regarding issuers acting as market-makers in their own

securities. The OSC further noted that in the case of venture markets, like the ASE, investment

banks may be reluctant to act as market-makers, but may require a market-maker before

recommending a stock. The OSC held that “[a] company in these circumstances may feel it has

no alternative but to act as its own market-maker” and would go about doing so by opening an

account at a brokerage and granting a broker discretion to buy-and-sell its shares as a market-maker

[emphasis added].

[289] The problem that NBFL faces is that even if companies can act as their own market-makers,

there is not even an air of reality to the argument that Clarke was acting as a market-maker on behalf

of KHI. There is no documentation whatsoever to establish this role. Moreover, the TSX, on which

KHI traded, requires formal registration of any market-makers. Clarke was not formally registered

as the market-maker for KHI. In fact, another individual, Mr. Watson from BMO, was already

registered as the official market-maker.

[290] NBFL’s final argument is that Clarke’s trading activity was not manipulative either because

he failed to create an artificial price and/or because he had no intent to create an artificial price. I

find that Clarke’s activities were manipulative and were intended to be manipulative.

[291] From a very early stage, Clarke had a personal pecuniary interest in KHI and a close

relationship with Potter, the CEO of KHI, and Colpitts. In October 1997, for reasons that Clarke was

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unable to explain, Potter gave Clarke an option to purchase 100,000 common shares of KHI at $0.50

per share. In July1999, with KHItrading at $4.20, Clarke exercised his option, placing $420,000.00

worth of KHIstock, for which he paid only$51,808.22 (with interest), in a joint margin account held

by himself and his wife.

[292] Clarke also traded KHI in another margin account, the 540 account, which was opened in

the name of his numbered company, 2317540 Nova Scotia Limited. It was this account where

Clarke conducted the majority of his trading activities in KHI. Clarke testified at trial that all

decisions concerning this account were made by him, even though he admitted before the Securities

Commission to using the account to execute trades on behalf of a KHI insider’s group. Clarke

testified that he admitted to this wrongdoing and paid a $150,000.00 fine because he was fed up with

the ongoing Securities Commission process and did not have money to continue to pay his lawyers.

[293] Clarke testified at trial that Potter loaned him $100,000.00 to place in the 540 account to

allow Clarke to buy KHI on margin. Clarke further testified that this was an informal loan and that

the beneficial ownership of the KHI stock purchased would remain his. Clarke acknowledged that

he received a share certificate for 220,000 KHI shares from Wadden via Potter or Colpitts and that

this was placed in the 540 account. At the time, these shares were valued at $1.5 million and

allowed Clarke to purchase further KHI stock on margin. Clarke could not explain why there was

no documentation for this share transfer, but claimed that it was received as a loan.

[294] Clarke also had difficulty explaining the trading activity within his 540 account and joint

spousal account. He testified that he was simply acting as a market-maker during times when KHI

insiders were unable to trade in the stock. Clarke testified that Potter and Colpitts informed him of

these restricted periods.

[295] Clarke further testified that he did not know that Watson was the designated market-maker

for KHI. He refused to acknowledge that he was aware of the TSX market-maker designation

process. I find Clarke’s evidence on this point to be without credibility. During his testimony he

was evasive. More important, Clarke was an experienced investment advisor with more than 25

years of experience in the industry. He testified that he was aware of the market-maker designation

process for the Montreal Stock Exchange as a result of trading activity that he conducted before his

involvement with KHI. Further, Clarkehadpreviouslybeensubjectto discipline proceedings before

the Montreal Stock Exchange and internally by NBFL’s predecessor. It is simply not plausible for

Clarke to submit that he was unaware that he had to be designated by the TSX as a market-maker

for KHI.

[296] Clarke’stradingactivitywithin the 540 and joint spousal accounts doesnot supporthis claim

that he was acting as a market-maker. Between March 2000 and July 2001, Clarke executed 707

trades in KHI. The vast majority of these trades were buy orders. Clarke bought KHI 636 times

during this period and sold KHI 71 times. Combined, Clarke traded 1,281,000 shares of KHI during

this period. This accounted for 29 percent of the total volume (4,390,000) of KHI shares that were

traded during this period.

[297] A true market-maker takes both sides of the equation. For the most part, Clarke only bought

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KHI, in what appears to have been a concerted effort to absorb excess supply of the stock. This does

not immediately mean that Clarke was attempting to manipulate the market, but it is one indicium

of manipulation, particularly when considered against the other evidence before the Court.

[298] Clarke was adamant that he, and he alone, controlled the 540 account. I find this assertion

to be without credibility. Beyond the unexplained financing of the 540 account by Potter and

Wadden, Clarke also took instructions from both Potter and Colpitts on how to operate the account.

Thedocumentaryevidenceshows that whenWaddenandhis counselbeganeffortstorecovercontrol

of the KHI shares that were deposited in the 540 account, Clarke sought advice and instruction from

Potter and Colpitts.

[299] Clarke was also in communication with both Potter and Colpitts when arrangements were

made for large purchases of KHI by outside investors. Clarke denied being aware of Derek Banks’

intention to buy $1,000,000.00 worth of KHI, but I find this denial to be without credibility,

particularly given Clarke’s knowledge of other transactions.

[300] Clarke acknowledged that he became aware of Barthe’s intention to invest in KHI through

Colpitts. He was brought in by Potter and Colpitts to facilitate this investment on the open markets.

Clarke opened an account at NBFL in order to receive Barthe’s $1.7 million that would then be used

to purchase KHI stock. Almost all of Clarke’s communication for this transaction was through KHI

insiders.

[301] The transactions that Clarke executed to purchase KHI on behalf of Barthe are particularly

troubling. Clarke first sold 43,300 KHI shares at $6.50 from his personal account to an account

owned by Colpitts. He then sold 73,300 KHI shares at $6.55 from Colpitts account to Barthe’s

account that Clarke had just set up. Clarke also sold KHI shares from other insiders to Barthe.

Clarke could not explain to the Court why Colpitts account had to be used as a conduit for some of

the shares that Barthe purchased. Clarke also could not explain why Barthe paid $0.05 per share

more than what Colpitts paid for purchasing the shares from Clarke.

[302] I find that the manner in which KHI was sold to Barthe was a wash trade or matched trade

for the purpose of creating a false impression of trading volume in KHI stock. There is no

explanation as to why the 43,300 shares had to first be sold to Colpitts before they were sold onto

Barthe. There is no explanation as to why there was a price differential. This leads to the inference

that the trade was manipulative.

[303] Shortly after the sale of KHI shares to Barthe, Clarke contacted Potter to advise him that

Barthe’s purchase had taken a lot of buying pressure off of KHI. If Clarke was acting independently,

there is no reason why he would be advising Potter on the trading activity in KHI.

[304] Anotherhighlydubious tradeoccurredin September2000. Atthattime, Clarkesold 150,000

KHI shares for $990,000.00. This was a very significant amount of shares given the trading volume

in KHI. Clarke could provide no explanation or recollection of this share purchase. The

documentary evidence suggests that this sale was particularly timely given that NBFL at that time

was instructing Clarke to reduce his margin debt. This sale, combined with Barthe’s purchase of

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259,000 KHI shares, significantly reduced Clarke’s margin debt at the precise time that was needed.

I find that this timing was not coincidental.

[305] Counsel for NBFLpresented documentaryevidence to Clarke that showing that the 150,000

shares were purchased by David Fountain, who also purchased another 150,000 shares directly from

the KHI treasury. This did not refresh Clarke’s memory. The documentary evidence shows that

Fountain purchased 150,000 shares from the treasuryat $6.65 per share. The shares that Clarke sold

were also sold for $6.65 per share. Given how thinly traded the KHI stock was, this suggests that

Clarke’s sale of 150,000 shares was an arranged sale by a KHI insider and not a coincidence.

[306] In October 2000, Clarke immediatelyresumed buying KHIshares on margin, which brought

his margin debt from $419,000.00 to $1.4 million. Clarke testified that he had no recollection of

whyhis self-appointed market-maker status required such an active period of purchases at that time.

In what does not appear to be a coincidence, the price of KHI during this period was maintained at

the precise level that ensured there would not be a margin call in Clarke’s account.

[307] As will be seen in the detailed discussion of each Dunlop Client, Clarke also used his clients’

accounts to buy KHI on margin. He ignored explicit instruction to sell KHI from these accounts.

Instead, he advised Potter and/or Colpitts of who was considering selling KHI stock so that they

could put pressure on these individuals not to sell. In at least one case, Clarke ignored an explicit

standing order to sell KHI stock. The only time Clarke would sell KHI stock for his clients was

when it was needed to prevent a margin call.

[308] In my view, the above, when taken together, is clear and convincing proof that establishes,

on a balance of probabilities, that Clarke was attempting to manipulate the market in KHI. The

Dunlop Clients have established that Clarke, along with Potter, Colpitts, and others, executed a

manipulative scheme to maintain the price in KHI. This scheme started with KHI stock being

warehoused in Clarke’s accounts. KHI stock was also either parked in Clarke’s accounts or sold to

him at well below the market value as a quid pro quo for his involvement in the manipulative

scheme. Clarke then proceeded to engage in a variety of transactions to send false market signals

in the form of artificial trading volume. This included a series of matched orders. This satisfies the

actus reus of market manipulation.

[309] In this case, the inference of Clarke’s intent can be drawn from the circumstances. Clarke

was an experienced investment advisor. He knew exactly what he was doing when he executed the

various transactions detailed above. He knew that he was acting on behalf of insiders. He also knew

that his actions were in conflict with his clients. Clarke’s inability to recall his actions speaks of an

individual who is facing the possibility of serious criminal sanctions as a result of his wrongdoing.

Based on the specific transactions that Clarke executed and their non-coincidental timing, I am

satisfiedthat theDunlop Clients haveestablishedtherequisitemensreaformarket manipulationand

I find that Clarke was clearly intending to manipulate the market.

D.

Analysis of the liability issues of each of the Dunlop Clients against Clarke and NBFL

D.1 Liability to Dunham

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[310] Craig Dunham attended university but did not graduate. He then worked as a bookkeeper,

successivelyfor a fast food restaurant, a chemical companyand a personal tax return business (H&R

Block). In 1991, he started work at Innovative Systems Inc., a small Annapolis Valley computer

hardware and software retailer. In 1995, he and a partner, Steven Wilsack, bought the company.

[311] Innovative had the Apple distributorship, first for their part of Annapolis Valley and

eventuallyfor all of Atlantic Canada. Theyoperated a store front, retail and service-business as well

as a separate component that created an education/school network. In the original location, the

company grew to sales of over one million dollars. The business expanded with three other outlets.

Dunham’s skills were as a jack-of-all trade but mainly in sales, some bookkeeping and some

services.

[312] Innovative joined forces with Micronet, and a CapeBretoncompanycontrolledbySnow and

MacLeod, to tender to the Province of Nova Scotia to sell, install and service computer software and

hardware to Nova Scotia’s school system on a long-term contract.

[313] By mid-1999, Innovative had 20 employees with gross sales of approximately 3.5 million

dollars.

[314] Shortly after KHI purchased the Cape Breton business from Snow and MacLeod, and the

Micronet business from Wadden and his partner (Courtney), Dunham and Wilsackwere approached

to sell Innovative (including their recently awarded contract with the Nova Scotia Department of

Education).

[315] After minimal discussions, KHI offered to buy Innovative for one million dollars cash

($500,000.00 to each of Dunham and Wilsack) or, alternatively, 300,000 shares of KHI, valued at

$4.00 per share (150,000 shares each), which shares would be released over a five-year period,

during which period each would be employed by KHI at a salary of $90,000 per year. Dunham and

Wilsack accepted KHI’s offer. The offer provided that Dunham would continue to run the New

Minas operation.

[316] Counsel for KHI in the transaction was Colpitts. Dunham appears not to have relied upon

a lawyer to negotiate or conduct due diligence in respect of the sale of the business. He rather

naivelytrusted KHIand its lawyer to act fairly. He did cause a lawyer to provide KHI’s counsel with

a certificate on behalf of the vendors.

[317] The terms of the agreement of sale provided for an adjustment of the share price after

closing, based on an audit by KHI. As a result of the audit, Dunham was required to pay KHI

$141,347.50. He had no money.

[318] Tofacilitate payment of his debt, it wassuggestedto DunhambyPotter andKHI’scontroller,

Gerard McInnis, that he open an account with Clarke at NBFL. KHI released 30,000 of Dunham’s

KHI shares from escrow into an account opened by Dunham with Clarke at NBFL in order to permit

Dunham to repay the amount he owed to KHI. Dunham did not initially understand that his account

Page 55 of 139

would be a margin account, or that his KHI shares might not be sold, but rather that NBFL would

lend to Dunham monies on margin secured by his KHI shares.

[319] It is clear that Dunham was initially somewhat trusting and naive. He relied on what he was

told and did not read the documents used to open the margin account or his initial account statement.

The margin account was opened with the receipt of 30,000 KHI shares on March 8, 2000.

[320] At 8:31 a.m. on March 23, Clarke emailed Dunham that he had completed the sale of

Dunham’s shares and raised about $196,000.00. Based on Clarke’s e-mail, Dunham immediately

authorized payment of his audit debt to KHI.

[321] When Clarke transferred $141,347.50 to KHI from Dunham’s account on March 24, he had

not sold a sufficient number of Dunham’s KHI shares to pay that amount. By March 28, Clarke had

sold Dunham’s 30,000 KHI shares at prices of between $6.50 and $6.75, from which $141,347.50

had already been paid to KHI. The remaining $55,042.50 was paid to Dunham on March 28.

[322] With the exception of one interview and very few telephone conversations, all

communication between Dunham and Clarke respecting the investment account managed byClarke

for Dunham were by e-mail. These e-mails are in evidence.

[323] A review of these e-mails clearly demonstrates that at the beginning of the relationship

between Dunham and Clarke, Dunham was a naive, novice investor. He expressly said so, stating

that he relied upon Clarke to diversify his account as he received KHI shares into the account.

[324] NBFLsubmit that Dunhamwasaneducated,experiencedbusinesspersonandinvestorbefore

he sold Innovative to KHI and opened the margin account with Clarke at NBFL.

[325] I disagree. Dunham had attended university but had not graduated. After university, he

worked as a bookkeeper, for a fast food restaurant, then a chemical company. In 1990, he worked

at H&R Block preparing personal income tax returns. He commenced employment at Innovative

Systems in 1991.

[326] The documentary history of Dunham’s investment experience, beginning in the 1990's,

shows that Dunham made small investments in mutual funds through a mutual fund salesperson

(David Chandler), who appears to have been associated with various fund companies over the years.

At the end of 1999, Dunham held three mutual funds valued at about $12,000.00 in an RRSP plan,

and, with borrowed money, owned with his spouse a non-registered portfolio of 27 mutual funds

valued at about $61,000.00. Dunham’s pre-NBFL investment history does not show knowledge,

experience or sophistication in investing, let alone knowledge and experience in investing in the

stock market as conducted by Clarke or in the operation of a margin account. A $61,000.00

investment account divided amongst 27 mutual funds, many of which were overlapping, is a clear

sign of Dunham’s lack of knowledge of basic investing principles. On the contrary, Dunham’s

investment history, like his emails to Clarke, show Dunham to be an unsophisticated person, trusting

of his professional advisors, and without the personality to be an inquisitive, prudent or disciplined

investor.

Page 56 of 139

[327] Dunham’s trust in Clarke was solidified when Clarke was able to liquidate his 30,000 KHI

shares within a few weeks of them being deposited into Dunham’s account in March 2000.

[328] In hindsight, it is obvious that this sale was accomplished solely because it facilitated the

payment by Dunham to KHI of the audit adjustments of $141,000.00. The only other sales, three

totalling 13,000 shares, on September 13, November 7, and December 19, 2000, occurred when

Dunham’s margin debt had grown so close to its upper limit, that his account was at risk of

becoming “offside”, an event that would have caused NBFL head office to take a closer look at a

number of Clarke’s clients margin accounts (including the 540 account) dominated by margin loans

secured by KHI shares.

[329] Thee-mailchainreflectingtherelationshipbetweenDunhamandClarkebegins with Exhibit

1.3, Tab 71. Dunham communicated with KHI’s controller, Gerard McInnis, as to how the audit

adjustment owed by Dunham to KHI is to be raised through the release of 30,000 escrowed shares

to Clarke. On February 26, 2000, Dunham copied this e-mail to Clarke. He writes in part:

I would like to get this cleared ASAP as I need to sell additional shares to look after some personal

debts beyond the adjustment to the purchase price.

I assume you will need to have some legal notification from me to proceed?

I am new to all this so please bear with me if I don’t know all the proper steps.

[330] Three days later, on February 29, Dunham and Clarke exchanged five e-mails in relation to

obtaining the 30,000 shares from KHI through KHI’s lawyer to pay off the KHI debt and release

money to Dunham for his personal needs. In one, Clarke writes that he had a quick discussion with

KHI’s controller and lawyer and adds:

You had earlier indicated to me that you wanted to sell some shares to help tidy up some bills, or other

payables, thus the above would not accomplish that. I can’t say for certain, and you should check with

Andrew [a KHI lawyer] but I think if the above payable to Knowledge House is settled it may free up

some non-escrow shares that you could then sell and use the proceeds in any way you want to. Give

the above some thought as to whether or not this is correct ...

[331] Dunham replied that he understood that:

The shares will be sold on the open market until the debt is fulfilled. The remainder if any of that

block of shares (30,000 shares) will be available to us. Using today’s value this would leave me with

some capital to clean up some personal debt.

He went on to advise Clarke that he expects to receive more of his shares, held in escrow by KHI,

to improve his personal financial situation.

[332] On March 1 and 2, Dunham communicated by e-mail with Gerard McInnis. McInnis

confirmed that KHI (“Dan Potter”) had agreed to allow the release of another 30,000 of Dunham’s

KHI shares from the back end of the escrowed shares and closed with the sentence: “Again, we

request you co-ordinate the sale of these shares into the market with Bruce Clark[e].”

Page 57 of 139

[333] By March 28, 2000, the first 30,000 shares had been sold on the market; the debt to KHI had

been paid and about $55,000.00 had been deposited into Dunham’s account.

[334] On April 5, Dunham e-mailed Clarke:

Hi Bruce,

I thought I should drop you a note about the future share sales. I am planning to purchase or build a

home this summer and will likely use proceeds from the sale of shares to pay for all or part of this.

The plan is to then re-borrow against the property to reinvest so that I can benefit from the deductible

interest on money borrowed for investments rather than lose it all to the bank out right.

To this end, I was wondering if you were able to take me on as a client beyond the present

arrangement? In talking to my loans officer, Archie Seamone at the CIBC here in Kentville, he

recommended you highly. The idea would be to reinvest the loan proceeds with you.

Let me know your thoughts.

Thanks,

Craig

[335] On April 13, Clarke e-mailed Dunham advising he had received a further certificate for

30,000 KHI shares in Dunham’s name. Dunham replied the same day by an e-mail, which read in

part:

I also wanted to mention to you that there was no big hurry to sell these off, as I have looked after most

of my immediate cash needs.

I do want to start a more complete portfolio with you however. I may or may not be staying on with

Knowledge House, so I could be taking possession of the remaining 90,000 shares as well, if I do

chose to move on.

While I believe KHI will continue to grow above the market I would still feel better if I diversified a

little more. Archie Seamone recommends you highly and I would like your advise on some

investment. I have approx. $1 Million dollars at the current stock price but I would like to grow this

as I do have plans to build a house this summer, which will set me back about $300,000 by the time

the lot, house and some landscaping is done. My plans are to pay this off through the sale of the shares

and then borrow the same (or close) to reinvest. I would like you to advise me on this. Perhaps you

know of some other companies that might offer returns a little better than average.

Anyway, I look forward to working with you if you have the time to take me on.

Thanks

Craig

Clarke’s reply of the same day says:

Thanks for the e-mail, would love to get together to discuss your portfolio and house idea. Will give

you a call in the next week or so to begin discussions.

Page 58 of 139

[336] On April 18, Dunham requested a meeting with Clarke, which meeting was confirmed for

April 25. It was the only in-person meeting between them. Dunham e-mailed Clarke on April 26

thanking him for the time on Tuesday as follows:

It was good to have someone in the know reassure me that I was able to do things a certain way. I like

the idea of the margin account it provides great flexibility.

I would like to see some hard numbers on paper (email) to support my financial commitments.

He asked for $34,000 to be sent to his lawyer’s account (for his new home construction) and

continued:

Further to our discussion of yesterday, would I be wiser to return my leased vehicle and repurchase

same (or different) for cash under the same margin account? It would seem that most major purchases

would be best handled this way. I would also like to know how or if this same set up will allow to

have additional, readily accessible income or is it all going into the pooled funds.

[337] On May 15, 2000, Dunham again e-mailed Clarke advising that he was purchasing a new

vehicle and asked for funds to be forwarded to the dealership in the amount of $39,000.00 to pay for

it. He added:

Also, things are winding up with KHI, and I have spent my last official day in the office last Friday.

As discussed the transfer of all shares will be completed on June 30^th. As for the margin account, you

presently only have 30,000 shares in your possession so I assume this about uses up the borrowing

until the other 90,000 shares are transferred.

I am still a little unclear about how the accounts are looking after themselves at the moment. I

understand if they are interest bearing or pay dividends then the assumption is [I] would be earning

more on the total asset base than paying on the borrowed funds. But is there any interest being earned

at the moment or am I accumulating interest charges without any offsetting debits along with the

credits?

Sorry to bother you with this, I still [need,sic] a little reassurance I guess. ...

[338] This e-mail referenced the fact that Dunham was not comfortable working for KHI, felt out

of place and had resigned from the company. Byreason of his resignation, Dunham understood that

his remaining 90,000 KHI shares were to be released from escrow, and he believed that he was free

to sell them.

[339] On June 8, Dunham e-mailed Clarke looking for $20,000.00 to paythe contractors who were

starting on his new house. On June 28, Clarke advised Dunham that he did not have margin room

until Clarke received from KHI the share certificate for the 90,000 shares.

[340] On July 6, 2000, Guy Roby, Senior Vice President, Compliance Department of NBFL, sent

a letter to Dunham noting that his account was 100% invested in KHI shares and that such

concentration is considered speculative, stating that NBFL believed that asset diversification is a

reasonable way to decrease risk. Dunham testified he was not concerned with the letter because he

believed he alreadyhad arranged with Clarke for the diversification of his account out of KHI shares

as initially reflected in his April 13 e-mail.

Page 59 of 139

[341] NBFL’s submission concentrated on Dunham’s understanding that he had opened a margin

account; that he was borrowing against that account; and that Clarke was not selling KHI shares.

It is not clear to the Court that Dunham really understood what the margin account until at least late

July 2000 (as reflected in an e-mail from Dunham to Colpitts). His confusion, and questions to

Clarke about how his account operated, continued from the time he opened the account. The

confusion is evident in the “PS” to his e-mail to Clarke of June 28, 2000.

[342] Dunham continued to believe that Clarke would sell his KHI shares and diversify his

account. Dunham’s July 10 e-mail to Clarke asking him to buy shares of a technology companyand

to sell enough KHIstock to cover the purchase is tangential evidence. Clarke’s one-line replyis that

he had bought the shares. He did not, in fact, sell KHI shares; nor did he advise in his reply why he

had not sold KHI shares.

[343] Through July 2000, KHI still had not released from escrow the remaining 90,000 shares that

Dunham expected to receive upon his resignation on June 30. Dunham did not understand KHI’s

delay. He asked for Clarke’s advice in an e-mail on July 26:

I would also like to make another appointment with you to discuss my plans for these shares once we

have control. I would like to set up the portfolio so there is a small income through dividend yielding

stocks as well as hear your ideas on growth as well as set a smaller portfolio from stocks I have been

interested in tracking.

[344] The reference to a “smaller portfolio” was Dunham’s desire, communicated to Clarke, that

he would like to invest a small portion of the proceeds from the sale of KHI shares in technology

stocks, which he was following on his own. The size of this part of his portfolio, about which he

intended to be involved, as opposed to the remaining portfolio that Clarke would invest for him, was

about 10%. It is a theme throughout Dunham’s e-mail correspondence with Clarke. It does not

detract from Dunham’s express communications to Clarke that he was relying on Clarke to diversify

his account in a manner about which Clarke would advise.

[345] By July 28, Dunham’s remaining 90,000 KHI shares had still not been released by KHI. He

contacted Colpitts, the lawyer who had acted for KHI in the purchase of Innovative, for help. He

expressed urgency to complete the release of his shares. He was relying upon the sale of KHI shares

to finance his ongoing house construction.

[346] On August 1, Colpitts sent Dunham a “draft settlement agreement”, a release respecting the

end of Dunham’s employment and relationship with KHI. Colpitts included a provision giving a

KHI a right of first refusal to buy Dunham’s shares, exercisable for 96 hours after Dunham’s notice

of any intent to sell.

[347] Iconclude, fromthetotalityoftheevidence, includingtheexchangesbetweenDunham,KHI,

and KHI’s lawyers (Colpitts and his associate Burke), that KHI was following a pattern of conduct

that would delay putting on the market for sale KHI shares, because there were fewer buyers than

sellers. The delayin arranging for Dunham to get his remaining KHIshares, a simple process, which

shares Clarke knew Dunham wanted to sell to pay his accumulating house construction bills and to

diversifyhis portfolio, is one of the manysmall seemingly-innocuous actions that affirm the Dunlop

Page 60 of 139

Clients’ claim that KHI insiders were trying to delay and discourage share sales. This delay was to

maintain KHI’s share price while KHI insiders created a viable business and resultant market for its

shares. Clarke acted as one of their instruments in that endeavour, by his purchases of KHI shares

on margin in the 540 account, and by declining to attempt to sell Dunham’s KHI shares, and create

a diversified account, when it was obvious that Dunham trusted Clarke, and relied on his expertise

and advice to diversify.

[348] On August 4, Dunham advised Clarke of the fact that he had executed Colpitts’ release and

given KHI 96 hours to respond to his notice of intention to sell. In that e-mail he continued: “Once

this is complete (shouldn’t be more than a couple of days) I would like to meet again to take specific

actions on diversifying my account.”

[349] In early September 2000, Clarke e-mailed Dunham that he had an opportunity to sell 5,000

KHI shares for about $6.50. What Dunham did not know was that Clarke was gathering shares to

fill an order for the purchase of KHI shares by Barthe.

[350] Dunham verynaivelyreplied, the same day: “Thanks Bruce, But Ithink Iwill hold onto them

for a few more months to see what happens with the price. I really sense that something is about to

happen with this stock . . . especially given the volume in it lately.” What Dunham did not know,

and was not told by Clarke, was that the volume of trades Dunham observed was caused by Clarke’s

purchase of 259,000 KHI shares for Barthe from insiders, the volume of which trades would be

apparent as they were executed on the TSX.

[351] Clarke asked Dunham to call him; he did. Shortly afterwards, Clarke e-mailed Dunham:

“Further to our conversation I sold 5,000 KHI shares at $6.55 to give you net proceeds of $32,250

which will lower your current debit balance until you require additional funds.”

[352] The Court is satisfied that Clarke was aware at this time that the only large volumes of trades

in KHI shares were trades arranged by KHI insiders. At the time of this transaction, it was the

substantial purchase by Barthe of KHI shares as a result of the sales efforts of Potter and Sullivan

(KHI insiders). It was Colpitts, another insider, who had referred Barthe to Clarke to arrange for the

purchase of shares, knowing that Clarke would arrange those shares to be purchased from those

persons whose margin requirements required sale to Barthe.

[353] Throughout the rest of 2000 and into January 2001, Dunham continued to seek Clarke’s

advice respecting sale of KHI shares. Clarke either ignored the requests, which lead Dunham to

believe that he was attempting sell his KHI shares, or otherwise mislead him.

[354] For example, in late September 2000, Dunham asked Clarke to sell KHI shares to buy Cross

Off shares. Clarke’s e-mail of September 29, 2000 reads: “We have purchased 20,000 Cross Off at

$1.10 and have not sold any KHI, trying to work it into the market.” I am satisfied that Clarke was

not trying to sell Dunham’s KHI shares into the market. At the same time, he was using margin to

purchase KHIshares in the 540 account to maintain to the price. Clarke deliberated misled Dunham.

Page 61 of 139

[355] On October 17, 2000, Dunham e-mailed Clarke: “to sell some KHIfor a purchase of Nortel.”

Clarke replied: “Further to your e-mail we purchased 100 shares of Nortel at $97.75 per share, but,

we are still working on the Knowledge House and will get back to you.” I am satisfied that the

answer was untruthful. He was not working on selling Dunham’s KHI shares.

[356] On November 29, 2000, Dunham sent Clarke a lengthy e-mail about his need for cash to pay

the holdback to his contractor. Dunham’s request is not articulate, but it is clear that he is seeking

advice on setting up his account to get some income, and specifically to diversify his account. The

e-mail reads:

Hi Bruce,

my last payment (the holdback) is coming due within the week.

what is my best option? Do I need to sell more shares for cash like before?

I also need more money to live on over the next six to seven months as I get re-established in business.

I am trying to set myself up in the brokerage business (import/expert, not stockes), but it will take time

to get rolling. If there was a pool of money in bonds, GIC’s or similar vehicle that was eligible for

higher margin (maybe even dollar for dollar like cash), would that help? ... or is this what the cash

generated from previous sales actually in? I’m hoping it is earning some interest.

I figure I need about $50,000 to get me through to June 2001 (this includes the $35,000ish I need to

settle with the contractor), by which time I am confident I will be earning some real money again. I

also assume the market will turn around before then and allow us to diversify and make some real

gains again.

Give me a call or email me with your thoughts on what I should be doing. I can be available to meet

most any time.

You can reach me by e-mail, (phone ...)

Thanks

Craig

[357] The note on the exhibit (Clarke’s copy of the e-mail), in Clarke’s handwriting says that he

called Dunham on December 4 and advised him to get a one-year mortgage as the market was no

guarantee to give him the money he needed. Clarke’s note says that Dunham agreed.

[358] On January 4, 2001, Dunham e-mailed Clarke:

What progress have you made on getting me out of the KHI stock?

I would much rather sit on cash than watch the stock continue to drop.

What about seeing if KHI is interested in buying all the remaining shares, except maybe 5000, at $6.

They did stipulate they wanted that option. And seeing as they are buying the options in the Limited

Partnership they may be receptive. Is this something I would initiate?

Page 62 of 139

I’ve got to start diversifying and I want to take advantage of the coming market rebound. I don’t think

KHI will return what others can.

Please call me to discuss this.

[359] On January 4, 2001, Dunham e-mailed Cate MacNutt to see if Knowledge House was

interested in buying back his shares. He writes: “. . . I would however, like to get diversified in my

stock portfolio. You stated in the contract that KHI would be interested in purchasing the shares

back. What are the details of how this would work?”

[360] Cate MacNutt replied on January 9, with a copy to Clarke and Potter. Mixed in with her

good news story about the progress KHI was making, she wrote: “. . . I spoke to Bruce Clarke

respecting your inquiry and he will proceed with helping you diversifyyour portfolio, as reasonably

as he can, in today’s environment. . . . As far as the process regarding your shares, please work with

Bruce who will manage it from our end. Bruce will keep in touch with you. If you have any

questions, please call Bruce or email me or call xxx-xxxx.”

[361] Within ten minutes, Dunham had e-mailed Clarke:

Thanks for the follow up with Cate.

I mentioned to Cate that I would like to hold on to anywhere from 5-10,000 shares, as I still believe

in what they are doing too.

I will forward to you via fax my list of stocks to purchase form the technology side of my portfolio.

The other market segments I would like to speak to you about for recommendations. ...

[362] Nothing happened after January 9. On January 14, 2001, Dunham e-mailed Clarke:

Hi Bruce,

Please do not take offense, but I am wondering whether you have the time to manage my account to

my liking.

I have a difficult time getting through to you and nothing seems to happen with any real immediacy.

Perhaps the lack of wide spread interest in the KHI stock is at the heart of this, but all the more reason

to get out of it as my only investment.

My most recent request to get out of the KHI stock seems to be stalled ...

I have also requested several meetings with you but have yet to get a meeting.

maybe my expectations are too high, but I feel I have a fairly large account and would like to have a

better response from my broker. I would have expected you would be stressing that I diversity my

portfolio and make recommendations for other stocks.

Like I said in the opening line Bruce, I don’t mean to offend with this note, I simply want to get my

portfolio working for me. I have watched it lose value over the last year and have done nothing to help

my position one way or the other. I really need to see some positive to grow this portfolio over the

next few years.

Page 63 of 139

Please call me ASAP to discuss how we proceed form here.

Thanks

[363] The e-mail exchanges clearly identify the basis of the Court’s conclusion, confirmed by the

oral evidence of Dunham, that he was a naive novice with respect to the investment industry; that

he put himself in the hands of Clarke to cash in his KHI shares; and that he terminated his

employment with KHI because of concerns about how KHI was operated. Further, Dunham relied

on Clarke to give him good advice with respect to diversification of his portfolio. Because of a

conflict of interest, Clarke did not disclose to Dunham that which he knew and had a duty to

disclose. Clarke owed a duty in contract and as a fiduciary to help Dunham diversify his account.

He did not do so because of his conflict of interest.

[364] A fiduciary relationship existed between Clarke and Dunham. His e-mails clearly

demonstrate that he was placing trust, confidence and reliance on the skill, knowledge and advice

of Clarke.

[365] It was not possible, as a matter of common sense, for Clarke not to understand that Dunham

was placing complete trust, confidence and reliance upon Clarke’s skill and knowledge.

[366] The text, Securities Litigation and Enforcement, beginning at p. 171, describes the factors

applied by courts to determine when the relationship between a broker and client is a fiduciary

relationship. The Supreme Court of Canada’s 1994 decision in Hodgkinson, adopted the description

of fiduciary relationship from Varcoe v Stirling, [1992] OJ No. 1501 (ONCA) and Lac Minerals,

[1989] 2 SCR 594. The e-mail correspondence and the trial evidence of Dunham clearly establish

that a fiduciary duty was owed by Clarke to Dunham, a vulnerable, naive and unsophisticated

investor to follow up on Dunham’s rudimentary understanding that he should have a diversified

portfolio.

[367] Instead, he was diverted Dunham into a margin account, in which he continued to hold KHI

shares as security for debt. Clarke had enough insight into the risks associated with a client holding

KHI shares, particularly when this risky stock was almost his only stock, that, in failing to diversify

his account (and sell KHI shares), he breached his fiduciary duty to Dunham. He did not give full

disclosure of what he knew about KHI, including his own very significant investments on behalf of

KHI insiders and in his 540 account. Clarke owed a duty of loyalty to Dunham. He did not disclose

that he had a conflict of interest both in respect of his own holdings and his dealings on behalf of

other KHI insiders. He had an obligation to act prudently, and with candour in his advice to

Dunham. He did not.

[368] Dunham pleads not only that Clarke breached his fiduciary duty to Dunham, but was

negligent (in his misrepresentations) and acted in breach of a contractual duty.

[369] In light of the Court’s findings that Clarke was a fiduciary, and breached his fiduciary duty,

it is unnecessary to determine any other basis for liability. However, I find that the same conduct

that constituted a breach of Clarke’s fiduciary duty to Dunham, also constitutes a breach of his

contractual dutyto Dunham, a dutycreated when Dunham retained Clarke as his investment advisor.

Page 64 of 139

[370] I find that Clarke did not make negligent misrepresentations to Dunham. He intentionally

failed to disclose, and by his silence, intentionally misrepresented the circumstances of KHI and the

trading of KHI shares, because of his conflict of interest.

D.2

Liability to the Weirs and Blackwood

[371] The members of the Weir family held shares in KHIthrough accounts with Clarke at NBFL.

However, the only parties to this litigation are, as defendants and plaintiffs by counterclaim in the

Debt Action Hfx 174294, Lowell Weir and Blackwood Holdings Incorporated, a wholly owned

subsidiary of Blackwood Consultants Limited, owned 87% by Carol McLaughlin-Weir; and, as

defendants and plaintiffs by counterclaim in the National Bank/Weir action Hfx 246337, Lowell

Weir and Carol McLaughlin-Weir.

[372] The factual matrix between the Weir family and Clarke / NBFL / NBC was not the same as

that between Dunham and Clarke / NBFL. The difference affects the legal analysis.

[373] The basis of the Weir family claims against Clarke / NBFL is founded on breach of contract

and negligence and fraud, not on a breach of fiduciary duty.

[374] Weir was a chartered accountant and sophisticated investor, beingthe principal in a publicly

traded company. McLaughlin-Weir is a chartered accountant.

[375] Both McLaughlin-Weir and Weir testified at trial respecting their dealings with Clarke at

NBFL, and with NBFL and its parent NBC after KHI collapsed.

[376] For the most part, their evidence was uncontradicted. The only evidence that might be

considered contrary is some of Clarke’s evidence.

[377] The Court found both Weir and McLaughlin-Weir to be credible and reliablewitnesses. The

Court accepts their evidence. Where it differs from that of Clarke, the Court prefers their evidence

to that of Clarke.

[378] McLaughlin-Weir caused her consulting company to incorporate Blackwood in the late

1990s as a vehicle to invest excess earnings in her accounting practice. Blackwood opened an

investment account in March 1998 with Clarke at Levesque Securities (later NBFL) on the

recommendation of her lawyer Colpitts. On the advice of Clarke, the investment account was

opened as a margin account. It was Blackwood’s only investment account.

[379] McLaughlin-Weir testified that her intention with respect to the investment account and her

directions to Clarke were to use it to make safe, dividend-producing investments. She was shown

the “Know Your Client” form, signed by her in March 1998, on the opening of Blackwood’s

account. She says the form was completed by Clarke, not by her. She confirms that the account

accurately set out her net worth at the time but it did not describe what she instructed Clarke to be

her “investment objectives” and “risk factors”.

Page 65 of 139

[380] McLaughlin-Weir testified that she never advised Clarke, or agreed, that her “investment

objectives” were 80% short-term, 20% medium-term and 0% long-term or that her “risk factor” was

0% low, 0% medium and 100% high. Her purpose in incorporating Blackwood was to invest cash

for her retirement and for her children’s education.

[381] McLaughlin-Weir signed the account as a margin account because she understood it was a

good way to trade and borrow moneyto make more investments. She wanted her account to include

dividends, interest income and stock with potential for growth appreciation.

[382] McLaughlin-Weir authorized NBFL to deal with Weir, her husband, as an agent in respect

of the account.

[383] Her initial investment in Blackwood was approximately $50,000.00, of which $25,000.00

was invested in her husband’s publicly traded company and $20,000.00 in corporate bonds

recommendedbyClarke. BytheendofJanuary1999, Blackwoodhadpurchased10,000KHIshares.

She says this investment was on the advice of Clarke. Clarke at no time disclosed to her his own

involvement or that of his numbered company(the 540 account) in KHI shares. ByMarch 1999, the

Blackwood portfolio was worth $90,000.00 with margin debt of $50,000.00.

[384] McLaughlin-Weir held three accounts in her personal name with Clarke at NBFL. One was

a margin account and two were RRSP accounts. The largest RRSP account consisted mostly of TD

Bank bonds. On June 29, 1999, her account statement showed a purchase of 5,000 KHI shares for

$16,450.00. These shares were still in the account at the end of 2001. They were worthless after

KHI collapsed.

[385] Blackwood purchased 10,000 KHI shares on March 2, 1999, for $21,750.00. This was on

the advice of Clarke. By December 31, 1999, the shares were worth $62,500.00 and on March 31,

2000, $85,000.00 (and constituted 40.4% of Blackwood’s account).

[386] On McLaughlin-Weir’s instructions, Clarke sold 2,000 KHI shares on December 19, 2000

for $12,105.20 (net of commission) and on March 28, 2001 1,000 KHI shares for $5,055.10 (net).

Seven thousand worthless KHI shares were held in the Blackwood account after KHI collapsed.

[387] McLaughlin-Weir states that as a result of a discussion between herself and her husband, her

husband e-mailed Clarke on January19, 2001, instructing him to sell all of the Weir familyholdings

in KHI if the price fell below $5.00. The Weirs were getting nervous about KHI because the price

had slowly declined since March 2000. McLaughlin-Weir states that while the KHI price did fall

below $5.00 after January19, 2001, Clarke did not sell the Weir familyholdings, including the 8,000

then held by Blackwood or the 5,000 held in her spousal RSP account.

[388] In earlyApril2001, McLaughlin-Weirreceivedaletterfrom NBFL’scompliancedepartment

noting that 67% of Blackwood’s account was in KHI stock and advising that this concentration was

considered speculative and that NBFL believed that asset diversification is a reasonable way to

reduce investment risk. Upon receipt of the letter, on April 10, McLaughlin-Weir called Clarke to

set up a meeting to talk about her children’s investments accounts and to talk about the compliance

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department letter. It took her several phone calls before she was able to set up the meeting with

Clarke, which meeting, she says, occurred about the end of April 2001.

[389] Her intent when she went to the meeting and her instructions to Clarke was to do a better job

with her children’s investment accounts and to sell all her KHI shares. As the meeting was coming

to an end, Clarke told her that he did not want her to sell her KHI shares because of an impending

announcement of a contract with the Province of Nova Scotia and the KHI shares were going to go

to $8.00 and she was going to lose $3.00 per share. Based on this representation, she revoked her

instructions to Clarke to sell all her KHI shares. Clarke’s reference to a pending contract between

KHI and the Province of Nova Scotia was not public information, but was an accurate statement of

a contract that Potter was working on and hoping to obtain. It is evidence of Clarke’s status with

KHI’s insiders and how he used that status to assist in the scheme to prevent sale of KHI shares and

maintain its market price.

[390] Based on Clarke’s knowledge of the substantial efforts of himself and KHI insiders from at

least March 2000 to maintain KHI share price with purchases using margin debt, and in April 2001

to maintain the market price above $5.00, to prevent margin calls and maintain the existing margin

debt on KHIshares, this was clearlya fraudulent misrepresentation. Clarke knew of the great efforts

made by himself until he ran out of margin room in 540 account in January 2001, and by other KHI

insiders thereafter, to maintain the KHI share price above $5.00.

[391] Oncross-examination, McLaughlin-Weiracknowledgedthatshereceivedaccountstatements

in February and March 2001 which showed the share price of KHI shares had dipped below $5.00.

She says it caused her no concern because by the time the statements were received, the price had

increased to more than $5.00 again (unbeknownst to her, by the artificial efforts of KHI insiders).

[392] On cross-examination, McLaughlin-Weir stated that she did not understand KHIto be a high

risk stock because of what Clarke had told her, and because of its performance after she bought its

stock. She did not consider KHI to be too big a part of her portfolio at the end of 1999 because the

only the reason it was a substantial portion was because it had increased in value, not that she had

purchased too many shares.

[393] McLaughlin-Weir acknowledged that she had sufficient funds in her personal investment

accounts at NBFL to pay the margin debt of Blackwood of about $10,000.00 but says she was not

asked to do so until the Demand Letter of November 15, 2001. By then she had come to the belief

that NBFL had mislead her. This is reflected in the letter she helped her husband draft, outlining the

Weir’scomplaints aboutNBFL’sconduct, whichletterwas sent to Eric Hicks on September 9, 2001.

[394] Weir worked first as a chartered accountant, then for 20 years in the food processing

industry, before becoming president and a major shareholder in a “waste-2-energy” technology and

fabrication business. At the time he joined the corporation, it was known as Castle Capital. It later

changed its name to Enervision, and later still to Helical.

[395] In 1998 Weir opened two small RSP and one non-registered cash investment accounts with

Clarke at NBFL (then known as Levesque Securities). When he opened those accounts, he had not

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discussed either his net worth or his investment objectives with Clarke. The “Know Your Client”

form completed byClarke at this time was not based on anything Weir told Clarke and was incorrect.

[396] In February 1999, Weir transferred his LIRA account, consisting of bonds and blue chip

Canadian stocks from the TD Bank to NBFL. In an interview at Weir’s office at the time that

account was transferred, Weir told Clarke that it was his pension money and that he wanted it to be

kept safe. The “KYC” form completed by Clarke at that time was, says Weir, accurate. His

investment objects were 25% income. His risk criterion was 40% low risk; 40% medium risk and

20% high risk.

[397] In December 1999, Weir was approached byhis lawyer Colpitts to invest $150,000.00 in the

Knowledge House Limited Partnership (KHLP). Weir says Colpitts flattered him with this “special

opportunity” to invest and associate with some well-known business people. Colpitts arranged for

him to borrow $100,000.00 from the Royal Bank toward the purchase of the KHLP units.

[398] Also, in December 1999, 5,000 KHI shares were purchased in Weir’s LIRA account. Weir

says that he only learned about this purchase after the fact. He did not cancel the purchase. He states

that at no time did Clarke advised him of Clarke’s own purchases of KHI shares, or of his activities

on behalf of KHI insiders.

[399] Weir also began dealing with Clarke at NBFLon behalf of Castle Capital. The companyhad

excess capital. Castle needed to park it in short-term investments until Castle needed the money.

Clarke invested part of the money in KHI shares. Weir did not ask Clarke to cancel the purchase of

KHI shares from that account when he learned of the purchases. Before trial, on NBFL’s motion,

this Court dismissed the action by Castle Capital (by then called Helical) against NBFL, not on its

merits but on procedural grounds.

[400] In January 2001, the Weirs became nervous about their KHI holdings because of the steady

decline in the share price since March 2000. On January 19, 2001, Weir e-mailed Clarke as follows:

Bruce:

I am very nervous on Knowledge House. If the stock falls below $5.00 I would like the holdings of

Enervision sold immediately at market. In addition, I want the same to apply to the Knowledge House

stock held by Blackwood Holdings and any other held by my wife and children and myself directly

or through RRSP.

Lowell

[401] Weir testified that on at least three occasions the price dipped below $5.00. Each time Weir

called Clarke; Clarke made excuses as to why those trades were aberrations and he need not sell.

[402] The KHLP units purchased by Weir in December 1999 contained a call option in favour of

KHI. It required unit holders to convert their units into common shares at KHI’s option. The

Offering Memorandum, and Subscription Agreement, provided that if KHIexercised the call option

before December 30, 2000, KHI had to issue shares worth 120% of the original KHLP unit price.

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[403] OnDecember 21, 2000, KHIgave notice to the unit holders that it wasexercisingthatoption.

Weir expected to receive share certificates for the partnership units byJanuary 1, 2001. He intended

to transfer some of the KHI shares as contributions into his and his wife’s RRSP accounts before

March 1, 2001. The shares did not arrive on January 1. For the next two months Weir hounded

Colpitts to get his share certificate. At one point he called the Nova Scotia Securities Commission.

Shortly after that call Colpitts called Weir and said the certificates were being sent to NBFL.

[404] On February28, 2001, Weir contacted Clarke who told him that the share certificates for the

Partnership Units had not yet arrived. Clarke suggested that he open a margin account and borrow

temporarily on the margin account to make his RRSP contributions before the March 1 deadline.

Weir opened a margin account on February 28 and on March 1, using margin, transferred about

$18,000 to his and McLaughlin-Weir’s RRSP accounts.

[405] The Court notes that, contrary to Clarke’s advice to Weir on March 28, Weir’s portfolio

statement shows that on February 28, 2001, 28,125 KHI shares were deposited into Weir’s new

margin account.

[406] The Court also notes that Wadden and Potter appear to have received their share certificates,

exchanged for the KHLP units, within the first week of January 2001, and to have placed these

shares in margin accounts with Clarke at NBFL, where the margin available on those shares allowed

them to buy more KHI shares as part of their scheme to maintain the KHI share price. This is

reflected in Wadden’s account statements, and in emails and phone messages. Wadden’s email to

Colpitts of 10:50 a.m. January 4, 2001, reads:

Blois, Please forward my share certificate for the converted LP to Bruce as soon as possible. I will be

depositing to my margin account and will be able to help Bruce take 20,000 shares of KHI out of the

market if we can do this today.

Wadden’s phone message to Colpitts of January 5, 2001, admitted for all purposes by agreement of

Counsel, reads:

Hello Blois, is Calvin calling. Just talking to Dan and he had give me an idea with the LP being

converted back - there were shares available and he expedited those over to Bruce to allow some

support from this account and just.... and I’m going to ask Bruce to do the same for mine if you can

– this is an authorization I guess if that’s okay with you to send them over and if you see maybe a

pickup well maybe 20,000 shares in the market with that use in the leverage - I guess as long as

National approves it, I’m going to give them a call right now and see if that’s okay on his side and

maybe you can give him a call when you get a second. Thank you.

[407] Wadden’s Margin account at NBFL (11AK84-E) shows receipt into that account of 28,125

KHI shares on January 4, 2001. This is the number of shares issued when KHI exercised its call

option to convert the KHLP units into shares.

[408] It appears that it might not have helped Weir to fulfill his RRSP obligation and his desire to

sell some of the KHI shares to purchase his wife a new vehicle on their upcoming 25^thwedding

anniversary. The reason is that Clarke advised him, after he received the KHI share certificate, that

the certificate came with a restriction preventing transfer of the shares for six months. The Court

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notes that neither the terms of the Offering Memorandum nor the attached KHLP Agreement dated

July 12, 1999, contained a term or condition that, if KHI exercised its call option and converted the

Partnership Units for shares, the shares would be subject to any such condition.

[409] The attempt by KHI to add restrictions to any share transfer first appeared on the share

certificate issued to Weir in exchange for the KHLP units. They were very likely unenforceable.

More significant, for the purposes of this litigation, the delay in issuing the share certificate and the

addition of the condition respecting transfer is collaboration of the Court’s determination that it was

the intent of KHI insiders, working with Clarke, to discourage and inhibit sale of KHI shares until

KHI was able get its financial house in order and bring on board more wealthy individuals and

institutional investors.

[410] This intent is reflected in several other communications between Potter and KHI directors

and insiders in January 2001.

[411] They include Potter’s letters to Barthe and/or Ristow on January 19, 20 and 28 [the latter

actually sent February 4], and March 2, 2001.

[412] The first (which attaches a copyof an urgent January15 memo to the Directors) reads in part:

The immediate and critical problem is that we need to maintain daily market support for the stock

while we are getting this financing done. You can see from recent trading in KHI on the [TSX] that

the stock is under pressure. Our local sources of support to buy the stock on a daily basis are exhausted

. . . there is a real and present risk that the stock price will collapse . . . This would be a classic case

‘running out of steam’ before reaching the finish line. . .

The second letter adds: “The support of the stock must begin on open of market, Monday morning,

if we are to maintain the ability to achieve our goals . . . my capacity and our local supporters’

capacity to support the market price of our stock has been exhausted.”

The third reads in part: “I would ask that you consider immediately (Monday, Feb.5) providing

instructions to Bruce Clarke at NBF to buy an initial 20,000 shares on the market to provide needed

investor confidence and support.”

The fourth reads in part: “But these [local] sources of market support are truly becoming exhausted.

The stock has started to falter (Thursday) as a result. Accordingly I am repeating my earlier request

. . . I sincerely hope that you will provide instructions and funding to this effect to NBF via Bruce

Clarke at your earliest convenience today . . .”

[413] They include email exchanges and documents between Potter, Wadden, and other insiders

as follows: from Potter, January 14, 2001, 10:10 p.m.; from Wadden, January 31, 4:03 p.m.; from

Potter, February 1, 8:18 a.m.; from Potter, February 4, 6:48 p.m.; from Wadden, February 8, 5:18

p.m.; from Potter, 12:13 p.m.; from Wadden, February 13, 7:36 p.m.; from Wadden, February 14,

1:08 p.m.; from Potter, February 19, 7:46 a.m. and 3:24 p.m.; from Schelew, February21, 8:11 a.m.;

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from Potter to KHI Board (memo); February 21, from Colpitts (managed sell agreement); from

Macleod, March 1, 9:12 p.m. and 10:13 p.m.; from Potter, March 2, 3:35 a.m.; from Wadden, March

2, 9:03 a.m.; from Potter, March 2, 5:05 p.m.; from Colpitts, March 6, 10:10 a.m.; from Potter,

March 8, 8:12 p.m. and March 26, 9:47 p.m.; from Wadden, June 21, 7:43 a.m. and 10:47 a.m. and

July 1, 10:17 p.m. and July 8, 2:49 a.m.. These messages show that Clarke was in the loop and

executing trades to carry out the scheme.

[414] These circumstances, with many others, led me to find that Clarke, and KHI insiders,

including Potter, Wadden, and Colpitts, were doing whatever it took to prevent and discourage, by

deception if necessary, anyKHIshares from being put on the market until a viable business plan was

developed, and institutional or wealthy investors were found.

[415] In the Weir KHLP matrix, the clear intent of the actions of Clarke, and the insiders was to

make it difficult for the Weir family to liquidate their KHI shares. The intent of the insiders is

evidenced by other actions referred to in this decision. One example is the expressly-stated intent in

the 8:50 p.m., November 19, 2000, email from Potter to Wadden and Colpitts about the pending

private placement of $3,250,000.00 to Barthe and Ristow, and the need to keep the KHI share price

from being driven below the issue price of $6.50.

[416] OnJune5, 2001, Weir borrowed$40,000.00onthemargin account to purchaseMcLaughlin-

Weir a vehicle for their 25^thwedding anniversary. When the KHI share price collapsed in August

2001, Weir’s margin account went from a surplus (based on the value of the 28,125 KHI shares) to

a deficit of about $60,000.00.

[417] The Weirs were out of the country when KHI collapsed and only learned about it in the

newspapers upon their return. Weir made several calls to Clarke, who did not return Weir’s calls.

On August 28, Clarke called him to advise that he owed NBFL margin debt on his own account and

the Blackwood account. Weir acknowledges that he had sufficient financial ability to pay these

margin debts but he told Clarke that he had questions about the proprietyof the trading in KHIshares

and the collapse of KHI that involved NBFL. Clarke told him to take this up with his manager

Hicks.

[418] Weir arranged a meetingwith Hicks, managerof the Halifax branch of NBFL, for September

4. In the meantime, he researched the trading records for KHIand became convinced that NBFLhad

participated in suspicious trading in KHI shares and had been negligent.

[419] Weir testified that at about this time he received a phone call from a gentleman claiming to

represent NBFL, whose name he does not know, calling from area code 416, who spoke in a very

abusive manner and directed him to pay the margin debts. This evidence is consistent with the

written record Clarke made of a phone call he received from Hicks at 9:50 a.m. on August 31, 2001,

which reads in part: “Eric called to saythat from his trip to Montreal, a strategy has been put in place

to recover all moneylost. He said they (national people) will continue to call clients daily(2/3 times

a day) until the client agrees to come and negotiate some arrangement to pay the debts.”

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[420] Weir described his September 4 meeting with Hicks. He says no one else was present.

Hicks met him in the NBFL boardroom and during their discussion Hicks became very aggressive

and abusive. Weir felt offended and left the boardroom to leave the building.

[421] Hicks approached him at the elevator as Weir was leaving, and apologized to Weir. They

returned to the boardroom where theyspoke for about an hour about Weir’s suspicions of negligence

and wrongdoing byNBFL. Weir, as president as Castle Capital, then called Enervision, was leaving

the next day for Norway for a week or two to make or complete an important business contract.

Weir wanted to ensure that nothing would occur with respect to the demand for payment of the

margin debt owed in his and the Blackwood accounts. Hicks advised him to put an offer in writing

to settle the matter and Weir agreed that he would do so while he was in Norway.

[422] Weir states that Hicks agreed that NBFL would do nothing to pursue its margin debt while

they negotiated Weir’s claim of negligence by NBFL. NBFL subsequently denied any agreement,

but it produced no evidence at trial to negate Weir’s evidence.

[423] As promised by Weir, he wrote to Hicks from Norway on September 9, 2001. His letter sets

out a claim of negligence against NBFL and made a settlement offer that was open for acceptance

to September 14.

[424] By letter dated September 14, 2001, NBFL’s Montreal legal department acknowledged

receipt of Weir’s September 9 letter. The writer said: “Your request has been forwarded to the legal

department under the direction of Mr. André Gibeault, Senior Vice President. Please be assured that

your file is receiving our full attention. We will communicate our position to you in writing as soon

as possible.” The letter was copied to Joel Wiesenfeld, a lawyer at Torys. From this reply, Weir

believed the “standstill” agreement was still in place.

[425] It is apparent that NBFL took Weir’s September 9 written complaint re misrepresentations

and lies by NBFL seriously. At 3:05 pm on September 11, 2001, Hicks told Clarke that NBFL was

doing an investigation into the trading of ITI and KHIas theyfelt the shares of each were “managed”

by a small group of insiders.

[426] Weir returned to Canada from Norway on or about September 14, 2001. His travel was held

up by the 9/11 events.

[427] While in Norway, Weir, on behalf of Enervision, had entered into a major contract with the

Oslo airport authority for the de-icing of air planes. This contract was publicly disclosed about

September 19.

[428] On September 19, Weir received phone calls that Enervision shares were being dumped on

the market. In fact, without further notice to Weir, and contrary to the standstill agreement with

Hicks and NBFL, NBFL did, pursuant to its margin call, dump 325,500 Enervision shares held in

the Blackwood account on the market on September 19, receiving about $6,500.00 or $0.02 per

share.

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[429] The same day Weir called Clarke and asked what happened. Clarke referred him to Mr.

Gibeault in Montreal. He called Mr. Gibeault, told him about the standstill agreement, and asked

if he was selling the Enervision shares. Gibeault denied that NBFL was selling the Enervision

shares. Weir called Clarke back and Clarke confirmed that NBFL was, in fact, selling the shares.

Weir called Gibeault again. This time Gibeault denied that there was a standstill agreement. Weir

offered to send Gibeault the letter discussing the standstill agreement. After Weir had faxed it to

Gibeault, Gibeault called him back and told there was no standstill agreement and hung up the

phone. Weir testified that because he (Weir) was an insider respecting Enervision, and the company

was in the midst of a “material event”, he was prevented from mitigating the sale of Blackwood’s

Enervision shares by purchasing them back himself.

[430] On September 20 Weir sent a letter to Gibeault, the President of NBFL, and to the chairman

of NBFL expressing dissatisfaction with the manner in which they had liquidated the Enervision

shares.

[431] Weir states that NBFL’s reply was a phone call from the same gentleman at the same area

code 416 number who had previously called and abused him, stating that NBFL had taught Weir a

lesson and next time he had better listen.

[432] On September 21, Weir wrote a second letter to Gibeault, Anthony and Turmel in response

to their reply (not produced at trial) to Weir’s September 20 letter. He copied the letter to Joel

Wiesenfeld, the Torys lawyer who had been copied in NBFL’s September 9 letter to him.

[433] Weir testified that at about 6:00 p.m. on September 21 he received a phone call (while

driving in his vehicle) from Daniel Boucher. Boucher was with NBFL Investor’s Services

Department. He stated that he had been instructed to call Weir and ask for time. He acknowledged

that the NBFL Credit Department should not have sold the shares. He stated that he was instructed

to review the matter and was going to work on it all weekend and he would give Weir a call the next

Tuesday, after he had completed his investigation.

[434] When Weir did not receive a call from Boucher by 5:00 on Tuesday, he called. Boucher told

him that he had reviewed the matter and Weir would hear from their lawyer.

[435] On September 25, Wiesenfeld e-mailed Weir denying a standstill agreement existed and

advising that he would he held liable for defamatory statements made about Hicks and NBFL. He

stated that NBFL was conducting a review of his accounts and would not be forced into a hasty

review and would provide an appropriate response.

[436] On October4, Weir receivedaletter of demand for payment of his margin account from Alan

Parish, a Nova Scotia lawyer. On October 16, 2001, Weir received a further letter from Wiesenfeld

rejecting Weir’s settlement offer. Shortly thereafter, Weir and Blackwood were sued by NBFL.

[437] Weir continued his efforts to settle with NBFL. He was a shareholder of National Bank of

Canada. He attended the annual meeting in March 2002 and asked the chairman to investigate his

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complaints. In August 2002 he met with the new CEO of National Bank of Canada, who referred

him to the Bank’s ombudsman. The ombudsman acknowledged he was aware of the situation and

that the chairperson and CEO of the Bank wanted to resolve the matter. After the ombudsman spoke

with Gibeault, he advised Weir that because there were legal processes in place, he could not deal

with it. He said the Bank would give serious consideration to a new settlement offer. Weir sent one

and received no response from Gibeault.

[438] On March 11, 2003, Weir went to Montreal for National Bank’s annual meeting, scheduled

for March 12. He wanted to speak to the President, who was busyat a board meeting. The President

asked Mr. Houde and Ms. Catyto meet him. Houde was a senior vice president and general counsel;

Caty was secretary of the Bank. They met all day on March 11. Houde was gone for a couple hours

during the middle of the day; he returned and stated to Weir that Weir was an innocent victim.

Houde apologized. He advised Weir that the Bank had formulated a new lawsuit against those who

they believed were responsible, and they wanted the other responsible parties to share in the

resolution of Weir’s losses.

[439] Houde advised that the process would take three to six months. Weir was asked to make a

proposal to the Bank as to a temporary measure until the Bank could get the other responsible parties

into the process.

[440] The Court notes that the litigation Houde referred was the action known as the Main Action

(206439), commenced by NBFL against Clarke and about twenty insiders for stock manipulation

shortly after March 2003.

[441] At 10:00 that night(March 11, 2003), Weir e-mailedHoudeaproposedinterim arrangement.

It contained three parts. One of them was that NBC or NBFL would provide Weir with the demand

loan for $100,000.00, repayable in full out of the settlement of Weir’s claim against NBFL. The

Court notes that this proposal dealt with the effect of NBFL’s sale of the Enervision shares out of

the Blackwood account on September 19, 2001.

[442] Shortlythereafter, Weir andMcLaughlin-Weir executedaPromissoryNotefor$100,000.00.

Houde advised them that they had to document the $100,000.00 advance on the settlement as a

Promissory Note to comply with the requirements of their auditors. The note provided for interest

at 4.75%. Weir was required to provide NBC with a blank cheque on his wife’s chequing account.

Life insurance on the loan was automatically withdrawn by NBC for her account each month, but

interest was not withdrawn. Weir says that, notwithstanding the execution of the Promissory Note,

it was agreed that no interest was payable. No interest was ever actually taken out of McLaughlin-

Weir’s account by NBC pursuant to the agreement made on March 11/12, 2003, nor otherwise paid

by the Weirs. I find that the agreement respecting the advance on the settlement did not include

interest.

[443] Eventually NBC sued Weir and McLaughlin-Weir on the Promissory Note (Hfx 246337).

That action was heard as part of this litigation.

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[444] Weir says that the understanding from Houde was that in three to six months NBFL would

settle with the Weirs, and the $100,000.00 was simply an advance against that settlement. After the

action was commenced on the Promissory Note, Weir called both Houde and Caty, but was advised

that both were no longer at the National Bank. He then contacted a Ms. Carr, a public relation

officer at the Bank, who referred him to Michel Lebonte. He was advised to attend at Montreal with

his lawyer to finalize a settlement. He attended at Montreal, but the matter did not settle.

[445] On January 19, 2001, Weir gave specific instructions to Clarke to sell KHI shares if they fell

below $5.00. They did; Clarke did not sell. When Weir raised it with Clarke, Clarke persuaded

Weir not to insist upon sale of the KHI shares. Based on Clarke’s knowledge of KHI, and his own

precarious margin debt position related to his purchases of KHI shares, it is clear and I find that

Clarke breached many of his obligations to the Weirs and Blackwood. He misrepresented the

circumstances of KHI, as he knew them to be. It was reasonable for the Weirs, both Lowell Weir

and Carol McLaughlin-Weir, to rely on his advice. This advice caused them not to insist on

execution of their sell instructions.

[446] There were more than 12,000,000 KHI shares outstanding. The stock was thinly traded. It

is reasonable to infer that a large quantity of KHI shares may not have sold for about $5.00, but the

Weirs did not own a large number of KHI shares. I infer that it is likely that the relatively small

number of KHI shares held by Weir and Blackwood would have sold on the market for at least $5.00

per share.

[447] Blackwood held shares that should have been sold by Clarke. Because the market was being

artificiallysupported, it is not known at this time whether those 8,000 shares or the 5,000 shares held

byWeir in hisLIRA account, or the 5,000 held in McLaughlin-Weir’s RSP account, wouldhavesold

for $5.00. That is, however, because Clarke did not follow the directions of his clients and acted

dishonestly toward them.

[448] On February 28, 2001, Weir received 28,125 shares into his margin account. At $5.00 per

share, they were worth $140,625.00. The Court notes that they were issued at a higher value than

$5.00. I find that Clarke was aware of the stock manipulation scheme of KHI insiders, and actively

assisted in that scheme. I infer that Clarke did not believe that the restriction on the share certificate

issued to the KHLP was bona fide.

[449] The Court notes that the complaints by Weir to the head office of NBFL related to its sale,

contrary to the standstill agreement, of Enervision shares held by Blackwood Holdings. I accept

Weir’s evidence respecting the standstill agreement and its effect. It prohibited NBFL from

liquidating the Blackwood account’s Enervision shares until it responded to Weir’s proposal. It had

not done so when it dumped Blackwood’s Enervision shares on September 19, 2001 (a settlement

date of September 24). The Court disagrees with NBFL’s submission that, if a standstill agreement

existed, it expired on September 14, when Weir’s September 9 offer expired. NBFL wrote on

September 14 asking for time to reply and continued their discussions thereafter. I find that the

standstill agreement was a binding agreement on NBFL at the time of their liquidation from the

Blackwood account of 325,500 Enervision shares. Blackwood is entitled to recover for the

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liquidation of Blackwood’s Enervision shares contrary to the standstill agreement. NBFL should

have known that the dumping of those shares would have had a serious damaging financial effect

on both Blackwood and Weir.

[450] Weir madeseveralcomplaints against NBFL. Thecorrespondenceexchangedbetween Weir

and NBFL after September 9, 2001, centred on NBFL’s sale of the Enervision shares contrary to the

standstill agreement. The interim settlement negotiated between Weir and NBFL / NBC in March

2002 related to the Enervision claim. This is apparent from the e-mail Weir sent to Houde on March

11, 2003, which preceded the execution of the Promissory Note on March 19, 2003. The loan was

an advance on the settlement of the Enervision claim.

[451] NBFL submits that any award of damages in favour of Weir and/or Blackwood Holdings

should be offset by the $100,000.00 advanced. The advance of $100,000.00 was regarding NBFL’s

dumping of Blackwood’s Enervision shares. It should offset the other claims of Weir and

Blackwood.

[452] The Weirs claim punitive damages in respect of the conduct of NBFL toward them and

Blackwood Holdings. This claim will be dealt with under the “remedies” portion of this decision.

D.3

Liability to the Michael (Ben) Barthe Estate

[453] As noted in part C.2 to this decision, and in the useful summary in the Biron/Boutin article

(beginning at p. 318), the broker - client relationship is first one of agent and principal. The broker

receivesinstructionsfromtheclientandmust performthoseinstructions whileactingwith care, skill,

diligence, honesty and good faith. Not to do so gives rise to an action for breach of contract and

breach of a duty and standard of care in negligence. Statutes, regulations and codes of conduct of

industry and employers also create duties and standards of care. They can infuse the common law

contractual and negligence duties and standards of care.

[454] As noted, the duties of a broker depend upon the relationship between the broker and the

particular client. In respect of Barthe, Clarke was simply an “order taker”.

[455] Barthe made a deal with Potter to buy 250,000 KHI shares for 1.7 million dollars on August

3, 2000. Colpitts directed Barthe to Clarke to open an account to purchase the shares on the market.

The Canadian securities system is a closed system and Barthe had to purchase through the stock

exchange. Clarke executed the instructions to purchase shares and provided reports to Barthe with

respect to his instructions, including the fact that he had carried them out.

[456] Barthe did not seek advice from Clarke.

[457] The basis of the claim for liability against Clarke (and NBFL) is that before Clarke received

the instructions to execute the purchases on the market, Clarke was part of a conspiracy with KHI

insiders to manipulate the public stock price. Clarke did not disclose to Barthe his personal

involvement in the scheme to purchase shares on the market, mostly from insiders (which was not

Page 76 of 139

a breach of his duty, as Barthe was aware that he (Barthe) would be purchasing shares from KHI

insiders). Clarke did not disclose and Barthe had no idea that the public market price of KHI shares

was artificially maintained by reason of the conduct of Clarke and some KHI insiders.

[458] The only potential liability of Clarke (and NBFL) to Barthe is if, as an order taker, Clarke’s

duty as Barthe’s agent included that he either refuse to become agent for Barthe or to disclose to

Barthe the stock manipulation scheme, because of his duty of honesty and good faith as an agent.

[459] Michael (Ben) Barthe passed awaybefore he could be discovered. His wife, Barbara Barthe,

and his friend Dr. Lutz Ristow, who, at one time, was a party to this proceeding, were discovered.

No oral evidence was produced at trial on behalf of the Barthe estate. Several documents, including

correspondence and e-mails to and from Barthe arein evidence. NBFL tendered short excerpts from

the discoveryevidence of, and interrogatories completed by, Barbara Barthe as representative of the

Barthe estate. NBFL also tendered short excerpts of the discovery examination of Ristow as

evidence against Barthe. The evidence was admitted by consent.

[460] Barthe was a wealthyGerman business man who sold his company(Rotring) to an American

multinational for several million dollars in or about 1998. About the same time as he sold his

business, he purchased property at Guysborough, Nova Scotia, where he began spending time and

developing small enterprises in that rural community.

[461] Barbara Barthe’s discoveryevidence shows an absence of knowledge of the financial affairs

of Barthe. She was unsure of the sale price of his business Rotring, including whether it was in US

dollars or Deutsche marks (there was a big difference). There was no evidence as to the net proceeds

from the sale of that business or his net worth after the sale of the business. Barthe reported his net

worth on the KYC form, completed for Clarke on August 23, 2000, as five million dollars, at the

time that he invested 1.7 million Canadian dollars in KHI. The Court accepts that his net worth was

likely much more than the five million dollars declared on the KYC form.

[462] In 2001, Barthe’s communications with Potter indicate that he had lost much money on the

stock market and was having trouble raising his half (approximately 1.6 million dollars) of a private

placement for purchase of shares for KHI treasury, which he entered into jointly with Ristow, for

which his share of the payments was due in 2001.

[463] NBFL suggests that Barthe was a sophisticated investor. The Court is not satisfied that the

evidence before the Court establishes that Barthe was a sophisticated investor. Ristow had no

knowledge of Barthe’s prior investment history nor was the evidence tendered from Ms. Barthe

helpful in determining his investment prowess.

[464] One of Barthe’s neighbours in Guysborough was Jack Sullivan, a shareholder and vice

president of KHI. At the time, KHI was looking for wealthy investors. Barthe was interested in

technology. It had dramatically changed the German business that he has recently sold. He was

enthusiastic about the “new economy” and about “web education”. Sullivan introduced Barthe to

Potter.

Page 77 of 139

[465] It appears that Sullivan or Potter provided Barthe with information about KHI, its finances,

its shareholders and its business activities. Barthe caused a German accountant, who had worked

for him at Rotring (Mr. Rehbein) to review the material. On April 17, 2000, Mr. Rehbein faxed

Barthe a ten-page handwritten report on KHI, its share structure and business activities with some

of its financial statements, which appears to summarize information supplied by KHI.

[466] Rehbein posed several questions for Barthe that he was unable to answer from the

information provided. The materials reviewed by Rehbein do not suggest that they were derived

from any sources independent of KHI. His conclusion in one sentence is: “As I see it, stock holds

significant opportunities but equally many risks.”

[467] On May 31, 2000, Potter faxed Barthe a proposal to subscribe for 500,000 KHI shares from

Treasury at $7.00 per share, with an option to purchase 500,000 more KHI shares within three years

at $10.00 per share. Potter suggested that this option was a substantial discount to the anticipated

KHI share price within five years.

[468] It appears that Barthe did not bite at this sales pitch. From a memo Barthe wrote on June 8,

2000, it appears that on that date Sullivan called Barthe to convey “confidential information” about

KHI. The Government was going to spend a large sum on an education/training, of which KHI

would be a significant beneficiary. The memo notes that Barthe was told that Potter was meeting

with a New York broker on June 25 to obtain financing and begin the wide distribution of KHI

shares. IBM and Intel were in the picture. KHI was ahead of its competition. Barthe should buy

500,000 KHI shares while he could.

[469] On June 11, Sullivan faxed Barthe a press release and reiterated that the deal Potter had

offered him “is a bargain at this point in time. I anticipate it will begin to move very soon.” Still

Barthe did not bite.

[470] On August 3, 2000, Blois Colpitts faxed Barthe a letter, to which was attached a Term Sheet

and Option Agreement for Barthe to purchase 250,000 KHI shares for 1.7 million dollars and to

receive an option to buy 150,000 KHI shares at $4.00 per share within two years. The seller, under

the Term Sheet, was described as ‘Dan Potter or his designates’. The Option Agreement was

explained to Barthe by Colpitts as involving the holdings of a former management individual. On

August 4, Barthe returned to Colpitts a signed copy of the Agreement with four conditions to the

effect that the shares and options be freely tradeable and clear of encumbrances.

[471] On August 14, Colpitts sent Barthe copies of the agreements signed by Potter. At the same

time, Colpitts forwarded a copy of the agreement to MacLellan, Wadden’s lawyer. Potter was

offering Wadden the opportunity to assume the Barthe agreement as a way to sell KHI shares and

reduce his margin debt.

[472] On August 21, Barthe faxed Colpitts to advise that the 1.7 million was available for transfer

and asking Colpitts how it was to be done. An August 23 fax from Clarke to Barthe referred to a

phone call with Barthe as well as discussions with Potter, Sullivan and Colpitts Clarke included a

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Cash Account Agreement to be completed together with instructions on wiring money to Clarke at

NBFL.

[473] On August 24, Barthe sent Clarke the signed Cash Account Agreementandcompleted KYC,

advising that the money would be received by NBFL by Monday, August 28. The same day Clarke

contacted NBFL’s credit department to approve the opening of the account immediately so that it

would not lose Barthe’s wire transfer. On August 25 Clarke faxed Barthe for more information and

a copy of his passport. Barthe’s 1.7 million dollars were received by NBFL on August 28. Clarke

began immediately to purchase KHI shares. The purchase prices varied as if the purchases were on

a truly open market.

[474] NBFL, in its submissions, makes note that Barthe was aware from the Term Sheet that he

was buying shares from KHI insiders, even though the shares were being purchased on the TSX

through NBFL.

[475] There is no evidence before the Court that Barthe knew that, from at least March 2000,

Clarke had been purchasing KHI shares on the market using margin debt in the 540 account as part

of the stock manipulation scheme, or that the 540 account’s margin debt was made available by

reason of the deposit (“loan”) of $100,000.00 by Potter and the deposit of 220,000 KHI shares by

Wadden (later replaced by 220,000 shares from Potter and MacLeod). There is no evidence that

Barthe was aware of the scheme bywhich KHIinsiders, and Clarke, were attempting to maintain the

KHI share price. The evidence is that Clarke did not advise Barthe of any of this.

[476] The trading records of the various accounts of KHI insiders, such as those of Potter

(including of his family and numbered companies) and of Colpitts, are not in evidence. Only the

records of Wadden and his family as well as some of the records of Clarke (including the 540

account) are in evidence.

[477] Some stock manipulation is evident from these incomplete records as they relate to the sale

of 259,000 KHI shares to Barthe, beginning on August 29, 2000.

[478] Clarke described the illiquidity of KHI shares in a June 29, 2000, proposal to Dennis

Gagnon, Senior Vice President and Managing Director, Individual Investor Service at NBFL, and

the need for immediatelyliquidity by some of those insiders. This is further evident in the follow-up

to Clarke’s memo - telephone call between Clarke and Daniel Bouchard on June 30.

[479] On July 17, 2000, the situation regarding the value of KHI shares got worse with the e-mail

from Guy Roby, Senior Vice President, Compliance, NBFL. Roby advised Clarke that based on the

heavyconcentration ofKHIholdingsamongst Clarke’s clients, andpreviouscommunicationsNBFL

about seeking to reduce that concentration, he was recommending a substantial reduction in the loan

value of KHIshares, which, at that point, was 50% of market price. Robynoted that this “could have

a material effect on the clientele and maybe the market itself”. At this time the 540 account owed

margin debt to NBFL of 1.51 million dollars, secured by 452,200 KHI shares (nominally valued at

$6.70 each).

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[480] In Clarke’s July 28, 2000, e-mail to Roby he untruthfully stated that “the large number of the

shares that I hold in each company [at that time 900 ITI Education Shares and 452,200 KHI shares]

is due in part by the fact that these shares came to us through the exercise of warrants, the releasing

of shares from escrow, the set up of trust or numbered companies for tax planning, the exercising

of stock options, etc.” The truth was that the overwhelming majority of these shares had been

acquired on NBFL margin debt premised on the loan from Potter to the 540 account of $100,000.00

cash and the loan of the 220,000 KHI shares (originally by Wadden, replaced later by MacLeod and

Potter).

[481] On August 29, Clarke faxed NBFL’s head office for approval of two trades connected with

his client Barthe. The request reads:

Wayne, For my client Blois Colpitts account 81-CDAE-7, I first will sell 73,300 KHI at $6.55 to my

buyer, AC81-D7SA-7, M. Barthe. Secondly, Iwill sell frommypersonal account 00-8ANX-0, 43,300

KHI at $6.50 to Blois Colpitts account 81-CDAE-7 per his attached e-mail. Please call me with your

approval. Thanks, Bruce.

[482] This fax refers to a Clarke account for which the trading records were not produced at trial.

Clarke sold 43,300 KHI shares from his personal account to Colpitts at the same time as Colpitts

sold 73,300 KHI shares to Clarke. Indirectly Clarke sold 43,300 KHI shares to Barthe from a

personal investment account. At that time, Clarke’s 540 account was maxed out on its margin debt

and holding over 450,000 KHI shares. Clarke did not advise, or obtain the consent of, Barthe for

what was in effect a matched order, involving him personally. Clarke forwarded the consent of

Colpitts to NBFL’s head office for approval of that sale, but not the approval of Barthe. NBFL

negligently failed to catch the obvious conflict of interest and breach of its own policy respecting

trades by its brokers.

[483] Barthe was expecting, pursuant to the August 3 Agreement with Potter, to purchase 250,000

shares at $6.80 per share. Each day from August 29 to September 9, Clarke faxed Barthe a report

with the number of purchases that dayand the net cost per share. Each dayBarthe was buying shares

for a different price, none of which were as high as $6.80. After the first day, Barthe thanked Clarke

for the “birthday present” of 7,350 extra KHI shares. It is clear that Barthe was not advised that

many of the purchases were arranged sales at arranged prices and was not the real market price for

KHI shares.

[484] On September 8, 2000, Clarke e-mailed Potter a detailed record of the share sales to Barthe.

He was keeping him in the loop with regards to who sold what shares.

[485] The 540 account did not appear to have participated directly in the sale of shares to Clarke.

Clarke’s apparent indirect participation was his personal sale of 43,300 shares to Colpitts at the same

time that Colpitts sold 73,300 shares to Barthe.

[486] The Court notes a sale from the 540 account of 150,000 KHIshares at $6.65 at 14:52:00 p.m.

on September 7, 2000. This sale was at the exact same instant 14:52:00 p.m. as another NBFL

account sold 150,000 KHI shares for $6.65 each. The broker for the purchaser of the 300,000 KHI

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shares was RBC Dominion Securities. The Court’s review of the documents filed in these

proceedings show the only record of purchases of KHI shares for $6.65 at that time were purchased

by David Fountain of 150,000 shares on the market and 150,000 shares from the KHI Treasury in

September 2000. As noted, Clarke incredibly had no memory of this significant and fortuitously-

timed sale from his 540 account.

[487] Immediately after the sale of the 150,000 KHI shares from the 540 account, which had the

effect of reducing the margin debt on the540 account (which stood before the sale at $1,409,778.00),

the 540 account went on a four-month buying spree of KHI shares until the 540 account ran out of

margin debt again. The 540 account held 285,970 KHI shares after the September 7^thFountain sale.

Over the next four months, it made 306 purchases of KHI shares with the margin debt re-ballooning

to $2,160,141.00. The number of KHI shares held in the 540 account when it again ran out of

margin debt by early February 2001 was 710,170.

[488] NBFL’s submissions were primarily to the effect that Clarke did nothing wrong. It submits

that the activity in the 540 account and by Clarke was a very insignificant portion of the trading KHI

shares. I disagree. Other than the arranged sales by Potter to wealthy investors, the 540 account

represented a significant portion of the market activity in KHI shares, from March 2000, when KHI

insiders lent money and shares to the 540 account, until the end of January 2001, when the 540

account ran out of margin debt for the last time.

[489] Some of the TSX dailytradingrecords respecting the activityin KHIshares were in evidence

before the Court; particularly, the daily records from December 6, 1999 to December 29, 2000. The

records do not identify the buyer and seller but identifythe selling broker and the purchasing broker.

NBFL operated through at least two brokerage accounts, Byron Securities Inc., Broker #63, and

NBFL, Broker #80. These records show NBFL to be a significant trader in the buying and selling

of KHI shares. It is not possible, from the evidence before the Court, to determine how much of that

activity was directly by Clarke.

[490] As noted, all of Clarke’s trading accounts have not been produced at trial. A review of his

540 account and Clarke’s joint investment account (between him and his spouse) for the period

March 2000 to the end of January 2001, shows 636 buy orders and 71 sell orders for a total 707

transactions. The largest was the 150,000-share sale on September 7, 2000. Of the total number of

shares traded on the TSX between March 2000 and January 2001 (approximately 4,390,000),

1,281,000 or about 29% were purchases or sales in the 540 account or the personal joint trading

account of Clarke and his spouse.

[491] Dr. Lutz Ristow lived and worked in Hamburg, Germany like Barthe. He had no business

dealings with Barthe before their joint investment in KHI. He had no knowledge of Barthe’s prior

investment history. For 35 years, Ristow knew Barthe as a citizen as Hamburg, a very successful

entrepreneur, a successful sportsman, and “a very fair gentleman”.

Page 81 of 139

[492] Ristow himself had been involved in real estate development in Germany, and had recently

sold, and resigned from running, his publicly-traded real estate business. He had participated in a

few private placements of shares in publicly-traded companies before October 2000.

[493] When visiting with Barthe in Guysborough in October 2000, Ristow was introduced to

Sullivan and learned about KHI and its business model. He was impressed by Sullivan and his

history as a school superintendent and saw the possibility of exporting KHI educational programs

to Europe.

[494] On Thursday, October 19, 2000, at the time that he was returning to Germanyfrom this visit,

he and Barthe attended a meetingwith Potter and Sullivan at the Halifax Airport for about two hours.

Potter proposed that Barthe and Ristow purchase 800,000 KHI shares. They verbally agreed to a

private placement of 500,000 new shares paid for in four installments.

[495] Duringthediscussion, BartheandRistowaskedaboutKHI’sfive-yearplanandwereadvised

that they would get that plan before November 5, 2000. The request for KHI’s five-year plan was

repeated in several follow up communication (beginning October 25) and always put off by Potter

and KHI’s vice president of finance, Gerard McInnis. It appears that, despite several requests and

promises, the promised five-year plan was never delivered.

[496] The outline of the agreement made at the Airport is reflected in an October 22 memo that

Potter sent to McInnis, Sullivan and Colpitts. Barthe and Ristow were to purchase 500,000 shares

from Treasury for $6.50 each by a private placement payable in four instalments for a total

investment of 3.250 million dollars. In addition, Ristow was to be appointed to the Board of

Directors of KHI. The deal was contingent on Board approval and that it did not interfere with other

KHI Board of Directors sales plans.

[497] On October 23, McInnis faxed Barthe a draft agreement in the form of a Term Sheet. On

November 8, Potter faxed Barthe and Ristow confirming a November 15 closing for the deal and

suggesting that Ristow open an account with Clarke at NBFL for the transfer of funds for the first

of four equal instalments of $812,500.00. Potter then contacted Clarke who, on November 9, faxed

to Ristow a letter and forms outlining the requirements for opening of an account and the transfer

of funds to NBFL. On November 10, Ristow sent Clarke the required documents, including an

account agreement and KYC form, as well as the first of the four instalments.

[498] Stewart McKelveyStirling Scales (“SMSS”) prepared the documents to conform to the TSX

rules respecting private placements in public companies. The documents included an Escrow

Agreement naming SMSS as the trustee to hold the KHI shares being purchased until all of the

instalments were paid. SMSS arranged for the agreements to be executed on November 15 and

carried out the necessary communications to obtain TSX approval.

[499] On November 17, Ristow asked Clarke to confirm that 125,000 KHI shares were then in his

NBFL account. At this point the TSX had not approved the private placement.

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[500] In a November 19, 2000, e-mail from Potter to Wadden, copied to Colpitts, relating to the

demands of a friend of Waddens whose friend (“Steve”) was trying to sell his KHI shares on the

market, Potter stated that “we don’t have any liquidity solutions for Steve at this moment, however,

I’d be pleased to meet with him at[on] . . . Monday morning at our offices to put a plan together ...”

The next paragraph of the e-mail is significant:

As you know, we are closing on a $3,250,000 treasury issue to our German friends - we are hoping

to get this completed (closed) on Monday or Tuesday, November 20 or 21. The price of this issue is

$6.50 per share. If the market is driven down in advance of this issue, it is quite likely that the

investors will not close. This would be most harmful for the company and all of its shareholders,

including Steve. Hopefully, he can be convinced to proceed with care, prudence and caution.

[501] On November 21, Potter wrote to Barthe and Ristow advising that the TSX had approved

the agreement but required all of the shares to be held in escrow with the trustee until the final

payment, due on August 15, 2001. This would have been news to Barthe and Ristow. Potter

enclosed documents reflecting this condition for execution by them. Ristow and Barthe signed and

returned these agreements.

[502] On November 24, Potter advised Ristow to authorize NBFL to release his funds to SMSS

and KHI. On November 28, Ristow did. On November 29, Clarke transferred Ristow’s first

installment to SMSS. On the same day, Gerard McInnis e-mailed Potter that Barthe was asking

again for the five-year plan and the 2001 plan approved by the Board. This was their third request;

the first was at the Airport meeting on October 19, and the second on October 25. McInnis’ memo

shows that he put Barthe off respecting the five-year plan and said that the 2001 plan was not yet

presented. Barthe expressed displeasure and wanted access to the information.

[503] On December 22, 2000, Barthe again wrote Potter asking when he could expect to receive

the five-year plan. He also asked when the February board meeting was scheduled for, and that he

expected that Ristow would attend. On December 26, Potter wrote Barthe and Ristow that the 2001

plan and the five-year plan would be presented to the Board of Directors at a meeting January 18,

2001 and that there would be no meeting in February. In this letter, Potter asked Barthe and Ristow

to provide a banker’s letter of credit to guarantee their subscription agreement for the 3.250 million

dollars.

[504] On January 4, 2001, McInnis sent Barthe and Ristow a draft 2001 business plan and said the

five-year plan would be available January 18. On January 6, Barthe acknowledged the 2001 draft

plan and said that he and Ristow wanted to review it and the five-year plan before “indulging in any

further share acquisition ideas”.

[505] On January 8, Potter promised to send the five-year plan before January 18. He again asked

for the banker’s letter of credit to support the subscription agreement and enclosed a draft RBC form

for same. The same day Barthe and Ristow exchanged messages about the need for information

from KHI, including KHI’s expected results for the year 2000.

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[506] On January 10 Ristow wrote Potter bluntly rejecting his request to collateralize the

Subscription Agreement with a letter of credit, but stated he would agree to pay the second

instalment due February 15 immediately. The same day, Ristow arranged for his Bank to transfer

$812,500.00 to Clarke at NBFL.

[507] In correspondence between Clarke and Ristow, it appears that Ristow was still under the

misconception that the KHI shares being subscribed for would be in his NBFL account, when in fact

they were being held in trust by SMSS. On January 15, Clarke sent SMSS the second instalment of

$812,500.00.

[508] On January 19, 2001, Potter sent Barthe and Ristow a January 15 confidential memo

outlining KHI’s need for three million dollars in new equity immediately and advising of the

reduction of KHI’s bank operating credit lines. The Court notes that this memo was sent after the

second instalment was received. Potter asked Barthe and Ristow to immediately participate in this

“rights offering” by purchasing 285,000 KHI shares and receive warrants that would entitle them to

purchase more shares at $4.06.

[509] This letter was significant. It was the first time that KHI or anyone disclosed to Barthe and

Ristow the fact that KHI was in desperate needs of new equity, and involved in a daily market

support program because of the downward pressure on KHI’s market share price.

[510] Barthe sent Potter two replies the same day. In the first he wrote that he had tried to call

when he received this fax. He said he had lost a lot of money in the last three months; was trying

to survive and could not help the company. He added, “Further, I am not sure at the moment how

I can pay the shares in May and September. I will try to find a solution until then . . . My only hope

is that you and your Canadian friends will be able to avoid the worst for this fine company.” In the

second fax, he confirmed that he would still be able to make the May and August, 2001 final two

instalments on the private placement.

[511] The same day Sullivan called Ristow to promote the new “excellent opportunity” for

investment in KHI. Both Sullivan and Potter separatelyfollowed up with written pleas to Barthe and

Ristow on January 20. Potter emphasized the urgent need for new investment by Monday, January

22, and, as an inducement, offered to have Ristow replace him as chairman of the KHI Board and

to becomethe controlling shareholder. At this point, Ristow was still not a Director of the Company.

[512] In the letter, Potter discloses, as in the January 19 fax, the fact that he and local supporters

had been buying stock to maintain the market price but had exhausted their capacity to do so any

longer.

[513] The Court notes that Clarke, in his 540 account, made his last purchase of KHI shares (save

for one in mid-February from the proceeds of the sale of Cross-Off Shares) on or about January 19.

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[514] The Court notes that at the same time, Wadden’s broker at BMO (Richards), advised

Wadden that, because of the drop in the KHI price on the two previous days, he had been forced to

sell 2,000 KHI shares to keep Wadden’s margin account at BMO onside.

[515] On January 21 and February 3, Potter called Ristow and asked him to instruct Clarke to buy

20,000 KHI shares on the market to provide market support. He again promised to have a revised

2001 business plan and budget to Ristow within a few days. Ristow did not provide Clarke with

instructions to support the market. On the contrary, he appears, from the followup communications,

to have avoided phone calls from Potter.

[516] The Court finds that at no time did either Ristow or Barthe, together or separately, agree to

provide market support through purchases of shares on the market for the purpose of maintaining

the KHI price.

[517] On February 12, Potter faxed Ristow again asking him to provide market support by

purchasing 50,000 shares on the market. He appealed to the fact that Ristow was a substantial

investor. By February 22, Ristow had not replied. Potter sent him a memo containing a reference

to a “managed selling agreement” and market support arrangement amongst five other large

shareholders.

[518] On March 2, Potter sent Ristow and Barthe another letter describing how the stock price was

“holding up” because of the efforts of himself and other share holders, but that the stock was

faltering. He asked them to provide support by buying 20,000 KHI shares on the market through

Clarke. Potter copied the letter to Colpitts with the words “attached is another poke at Lutz /Barthe”.

[519] On March 5, Barthe acknowledged the request “to take up some more KHI shares” and to

give market support, but he did not have the means to do so.

[520] Based on Ristow’s avoidance of Potter after the January 19 e-mail, in which reference is

made to market support efforts, the Court is satisfied that Ristow at no time intended to support the

market himself or support the efforts of Potter and other KHI insiders to do so.

[521] On April 4, Potter sent Barthe and Ristow a direction to pay the next instalment in the

Subscription Agreement (due May 15). On April 18, Barthe e-mailed Potter asking for “the Board

Members judgment concerning KHI’s future development”. He indicated that he had a “slight

stroke”. The Court notes that Barthe’s health deteriorated thereafter and that he was soon

hospitalized.

[522] On the same date, Potter replied to Barthe and Ristow with an update on KHI’s affairs. The

letter referred to the fact that KHI had deferred on its commitment to have Ristow elected to the

Board, but advised that KHI planned to advance his name as a Director in the Information Circular,

for the June 27, 2001, Annual General Meeting.

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[523] On June 21, Ristow advised Potter that neither he nor Barthe could attend KHI’s Annual

General Meeting. The Minutes of the June 27 AGM show that they were not present, but Ristow

was elected to the Board.

[524] By a letter dated June 29, received by Ristow on July 12, Ristow was advised of his

appointment to the Board and provided with an Agreement, as part of his appointment to the Board,

to accept the grant of 10,000 options of KHI shares.

[525] On July19, Clarke was advised of Barthe’s urgent hospitalization. He forwarded to Barbara

Barthe information and a form to be completed to enable her to have a trading power of attorney on

Barthe’s NBFL account.

[526] On the same date, Ristow acknowledged receipt of the June 29 letter with the Option

Agreement. He returned the Agreement signed and asked questions about aspects of the KHI

Financial Statement that he did not understand. On August 9, Potter replied to Ristow that the KHI

financial results were worst than expected on the Financial Statement because of the acquisition of

the Knowledge House Limited Partnership into KHI in exchange for shares. This caused KHI to

absorb the very substantial losses of KHLP. It is apparent from this exchange that Ristow had not

been previously advised about the Limited Partnership, the exercise by KHI of the option to convert

the partnership units to shares, and of the potential consequences on KHI and KHI’s share value.

[527] On August 16, Torstar announced the write-off of its 25-million-dollar investment in ITIand

the appointment of a receiver. ITI was the corporation Potter had created and sold to Torstar

immediately before taking over KHI. The KHI shares went into a tail spin and, on August 23, the

TSX required KHI to explain to the public what was happening to its shares.

[528] On August 21, Ristow was forwarded a copy of a Notice of a Board Meeting, scheduled for

August 24. The Notice included information about the precarious nature of KHI’s finances. Ristow

did not travel to Nova Scotia to attend the meeting.

[529] On September 4 and 11, KHI sent Barthe copies of a memo seeking financial support for

KHI. On Wednesday, September 12, Potter asked for a Director’s Meeting for September 13, to

obtain $200,000.00 to meet that day’s payroll.

[530] OnSeptember13, PotterannouncedthatKHIwasunableto continueoperations. KHIclosed

its doors. On October 1, Potter sent Barthe and Ristow copies of a proposed filing KHI was making

under the Bankruptcy and Insolvency Act.

[531] It is not clear from the evidence when Barthe and Ristow paid the two remaining instalments

on their Subscription Agreement in the amount of $1,625,000.00. It is clear that they did pay this

remaining commitment.

[532] In December2001, on Barthe’sinstruction, NBFLsold Barthe’s259,000KHIshares, netting

$24,503.70. On January 25, 2002, Barthe’s account received his share of the private placement

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(250,000 KHIshares and 250,000 warrants). These shares were sold and Barthe’snet proceeds from

the sale were $10,867.50.

[533] In its post-trial brief, NBFL submits that Barthe was a sophisticated businessman. I agree;

he was a sophisticated entrepreneur.

[534] Secondly, they say Barthe was a sophisticated investor who accepted the risks of investing

in KHI. I do not agree that it was established that Barthe was a sophisticated investor. Neither his

wife nor Ristow knew anything about his investments. Barthe himself, in communications with

KHI, described his investment in KHI as substantial and noted that he had lost much money in the

stock market.

[535] NBFL says Barthe conducted his own due diligence. The research he appears to have

conducted was of two types. First was general reading in financial newspapers with respect to the

new economy and e-learning. The second was to have his former employee, Mr. Rehbein, review

the financial disclosure provided to him by Potter and Sullivan respecting Knowledge House. Mr.

Rehbein raised several questions to Barthe and identified the risk of the investment. It is clear Barthe

had no information regarding the KHLP before January 2001, or that KHI insiders, acting through

Clarke, were manipulating the stock price of KHI.

[536] NBFL notes that Barthe had access to a local and German lawyer, as well as a local and

German accountant. There is no evidence, direct or indirect, from any of them.

[537] Barthe, and later Barthe with Ristow, directly negotiated with Potter and KHI. The only

particular evidence as to involvement of any of their professionals was that Mr. Winter was

consulted about the first Term Sheet. Apparently, on his advice Barthe requested addition of four

conditions to the effect that the shares and warrants were unencumbered and KHI was authorized

to complete the agreement.

[538] There was no evidence that any legal or accounting professionals conducted independent

investigations into KHI or were aware or could have been aware of the stock price manipulation that

was going on from at least March 2000.

[539] I agree with NBFL’s third point that Barthe negotiated his first investment directly with

Potter and Sullivan. NBFL notes that the Barthe estate denied in its pleadings the existence of the

Option Agreement that accompanied Barthe’s first agreement with Potter to purchase 1.7 million

dollars worth of KHI shares. There is no evidence of knowledge or notice of conspiracy to

manipulate the KHI share price by Barthe. The Court fails to understand how the existence of the

Option Agreement puts Barthe on notice of the stock manipulation scheme.

[540] NBFL’s fourth point relates to the openingoftheNBFLaccount byBarthe. NBFLsubmitted

that Barthe contacted Clarke on August 23, 2000. Clarke’s letter of August 23, 2000, does not say

who contacted whom. It is clear that Barthe was referred to Clarke by Colpitts when he asked how

he was to proceed. It is also clear that Clarke was kept in the loop byPotter and Colpitts with respect

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to investors they were hustling. I do agree with NBFL that Clarke did execute Barthe’s instructions

to purchase the shares. He was paid commissions of $13,848.00 for doing so.

[541] I agree that there is no evidence of anyother transaction in Barthe’s NBFL account and there

is no evidence that the identity of the sellers would have affected Barthe’s decision to purchase

KHI’s shares in August 2000. Barthe would have been aware, by the term sheet, that Potter and/or

his designates would be sellers.

[542] NBFL’s fifth point is that Barthe knew that KHI was a start up company and that its market

capitalization bore no relationship to its underlying economical fundamentals. NBFL is attributing

the evidence of Ristow to Barthe. In discovery, Ristow testified, in effect, that he knew that start-up

companies were often starving for cash and were unprofitable or marginally profitable, and that this

was not determinative of their future prospects. In October 2000, Potter wanted Barthe and Ristow

to buy shares from existing shareholders. Ristow wanted to purchase shares from the Treasury, in

light of his understanding of the nature and needs of start-up companies.

[543] The Court agrees with NBFL’s point that the November 2000 Subscription Agreement

prepared by Colpitts, signed by Barthe, confirms that there is no assurance that the money that he

and Ristow were injecting into KHI would enable KHI to continue operations.

[544] NBFL sixth point deals with the extent to which Barthe and Ristow became tied up as

insiders in KHIthrough their private placement purchase of 3,250,000 shares of KHIfrom Treasury.

[545] NBFL submits that Ristow was to become a Director; Barthe was to act in his place as a

Director. It cites an October 23, 2000, communication from McInnis to Barthe attaching a draft

Term Sheet.

[546] The Court notes that Potter’s memo to McInnis dated October 22, 2000, outlining his

meeting with Barthe and Ristow at Halifax Airport on October 19, says: “It was agreed that, in due

course after the completion of the first closing, Lutz would be appointed to the Board, with the

understanding that if he is unable to attend certain meetings that Ben would be invited to attend in

his place.”

[547] The reality is that KHI deferred appointing Ristow as a Director until June 2001. While

Barthe received many of the same communications and information that Ristow did, Barthe was at

no time appointed a Director or given any legal status with respect to the Board of Directors or

management of KHI. He was not appointed an alternative director (assuming there is authority in

Nova Scotia company law for such an appointment). Barthe was never treated or expected to be

treated as if he was a Director of KHI.

[548] As previously noted, Barthe and Ristow had been asking for the five-year plan since their

first meeting with Potter and Sullivan on October 19, 2000, which lead to the private placement.

They never did receive it, despite repeated requests for it, both before and after they were informed

on January 19, 2001 of the market manipulation by KHI insiders. It appears that the only financial

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disclosure received by either Ristow or Barthe was the 2001 financial plan sent to them on January

4, 2001. It was from this draft business plan that Ristow became concerned and asked questions of

Potter, which lead to Potter’s disclosure, after the January 19 second instalment was made on the

private placement, that KHI had absorbed the significant losses incurred by the Knowledge House

Limited Partnership.

[549] The Court finds that what Barthe and Ristow received as disclosure before the January 19,

2001, was no relevant financial disclosure and, in some cases, misleading or deceptive financial

information.

[550] One of the most relevant points argued by NBFL in its post-trial brief respecting Barthe is

their submission that there is no evidence that Barthe would not have invested in KHI had he knew

that its share price was supported (or, in my finding, manipulated). They say the evidence is to the

contrary. When Barthe was advised that the stock was being supported, he did not complain.

[551] After January 9, 2001, the documents before the Court clearly show that almost all of KHI’s

communications (both by Potter and Sullivan) were to Ristow, with some being copied to Barthe.

It is equally clear that after January 9, 2001, Ristow was not returning or receiving phone messages

and phone calls from Potter. The only communications from Barthe appear to be on March 5 and

April 18, 2001.

[552] My inference from the totality of the communications between KHI, on the one hand, and

Barthe and Ristow, on the other hand, is that, while they did not expressly accuse Potter and KHI

of being dishonest and deceptive, the tone of their communications with KHI changed. Not only did

Ristow not return calls, but he and Barthe declined to make further investments in KHI despite

Potter’s pleas. At no time did either took Potter up on his repeated requests that they instruct Clarke

to start purchasing KHI shares on the market immediately.

[553] Ristow’s description ofBarthein thediscoveryexcerpttenderedbyNBFLcontains Ristow’s

description of Barthe as being a “very fair gentlemen . . . the type of person you would want to be

friendly with.”

[554] I conclude there are the reasons that Barthe (and Ristow) did not pick a fight with Potter and

KHI after January 19, 2001, when they clearly changed their tone, and appear to have understood

they had been taken was: (a) they were sophisticated enough to know that they were already heavily

invested into KHI. Making accusations against Potter, who was describing himself and his local

shareholders as being tapped out, was not going to get him out of KHI with his investment. Sitting

on the sideline and hoping for recovery was the most practical option; and (b) it is clear from the

tone of their communications that Barthe and Ristow were gentlemen. It would not have been their

style to pick a fight with KHI or Potter that, at the end of the day, was not likely to have a realistic

prospect of saving their already substantial investment in the company.

[555] I do not agree with the implication of NBFL’s submission that Barthe condoned the

manipulation of the stock price by Potter and other KHI insiders.

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[556] There is no evidence that Barthe would have invested in KHI had he known that the share

price had been manipulated when he made his first, 1.7 million dollar investment in August 2000,

or when he and Ristow made their 3.250-million-dollar private placement in October/November

2000.

[557] As noted, there was no legal authority for the so-called “price support” or manipulation of

the KHI market share price. Clarke was involved in with KHI insiders from at least March 2000,

when they lent to Clarke money and shares for his 540 account.

[558] The first legal issue is: did Clarke breach his duty of care to Barthe by agreeing to be an

“order taker” in August 2000 to purchase 1.7-million dollars’ worth of shares of KHI when he knew

and was part of the stock manipulation scheme?

[559] The second issue addresses NBFL’s counterclaim: was Barthe liable to NBFL for failing to

blow the whistle on KHI by reason of his receipt of financial information from KHI that was not

generally available to the public and KHI’s invitation to him to attend Board of Directors’ meetings

that Ristow was not able to attend in late 2001 (which never occurred)?

[560] Clarke had a duty to be honest and act in good faith toward his principal, Michael (Ben)

Barthe.

[561] NBFL had an obligation to take reasonable steps to identify existing and potential material

conflicts of interest between it, any of its brokers, and any of its clients.

[562] If NBFL had been supervising the activities of Clarke in his 540 account, it would have

known about the loans of money and shares from KHI insiders to Clarke, and their use by Clarke,

using NBFL margin debt, to prop up the KHI share price on the market.

[563] When NBFL did conduct its own investigation, after litigation began and in respect of its

commencement of the Main Action, its Senior Vice President swore under oath that the illegal

scheme to manipulate the KHI share price by KHI insiders and Clarke was clear. NBFLshould have

known this before late August 2000 when it took on Barthe was a client.

[564] There are different ways to avoid a conflict of interest. NBFL can stop providing service to

a client. It can, in some circumstances, create internal communication barriers between the brokers

who have conflicts and their client. Alternatively, it maydisclose the conflict and obtain the client’s

consent to proceed. NBFL did none of these. Clarke did none of these.

[565] Ihave found that Barthe did not know of the market manipulation scheme until after January

19, 2001. I find that NBFL should have known of it, as it swore in Court motions dealing with the

Main Action that it later learned, before Clarke agreed to purchase KHI shares for Barthe.

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[566] Because of my finding that Clarke was part of the scheme to artificially maintain the KHI

share price with KHI insiders, he clearly did not act honestly or in good faith in respect of his

agreement to act for Barthe as an order taker to acquire KHI shares on the market.

[567] The liability of Clarke and NBFL to Barthe does not arise because Barthe sought and Clarke

gave advice, nor because KHI, absent stock manipulation, was not a suitable investment for Barthe,

nor because the shares purchased by Clarke came largely from KHI insiders.

[568] The liability is because Clarke was part of a fraudulent scheme to artificially maintain the

KHI share price on the market and, for a fee, he agreed to buy approximately 250,000 KHI shares

for Barthe, knowing that the price was being artificially maintained by him and KHI insiders.

[569] The investment byBarthe in the private placement in November2000 is a different situation.

The liability of NBFLto Ristow is not in issue, as Ristow is no longer a litigant in these proceedings.

Ristow opened an account with NBFL to transfer money to KHI with respect to his contribution of

$1,625,000.00, to the private placement. There is no evidence that NBFL or Clarke charged a fee

for this service. It did not involve Clarke acting as an order taker, providing advice or providing any

other service.

[570] It appears from the evidence that, while there is no direct evidence of when Barthe made his

$1,625,000.00 payment to the private placement, he likelymade those payments when theywere due

for payment on May 15 and August 15, 2001. Whenever Barthe made those payments, it is clear he

made them after January 19, 2001, when he became aware for the first time that the KHI share price

had been manipulated.

[571] With that knowledge, any payment by Barthe to the private placement cannot make Clarke

or NBFL liable. Clarke’s wrongdoing (for which NBFL is vicariously liable) and NBFL’s

negligence were not the cause of Barthe making the $1,625,000.00 on the last two instalments of the

private placement after January 19, 2001.

[572] I find NBFL liable, both vicariously for Clarke, and by reason of its own negligence and

breach of contract to Barthe, for the Barthe investment in August 2001 of $1,700,000.00 in KHI

shares. The issue of remedy is dealt with later in this decision.

D.4

Liability to Wadden

[573] The evidence respecting the Wadden claims against NBFL arises from the exhibits and oral

testimony of Calvin Wadden, his wife Andrea, his lawyer Brian MacLellan Q.C. and his friend Hal

Greenwood. NBFL called no direct oral evidence.

[574] The reliabilityof oral evidence, with respect to historic events, is always problematic. In this

part of the case, credibility played a prominent role.

[575] In Re: Novak Estate, 2008 NSSC 283, at paras 36 and 37, I wrote:

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[36]

There are many tools for assessing credibility:

a) The ability to consider inconsistencies and weaknesses in the witness’s evidence,

which includes internal inconsistencies, prior inconsistent statements, inconsistencies between the

witness’ testimony and the testimony of other witnesses.

b)

testimony.

The ability to review independent evidence that confirms or contradicts the witness’

c)

The ability to assess whether the witness’ testimony is plausible or, as stated by the

British Columbia Court of Appeal in Faryna v. Chorny, 1951 CarswellBC 133, it is “in harmony with

the preponderance of probabilities which a practical [and] informed person would readily recognize

as reasonable in that place and in those conditions”, but in doing so I am required not to rely on false

or frail assumptions about human behavior.

d)

It is possible to rely upon the demeanor of the witness, including their sincerity and

use of language, but it should be done with caution (R. v. Mah, 2002 NSCA 99 ¶¶ 70-75).

e)

Special consideration must be given to the testimony of witnesses who are parties

to proceedings; it is important to consider the motive that witnesses may have to fabricate evidence.

R. v. J.H. [2005] O.J. No.39 (OCA) ¶¶ 51-56).

[37]

There is no principle of law that requires a trier of fact to believe or disbelieve a witness’s

testimony in its entirety. On the contrary, a trier may believe none, part or all of a witness’s evidence,

and may attach different weight to different parts of a witness’s evidence. (See R. v. D.R. [1966] 2

S.C.R. 291 at ¶ 93 and R. v. J.H. supra).

[576] Many documents, mostly e-mails and trading records, from the period 2000 to 2001, were

produced. They were the focus of the oral evidence.

[577] In my assessment of the evidence of Wadden and Ms. Wadden, it became apparent that

Wadden often failed to answer questions in a direct and responsive manner; in addition, he often

answered questions as an advocate. This detracted from his reliability and credibility. Ms.

Wadden’smemorybecameparticularvaguewhenshewasaskedpointedquestions aboutdocuments

not helpful to the Wadden’s claims. This affected the reliability and credibility of her evidence.

[578] Actions or conduct, reflected in this case in documents made contemporaneous with events,

spoke louder than testimony that many years later attempt to explain away or rationalize them.

[579] My analysis of the actions and conduct of Clarke (in respect of the claims of Dunham, the

Weirs and the Barthe estate), as reflected in his responses to the documentary evidence put before

him, led me to find that most of his explanations were incredible. The same analysis applies to the

often incredible and unreliable explanations by Wadden of the historic documentary evidence.

[580] In contrast, the evidence of MacLellan, hired by Wadden on July 17, 2000, and terminated

without explanation about August 24, 2000, was straightforward, apparently unbiased, and in

harmony with the apparent meaning of the notes, records and communications made by him at the

time of the events. His testimony was reliable and credible, and helpful. I relied on it.

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[581] Wadden attended, but did not graduate from, university. He worked for about ten years in

the banking industry, beginning as a credit officer. In 1994, he joined his long time friend and

computer whiz, RayCourtney, to create Micronet, a business that installed and distributed computer

hardware and software, primarily to educational institutions. By 1999, it had grown significantly.

[582] Wadden was aware of Potter through his successful development of ITI Education. He

learned from colleagues about Potter’s new efforts in KHI.

[583] Potter is a brilliant and persuasive entrepreneur. He was trained as a lawyer but saw himself

a new economy guru. Wadden clearly was impressed by Potter and his reputation for success.

[584] In a very short span in mid-1999, Potter convinced Wadden and Courtney to sell Microsoft

to KHI at the exact time that Micronet (with its partners) was awarded a very substantial and long-

term contract to install and maintain a computer network (hardware and software) in the Nova Scotia

school system.

[585] In exchange for Micronet, Wadden and Courtney received no money but each received 1.1

million KHI shares (and warrants) as well as executive jobs.

[586] Wadden and Courtney each became owners of more than 10% of KHI’s stock; only Potter

and his family were larger shareholders.

[587] Up to this point, Wadden had no substantial income or net worth, and did not have a high

standard of living. With the acquisition of these shares, Wadden naively believed he had become

a multimillionaire. Immediately, on the sale of Micronet to KHI, he and his wife (who retired),

purchased and started extensive renovations to a historic South End Halifax residence, and began

building a substantial summer residence in Cape Breton.

[588] Wadden believed in the KHI dream. He purchased more KHI shares.

[589] The shares were highly speculative. KHI did not have a track record or plan that would, at

that point, support the market share price. KHI was a thinly traded, small public technology

company. Wadden did not appear to appreciate that ownership of shares in KHI was not money in

the bank.

[590] In December1999, Snow, whohad, likeWadden, sold his CapeBretone-commercebusiness

to KHI for shares months before Wadden and Courtney, decided to cash in his KHI shares. Keating,

a successful, self-made entrepreneur who acquired wealth in the cable television industry, was

persuaded to buy one million shares for about $5,920,000.00 in January 2000. Keating did not buy

all of Snow’s shares. Wadden and Courtney agreed to each buy 100,000 shares at $6.00 per share.

[591] When Wadden and Potter sold Micronet, the shares they acquired were placed in escrow to

be released to them in equal portions over five years.

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[592] In exchange for Wadden and Courtney agreeing to buy 200,000 KHI shares from Snow,

Potter agreed that all of their shares would be immediately released from escrow, and Potter

promised that he would find buyers, or buy himself, from each of Wadden and Courtney, 250,000

KHI shares by June 2000. Wadden described this as a gentleman’s agreement.

[593] At this time, Wadden believed that KHI’s share price would double from January 2000 to

June (as it had in a few months in 1999). He thought it was a good investment.

[594] Wadden had investment accounts in the CIBC, and with his longest and best friend as well

as a former co-worker, Richards, who was a broker at FCG. Wadden used the KHI shares, which

constituted almost all of his net worth, as securityfor borrowingon margin accounts. The borrowing

was used to make other investments, to finance the renovation / constructions of his two residences,

and to live on.

[595] I conclude that in addition to being naive, Wadden did not paid attention to details or take

much time to analyse his situation objectively. He appeared to have been verytrusting of Potter and

his dream.

[596] This is reflected by an important event in early March 2000. The event is described in part

by Wadden in his testimony.

[597] In his examination-in-chief, Mr. Wadden testified that the circumstances which led to the

deposit of his 220,000 shares in the 540 account were as follows:

A. Okay. Throughout the winter, Knowledge House was in the process of doing some large deals -

several large deals, including a national partnership with IBM, a big deal with Bell Aliant. They were

going to buy a - their technology division Wave. There were several large deals under way.

And prior to us heading up to do the - the investor stuff, what do you call it the - going to Bay Street

to talk to institutional investors, there was a lot on the go and a lot of activity.

The stock had progressed from I think $6.00 to probably $7.00 and at the time, prior to me leaving for

Florida, I was in the offices at Spring Garden Road and Mr. Potter approached me about Knowledge

House’s orderly market account (p. 3759 - 60)

[598] Wadden testified that he had a discussion with Potter some time around lunch time and

Potter told him that KHI’s orderly market account was offside and he was going to ask all of the

founders that were partners in the business to each pledge security. He was asking everyone for

100,000 shares, since all of the founder shares were released from escrow.

[599] Wadden went upstairs to Richards’ office and asked him for a share certificate. Richards

gave Wadden the only one that he had available which was for 220,000 shares. Wadden took the

Certificate downstairs and gave it to Potter and Potter said - “sign the back of it and give it to Ruth

Cunningham”.

[600] Wadden then endorsed the certificate and gave it to Ruth Cunningham.

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[601] On his cross-examination, Wadden testified that when he delivered the endorsed Certificate

to Ruth Cunningham, he said to her - “Dan said to send this down to National Bank, to Bruce

Clarke.”

[602] At that time, Wadden understood Clarke was a stock broker at NBFL, used by Potter and

KHI. I find that at that time he did not know about Clarke’s numbered company and 540 account.

What Wadden understood Potter to be talking about on that March noon was that KHIhad an orderly

market brokerage account at NBFL (of which Clarke was the broker), which was used to buy and

sell KHI shares. Wadden believed that the account that he was lending shares to was to be used to

buy and sell KHI shares.

[603] I find that at that time, Wadden did not know how that account was used, and that, in fact,

that it was used to buy KHI’s shares, and to occasionally sell shares in deals that Potter arranged

with new investors.

[604] Wadden was careless in respect of Potter’s request in early March 2000, and agreed to it

without any further inquiry, either of Potter or otherwise, as to what it involved. At that time, he did

not know whether KHI was permitted to hold an account for the purpose of trading in its own shares.

There is no evidence that he was then aware that the only appropriate and legal orderly market

accounts were those operated by “market makers” designated as such by the stock exchange on

which the publicly traded shares were traded.

[605] In March 2000, Richards advised Wadden that he had reached the limit of his margin

borrowing at FCG on the security of the KHI shares.

[606] At the time that Potter asked Wadden to participate in the orderly market account, Wadden

opened a margin account at NBFLwith Clarke, transferred 220,000 KHIshares held byhim at CIBC

(with a margin debt of $300,000) to Clarke at NBFL, and arranged to get access to more margin.

This was in response to Richards’ advice that he had reached the limit of margin borrowing at FCG.

This move helped Wadden to access more margin, in part because the market price of KHI shares

continued to rise (or apparently so). The market price reached a peak on March 29, 2000, of $8.95.

[607] Also in the spring of 2000, Richards decided to move from FCG, which did not have full

brokerage standing, to a full standing brokerage firm. He made a deal with BMO and moved. He

believed that he could move with his two biggest clients, Wadden and Courtney, with their large

accounts and margin debts secured by KHI shares; Richards was wrong. When BMO head office

reviewed the accounts, after Richards had moved, they expressed concern about the margin debts

secured by KHI shares and, despite lobbying by the Halifax branch, BMO head office would only

agree to accept the Wadden accounts on the basis that the KHI shares would be liquidated by a

deadline. The first deadline was June 1; this was extended to June 30, 2000.

[608] I find that Wadden was kept informed by Richards about the position of BMO head office

and the lobbying by the Halifax branch on his behalf. Wadden was confident that Potter would find

him a sale for 250,000 KHI shares by the end of June as promised in December 1999. While he

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knew of the BMO’s position, this did not stop him from transferring his accounts to BMO under

their conditions.

[609] At the end of June 2000, Potter did not come through with a buyer for Wadden’s 250,000

KHI shares. This was now a big problem for Wadden.

[610] Shortly after, in early July, Wadden learned that Courtney, who was in a similar financial

circumstance as him, had been advanced a $400,000.00 loan by KHI. Wadden felt betrayed by

Potter by this secret loan, which he had not been offered. He was under the same financial pressure

to reduce his margin debts.

[611] In March 2000, Wadden had realized he was not a good fit as an executive at a public

company, so he had resigned his position as an officer and director of KHI, and in June he was in

the process of leaving KHI to become a self-employed real estate developer. His finances were not

helped by the absence of an income.

[612] On learning of the Courtney-KHI loan, Wadden lost his cool. He got into heated exchanges

with Potter and, on one occasion, Potter’s prime facilitator, Colpitts. He refused to have any direct

dealings with them. He decided to sell his KHI shares on the market and advised Potter. Potter,

unlike Wadden, fully knew that, if Wadden started placing significant amounts of KHI shares on the

market, the market could not absorb them and the share price would decline significantly. KHI

would be adversely affected. Potter’s attempts to appease Wadden were not successful.

[613] KHI, through Colpitts, made threats to Wadden that he was a still an insider and that he could

not sell KHI shares, except with the consent of KHI, and in particular, not during “closed” periods.

Colpitts advised that his resignation as a director had not yet been accepted by the KHI Board.

[614] Wadden became more frustrated, and, on July 17, hired and first met with Brian MacLellan

Q.C., a corporate lawyer.

[615] Shortly before this time, in response to pressure from Wadden, Potter had caused 120,000

shares, heldbyone his numbered companies, to be transferred to Wadden’sNBFLaccount to replace

some of the 220,000 KHI shares that Wadden had placed in what he thought was KHI’s orderly

market account. He was trying to take the financial pressure off Wadden by giving him or shares

against which to borrow on in Wadden’s margin account.

[616] On July17, MacLellan sent an e-mail to Wadden outlining his understanding of his retainer.

It included three things: (1) arranging a sale of 250,000 KHIshares to Potter; (2) obtaining the return

of the remaining 100,000 KHI shares that Wadden thought was in KHI’s orderly market account at

NBFL; and, (3) arranging to free up the KHIshares he had transferred from FCG to BMO, and which

BMO was not prepared to let him sell without paying off his margin debt.

[617] MacLellan worked in respect of these three objectives for about one month without success.

Without explanation, his services were terminated by Wadden on or about August 24.

Page 96 of 139

[618] On the early morning of August 24, Wadden, who up to that point had refused to speak to

Potter, met with Potter for breakfast and later that morning attended KHI’s Board of Directors

meeting.

[619] I conclude that on or about August 23, Wadden had an epiphany. He realized that there was

no market for large quantities of KHI shares. He realized that it was not that Potter did not want to

find a buyer for Wadden’s shares; Potter could not find a buyer for his shares. He seems, by this

about-face, to have realized that there was little liquidity in KHI shares and his KHI shares were not

money in the bank.

[620] His only hope was to assist Potter to find substantial investors. This included helping to

maintain the market price of KHI shares, until KHI had new investors.

[621] The actions of Wadden from August 24, 2000, until the end of August 2001, when KHI

collapsed, clearlydemonstrate his efforts, with those of others, includingPotter, Colpitts and Clarke,

to manipulate the share price of KHI shares while looking for new financing and investors.

[622] This conclusion is based mostly on the documentary evidence generated in 2000 and 2001.

[623] In early March 2000, Potter asked Wadden to lend KHI’s orderly market account 100,000

KHI shares. Wadden understood Potter was asking for the same from the other major shareholders.

The purpose was to support the buying and selling of KHI shares in KHI’s orderly market account,

which was offside. While a more savvy person might, at this point, have asked more questions or

investigated the operation of the orderly market account, Wadden did neither. He immediately

retrieved his only available share certificate and endorsed it in accordance with the request of Potter,

then provided it Potter’s assistant to deliver to NBFL.

[624] I am not satisfied, on a balance of probabilities, that at that time, Wadden was aware that the

account was not an account in the name of KHIand that it was not being operated in accordance with

the applicable securities regulations and stock exchange rules. I am satisfied that he understood it

simply to be a mechanism to smooth out the buying and selling of KHI shares.

[625] Because the only share certificate available to Wadden at that time was one in the amount

of 220,000 KHI shares (he received five certificates of 220,000 KHI shares in exchange for his

interest in Micronet), he simply, as requested by Potter, endorsed it and gave it to Potter’s assistant

to deliver to Clarke at NBFL. He did not ask for return of the remaining 120,000 KHI shares in a

new certificate. He did not pay attention.

[626] Wadden later asked for the return of his 120,000 shares when he realized that the other

founding share holders were resisting Potter’s entreaty to contribute. I find that Wadden did not

know how the orderly market account was operated or that it was operated in a manner that was in

violation of securities regulations and stock exchange bylaw.

Page 97 of 139

[627] NBFL submits that the McInnis e-mail of February 3, 2000, to Clarke, copied to Wadden,

is evidence that Wadden knew of the 540 account, or a similar account in the name of KHI, and that

the account was being used in contravention of securities laws. I do not read that e-mail as

supporting that submission. The reference in that e-mail is to the 40,000 KHI shares of Dunham and

Wilsack, required to be sold by them, to pay KHI the $281,000.00 they owed KHI as calculated in

February 2000 audit respecting the sale of Innovative to KHI. In fact, Clarke sold these shares for

Dunham and Wilsack, not for KHI, or through the 540 account.

[628] For the purposes of NBFL’s submission, I note that the e-mail does not refer to the 540

account or a KHI orderly market account. The last sentence in the e-mail refers to the use of the

shares to support the market or fill pending orders.

[629] I do not draw the inference from the e-mail that Wadden was aware at that time of what Ifind

Clarke was doing to support the market illegally.

[630] On June 9, 2000, after Potter had arranged for 120,000 KHI shares held in one of his

numbered companies to be transferred to Wadden to replace 120,000 of the 220,000 KHI shares of

Wadden in the 540 account, Clarke faxed Wadden a letter setting out that the 220,000 KHI shares

were in Clarke’s private 540 account; that 120,000 had been returned to Wadden’s personal account,

leaving him with 100,000 KHI shares in the 540 account; and that Potter had place 120,000 KHI

shares and $100,000 in cash in the 540 account. Clarke asked Wadden to sign and return a copy of

the letter; Wadden’s evidence is that he did not do so.

[631] I was not satisfied with Wadden’s evidence respecting the fax sent to him by Clarke on June

9, 2000. His evidence was simply that he did not have an arrangement with Clarke. The fact that

he did not sign a copyof the letter acknowledging its contents, does not answer his claim that he was

unaware that his shares had been put into the trading account of Clarke’s numbered company. There

was no evidence before the Court, oral or otherwise, that when Wadden received the June 9 letter

he took issue with its contents. In fact, he appears to have been satisfied with the fact that he was

contributing 100,000 KHI shares to the KHI cause.

[632] Iconclude that Wadden knew, bymid-June 2000, that the account into which his KHIshares

had been placed was the 540 account of Clarke’s private company.

[633] MacLellan’s July 17 memorandum, summarizing his retainer after his initial meeting with

Wadden, Greenwood and Richards, identifies the return of the 100,000 KHI shares belonging to

Wadden and held in an NBFL account as an issue. In MacLellan’s oral evidence, upon review of

his notes, he confirmed that Wadden was aware and had advised him that the shares were in Clarke’s

numbered company account. It appears to have been MacLellan who was unclear of the basis on

which Wadden’s shares were deposited with NBFL.

[634] MacLellan’s July 20 letter to Clarke is premised on this understanding. His follow-up letter

to Clarke’s manager Hicks on August 2 maintains that understanding. Clarke’s August 4 reply to

MacLellan, drafted by Colpitts after a meeting on August 3 with Clarke and his manager Hicks at

Page 98 of 139

the NBFL office, simply repeats what the June 9, 2000, letter from Clarke to Wadden previously set

out.

[635] Late on August 3, 2000, MacLellan left a voice message for Colpitts, in which he refers to

Colpitts’ phone call to him from NBFL’s office that afternoon. The message is clear that MacLellan

then understood that Wadden’s shares had not gone to NBFL but to Clarke’s numbered company

account. MacLellan tells Colpitts in the message that he could stop writing about the shares if

Colpitts’ people had the ability to give NBFL 100,000 KHI shares so that Wadden could receive his

100,000 shares back.

[636] It was against NBFL policy for Clarke to be doing business with a client without approval

from NBFL’s head office. It was negligent for NBFL not to have been supervising Clarke’s 540

account and therefore not know about the issue raised by MacLellan with Clarke. This does not

change the fact that at least from the time Wadden received the June 9, 2000, fax from Clarke, he

knew where his shares were, even if he did not know precisely how they were being used.

[637] After Wadden’s epiphany on August 23, and meeting with Potter early August 24, several

communications evidenced participation in the scheme to support the KHI market price. Neither

Clarke nor anyone at NBFL was the registered market maker with the TSX for the KHI shares. That

was a Mr. Watson with BMO.

[638] Whether or not Clarke was satisfied with Watson’s performance of his job, it does not

change the fact that the scheme by which Clarke assisted KHIinsiders to artificially support the KHI

share price was a breach by Clarke and NBFL of their respective contractual obligations as stock

broker and stock brokerage company.

[639] The fact that MacLeod deposited 100,000 KHI shares into Wadden’s account on August 29

to free Wadden from any financial support of the 540 account does not diminish the evidence of

Wadden’s involvement in the scheme. He was still the second largest share holder in KHI and his

financial well-being was dependent upon KHI’s increasingly precarious and fragile financial

situation. I reject the submission that Wadden made peace with Potter and went along with the

scheme under duress only because Potter and Colpitts would prevent him from selling any shares

if he did not go along. Rather he realized that his only hope was for Potter to find wealthy

individuals or institutions to buy, and keep the KHI market price up in the meantime.

[640] Immediately after Wadden made peace with Potter, he was asked and agreed to take on the

responsibility of investor relations for KHI, effective September 1, 2000.

[641] When Ristow and Barthe agreed to subscribe byprivate placement to purchase 600,000 KHI

shares for $3,250,000.00 in four equal instalments, payable on November 15, 2000 and January 15,

May 15 and August 15, 2001, Wadden was part of the team of KHI insiders attempting to maintain

the share price.

Page 99 of 139

[642] Ristow was in the process of opening an NBFL account during the week of Monday,

November 13, 2000. At the same time, Colpitts’ law firm was preparing the agreements and

documents for submission to the TSX for their approval of the private placement, which approval

was conditionally received on November 21, 2000.

[643] In that context, Potter e-mailed Wadden, with a copy to Colpitts, on November 19, 2000,

advising Wadden that “. . . we don’t have a liquidity solution at the moment, but we meet with the

shareholders tomorrow.” He goes on:

As you know, we are closing on a $3,250,000 treasury issue to our German friends - we are hoping

to get this completed (closed) on Monday or Tuesday (November 20 or 21). The price of this issue

is $6.50 per share. If the market is driven down in advance of this issue, it is quite likely that the

investors will not close. This would be most harmful for the company and all of its shareholders,

including Steve. Hopefully he will be convinced to proceed with care, prudence and caution.

[644] At a board of director meeting on August 24, 2000, attended by Wadden, the Board

authorized the exercise of the call option on the KHLP units. On December 21, 2000, KHI gave

notice of the exercise of the option to redeem the units for KHI shares before January 1, 2001.

[645] On January 1, 2001, Potter e-mailed Wadden:

This is just a note to let you know that there _______ significant selling pressure on KHI on December

29^th- about 40,000 shares offered which did not get bought by the end of the day - 20,000 out of

Montreal, 15,000 from former CDE employees etc. I assume they will be back on Tuesday, January

2^nd. If you can be of any assistance in helping to find some buyers, that would be great. We have been

and will continue to be working on this in the coming days, but I am concerned that the selling may

exceed any support bids we can engender in the next few days.

[646] On or about January4, (transcribed January 5, 2001), Wadden left a voice message for Blois

Colpitts:

Hello Blois, is Calvin calling. Just talking to Dan and he had give me an idea with the LP being

converted back - there were shares available and he expedited those over to Bruce to allow some

support from his account and just . . . and I’m going to ask Bruce to do the same for mine if you can -

this is an authorization, I guess, if that’s okay with you, to send them over and if you see maybe a pick

up, well maybe 20,000 shares in the market with that use in the leverage - I guess as long as National

approves it, I’m going to give them a call right now and see if that’s okay on his side and maybe you

can give him a call when you get a second.

[647] At 10:50 a.m. on Thursday, January 4, Wadden e-mailed Colpitts: “Please forward my share

certificate for the converted LP to Bruce as soon as possible. I will be depositing to my margin

account and will be able to give to help Bruce take 20,000 shares of KHI out of the market if we can

do this today. Thanks.”

[648] The same dayClarke’s sale assistant acknowledged receipt of Wadden’s share certificate for

28,125 shares. Immediately following the transfer, Wadden used the new margin available in his

NBFL account to buy 20,000 KHI shares. At 11:57 a.m. on January 4, Potter e-mailed Wadden, in

part: “Thanks for the participation in purchasing shares.”

Page 100 of 139

[649] Wadden’s motive for wanting to support the market price of KHI shares is reflected in his

January 17 e-mail to Potter:

I am sure this is no surprise Dan and is not a plea for assistance, but I am personally extended to the

limit and not able to come up with a solution for this new wrinkle. If you have any ideas you would

like to put forward, I would like to hear from you. I had a margin call today from Yorktown on my

personal account for $60,000 due to the close of KHI at $5.60. I am sure this is the last thing you need

to hear, but $5.90 to $6.00 is where my account is not under pressure. Also Bruce has my account at

National margined and becomes an issue and under pressure at under $5.90. . . .

[650] On January 22, 2001, Clarke advised Wadden that his margin account at NBFL, with

outstanding debt of $1,140,000.00, was under margin by$69,000.00. He set out some scenarios that

would get it on-side.

[651] On January 31, Wadden replied to Clarke that he would like to cross 60,000 shares of ITI

and replace the value with KHI shares and cash. He added:

I have noted the KHI price today is $5.40 but I am using $5.10 for my calculations. This should cover

any margin requirements and provide a cushion if the stock continues in the $5.15 to $5.40 range.

Please let me know as soon as possible as I’m heading to Toronto Thursday morning and would like

to have this completed by then.

[652] The same day, Wadden e-mailed Potter, in part, as follows:

I haven’t heard from you since last week so I thought I would drop you an e-mail. From the look of

the market, it seems that we have had success in stabilizing the market and I hope we can look forward

to better days ahead. I’m glad to see Donnie [Snow] working as part of the team, as well as Ray and

I communicating again.

[653] On February 1, Potter replied to Wadden, in part:

Regarding the market, while we have had a few easier day, our support buying capacity is currently

nil. We badly need a few interested buyers over the next few days. Important sales at KHI are going

well and we now have 1.1 million committed in the private placement - it’s a challenge but we’re

making progress.

[654] On February 8, Wadden again e-mailed Potter under the heading “market support”:

I have been speaking with Ray, Blois and Ken throughout the day and they have been in supporting

the market. Ray and I would really like to get stock to $5.45 and try to solicit more support from the

group going forward. If we can get to $5.45 to $5.50, I would like to see each of us put 5,000 shares

into the support side and try to inch up toward $6.00 to $6.50 until we get some positive news on the

street. If we could come up with a formula to provide support, say 5,000 shares each, at each 15 to

20 cent gain forward, we could be building some reserve and give each of us some breathing room

until we attract substantial buyers. . . . Ray and Ken each purchased 4,000 shares today and have

agreed to pick up an additional 1,000 shares each by the close. Blois and I bought as well. Aside from

all the bad feelings, it was good to see the team work this afternoon. ...

Page 101 of 139

[655] Thenext day, Potter e-mailed the other fiveinsiders (Schelew, Wadden, MacLeod, Courtney

and Colpitts) under the subject heading “Coordination - Investor Relations, etc. by Calvin”, in part,

as follows:

This memo confirms my telephone conversations with each of you regarding formalizing an

arrangement with Calvin, whereby he will take on an active role of investor relations consulting on

behalf of KHI on a month-to-month basis for $5,000 per month. This role will include overall

coordination of all day-to-day retail market support as well as specific initiatives, including, but not

limited to: acting as the “administrator” under the “managed selling agreement” (Blois, we need to get

this written up ASAP . . . acting as the coordinator of the major shareholder group (the six of us who

sign the managed selling agreement) for all purposes, including meetings and other discussions and

actions regarding market support . . . acting as main day-to-day coordinator with some market makers

in KHI shares, including Bruce Clarke and any others that are brought in from time to time . . .

[656] Wadden explained at trial that this e-mail followed a meeting at Colpitts’ office of those

receiving the e-mail, during which Potter stated a belief that these shareholders were selling shares

on the market. Potter was not prepared to continue supporting sales on the market if, as he believed,

he was supporting sales by the founding shareholders. Either “we” were to help support the market

or he was moving to Vancouver and we were all going bankrupt. Wadden acknowledged KHI was

fragile at that point. He stated that Potter did not believe that these shareholders were not out selling

shares and wanted us to all show our investment account records each month.

[657] The Court notes that the trading records in the week leading up to this February 9 e-mail, the

Waddens sold in 17 transactions about 12,000 KHI shares (with settlement dates on February 8 and

9). Beginning the next week (settlement date February 15), Wadden made 35 purchases of KHI

shares between the price of $5.70 and $4.99.

[658] On February 13, Wadden responded to a Steve Wilsack e-mail, in part, as follows:

I had a meeting with Ken, Dan, Ray, Bernard at breakfast . . . I made a point to tell the whole table you are not

selling into them, you are actually buying (big impact and helped me convince Ray and Bernard to support and

help put the stock in the $6.00 plus range) . . . Dan and crew (Bernard, Blois, Ray and Ken) voted to put me on

retainer 5,000 a month. Nice to feel wanted again but the answer was no! I am in this for my own benefit and

they know it. My position is if we work as a team for our mutual benefit we all win big time. . . . Give me a call

and keep an eye on the market! I can honestly say I is the reason the damn stock ain’t at $4.00. I am working

for the shareholders!

[659] In an e-mail exchange the next day (February 14) Wadden wrote to Schelew, in part:

I spoke with Bruce Clarke just minutes ago and he has Dan’s stock and Ken is also buying. Thanks

for the team support! I am confirming Ray’s stock today. Bruce has mine and should be in good

shape this week. I was also speaking with Donnie Snow last night and I asked him to pledge stock in

an account with us for support if need be. At first he said definitely no but I wore him down to a

maybe. He will be part of the solution, I’m sure!

[660] On February 19, Potter e-mailed the five insiders to the effect that Calvin and he had just

spoken today by telephone and are asking that we all meet tomorrow “. . . to discuss further market

support including by us directly, through an investment account to which we all contribute some

shares and by working with third parties such as Doug Rudolph.”

Page 102 of 139

[661] On February 21, Schelew gave Wadden a summary of his investment in KHI. He reported

he had not sold any KHI shares, but after reviewing his financial situation “. . . I’m afraid I can’t

participate in any more rounds of buying.”

[662] In a March 1 e-mail from MacLeod to Potter, Wadden, Courtneyand Schelew, it is clear that

the news from the market was all bad and that “. . . on the staying alive side, there’s still a lot of if’s

. . .” He comments on “Calvin’s latest brain wave” of a sale of a bulk of their shares at a discounted

price to Keating as a way that “. . . the company has a much better chance of surviving in the short

term.”

[663] Even Potter’s e-mail to MacLeod, Schelew, Wadden, Courtney and Colpitts early the next

morning was pessimistic. He noted Wadden’s willingness to offer to Keating or Fountain to sell 1.4

million shares at a $1.83 (the amount of his margin debt on the shares), in order to get a substantial

investoron board. Potter added a strong recommendation that the fivemajorshareholders, asateam,

immediately commit to buy 5,000 more shares while they work on the options.

[664] On Friday, March 2, Wadden e-mailed MacLeod, Potter, Schelew, Courtney and Colpitts

following a meeting to discuss market support. He wrote, in part:

As of yesterday, the only additional support for KHI was Dan and I’m sure there is a limit to that. If

everyone does not have the ability or desire to purchase shares again today, I am once again saying

that I will not participate without everyone in the group involved. This is a difficult time for everyone,

but it was evident to me that without market support “the five of us” all buying at the same time, we

were faced with a tough decision. I am still putting my hand up and will be prepared to sell my stock

to clear my outstanding margin and leave something at the end.

[665] Wadden testified that he pulled his offer to sell to Keating his shares for the amount of his

margin debt because of tax advice he received.

[666] On March 6, Colpitts e-mailed Wadden, Potter, Schelew and MacLeod to state that he had

spoken to Schelew about Wadden’s withdrawal of his offer and Schelew was prepared to do a deal

as long as Courtney, MacLeod, Wadden and Potter agreed to provide proportionately 100,000 of

market support “conditional on the managed selling agreement previously discussed”, a draft copy

of which had been prepared and circulated by Colpitts.

[667] In a March 19 e-mail to Schelew, Wadden, MacLeod and Courtney, Potter asked for a get-

together the next day, to discuss “the private placement, managed selling agreement, market support

matters” and that it was critically important that all attend. He stated that Wadden would call them

to follow up.

[668] On July 8, Wadden e-mailed Potter from outside of Canada thanking for him updates and

adding:

I noticed we are under pressure in the market again. I wonder if Bernard had any more thoughts on

lending or selling his stock to use for support. My own financial issues aside, I think we all could do

a little more on the positive front to change the direction of the pressure. I think we should have a talk

Page 103 of 139

with everyone again. Seems to me that some of the team are running for cover and by doing so putting

a negative cloud over our efforts. I understand Ray is continuing to move assets around and is

working with his lawyer and Eric on the details. I also know Blois is frustrated and may sell his stock

to just cover his margin (plus $1.80). Blois mentioned that me one day and I’m not sure if he was

serious or just frustrated as we all are.

[669] These are only some of the communications involving Wadden and the stock manipulation

scheme. The stock transactions by Wadden and his family coincide with the communications.

[670] I conclude that Wadden was actively involved with Potter, Colpitts, Clarke and others in

artificially manipulating the stock price of KHI shares, not for the purpose of facilitating an orderly

market, but rather for the purpose of maintaining the price to protect their margin debts and the value

of their shares, until such time as they could put together a business plan sufficient to attract wealthy

investors.

E.

Causation

[671] NBFL argues that even if Clarke is found to have breached the applicable standard of care,

liability is not established because Clarke's actions did not cause the losses experienced by the

Dunlop Clients. NBFL submits that with the exception of Blackwood, none of the Dunlop Clients

sought or relied on any advice of Clarke regarding the acquisition of KHI shares. NBFL notes that

a number of the Dunlop Clients acquired their KHI shares as payment for purchases of their

businesses or through the conversion of KHI Limited Partnership units.

[672] The Dunlop Clients do not make a common submission on causation. Dunham argues that

but for Clarke's failure to disclose the existence of the 540 account, Clarke's relationship with

insiders, and Clarke's conflict of interest, he would neverhave deposited his KHIshares with NBFL.

The Barthe Estate argues that but for this non-disclosure, Barthe would never have invested in KHI.

Wadden does not argue non-disclosure (at least in the post-trial brief) and instead argues that NBFL

wrongly converted his shares, at least temporarily, and thus exposed him to risk of a future decline

in share value. Weir and Blackwood argue that but for Clarke's failure to execute their sell orders,

they would not have been holding KHI shares when the stock collapsed.

[673] In theirrebuttalbrief(May31, 2012), theDunlopClients altertheirsubmissionsoncausation

and submit that Clarke's fraudulent misrepresentation both vitiates their respective margin debts

owed to NBFL and grounds the secondary liability they claim for the collapse of KHI. Dunham,

Weir, and Blackwood contend that this concealment induced them to invest on margin. Wadden

argues that the concealment prevented him selling his shares in a timely manner, which forced him

to acquire the margin debt. The rebuttal brief is silent on the claim of the Barthe Estate.

[674] From a pleadings perspective, it is important that anypurported claim or defencebe included

in the pleadings (Rowe v New Cap Inc. (1994), 134 NSR (2d) 52, 1994 CarswellNS 186 at para 15

(SC)). There may be some leniency for giving pleadings a broad and generous interpretation where

litigants are self-represented (Sullivan v Victoria (City), 2010 BCSC 218 at para 2), but even

self-represented litigants are expected to comply with the requirements of pleadings (Sokol v

Page 104 of 139

Photonics Research Ontario, 2009 CarswellOnt 521 at para 21(Ont Sup Ct J); Benson v United Steel

Workers Inter-Alia Brotherhood of Maintenance of Way Employees, 2008 MBQB 94 at para 14).

Lawyers are expected to do a better job.

[675] In myview, the allegation that Clarke committed a fraud, in manipulatingthe market in KHI,

has always been part of this case from the pleadings stage onward. The Dunlop Clients' claim has

always been that Clarke actively concealed his manipulation, not that he was careless in his actions.

Counsel for the Dunlop Clients advanced a claim for careless omission of material information and

then proceeding as though the case were advanced as a deliberate omission of material information.

The tests for negligence and breach of contract, and fraud, are different. The Dunlop Clients'

post-trial submissions do not clearly delineate the specific cause of action and test that applies.

Nonetheless, I am satisfied that the Dunlop Clients have adequately pleaded fraud as a defence to

the margin debt claims of NBFL.

[676] Therefore, for the purposes of this decision, there are two tests that are relevant: 1) the test

for fraudulent misrepresentation as a defence to the NBFLdebt claims, and 2) the test for negligence

or breach of contract for the Dunlop Clients’ claims against NBFL.

[677] To establish fraudulent misrepresentation as a basis for rescission of a contract, the plaintiff

must prove, on a balance of probabilities, that the defendant: (1) made a false representation; (2)

deliberately or recklessly; (3) with the intention of inducing the plaintiff to contract, and (4) that the

plaintiff was induced to contract to his/her detriment (United Shoe Machinery Co. v Brunet, [1909]

AC 330 (PC); Royal Bank v Druhan (1997), 163 NSR (2d) 174, 1997 CarswellNS 438 (CA)).

Whether the claim is in tort or in contract, a plaintiff must establish that the defendant's actions or

omissions were at least a proximate cause of the damages suffered.

[678] Active concealment by silence or non-disclosure of a material fact can constitute a false

representation (Bank of British Columbia v Wren Development Ltd (1973), 38 DLR (3d) 759 (BC

SC); Wallace v Gummerson (1915), 8 OWN 35, Ruthenian Farmers Elevator Co. v Hrycak, [1924]

3 DLR 402 (Sask CA); Leeson v Darlow (1926), 59 OLR 421 (Ont CA)). However, the Dunlop

Clients face two difficulties in establishing fraudulent representation as a defence to their debt

obligations. Firstly, active concealment of market manipulation must be held to be a

misrepresentation. Secondly, this misrepresentation must have induced the Dunlop Clients to

contract.

[679] Market manipulation is a form of representation. The very purpose of market manipulation

is creating an artificial stock price or trading volume that induces investors to buy or sell the stock

in question. It follows that failureto disclosemarket manipulation canconstituteactiveconcealment

or non-disclosure of a material fact for the purposes of meetingthe fraudulent misrepresentationtest.

[680] I am satisfied that Clarke actively concealed his market manipulation scheme from his

clients. The problem, however, is that the Dunlop Clients were not universally induced to open

margin accounts with NBFL as a result of this misrepresentation. Wadden's margin debt was

assumed by NBFL when his account was transferred. Weir did not start his margin account for the

Page 105 of 139

purposes of purchasing KHI shares. Dunham was advised by Clarke to open a margin account, but

not for the purpose of purchasing KHI. In short, none of the Dunlop Clients were induced by

Clarke's market manipulation to open margin accounts. This is fatal to any claim for rescission as

a result of fraudulent misrepresentation linked to the market manipulation.

[681] With that said, Clarke's actions constitute fraudulent misrepresentation with respect to the

Weirs. Weir testified that he opened his margin account initially for cash flow purposes because a

KHI share certificate had yet to arrive in his account and he wanted to buya car for his wife and meet

an RRSP contribution deadline. Weir further testified that Clarke advised, as of February 28, 2001,

that the share certificate had not arrived. The documentaryevidence shows that the share certificate

did in fact arrive on February 28, 2001.

[682] I infer that Clarke’s misrepresentation was for the purposes of getting Weir to open a margin

account and not sell their KHI shares. In this circumstance, rescission is a remedy available to the

Weirs.

[683] Rescission is obviously available to Dunham for breach of fiduciary duties.

[684] Full rescission may not be available where it has been established that the Dunlop Clients

received an enduring benefit from the margin debt accrued, such as the Weirs' purchase of an

automobile. It would not be equitable to absolve the Weirs of this component of their debt

obligation to NBFL. Moreover, inducement is extinguished once the misrepresentation is disclosed

(Burrows v Burke (1984), 49 OR (2d) 76 (CA), leave to appeal to SCC denied (1985), 10 OAC 354

(SCC)). Once the Weirs learned that the share certificate was in their account, any inducement to

maintain the margin account was extinguished.

[685] Causation in the context of secondary liability securities litigation is an evolving area of the

law. Where there is a fiduciary relationship and the fiduciary breaches that relationship by failing

to disclose a material fact, there is no need to establish what the plaintiff would have done with the

information. Liability is established and proving causation is unnecessary (London Loan &Savings

Co v Brickenden, [1934] 2 WWR 545 (Ontario PC); Canson Enterprises Ltd. v. Boughton & Co.

(1989), 39 BCLR (2d) 177 (BC CA); affirmed [1991] 3 SCR 534; Reidy Motors Ltd. v. Grimm

(1996), 38 Alta LR (3d) 131 (QB)); reversed in part on other grounds (1997), 52 Alta LR (3d) 343

(CA); leave to appeal to SCC refused (1997), 226 NR 315.

[686] Where there is no fiduciary relationship, the approach in Canada has tended to differ from

that of United States. It is generally easier to establish liability in the United States. In Chasins v

Smith, Barney & Co, 438 F.2d 1167 (2nd Cir. 1970), the United States Court of Appeals for the

Second Circuit held that a stock brokerage firm's failure to disclose its legitimate market-making

status, in a security that it recommended to a client, was a material non-disclosure sufficient to result

in civil liability under the Securities Exchange Act.

[687] When the defendant's actions rise to the level of manipulation, the plaintiff must establish

that "but for" the defendant's unlawful means, the loss would not have occurred (Bastian v Petren

Page 106 of 139

Resources Corp., 892 F.2d 680, 685 (7th Cir. 1990), but there is a rebuttable presumption that a

plaintiff hasreliedon amaterialnon-disclosureormisstatement (SeeAffiliated Ute Citizens v United

States, 406 US 128 (1972) and Shapiro v Merrill Lynch, Pierce, Fenner & Smith, Inc, 495 F.2d 228

(2d Circ. 1974) for examples of material non-disclosures; See Blackie v Barrack , 524 F.2d 891, 907

(9th Cir.1975) [Blackie] and Basic Inc v Levinson, 485 US 224 (1988) for examples of material

misstatements). The reason for this rebuttable presumption of reliance is the "fraud on the market"

theory, which the 9th Circuit explained in Blackie as follows:

A purchaser on the stock exchanges…relies generally on the supposition that the market price is

validly set and that no unsuspected manipulation has artificially inflated the price, and thus indirectly

on the truth of the representations underlying the stock price-whether he is aware of it or not, the price

he pays reflects material misrepresentations.

[688] The Supreme Court of the United States reaffirmed the "fraud on the market" theoryin Dura

Pharmaceuticals, Inc v Broudo, 125 S Ct 1627 (2005). There, the Court held that there is a

rebuttable presumption of reliance, but that the plaintiff must establish that the defendant's

manipulation was a proximate cause of the economic loss suffered. In proving such causation, the

Court rejected the argument that there must be a direct link between disclosure of the alleged

misstatement and the price drop/economic loss.

[689] In Carom v Bre-X Minerals Ltd (1998), 41 OR (3d) 780, 1998 CarswellOnt 4285 (Ct J (Gen

Div.), Winkler J (as he then was) rejected the application of the "fraud on the market" theory in

Canada:

35

This is a pleadings motion and the amendments sought must be granted unless, to use the

language of the Supreme Court of Canada in Hunt, supra, it is plain and obvious that the assertion is

certain to fail because of a radical defect. In my view, there are several radical defects in the

proposition that it would be open to an Ontario court to find that the presumption created by the fraud

on the market theory is applicable to the torts of fraudulent or negligent misrepresentation.

36

In the United States the fraud on the market theory has one application: it is asserted in a

cause of action founded on a breach of a statutory duty. Here, the plaintiff's seek to apply the fraud on

the market theory and the resulting presumption to common law causes of action. They also seek to

apply the theory in these actions without the limitations which circumscribe its application in the

United States. However, the nexus, between the plaintiffs' claims and the theory, is absent without the

necessary statutory framework from which it emanated. Moreover, attempts to advance the theory in

common law actions in the United States have been almost unanimously rejected, and no appellate

court there has approved of the theory in the context of such actions. The theory was developed in

support of a legislative objective directed at securities fraud and the cause of action is accordingly

circumscribed by two important limitations of the statute, as judicially interpreted, specifically the

unavailability of punitive damages and a shortened limitation period. In contrast, punitive damages

are available under the common law torts, are claimed in the instant proceedings and the limitations

periods here are significantly longer than under the U.S. statute.

37

Furthermore, the s. 10(b) and Rule 10b-5 legislative objectives have been interpreted as

providing a cause of action based on fraudulent behaviour. See Central Bank of Denver, N.A. v. First

Interstate Bank of Denver, N.A., 511 U.S. 164 (U.S. Colo. 1994) In the instant case, the plaintiffs

Page 107 of 139

allege as against all the defendants, inter alia, fraudulent misrepresentation, negligent

misrepresentation and a breach of the Competition Act with the exception that fraudulent

misrepresentation is not alleged against the SNC-Lavalin Group. The plaintiffs seek to obtain the

benefit of an application of the theory and the resulting presumption to all of the pertinent causes of

action as alleged, even though fraud is not an element of all such causes of action.

38

Finally, as noted, central to the development of the theory's presumption of reliance aspect

in the United States is the requirement of a predominance of common issues for class action

certification under Rule 23 of the U.S. Federal Rules of Civil Procedure. The presumption of reliance

was adopted in part as a means to counter attempts by defendants to defeat the certification of Rule

10b-5 actions as class actions on the basis that individual issues of reliance predominated. In

comparison, the predominance of common issues requirement has not been incorporated into the CPA

in Ontario. As Moldaver J. stated in Abdool at 471:

...Likewise, I must respectfully disagree with [the] statement that the Act was not

intended to be used in circumstances where the individual issues to be determined

could be said to predominate the common issues. As will be seen, while I am of the

view that individual issues ought not to be completely ignored when considering

whether a "class proceeding would be the preferable procedure for the resolution

of the common issues" as required under s. 5(1)(d) of the Act, I cannot accept that

the legislature intended to incorporate the predominate issue test into the Act.

39

The adoption of the fraud on the market theory by an Ontario court cannot be justified where

neither the statutory duty, the cause of action founded upon its breach, nor the predominance test as

a procedural barrier to class proceedings exist. More so, the plaintiffs seek to apply the theory to

common law causes of action, to which it would not be applicable in the United States, and in a

wholesale fashion, without the restrictions which circumscribe it there. Simply put, the proposition

advanced is ill-conceived.

40

The torts of fraudulent and negligent misrepresentation are neither novel nor undeveloped

in Canada. Both have been canvassed by the Supreme Court of Canada and the pronouncements of

that court on the elements of each must be considered to be settled law. In my view, the presumption

of reliance created by the fraud on the market theory can have no application as a substitute for the

requirement of actual reliance in either tort. In the context of the torts of fraudulent and negligent

misrepresentation a presumption of the nature advocated for by the plaintiffs does not exist in

Canadian common law. Indeed, to import such a presumption would amount to a redefinition of the

torts themselves.

[690] This approach was followed in CC&L Dedicated Enterprise Fund (Trustee of) v Fisherman,

2001 CarswellOnt 4206 (OSCJ) at paras 59 to 62.

[691] In Kripps v Touche Ross & Co (1997), 33 BCLR (3d) 254, 1997 CarswellBC 925 at para 98,

leave to appeal to the SCC refused 225 NR 236, the British Columbia Court of Appeal held that

establishing actual reliance was necessary, but

that liability may be found where the plaintiff's reliance on a fraudulent misrepresentation is only one

of several factors inducing her to act. And it held, relying on Parallels Restaurant, supra, that where

a defendant has made a material misrepresentation calculated to induce the plaintiff to act as she did,

and where the loss is consistent with the plaintiff having acted on the misrepresentation alleged, the

burden of proof shifts to the defendant to prove that the plaintiff did not rely at all on that

misrepresentation.

Page 108 of 139

[692] The Court then proceeded to extend these principles in the context of negligent

misrepresentation.

[693] The underlying principles behind the "fraud on the market" theory are not limited to the

American statutory context. Price and volume are proximate factors on which any purchaser of a

security relies, at least to some extent.

[694] It is not necessary to apply the “fraud on the market” theory to the circumstances of any of

the Dunlop Clients. Clarke was an agent of each and in breach of his duty of honesty and good faith.

He participated in a deliberate scheme. It would be contraryto common sense to suggest that Barthe

would have not considered and relied on price and volume of KHI transactions in agreeing to invest

in KHI at $6.50 per share, or that Dunham or the Weirs would not have insisted on sale of their

shares but for the apparent price and volume of trades. This is clearlyreflected in Dunham’s reaction

to Clarke offering to sell KHI shares at the time Barthe was buying; Dunham noticed the activity in

the stock and Clarke had to convince him to sell.

[695] Since the Dunlop Clients have not advanced a claim for fraudulent or negligent

misrepresentation, reliance is not an explicit element of the applicable test, and the only question is

whether general negligence or breach of contract causation is established.

[696] Recently, in Clements (Litigation Guardian) v Clements, 2012 SCC 32, the Supreme Court

of Canada reviewed the law on causation in Canada, in the context of a negligence claim resulting

from a motor vehicle accident.

[697] The Court reaffirmed that the "but for" test is the normal test to apply, and held that the

"material contribution to risk" test is only to be applied in situations where there are multiple

tortfeasors collectivelyresponsible for the loss and it is impossible for the plaintiff (through no fault

of their own) to identify which specific tortfeasor caused the loss on a "but for" basis. The Court

also made some helpful comments on how to apply the "but for" test:

The "but for" causation test must be applied in a robust common sense fashion. There is no need for

scientific evidence of the precise contribution the defendant's negligence made to the injury.

[698] A common sense inference of "but for" causation from proof of negligence usually flows

without difficulty. Evidence connecting the breach of duty to the injury suffered may permit the

judge, depending on the circumstances, to infer that the defendant's negligence probably caused the

loss.

[699] Where "but for" causation is established by inference only, it is open to the defendant to

argue or call evidence that the accident would have happened without the defendant's negligence,

i.e., that the negligence was not a necessary cause of the injury, which was, in any event, inevitable

[citations omitted] (Clements at paras 9 to 11).

[700] Case law applying the "but for" test in the securities context is consistent with the common

sense approach to the "but for" test advocated by the Supreme Court of Canada. This is important

Page 109 of 139

because investors will often be faced with arguments that they would have acted in a particular

manner despite the defendant's breach; such arguments may be hard to dispel if the plaintiff is

required to establish, with scientific exactitude and ignoring the benefits of hindsight, what he/she

would have done.

[701] In Northey-Taylor v Casey, 2007 ABQB 113 at para 62, additional reasons at 2007 ABQB

306, aff'd 2008 ABCA 149, the Court rejected the defendant stock broker's submission that the

plaintiffs would have proceeded with the purchase even if they were adequately advised of the risk

and held "that the focus should not be on the allure of the transaction but the fact that the Plaintiffs

were denied the chance to make an informed decision." In Chasins v Smith, Barney & Co, 438 F.2d

1167 (2nd Cir. 1970), the United States Court of Appeals for the Second Circuit held that a stock

brokerage firm's failure to disclose its market-making status, in a security that it recommended to

a client, was a material non-disclosure sufficient to result in civil liability under the Securities

Exchange Act. The Court reasoned that the focus was not on whether the firm sold the security at

a fair price, but whether it deprived the plaintiff of information that would have influenced his

decision to purchase the security.

[702] In this case, the only Dunlop Client who was aware of Clarke's activities was Wadden, and

he only learned of the 540 account at a later stage. It is true that Clarke did not generally advise the

Dunlop Clients to purchase KHI, but the evidence establishes that Dunham, at the very least, would

have diversified his holdings "but for" the actions of Clarke, and the Weirs would have insisted on

their January 19, 2001, e-mail instruction to sell “but for” the actions of Clarke. These actions

included deliberate refusals to execute sell orders and the creation of an artificial price and volume

in the KHI shares. The evidence suggests that Weir, in particular, relied on this price and volume

information in his decisions to not insist on selling at $5.00 at particular points.

[703] There is substantial evidence linking Clarke's market manipulation to the collapse of KHI.

The manipulation may not have been the only reason for KHI's collapse, but it was a fundamental

factor, and at the very least, prolonged the time before there was an ultimate reckoning in the price

of KHI. This prolongation allowed Barthe to be brought in and defrauded bythe conspiracybetween

Clarke, Potter andColpitts. Themarket manipulation deprivedDunhamandWeiroftheinformation

they needed to make informed decisions with respect to their portfolios.

[704] From the evidence of Clarke's market manipulation, which was a serious breach of the

standard of care, even at the most basic level of an order taker, and the linkage between this

manipulation and the losses suffered by the Dunlop Clients when KHI collapsed, it can be inferred

that Clarke's wrongdoing probablydid causethe losses suffered byDunham, Weir and Barthe. Ifind

that "but for" Clarke's failure to disclose his market manipulation and ongoing conspiracy, Dunham

and Weir would have liquidated their entire position in KHI, and Barthe would not have purchased

any stock in KHI. Subject to my finding respecting Barthe’s last two installments in the private

placement, I find that Clarke caused the losses experienced by these Plaintiffs.

[705] The same cannot be said about Wadden. Wadden discovered the market manipulation and

conspiracy. He was faced with a choice of losing everything and then suing to recover his losses or

Page 110 of 139

participating in the scheme with the hope that Potter would be able to find a buyer to allow him to

sell his shares and exit the conspiracy. He chose the latter.

[706] Wadden was certainly faced with a difficult choice, but it can hardly be said that "but for"

the actions of Clarke, Wadden would not have suffered the losses he experienced. Wadden’s losses

occurred after he assumed the risk and responsibilityof holding the second largest stake in the equity

of KHI.

[707] Wadden knew about the box account and that KHI was being manipulated by Clarke and

others. He took a chance; it did not pay off. It was Clarke that pushed Wadden to the precipice, but

it was Wadden who chose to remain there, and it is Wadden that must bear the responsibility for any

damages that resulted from him falling off.

F.

The Defence of Ratification

[708] NBFL pleads the defence of ratification. It argues that the Dunlop Clients' failure to

complain about the transactions in their respective accounts means that they acquiesced, and

therefore ratified, those actions of which they now complain. The Dunlop Clients argue that they

could not ratify that of which they were unaware.

[709] In Connolly v Walwyn Stodgell Cochran Murray Ltd (1993), 121 NSR (2d) 278, 1993

CarswellNS 436 [Walwyn], the Court of Appeal held that a failure by the plaintiff investor to

repudiate unauthorized trading on the part of his stockbroker meant that the plaintiff had acquiesced

to the trading, and as a result of this ratification, could not claim against the brokerage firm for

failure to supervise. The Court stated that when the plaintiff "first discovered the unauthorized

trading, his only option so far as [the brokerage firm] was concerned was to terminate the contract"

(Walwyn at para18). See also Grenkow v Merrill Lynch Royal Securities Ltd, MacFaddenand Smith

(1983), 23 Man R (2d) 54, 1983 CarswellMan 278 (QB) [Grenkow] for the proposition that silence

can amount to ratification.

[710] In Forrest v Gairdner & Co (1962), 33 DLR (2d) 575, 1962 CarswellBC 81 (BC CA), the

British Columbia Court of Appeal held that the time period in which an investor was required to

repudiate a transaction began to run when the investor knew or ought to have known of the

transaction.

[711] There are two general situations where silence or apparent consent will not amount to

ratification.

[712] The first is where the investor lacks knowledge of the transactions or the legal significance

of these transactions (Ryder v Osler, Wills, Bickle Ltd (1985), 16 DLR (4th) 80, 1985 CarswellOnt

1423 at para 43; Dixon v Deacon Morgan McEwen Easson, 1990 CarswellBC 1726 at para 17). As

theauthorofBowstead&Reynolds on Agency, 17th ed(London: Sweet&Maxwell, 2001)explains:

Page 111 of 139

In order that a person may be held to have ratified an act done without his authority, it is necessary

that, at the time of the ratification, he should have full knowledge of all the material circumstances in

which the act was done, unless he intended to ratify the act and take the risk whatever the

circumstances may have been. But knowledge of the legal effect of the act may be imputed to him,

and it is not necessary that he should have notice of collateral circumstances affecting the nature of

the act. [footnotes omitted]

[713] The second is where there is a fiduciaryrelationship between the broker and the investor, and

the broker's actions breach that relationship to the extent that "it corrodes the very nature of the

relationship itself" (Williamson v Williams (1997), 160 NSR (2d) 106, 1997 CarswellNS 283 at para

78 [Williamson]; See also (1996), Penner v Yorkton Continental Securities Inc., 183 AR 5 (QB)).

In Williamson, the Court of Appeal held that even though the plaintiff's acquiescence might have

amounted to ratification in contract, the broker's breach of the fiduciary obligations of trust and

loyalty owed to the plaintiff meant that ratification did not operate as a full defence.

[714] In a recent decision, Hayward v Hampton Securities Ltd (2002), 46 BLR (3d) 43, 2002

CarswellOnt 5919 (Ont Sup Ct J), the Ontario Superior Court of Justice reviewed this case law on

ratification in the context of an investment advisor/client relationship that was covered by a deemed

ratification clause. The Court noted that Walwyn and Grenkow "both involved sophisticated

investors who, after acquiring knowledge of unauthorized acts, participated in schemes to conceal

unauthorized transactions from the defendant brokerage firms" (Hayward at para 201).

[715] The Court concluded that even if ratification was available in a breach of fiduciarydutycase,

the plaintiff had not ratified the investment advisor's "exploitation of her trust and confidence." The

Court held, at para 206:

In my opinion she need not know the full legal effect of [her investment advisor's] actions but she did

need to know the material circumstances surrounding his actions so that she could make an informed

decision. This included knowledge that the rules of the firm and the industry did not permit

discretionary trades in these circumstances. It also included knowledge of the change in the stated

objectives for her account and awareness of the lack of suitability of the investments. Again like [in

Williamson], the advice [the plaintiff] received from [her investment advisor] was that she need not

worry, he was looking after her. She was not placed in a position to make an informed decision and

in those circumstances her actions or inaction may not be treated as constituting ratification. Lastly,

I accept her evidence that she repeatedly complained to [her investment advisor] about not trading

without her authority to no avail. She felt powerless in the circumstances. It was clear that she did not

intend to ratify his discretionary actions. In my view, he abused the trust she placed in him. He cannot

now shelter under her inability to deter him.

[716] The relationship between Clarke and the individual Dunlop Clients varied, ranging from a

mere order taker to a full fiduciary agent. These distinctions are irrelevant to the defence of

ratification in the circumstances of this case.

[717] With the exception of Wadden, none of the Dunlop Clients were aware of Clarke's market

manipulation scheme in KHI and his fraudulent behaviour. Even though the Dunlop Clients did not

advance a case for fraudulent misrepresentation, deceit, or conspiracy, I am satisfied that they did

plead fraud.

Page 112 of 139

[718] "A contract induced by fraud is voidable" by the defrauded party (GHL Fridman, The Law

of Contract in Canada, 5th Ed (Toronto: Thomson Carswell, 2006) at 293; Farah v. Barki, [1955]

SCR 107; TWT Enterprises Ltd v Westgreen Devs (North) Ltd (1991), 78 Alta LR (2d) 62 at 78

(QB)). To the extent that the Dunlop Clients' apparent ratification is an independent contract, I am

satisfied that it was induced by Clarke's fraud.

[719] More important, I am of the view that Clarke's market manipulation was a material

circumstance that the Dunlop Clients must be found to have been aware of in order to find that

acquiescence amounts to ratification. The various Dunlop Clients could not ascertain the suitability

of Clarke's investment advice, his management of their accounts holding KHI, or his buy/sell

decisions or omissions, without understanding that he was simultaneously manipulating the market

in KHI.

[720] Dunham and the Weirs were not aware of Clarke’s market manipulation activities. This

defeats NBFL’s ratification argument with respect to their claims.

[721] The situation is difference with regards to the Barthe and Wadden Claims.

[722] Barthe first became aware that Potter and others were supporting the stock in the January19,

2001 fax. The contents of their communications with Potter thereafter clearlyshow a change in their

attitude. As noted before, I conclude that Barthe (and Ristow) had their eyes opened with regards

to KHI’s market support program. There was no evidence at trial to suggest that Barthe (or Ristow)

knew the time frame for that market support activity; that is, how long before January 19, 2001, it

had begun. Further, there was no evidence before the Court as to the extent of the disclosure to

Barthe and Ristow of that market support before January 19, 2001.

[723] I have also already determined that Barthe did not participate in the stock manipulation

scheme. He politely made excuses not to participate, but he was in a quandary of what he should,

at that point, do.

[724] Barthe now knew that KHI insiders were manipulating the public stock price.

[725] He could either refuse to advance the remaining two instalments of $1,625,000.00 that he

was legally obligated to pay under the Subscription Agreement for the private placement and risk

litigation, both for the payment of that sum and possibly for any consequences to KHI flowing from

a refusal to paythe remaining subscription instalments, or, alternatively, lose the $3,325,000.00 that

he and Ristow had already invested in KHI by paying his remaining obligation and hope that KHI

survived. Clarke (and NBFL) was not in a fiduciary relationship with Barthe.

[726] While there is no evidence that Barthe should have known how long the manipulation had

gone on, or even, at that point, Clarke’s role in it, Barthe advanced to KHI the last $1,625,000 with

knowledge of the stock manipulation scheme by KHI insiders. For the purposes of the last

$1,625,000.00 payment, Barthe acquiesced to what he knew. He ratified payment with knowledge

of a stock manipulation scheme affecting the public share price of KHI shares.

Page 113 of 139

[727] He did not ratify Clarke’s fraud in respect of the 259,000 shares he had purchased in August

2000. It is not reasonable to expect that in the circumstances as described by Potter after January19,

2001, that he could have sold those shares on the market and recovered any of the $1,700,000.00

purchase price.

[728] Wadden knew, or should have known, of the stock manipulation efforts of Potter and Clarke

after he received Clarke’s June 8, 2000, letter outlining the deposit of his share certificate for

220,000 KHI shares into Clarke’s 540 account.

[729] By August 24, 2000, he had become a member of the stock manipulation scheme and, as of

September 1, was KHI’s “Investor Relations” coordinator. There is no evidence that Wadden was

refused by NBFL (or BMO) the opportunity to sell any KHI shares after August 24, 2000. The

evidence is that Wadden not only kept the shares he had, but purchased many more.

[730] Wadden’s claim against NBFL appears to be primarily that:

a)

b)

he never agreed to lend 220,000 KHI shares to Clarke’s 540 account and when he

tried to recover those shares, he was given back 120,000 KHI shares, but not his

120,000 KHI shares, and was unable to obtain the remaining 100,000 KHI shares

until September 25, 2000, after he had made peace with Potter on August 24; and

NBFL refused illegally to permit him to sell KHI shares between early July and

August 24, 2000.

[731] After August 24, 2000, Wadden was part of the stock manipulation scheme. It is not alleged

that he was prevented by NBFL from selling KHI’s share after August 24. Therefore, ratification

is not a live and real issue in the disputes between Wadden and NBFL.

[732] Iagree with NBFL’s post-trial submission (paras 105 to 122) to the effect that there was only

one instance when NBFL refused to follow Wadden’s instruction to sell KHI shares. On August 11,

2000, Wadden phoned Clarke to sell 3,000 KHI shares at $6.50. Clarke called Colpitts and, in the

advice of Colpitts, refused Wadden’s instructions. The Court does not accept Wadden’s evidence

that in mid-July, and in particular, on July 19, that he instructed NBFL to sell his KHI shares. For

that, the Court prefers the evidence of MacLellan and the analysis of NBFL in their brief. The issue

of ratification is not relevant to the Wadden claim.

G.

NBFL’s Claims against Barthe and Wadden

Against Barthe

[733] NBFL third-partied Barthe for any liability found against it.

[734] The actual basis of the claim is NBFL’s allegation that Barthe was treated as a director at the

time he was advised that the share price was being supported. Barthe took no steps to caused the

manipulation to be disclosed.

Page 114 of 139

[735] It cites United Services Funds v Lazzell, 1998 CarswellBC 245 (BCSC) at paras 307 to 310.

In that case, two directors became liable in a stock manipulation scheme, where they became aware

of it and did not disclose it. The relevant paragraphs in the decision are 307, 308 and 310, they read

as follows:

307

But not only was silence concerning these statutory breaches an act of assistance but so also

was silence when the price of the shares of the companies of which they were directors shot up not for

a rational reason but from trading which was patently a breach of s. 340(b) and (c) of the Criminal

Code. Although there was no evidence form any of the officers of the fund as to what they would have

done had they been apprised, in December 1984, of these goings on of illegal trading and breach of

the Securities Act, I am satisfied from the action which the fund took in May 1985 that, if so apprised,

it would have taken then the same action that it took in May 1985.

308

In my opinion, they had as directors a duty to the fund as a principle shareholder to apprise

it of the relevant facts as to control and illegal trading whether or not they had, as directors, a duty to

inform the fund of the scheme of bribery itself.

. . .

310

Thus, it follows that in my opinion they are liable to the plaintiffs, subject to which I have

to say about the application of the moneys recovered so far, for losses suffered on the purchase of

shares of the companies in which each of them was a director made on or after the respective dates

which I have determined were the dates of their knowledge.

[736] NBFL’s argument is novel.

[737] Barthe was never a director of KHIand was never offered the position of director. His friend

Ristow was promised a directorship in October 2000, when he and Barthe agreed to invest

$3,250,000.00 in the private placement, but even then KHI deferred appointing Ristow a director

until eight months later, on June 27, 2001. Ristow never attended a directors or shareholders

meeting.

[738] At the original meeting at the airport in October 2000 that lead to the Subscription

Agreement, KHI offered Barthe the opportunity to attend in Ristow’s place any directors meetings

that he may miss. Barthe never attended any directors or shareholders meeting.

[739] Ristow, andlikelythereforeBarthe, didreceivesomeinformationfromPotter/KHIbeginning

in January 2001 about the affairs of KHI. Some of that information was not generally available. In

that sense, it was confidential. From October 22, 2000, Barthe and Ristow had asked Potter and KHI

for a copy of its five-year plan. They had been promised it but were repeatedly put off and never did

receive it.

[740] NBFL did not advance, and the Court is not aware of any principle of law or relevant

legislation or case law, that would support the proposition that a shareholder in a company, who has

been provided with some of the memoranda to the directors, has an obligation to a third party like

NBFL to blow the whistle when he or she or it becomes aware of a stock manipulation scheme in

a company in which he is a shareholder.

Page 115 of 139

[741] Even if the principle in Lazzell applied to a shareholder like Barthe, this liability would only

relate to losses suffered on the purchase of shares in the company made on or after the date of their

knowledge (para 310).

[742] Three facts are relevant to any possible liability of Barthe, if Lazzell might impose liability

on him to NBFL.

[743] First, there is no evidence of purchases made by Dunham or the Weirs after Barthe became

aware that a stock manipulation scheme existed.

[744] Second, there was no evidence before the Court as to depth of Barthe’s knowledge of what

the stock manipulation scheme consisted of, other than the contents of Potter’s fax of January 19,

2001. There is no evidence if he ever became aware of the 540 account or the length of period of

time during which the manipulation had gone on. I would be surprised if he was aware that it had

been going on long before his first purchase of shares on the market using NBFL and Clarke as his

broker.

[745] Thirdly, NBFL had earlier access to more information and therefore more reason to be

suspicious of the activities of the stock manipulators, especially Clarke, than Barthe. Roby, Senior

Vice President Compliance at NBFL, had directed Clarke (and Hicks) to reduce NBFL’s position

(those of their clients and of Clarke personally) in KHI shares and to refrain from buying more KHI

shares in both July and September 2000. The account and trading records available to NBFL, and

upon which the decision by Roby to direct a reduction in exposure to KHI in 2000, should have

painted a clearer picture to NBFL than what Barthe saw after January 19, 2001.

[746] Barthe should not be liable to NBFL for a stock manipulation scheme that NBFLshould, but

for its failure to supervise the 540 account and Clarke generally, have known about since shortly

after March 2000 and especiallyafter the meeting held between Hicks, Colpitts and Clarke in Hicks’

office on August 3, 2000.

Against Wadden

[747] NBFLclaims against Wadden as a manipulator, as the onlyremaining defendant in the Main

Action, and as third party in the Debt Action and the Barthe action.

[748] Waddenjoinedas well as knowinglyand intentionallyparticipated in the stockmanipulation

scheme after August 24, 2000.

[749] Clarke knowingly and intentionally participated in the stock manipulation scheme, from not

later than the first of March, 2000.

[750] Dunham’s claim against NBFL is based upon Clarke’s breach of his fiduciary duty and

failure to diversify his account. While Clarke was a participant in the scheme from March 2000, he

is separatelyliable to Dunham by reason of his failure to full his fiduciary obligation and to diversify

Page 116 of 139

Dunham’s account. Said differently, Wadden’s participation in the scheme after August 24, 2000,

was not the cause of Dunham’s loss.

[751] In addition, NBFL’s liability to Dunham is, in part, based on the manner it treated Dunham

during this litigation.

[752] The Weirs/Blackwood claims are based on Clarke’s failure to sell their KHI shares when

instructed on January 19, 2001 (if the price fell below $5.00). Instead, he actively dissuading them

from selling without disclosing his conflict of interest and the stock manipulation scheme.

[753] The reason Clarke did not sell the KHIshares held bythe Weirs and Blackwood was because

of his participation in the stock manipulation scheme. Clarke and his cohorts were running out of

money to support the public market price of KHI; additionally, they were at the limit of their margin

debt and in danger of facing margin calls if the KHI price dipped.

[754] Wadden was an active participant in the scheme at this time. Wadden is liable jointly and

severally with NBFL for the loss to the Weirs and Blackwood in the value of their KHI shares.

[755] NBFL’s liability to the Weirs and Blackwood is based in part on the manner in which NBFL

treated them in this litigation. Wadden is not liable to NBFL for that aspect of NBFL’s liability to

the Weirs and Blackwood.

[756] Barthe’s claim against NBFL is based solely on Clarke’s participation in the stock

manipulation scheme and the fraud perpetrated Barthe by reason of it.

[757] NBFL’s liability is limited to the original August 2000 purchase of 259,000 KHI shares by

Clarke for Barthe on the market, mostly from KHI insiders as directed by Potter. His liability does

not extend to thelast two instalment payments on the Subscription Agreement, madebyBarthe, after

January 2001, when he became aware of a stock manipulation scheme.

[758] The original deal between Barthe on the one hand and Potter / Sullivan / KHI on the other

was made on August 3, 2000 (signed all parties byAugust 14). On August 23, Clarkecommunicated

with Barthe with regards to setting up an account at NBFL and act as his agent to purchase the

shares. Barthe’s account at NBFL was open and in receipt of Barthe’s money by Monday, August

28, 2000. Clarke immediately commenced purchasing shares. On August 29, he did the trade from

himself to Colpitts for 43,300 KHI shares and of Colpitts to Barthe for 73,300 shares. At the same

time, he arranged for the sale by Wadden and Courtney of 50,000 KHI shares each.

[759] Wadden was aware, at the time that the purchases were being made by Clarke for Barthe, of

the stock manipulation scheme and he participated in the sale and benefited by it. He is liable to

NBFLjointlyandseverallyforthe liabilityof NBFLto Barthe respecting the purchaseofthe259,000

KHI shares.

H.

Waddens’ Claims against BMO Nesbitt Burns

Page 117 of 139

[760] Calvin Wadden, Andrea Wadden, and Wadden’s numbered company3019620 Nova Scotia

Limited, claim against BMO for breach of contract and negligence. Both before and during trial,

counsel for the Waddens and BMO expressly represented to the Court that, despite the plaintiffs’

pleadings, they were not advancing the pleading that BMO participated in the stock manipulation

scheme. BMO Nesbitt Burns was not required to evidence with respect to any other claim except

breach of contract and negligence.

[761] In post-trialsubmissions, counselfortheWaddensparticularized BMO’s conductunderlying

their claim as:

a)

failureof BMO Nesbitt Burns to advise the Waddens in advance of transferringtheir

accounts of the restrictions that would be placed on their accounts if they were

moved to BMO.

b)

improper “freezing” of their account from July 10, 2000, to August 24, 2000.

[762] The only evidence called by BMO was Robert Lowe (“Lowe”), a chartered accountant and

business valuator. Hegaveopinion evidencewith respecttotradingin KHIshares. Lowe’s evidence

was to assist the Court in calculating losses claimed to be suffered by the Waddens from the alleged

freezing of their accounts between July 10 and August 24, 2000. BMO called no witnesses

respecting liability itself.

[763] The Waddens submit that the failure of BMO to call evidence should lead the Court to

exercise the discretion to drawan adverse inferenceagainst BMOwith regards to anyof the evidence

given by the Waddens and not contradicted by evidence of witnesses under the control of BMO.

Counsel cites the text by Allan W. Bryant, Sidney Lederman and Michelle Fuerst, The Law of

Evidence in Canada, 3^rdEd., CR Faulkenham Backhoe Services v Nova Scotia, 2008 NSCA 38 and

Northern Wood Preservers v Hull Corporation Shipping (1969) Limited, [1973], 42 DLR (3d) 679.

[764] Counsel argues that the issue of credibility should be resolved on the basis of the only

evidence given orally at trial: Wadden, Ms. Wadden, Banks and MacLellan.

[765] Counselsubmits that BMOfailedto callRichards, ShirleyLocke, Michael Meredith orCarol

Cushing, and no other evidence, expert or otherwise, that would show it was legallyentitled to freeze

the Wadden accounts, which, Wadden alleges, was done wrongfully at the request of Colpitts.

[766] Effectively, Wadden asks the Court to find that on August 24, 2000, Wadden gave up in his

efforts to fight Colpitts and Potter because of their seeming ability to have his accounts frozen

wherever they were held. After that date, Wadden began cooperating with Colpitts and Potter,

making no further efforts to sell large amounts of shares, because he knew that the moment he

stepped out of line, conditions, like those imposed by BMO, would be reimposed. Based on that

scenario, BMO was the keyplayer in putting the “screws” to the Waddens who, under duress, agreed

to terms with Potter and Colpitts and did not thereafter attempt to sell their shares. Their direct

losses from foregone share sales after July 10, 2000, are claimed in the amount of $2,261,939.00.

Page 118 of 139

[767] TheWaddensalsoclaimconsequential lossesflowingfromthefreezingoftheiraccountsand

their inability, between July 10 and August 24, 2000, and thereafter, to sell their shares. They point

to Athey v Leonati, [1996] 2 SCR 458, for the proposition that they need not prove that BMO was

the sole cause of the consequential damages, only a cause.

[768] The consequential damages they claim are: interest paid on margin debt, losses on trades in

non-KHI shares, mortgage interest paid on real estate, certain life insurance fees, legal fees, the

losses arising from the forced sale of their Halifax South End residence and Baddeck summer

property, and Calvin Wadden’s loss of income for three years. The total is $3,374,592.20.

[769] In its post-trial submission, BMO denies that it breached its contract or acted negligently in

relation to the transfer of the Wadden accounts from FCG. With respect to the second claim

(refusing to execute orders to sell KHI shares from July 10 to August 24, 2000), its defence is that

it was reasonable to treat Wadden as an insider and in a special relationship with KHI during that

period of time.

[770] BMO disputes many of the Waddens post-trial factual submissions, as referring to facts not

in evidence.

[771] Regarding the Waddens submissions about drawing adverse inferences by its failure to call

Richards, Locke, Meredith or Cushing, BMO says that at the end of Wadden’s case there was no

need to call evidence. These witnesses were no longer employees of BMO and not in their exclusive

control. These witnesses had been discovered by the Waddens. The Waddens had been free to call

them as witnesses themselves. BMO at no time undertook to call them as witnesses. Counsel cites,

St. Elizabeth Home Society v Hamilton, 2010 ONCA 280; Lambert v Quinn (1994), 110 DLR (4^th)

284; Levesque v Comeau, [1970] SCR 1010; Canada Trustco Mortgage Co v Co-operators General

Insurance (1997), 1 CCLI (3d) 22 (NSCA) and Doiron v Hache, 2005 NBCA 75.

[772] BMO says credibility (and I infer reliability) of the Wadden witnesses is an important issue.

It argues that the Wadden’s evidence is not credible or reliable. The Waddens’ evidence was

coloured by the numerous discussions they had over the years; the absence of any contemporaneous

notes by Wadden, and the fact that the notes of Ms. Wadden (her diary), do not corroborate

Wadden’s version of events. BMO submits that Ms.Wadden was strongly motivated to support her

husband, and even testified that “the ends justify the means”.

[773] BMOsubmits thatGreenwood’s evidenceshould beviewedfromtheperspectivethathewas

a close friend and employee of the Waddens and, at one point, sent a letter on their behalf that

contained untrue statements. Banks’ memory of events is suspect by reason of his failure to make

contemporaneous notes and his admission that a little of his memory of events was faulty.

[774] Finally, BMO submits that, where there is a difference in the testimony of the Waddens and

their lawyer MacLellan, the evidence of MacLellan, who had no vested interest in this litigation and

who made extensive contemporaneous notes, should be found credible and reliable.

Page 119 of 139

[775] Forreasons, manyofwhichareexpressedearlierin this decision, IfoundWadden’sevidence

to be not credible or reliable. BMO submits that Wadden’s tendency was to look for reasons to

blame others for his own actions and not take any responsibility for his own decisions; I agree.

[776] The effective cross-examination of Ms. Wadden left the Court placing no reliance or credit

on her evidence.

[777] The Court found the evidence of MacLellan to be both credible and reliable.

[778] Contrary to the submissions of BMO, the Court found the evidence of Banks to be

straightforward. Headmitted to the limitations of his memorywith regards to the particulars of dates

and times of conversations between him and Locke, but he was firm in his memory of the

discussions. He had no agenda. He has remained a client of BMO throughout, and of Locke - the

latter until the commencement of the litigation when, at her request, he ceased being her client. His

evidence was credible and reliable. I accept his evidence.

[779] To establish that BMO was negligent, the Waddens had to prove that BMO owed them a

duty of care; that BMO breached the duty and standard of care; that the Waddens suffered a loss or

damage; that the breach of the duty and standard of care by BMO was the proximate cause of the

Waddens’ loss, and that no defence or bar to recovery negated or mitigated their loss.

[780] Prior sections of this decision deal with the duty and standard of care of a stock broker to its

client and to the issue of causation. Those statements of law apply to the Waddens claim against

BMO.

[781] The starting obligation of a broker, as an agent, is to act scrupulously, fairly, openly and

honestly with its principal.

[782] The particulars of the agent’s duties and standard of care depend upon the particular

relationship. The circumstances differ in each case.

[783] Thetwo particularbreachesofthestandard of care alleged bytheWaddensagainstBMOare:

a)

b)

not advising of restrictions that would be placed on their margin accounts on moving

from FCG to BMO; and,

improperly freezing their accounts between July 10 and August 24, 2000.

[784] The standard of care is informed by the provisions of the Account Agreements (Austral

Imports Inc. v Bank of Montreal, [2006] ABQB 428). The duty and standard of care are the same

in contract and in negligence. The standard of care is also informed by any evidence tendered of the

applicable statutes, regulations, stock exchange rules and industry practice.

[785] In this litigation, the Waddens have not directed the Court to any statutes, regulations, stock

exchange rules or industry practices that relate to either of the two particular alleged breaches.

Page 120 of 139

[786] The Account Agreement between the Waddens and BMO Nesbitt Burns provide basically

as follows:

a)

b)

it permitted BMO to determine in its discretion whether or not any order was

“acceptable” and whether to execute said order;

it gave BMO a broad and sole discretion whether to grant a margin facility to the

Waddens, to reduce or cancel anymargin facility once granted, and to refuse to grant

any additional margin; and,

c)

it gave BMO authority to cancel any outstanding orders if the Waddens failed to pay

any indebtedness when due, without prior notice or demand.

[787] In Venture USA Inc. v Yorkton, [2005] OJ No. 1885 at paras 25 to 34, the Court determined

that a more narrowlyworded “refusal clause” should be interpreted in a manner that affords a broker

like BMO “burdened with the gatekeeper function” latitude “to refuse suspect transactions despite

a lack of clear proof of illegality”.

[788] An investment dealer’s ability to execute a client’s order is subject to its overarching

regulatory obligations as “gatekeeper”.

[789] The “gatekeeper” function refers to the obligation of a securities registrant like BMO to

“detect and forestall” activities that should contravene securities law.

[790] BMO’s decision to refuse to execute trades in KHI shares for the Wadden accounts on or

about July 13 was consistent with its obligations as “gatekeeper” and reasonable in the

circumstances. (See: RE: Wentzel [2005], ASCD No 153 (Alberta Securities Commission)).

[791] I find that Locke had a very close and special relationship with Colpitts. It is evident in her

conduct and was the subject of oral evidence the Court found credible. It is evident in her

aggressive peddling to Banks (whose evidence Iaccept completely) of various investment proposals

in KHI. The evidence generated enough concern respecting her possible knowledge of the scheme

by KHI insiders to inhibit sales of KHI shares while finding new investors that it merited closer

scrutiny.

[792] In the end, I am not persuaded, on a balance of probabilities, that she, and therefore BMO,

knew or ought to have known of the stock manipulation scheme by KHI insiders, including Colpitts,

so as to infuse BMO with that knowledge.

[793] I conclude that BMO did not act dishonestly or in bad faith in its assessment of the credit

worthiness of KHI shares and its assessment of Colpitts’ representation to BMO that BMO could

be subject to litigation if it permitted Wadden, an insider, to sell KHI shares.

[794] BMO submits that the approach by MacLellan in July and August 2000 in his dealings with

Colpitts, is a useful guide in assessing the reasonableness of BMO’s response to the information

Page 121 of 139

conveyed by Colpitts to Meredith, BMO’s legal counsel. MacLellan, despite some indicia that

Wadden was not a director, proceeded on the assumption that he was. MacLellan assumed Colpitts

was in a better position to determine that and whether Wadden had insider information. MacLellan

was not prepared to assume that Colpitts, as an officer of the Court, would be motivated to lie.

[795] While the Halifax branch of BMO was interested in hiring Richards, at least in part, because

two of his clients, Wadden and Courtney, who had substantial accounts, BMO’s head office was

never satisfied that KHI was worthy of the kind of margin debt that existed on these accounts when

they were transferred to BMO. BMO’s assessment of the credit worthiness of KHI for the purposes

of margin debt was reasonable and made in good faith.

[796] Because of the resistance to head office views by the Halifax branch, BMO agreed to accept

the Wadden accounts, but only on the condition that the margin debt be reduced immediately.

[797] Both Wadden and the Halifax branch believed that this would happen. At that point,

Wadden and his broker Richards, believed that Potter would be purchasing or arranging for the

purchase of 250,000 KHI shares by the end of June, 2000.

[798] BMO submits that on the facts of this case, it was not negligent in failing to advise the

Waddens of the account conditions before the opening of their accounts; I agree. There is no

evidence that anyone at BMO represented to the Waddens that their margin debts would be accepted

by it unconditionally when the Waddens applied to open accounts.

[799] BMO accepted the transfer of the Wadden accounts from FCG on May 23 and paid out

approximately 1.3 million dollars in margin debt owed to FCG. If Wadden wanted to transfer the

accounts out of BMO before the end of June, he still could have done so. He did not because he

trusted that Potter would find a purchaser for 250,000 KHI shares by June 30 and because of his

close relationship with his best friend Richards.

[800] When the Waddens initiated the transfer to BMO, the Wadden’s margin debt at FCG totalled

approximately 1.3 million dollars. The KHI shares constituted almost the entirety of their accounts.

In effect, BMO was being asked to lend 1.3 million dollars to the Wadden accounts on the security

of KHI shares. At that time, there was no assurance of BMO accepting their applications to open

margin accounts.

[801] I agree with BMO that Ms. Wadden testified that she appreciated that a brokerage firm did

not have to offer margin to a particular client if it was not satisfied with the client’s credit worthiness

or the securities that it would be getting the loan. On May 23, 2000, BMO transferred funds to FCG

to discharge the Waddens’ margin debt and to accepted transfer of the shares.

[802] I agree with BMO’s submission that the Wadden’s evidence that they were not informed at

any time prior to mid-July that their accounts were accepted on the condition that the margin debts

be paid down by the end of June is simply not credible.

Page 122 of 139

[803] It was not of concern to Wadden because he believed, at that time, that Potter was arranging

a sale for 250,000 KHI shares by the end of the June and the proceeds would be used, at least in part,

to pay down their margin debt. Wadden agreed that having a June 30 deadline to pay down his

margin debt would not have been a big issue for him.

[804] The relationship between Richards and the Waddens was of long duration and very close.

Richards was Wadden’s best friend. They socialized frequently. It makes no sense that Richards

would have risked his friendship and business relationship with Wadden by attempting to conceal

information about the condition respecting the account transfers when Richards learned of them.

There was no reason Richards would not have told Wadden of the conditions respecting the transfer

of the accounts to BMO.

[805] In Wadden’s trial evidence, there were many examples of advice given by Richards to

Wadden that was clearly in the best interests of Wadden. For example, when Wadden was

contemplating purchasing the 100,000 KHI shares in January 2000 from Snow; Richards advised

against it. Further, when Richards learned that FCG would no longer advance further margin to the

Waddens, he disclosed it and provided them with the opportunity to open margin accounts

elsewhere. Both of these would have been adverse to Richards’ own economic interests. Hiding

information about BMO’s transfer conditions would have been entirely out of character.

[806] I find that Wadden was advised by Richards and was aware of the transfer conditions when

he knew and prior to June 30.

[807] The Wadden’s second claim against BMO is its refusal to accept orders to sell KHI shares

between July 10 and August 24, 2000.

[808] On July 10, 2000, Wadden had an angry telephone call with Potter, in which he expressed

concern about, among other things, the fact that Potter had not arranged a buyer for his shares as

promised, and had made a $400,000.00 loan to Courtney that had not been disclosed to him.

Contrary to his previous undertakings not to sell shares of KHI, Wadden communicated his clear

intention to begin selling KHI shares into the market.

[809] Immediatelyafterthat phonecall, andthefirsttime sinceopeningaccounts atBMO, Wadden

instructed Richards to start selling shares of KHI from his margin account.

[810] BMO makes the point that as of July10, 2000, there had been no public disclosure of the fact

that KHI had made a $400,000.00 loan to Courtney, an insider, an action that Wadden considered

to be have been illegal and a misuse of corporate funds. At the same time, Wadden was aware of

the existence of the 540 account and, after the June 8 letter, knew that 220,000 of his shares had been

used in connection with that account. He was in a dispute with NBFL about what he believed to be

an improper use of his shares and his inability to get them back. There had been no public disclosure

by KHI of this fact.

[811] Pursuant to Wadden’s instructions, Richards succeeded in selling 6,155 KHI shares on July

10 (settled on July 13).

Page 123 of 139

[812] The next day, Wadden instructed Richards to sell KHI shares held by his father, due to

Wadden’s concerns about the fact that KHI was making inappropriate loans to insiders, a fact not

publicly known. It was this concern that Wadden acknowledged was one of the factors that caused

him to place an order to sell his own shares.

[813] On July 12, Wadden instructed Richards to sell an additional 5,000 KHI shares from his

margin account.

[814] Wadden acknowledges that it was not a secret that he had accounts at BMO. He

acknowledged that Colpitts subscribed to a servicethat allowed him to view trading in shares of KHI

on the TSX in real time, and that would have permitted Colpitts to see which brokerage firms were

selling shares of KHI. He acknowledged that the trades being executed through BMO would have

been visible to Colpitts. He acknowledged that it would not have taken a rocket scientist to figure

out that the shares were being sold through BMO beginning on July 10, and that the shares were

probably being sold by him.

[815] At about this time, Wadden informed Colpitts that he was “dumping garbage” and Colpitts

told Wadden that he was in breach of his duties as a director.

[816] On or about July 12 or 13, Richards advised Wadden that he could not execute the last order

and that Wadden’s accounts had been taken out of his control. He disclosed that there had been a

threat of legal action by KHI and suggested that Wadden get legal advice. Shortly after, Richards

arranged a three-way phone call between Wadden, himself and Meredith, BMO’s legal counsel.

[817] Wadden’s evidence was that he interpreted what Meredith told him as beingto the effect that

BMO was takingdirection from KHI’s legal counsel. Iprefer to accept, as reliable, not that Meredith

was taking instructions from KHI’s legal counsel, but the answer Meredith gave to MacLellan in

his phone call and correspondence with Meredith on August 3. MacLellan says that Meredith told

him that Colpitts had advised him (Meredith) that Wadden was in breach of his duties as a director

and that BMO faced the prospect of legal action if he continued to trade in KHI shares.

[818] I accept BMO’s submission that MacLellan’s characterization of Meredith’s statement is

likelyamore accuratereflection thanWadden’sunderstandingthatBMOwastakingdirections from

Colpitts.

[819] MacLellan testified that, in his discussions with Colpitts, Colpitts took the position that

Wadden remained a director and was bound by a fiduciary duty to KHI. He had threatened action

against Wadden in connection with that breach. Greenwood testified that he was aware of the threat

of legal action by KHI against Wadden and that he took that threat of litigation very seriously.

MacLellan said that one of Wadden’s objectives was to avoid being sued.

[820] I accept BMO’s submission that, in the circumstances, it was reasonable for BMO to take

the same view of Colpitts’ statement of KHIintentions and to decide not to accept orders byWadden

to sell KHI shares from any account over which he exercised control. The information available to

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BMO, as of July 12, raised bona fide issues about the acceptability and legality of Wadden’s trades

and whether he may be in breach of his duties as a director of KHI.

[821] It is significant that, based on MacLellan’s interviews with Wadden and his research,

MacLellan at no time took steps to caution BMO that Wadden was not a director or insider trading

on insider information. It is not disputed that Wadden was a director of KHI from 1999 up until at

least June 2000. Wadden says he resigned in June 2000; Colpitts says the resignation was not

effective as it had not been accepted by KHI.

[822] It is clear that, at this time, Wadden was in possession of insider information not generally

available to the public. He owned more than 10% of the issued shares of KHI.

[823] I find that Wadden was an insider and a “person in a special relationship” with KHI, as

defined in the Ontario Securities Act and the Nova Scotia Securities Act. That status imposed upon

him statutory obligations to file public reports disclosing purchases and sales of KHI shares, not to

sell KHI shares while in possession of material undisclosed information, and not to tip others to do

so.

[824] Even if Wadden ceased being a director upon the tender of his resignation in or about the

first of July, he still was prevented from trading for so long as he remained in possession of material,

undisclosed information about KHI, obtained while he was an officer, director or 10% shareholder.

[825] It was prudent and reasonable for BMO to treat the threat of litigation from KHI seriously

and to have considered that there was potential for a breach of securities law and/or a fiduciary duty

by Wadden.

[826] Despite the Court’s suspicions about the relationship between Locke and Colpitts, the Court

finds it more likely than not that the impetus for BMO’s actions on July 13 in refusing to permit

Wadden to continue to execute trades in the shares of KHI until the issues discussed above had been

sorted out was reasonable. It was consistent with BMO’s gatekeeper function, which included an

obligation to decline to execute trades in circumstances suggesting potential illegality. It was not

negligent.

[827] BMO submits that there is no evidence that it refused to accept orders to sell from Wadden

after July 13; therefore, the Court should not infer that the Wadden accounts were “frozen”. I

disagree.

[828] ThenatureofthecommunicationsbetweenMeredith andMacLellanreinforcestheinference

that BMO would not permit tradingwhiletheunresolvedallegations of illegalities were outstanding.

[829] The fact that Wadden was focussed after July 17 upon negotiating a term sheet for the sale

of a block of KHI shares at a guaranteed price, and therefore not attempting to sell KHI shares on

the market, does not detract from the inference that if he had attempted to sell shares before BMO

began selling shares about August 16, on its own account, that he would have been prevented from

doing so.

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[830] The Wadden’s claims against BMO are in contract and negligence.

[831] With respect to the claim in contract, the allegation that BMO failed to advise the Waddens

of the conditions of their accounts before the transfer is not alleged to constitute and could not

constitute a breach of contract. They preceded the execution of the account opening documents and

KYC form, which constitute the contract between the Waddens and BMO.

[832] BMO submits that it had the right, on or about July 13, to refuse to execute Wadden’s orders

to sell shares under the account agreements.

[833] The account agreement specifically provided: “Upon acceptance of the Application, I agree

to the terms and conditions set out on the reverse side of this application form which, together with

the completed application form, constitutes this Agreement . . .” The terms and conditions gave

BMO the express right to determine the acceptability of anyorder and to refuse to execute anyorder.

[834] Condition Number 3, titled “Operation of the Account”, para (a) reads: “Nesbitt Burns has

the right to determine in its discretion whether or not any order for Transactions in Securities for the

Account is acceptable or whether to execute said order.”

[835] Like the refusal clause in issue in Venture Capital (see paras 25 to 34), para 3 gives BMO

the right to refuse to execute trades, “beyond those provided for provided by the common law”.

Paragraph 35, in part, states:

. . . is to be interpreted in the context of the complex world of securities regulation. Large volume

transactions involving large sums of money proceed at a rapid pace, and the risks are high . . . the

agreement between the broker and the client should be interpreted in a manner that affords the broker

burdened with the gatekeeper function latitude to refuse suspect transactions despite a lack of clear

proof of illegality.

[836] The term “acceptable” in para 3 of the BMO Agreement is broader than the term found in

Venture Capital. The ordinary meeting of “acceptable” includes “suitable” and “satisfactory”.

[837] Of course, BMO cannot justify actions taken in bad faith but, in this case, I find that BMO

had sufficient grounds to determine that Wadden’s orders to sell KHI shares were not acceptable or

suitable. They raised the possibility that the Waddens would be contravening the prohibitions

against insider trader and tipping. Additionally, they also raised the possibility that Wadden may be

acting in breach of a fiduciary duty to KHI.

[838] BMO also relies upon para 5 of the account agreement, which dealt with margin. Paragraph

5 reads, in part:

If the Client applies for a margin facility, Nesbitt Burns may, in it sole discretion, grant the facility to

the Client provided that Nesbitt Burns may, at any time and from time to time

a)

reduce or cancel any margin facility available to the Client or refuse to grant any

additional margin facility to the Client; or

Page 126 of 139

b)

require the Client to provide margin in additional to the margin requirements of the

applicable Regulatory Authorities.

[839] BMO, when it decided to accept the account, had reservations with respect to the suitability

of KHI as security for the margin debt that it agreed to take over from FCG. It had provided the

Waddens with notice requiring the margin debt to be cleared byJune 30, 2000. I have alreadyfound

that the Waddens were aware of this before June 30. It was not a breach of contract for BMO to

refuse to execute trades thereafter until the margin debt was cleared.

[840] Paragraph 8 of the Agreement also authorized BMO to take steps to protect itself. This

included cancelling outstanding orders without prior notice.

[841] In summary, any refusal to execute Wadden orders to sell KHI shares on or about July 13,

2000, was made in accordance with the rights of BMO under the Account Agreements entered into

with the Waddens, and in good faith.

[842] BMO submits, in the alternative, that the Waddens were at fault for the loss of their

investment in KHI, either entirely or by contributory negligence. In its post-trial brief, it itemized

ten particulars of the Waddens’ failure to act reasonably to protect their own interests. These

include:

a) Wadden’s failure to undertake proper due diligence prior to selling his interest in

Micronet to KHI for shares and not for cash.

b)

Ms. Wadden’sfailuretoundertakeproperduediligencebeforeinvesting $250,000.00

in a private placement in the fall of 1999 and borrowing money for that purpose.

c)

The Waddens’ purchase of another 100,000 KHI shares from Snow in January 2000

for $600,000.00, purchased entirely on margin, even though Richards advised them against the

transaction.

d)

e)

The Waddens signing their account opening documents without reading them.

Wadden quitting his job and arranging no alternative employment, in reliance on the

fact that Potter would arrange, by the end of June 2000, for the same of 250,000 KHI shares held by

the Waddens (which Ms.Wadden acknowledged in hindsight was “not a wise thing to do”.)

f)

In addition to borrowing a million dollars to invest in KHI, between March and June

2000, borrowing another million dollars on margin to live on and to spend on other projects, which

appear to include over a million dollars on renovations to a home and summer property.

[843] I agree that the Waddens made several significant decisions that show they did not act

reasonably in their own best interests with respect to their investments in KHI, separate and apart

from the sale of the business for shares and no cash. However, because I find that BMO was not in

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breach of its duty and standard of care in contract or in negligence, it is unnecessary to apportion

liability between the Waddens and BMO.

[844] BMO also asserts that the Waddens ratified any wrongdoing by it.

[845] Ratification is limited to that which the Waddens knew or ought to have known at the time

of ratification. As previously noted, the Waddens and BMO, both before trial and at the

commencement trial, put on record their agreement that none of the Wadden claims against BMO

rely upon fraud arising from the illegal stock manipulation scheme or an allegation that BMO was

a part of it.

[846] Wadden testified that, as of August 2000, he believed the conduct of BMO was wrongful.

If the Court is wrong in its finding of no breach of contract or negligence, I agree with BMO’s

submission that the Waddens accepted and acquiesced after August 24, 2000, that which they now

complain to have been the consequence of the alleged misconduct by BMO.

[847] This Court has previously outlined its position with respect to causation and, in particular,

proximate cause.

[848] If I am wrong in finding that BMO did not breach either of the two alleged breaches of

contract and negligence, I am not satisfied that any of the claimed losses were caused by BMO.

[849] The Court has alreadyfound that KHI was a thinly-traded stock. While the Court is satisfied

that small quantities of stock may have been salable on the public market, the large quantity held by

the Waddens - the second largest share holdings in KHI, were clearly not salable, other than the

blockbuster sales arranged by Potter and other KHI insiders. Nothing BMO did was the proximate

cause of the failure of Waddens to sell any significant amount of their shares.

[850] More important, after Wadden’s epiphany of August 24, 2000, he became an active buyer

of shares on the market for the purpose of maintaining the price while he, Potter and other insiders

sought new investors. Theydid this as a group working together. Wadden had an active part of that

group.

[851] BMO advanced opinion evidence to quantify the trading in KHI shares, and effectively

estimate how manypotential shares could have been sold between July13 and August 31 if Wadden

had been permitted to sell 5,000 KHI shares per day.

[852] Iam somewhat sceptical of the calculations and conclusions because the report and evidence

did not include the fact that most of the volume of shares consisted of three sales arranged by KHI

insiders: to Banks, Barthe and Fountain. Without these purchases, arranged by the insiders, there

was a very thin market for KHI shares.

[853] In their post-trial brief, the Waddens submit that BMO is responsible for the fact that none

of Wadden’s shares were purchased by Banks on August 3, 2000. There is no evidence that Banks

was prepared to buy shares of KHI at a higher price than what he negotiated following his own

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inquiries. Wadden was, throughout, not prepared to sell his shares on the terms that Banks was

prepared to buy.

[854] While not directly determinative, I observe that Wadden was always trying to get more for

his shares than the market would bear. He declined, at one point, Potter’s offer to assign to Wadden

the Barthe agreement of July 2000. He repeatedly failed to see where KHI’s share price was

heading.

[855] BMO claimed that there were no restrictions on Wadden’s trading after July 13, and I

concluded that there would have been (if Wadden had asked to sell after July 13), so long as

Meredith was of the view that BMO was subject to possible litigation by KHI. However, there was

nothing to prevent the Waddens from attempting to sell shares after August 31, which they claim

they wanted to do on and after July 17. I do not accept Wadden’s evidence that he did not attempt

to sell after August 31 because he believed that if he did he had been closed down again. If there

was a market for KHI shares, the Waddens could have mitigated any freezing of the BMO accounts

between July 10 and August 24. Theydid not do so. Their failure to attempt to sell after August was

not caused by anything BMO did.

[856] In an exhibit presented at trial, the Waddens claimed total loss of $6,591,922.41. Of this,

$5,292,641.00 was with respect to the loss in the value of KHI shares. The remainder was

consequential losses. Because of the finding that BMO did not breach its duty and standard of care

in contract and negligence, it is unnecessary to deal with their claim for consequential losses.

I.

Assessment of Damages against NBFL

I.1 Dunham’s Loss and Damages

[857] The analysis of NBFL’s liability for damages to Dunham starts with the following factual

findings:

a)

Clarke, as the agent for Dunham, breached not only his duty and standard of care in

contract but a fiduciary duty. He took advantage of Dunham’s vulnerability because

of his conflicts of interest, including his own investments in KHI and his

participation in the stock manipulation scheme. He did not attempt to diversify

Dunham’s account. He acted fraudulently in ignoring Dunham’s instructions to sell

and requests for professional advice;

b)

c)

NBFL’s breached its duty and standard of care owed to Dunham in contract and in

negligence by failing to proper supervise Clarke and his 540 account. It failed to

uncover, as it should have uncovered, Clarke’s conflicts of interest and fraud in his

dealings in KHI shares;

As between NBFL and Dunham, NBFL is and should be liable for the loss and

damage to Dunham from Clarke’s wrongdoing, not only by reason of its negligence

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and breach of contract, but by reason of its vicarious liability for Clarke’s

wrongdoing;

d)

By reason of its own investigation in 2003, NBFL believed, on the basis of

“overwhelming evidence”, that Clarke had participated in the stock manipulation

scheme that had lead to NBFL’s losses (mostly in respect of margin debt). It has

always been in the best position to know what Clarke did, and that it was wrongful

in every sense.

Lost Value of KHI Shares

[858] It is not possible to determine exactly what would have happened if Clarke had not acted

fraudulently and breached his fiduciary duty to Dunham - sold his KHI shares and diversified

Dunham’s account between June and August 2000. That said, it is not speculative to calculate the

loss in the KHIshare price, but for Clarke’s breach wrongdoings. There was a market price at which

KHI shares were traded on the TSX.

[859] KHIwas a thinly-traded stock. Except for the arrangedblockpurchasesbywealthyinvestors

(Keating, Banks, Barthe and Fountain) and by Clarke, there was no obvious large purchasers.

Nevertheless, the number of the shares sought to be sold by Dunham was not substantial.

[860] I conclude that it was likely that, but for Clarke’s failure to give prudent investment advice

and his dishonesty in diverting Dunham from selling KHI shares and, instead, creating margin debt,

Dunham would have sold almost all (and possiblyall) of his KHIshares before the end of September

2000. I therefore calculate the loss of KHI share value as being the market value at which KHI

shares sold between June 30 and September 30, 2000.

[861] For the most part, KHI shares sold between $6.65 and $6.80. The highest price during that

period was $6.95 and the lowest price (on two different days) was $6.40. I estimate that the median

price at which KHI shares sold during the period was $6.75.

[862] Excluding the first 30,000 shares, which were sold by Clarke to pay off Dunham’s debt to

KHI and withdrawn for personal use, I calculate the loss to Dunham from the failure to sell his KHI

shares as 120,000 KHI shares at $6.75 or $810,000.00. From this, I deduct the net proceeds from

the sale of the 13,000 KHI shares on September 13, November 7, and December 19, 2000.

[863] The law is clear that for a breach of fiduciary duty, one of the remedies is to disgorge the

wrongdoer from profits.

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[864] Clarke acted fraudulently and in breach of his fiduciary duty. I disallow deduction of any

brokerage fees that would normally be incurred on the sale of these shares. For the same reason, in

giving credit for the sale of 13,000.00 KHI shares, I give credit for only the net amount received.

[865] Second, NBFL argues that from this should be deducted the margin debt of $353,021.96.

[866] Dunham argues that, by reason of Clarke’s fraud and breach of fiduciary duty, for which

NBFL was liable, Dunham should not be liable for any of the margin debt.

[867] It appears from the submissions of the parties, that of the margin debt, $34,418.00 was

interest charged monthly on the margin debt by NBFL. The remainder of the margin debt appears,

for the most part, to be in the form of withdrawals by Dunham for his personal use. The personal

use appears primarily to relate to the construction of a residence and the purchase of a vehicle, but

may have included monies for investments in other projects pursued by Dunham after he left KHI

in April 2000.

[868] The principle that wrongdoers, especially those with a fiduciary duty or who acted

fraudulently should be disgorged of any profit, means that it would be inequitable for Dunham to be

liable for the portion of the margin debt related to interest charged by NBFL on the debt.

[869] At the same time, the Court fails to see the rationale for deducting from the value of the KHI

shares that should have been sold by Clarke the principal amount of margin debt that was withdrawn

by Dunham for personal purpose. For that reason, the Court deducts from the $810,000.00 loss in

the market value of his KHIshares not the just the net amount recovered from the sale of 13,000 KHI

shares, but the principal portion of the margin debt, which I believe is $318,603.96.

[870] Dunhamis entitled toprejudgmentinterestfromSeptember1, 2000. Absentbetterevidence,

the default prejudgment interest rate, set out in the Civil Procedure Rules is 5%. NBFL, in its post-

trial submission, provides detailed calculations supporting a prejudgment interest of 2.614%. This

rate is calculated on the basis of the average of the one-year TreasuryBill and two-year Government

of Canada Bond Rate for the relevant period. I adopt that rate, compounded and calculated monthly,

not in advance.

Consequential Losses

[871] The claimed consequential losses over 11 years include:

a)

Lost income from June 30, 2000 to December 31, 2012, at the rate of the $40,000 per

year ($440,000.00).

b)

c)

Loss of the value of investments ($80,000.00).

Loss of his investment in a business project “Fantasy Stocks”, which he claims he

was unable to complete because of lack of financing - $113,000.00.

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d)

e)

f)

Interest paid on credit cards - $51,576.00.

Professional fees paid in relation to his filing for personal bankruptcy - $2,200.00.

Interest paid on the mortgages he took out on the home that he mortgaged to live on

and pursue his projects on - $126,000.00.

[872] The law permits claims for consequential losses. The starting point, however, is causation

and the application of the “but for” analysis to the connection between the wrongdoing of the

defendant and the loss to the plaintiff.

[873] Dunham did not cease his employment with KHIand was not prevented from pursuing other

employment, by reason of the failure of Clarke to diversify his account.

[874] As a result of his withdrawals in his margin account, Dunham’s home appears to have been

paid in full, until he took a collateral mortgage on July 31, 2001 in the amount of $159,000.00 and

remortgaged the property on August 30, 2002 for $337,533.75 (of which some of the proceeds were

used to pay off the earlier mortgage). I agree with NBFL that the timing of the mortgage advances

negates Dunham’s claim that the failure of Dunham’s various business projects, including “Fantasy

Stocks” was casually connected to the failure of Clarke / NBFL to liquidate his KHI shares.

[875] Dunham has failed to establish that the consequential losses were caused by Clarke’s

wrongdoing. A determination of what other reason may have led to the failure of those business

ventures, and the money borrowed through the two mortgages is not necessary.

Punitive Damages

[876] Dunham claims a substantial award of punitive damages. He cites Whiten. He notes, in

particular, that NBFL had no defence to Dunham’s claim for the loss of the value of his KHI shares,

and that NBFL itself had taken the position in 2003 and 2005 that it had overwhelming evidence to

believe that Clarke and others had conspired to manipulate the stock price of KHI shares. This view

was acted upon with commencement of the Main Action in 2003, and defended in this court in 2005.

[877] In 2005, Justice Scanlan urged NBFL to settle with those who were not implicated in the

stock manipulation scheme. Clearly Dunham was not implicated. NBFL never alleged that he was.

NBFL continued to fight Dunham’s claim with what his counsel described as a “litany of tactics,

stratagems and rouses” over twelve years.

[878] His counsel describes the treatment of Dunham (and the Weirs) as similar to that imposed

on the Blackburns in Blackburn (upheld by the Ontario Court of Appeal, 2005 CarswellOnt 671).

In that case, punitive damages were not awarded but costs were awarded at three times the normal

rate. Counsel argues that the ten factors considered at para 24 in the Court of Appeal decision in

Blackburn support a claim for punitive damages in this matrix. In Blackburn, the Court denied

punitive damages because the stockbrokers had been otherwise punished. In this case, no one had

been otherwise punished.

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[879] Dunham’s counsel directs the Court to para 79 in the Whiten decision. It distinguishes the

failure to honour the contractual duty of good faith, from liability for the actual breach of the

contract, in setting up the basis for an award of punitive damages.

[880] NBFL argues that Dunham has not established an independent, actionable wrong on the part

of Clarke or NBFL that would put this case in the category of exceptional cases for which punitive

damages are awarded. Citing Honda v Keays, 2008 SCC 39, NBFL argues that punitive damages

are restricted to “advert wrongful acts that are so malicious and outrageous that they are deserving

of punishment on their own.”

[881] With respect to punitive damages for breach of contract, the Nova Scotia Court of Appeal

stated in Plaza Corp. Retail Properties Ltd. v Mailboxes Etc, 2009 NSCA 40, that “a very high

threshold must be met before an award of punitive damages is merited.” And, quoting from Fidler

v Sun Life Assurance Co. of Canada, [2006] 2 SCR 3, “[b]y their nature, contract breaches will

sometimes give rise to censure. But to attract punitive damages, the impugned conduct must depart

markedly from ordinary standards of decency . . .”

[882] NBFL notes that in Blackburn, no punitive damages were awarded in a case in which the

broker had engaged in unauthorized trading on a regular basis and that his employer had been aware

of his breaches.

Analysis

[883] Punitive damages is relevant to both the Dunham and Weir claims. This part of the decision

deals with general principles, and the application of those principles to the Dunham matrix.

[884] The starting point for assessment of punitive damages in Canada is Whiten, as explained in

Fidler and Honda v Keays.

[885] For the purposes of this litigation the first eight of the ten conclusions of Justice Binnie in

Whiten (para 67) are helpful. I summarize them as follows:

a)

The attempt to limit punitive damages by categories does not work. The control

mechanism lies not in restricting the category of case but in rationally determining

circumstances that warrant the addition of punishment to compensation in a civil

action. The nature of the remedy is that punitive damages will largely be restricted

to intentional torts or breach of fiduciary duty, but may be available in exceptional

cases in contract and in negligent cases.

b)

c)

The general objectives of punitive damages are punishment (in the sense of

retribution), deterrence of the wrongdoer and others, as well as denunciation.

The primary vehicle of punishment is criminal law and regulatory offences;

therefore, punitive damages should be resorted to only in exceptional cases and with

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restraint. The fact and adequacy of any prior penalty imposed in any criminal or

other proceedings is a factor to be considered.

d)

The incantation of time honours pejoratives such as high-handed, oppressive,

vindictively, provides insufficient guidance or discipline to the judge and a more

principled, less exhortatory approach is desirable. The Court should relate the facts

of the particular case to the underlying purposes of punitive damages and ask how,

in particular, an award would further one or other of the objectives of the law and

what is the lowest award that would serve the purpose.

e)

f)

It is rational to use punitive damages to relieve a wrongdoer of its profit where

compensatory damages would amount to nothing more than a license fee.

The proper focus is not on the plaintiff’s loss, but on the defendants misconduct. A

mechanical or formulaic approach does not allow sufficiently for the manyvariables

that ought to be taken into account at arriving a just award.

g)

The governing rule for quantum is proportionality. The overall award should be

rationally related to the objectives for which the punitive damages are awarded

(retribution, deterrence and denunciation).

[886] Beginning at paragraph 111, Justice Binnie wrote that proportionality was the key to the

permissible quantum of punitive damages. He identified proportionality in seven contexts: the

blameworthiness of the defendant’s conduct; the degree of vulnerability of the plaintiff; the harm or

potential harm directed specifically at the plaintiff; the need for deterrence; the recognition of any

other penalties, civil and criminal, which are or likely to be inflicted on the defendant for the same

misconduct; and, the advantage wrongfully gained by the defendant from the misconduct.

[887] Clarke’s failure to follow Dunham’s request for advice respecting the diversification of his

account, and NBFL’s failure to properly supervise and uncover his conflict of interest and

participation in a stock manipulation scheme is not the independent cause of action that will found

a claim for punitive damages.

[888] The motive and intent of Clarke to use his position, vis-a-vis Dunham, a position of trust (as

a fiduciary) was for the purposes of furthering the scheme of preventing or attempting to prevent the

selling of KHI shares on the market, which persisted from June 2000 through to and including

August 2001. The vulnerability of Dunham and very precarious position that, to the knowledge of

Clarke, his conduct put Dunham in, does raise Clarke’s conduct to the level of advertent wrongful

acts that are so outrageous as to be deserving of punishment on their own. Clarke’s misconduct was

more than the simple breach of a contract. It was a very serious breach of a fiduciary duty.

[889] The unfortunate personal circumstances of Dunham that followed, which the Court has

determined were not proximately caused by Clarke’s failure to sell his KHI shares, was something

which Dunham made Clarke aware of but did not affect Clarke’s selfish priority of maintaining the

value of KHI shares through attempts to prevent sales. It was in his personal best interests and those

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with whom he was associated in the manipulation scheme to breach the most fundamental of his

duties to Dunham.

[890] The public securities market involves enough risks without the risk that an investor’s broker

or investment advisor cannot be trusted to act honestly and in good faith, especially in those

circumstances where the relationship is more than a simple order-taker and rises to a fiduciary-like

relationship. Investment advisors are generallylooked on as professionals. Theyhave an obligation

to act prudentlyand to protect their client’s interests. Their dutyis infused bythis obligation. Clarke

had been on the receiving end of securities industrydiscipline before his employment byNBFL. His

dishonesty toward Dunham is inexcusable. NBFL’s duty is infused by this with an obligation to

have systems in place to inspect for, monitor, and enforce statutory, exchange, industry, and their

own rules. They should not be forced by civil litigation proceeding to carry out their duty.

[891] The failure by NBFL to properly monitor him was more than a minor glitch or aberration.

It appears in this case to have been a major failing.

[892] The aggressive, no-holds-barred, prolonged pursuit of litigation against Dunham, with

respect to liability more than quantum, in light of what NBFL knew when it commenced the Main

Action about Clarke’s misconduct, and which it defended in motions before Justice Scanlan in 2005,

is not justifiable. It was, in hindsight, outrageous.

[893] The conduct is exceptional. It merit punitive damages.

[894] The difficult analysis is determining the appropriate quantum of punitive damages. The

purpose clearly has to be denunciation and deterrence - to discourage investment advisors and their

employing brokers from conducting their affairs with clients in circumstances where conflicts of

interest can exist, and go undetected. Deterrence to employers of advisors who mayact fraudulently

and in circumstances of conflicts of interest, and who fail to protect their clients, is important

[895] This litigation commenced with 54 sets of parties, the overwhelming majority of whom are

no longer part of this litigation. Many of those parties were clients of NBFL and investors in KHI.

Many were not alleged by NBFL in its Main Action (in which they allege a stock manipulation

scheme by many insiders) to have been insiders.

[896] Rousseau swore in 2005 that NBFL had overwhelming evidence that Clarke was part of the

stock manipulation scheme. It continued the litigation with Dunham, a clear vulnerable victim of

Clarke’s wrongdoing for several years thereafter.

[897] Assessment of a quantum for punitive damages is not a precise science. The circumstances

in respect of Dunham, based on the harm to him; based on the need for deterrence and to recognize

that the defendant should not benefit from the misconduct of its broker, suggests that punitive

damages should at least be in the amount of $200,000.00.

I.2

Damage Claim of the Weirs / Blackwood

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[898] Counsel for Weir and Blackwood claim for the loss in the value of KHI shares: for

Blackwood Holdings, $42,000.00; and for Lowell Weir in his LIRA account, $26,250.00 and in his

margin account, $157,500.00; plus prejudgment interest at 5%. Theyclaim punitive damages based

on the manner in which NBFL has conducted this litigation. Also, they claim costs on a solicitor -

client basis.

[899] NBFL submits first that if the Court finds it liable to Weir and Blackwood, that the amount

of the Promissory Note with prejudgment interest should be deducted from the award; otherwise,

NBC should have judgment against the Weirs for $100,000.00 plus prejudgment interest. In

addition, credit should be given against any claim of Weir for the amount of his margin debt,

$60,177.00.

[900] Similarly, if the Court finds NBFL liable to Blackwood for failure to sell its 7,000 KHI

shares, NBFL should have credit for its outstanding margin debt of $10,404.00.

[901] NBFL argues that it is not liable for the consequential damage caused by the liquidation of

the 325,500 Enervision shares held by Blackwood on the basis that it had sole discretion respecting

the margin called per the margin agreement and had no duty to Blackwood regarding how it

liquidated the Enervision shares. It cites Paciorka v TD Waterhouse [2007], OJ No. 289 (OSC) at

paras 76 and 80.

Analysis

[902] I found that Clarke / NBFL are liable to Weir and Blackwood for failing to sell their KHI

shares when they dipped below $5.00 after Weir’s communication to Clarke on January 19, 2001.

[903] As I noted in the analysis of Dunham’s claim, KHI was a thinly-traded stock, but not so thin

that, if Clarke had followed instructions, the small quantum of shares held by Weir and Blackwood

would most likely have sold on the market. The Court notes that the sale of 1,000 KHI shares on

March 24 brought more than $5.00.

[904] Because the failure to follow instructions was intentional and based on Clarke’s conflict of

interest and fraud, NBFLshould not be entitled to profit from broker fees or commissions respecting

the sale of the shares. The principle of disgorgement applies.

[905] The loss to Weir in his LIRA account is $25,000.00, calculated as 5,000 KHIshares at $5.00.

The loss to Blackwood in its margin account is $35,000.000, calculated as 7,000 KHI shares at

$5.00. The loss to Weir in his margin account is $140,625.00, calculated as 28,125 KHI shares at

$5.00.

[906] Respecting the latter shares, Ifound that the standing instructions to sell of January19, 2001,

applyto the shares placed into Weir’s margin account on February 28 (unbeknownst to him). NBFL

argues that those shares were restricted from being sold until June 27, 2001. I disagreed in my

analysis. Even if I was wrong, they should have been put on the market on June 27, 2001. I am

satisfied that it is likely that they would have been sold if that had been done.

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[907] Consistent with my analysis respecting Dunham’s claim for damages, the principal portion

of the margin debt owed by Weir and Blackwood to NBFL is deductible from the award for loss in

the value of the KHI shares.

[908] The interest portion (all interest charged and/or paid at any time) is not deductible from the

claim for the loss in value of the KHI shares on the same principle that Clarke / NBFL should not

profit, or should be disgorged of any profit from Clarke’s intentional wrongdoing.

[909] I agree with Weir and Blackwood that the manner in which NBFL dumped Blackwood

325,000 Enervision shares on the market on September 19, 2001, for a nominal price (about two

cents per share) was unreasonable, and not done in good faith. Just because NBFL had a sole

discretion under the margin account agreement to deter how to handle margin debt and had no duty

to maximize the price, its conduct in this case clearly was not intended to benefit NBFL so much as

to cause damage to Weir, who at that time was accusing (with the benefit of hindsight rightly) NBFL

of wrongdoing.

[910] Blackwood has produced no evidence as to what the market value of the Enervision shares

would have been, “ but for”NBFLdumping them on the market on September 19. Weir has testified

with respect to the loss of his business reputation and its consequences upon Enervision. That loss

has not been quantified.

[911] The Court found that because Enervision had just entered into a major contract in Norway

that Weir was not able to mitigate the damage caused by NBFL’s dumping of the shares, by

purchasing them himself.

[912] Absent evidence of the quantum of the loss to Blackwood respecting the manner in which

NBFL dumped those shares; I decline to award damages. However, that is not the end of the matter.

My interpretation of the evidence of Weir, and the communications and documents associated with

the advance of the $100,000.00 by NBC in March 2003, is that the $100,000.00 advance by NBC

to the Weirs related primarily to the settlement of Weir’s (and Blackwood’s) complaint against

NBFL related to the damage to Enervision and Blackwood’s investment in Enervision.

Consequently, I find that NBC is not entitled to repayment of the $100,000.00 advanced towards a

settlement of the Enervision aspect of the Weir / Blackwood claim against NBFL’s liability to Weir

and Blackwood with respect to its loss of the KHI shares, nor to a set-off against the other damages

awarded to Weir and Blackwood.

[913] Weir and Blackwood claim punitive damages. I adopt my review of the law respecting

punitive damages in the preceding section of this decision. The Weir / Blackwood claim has a

different foundation than Dunham’s claim. Dunham’s claim was founded in breach of contract and

the advertent abuse by Clarke of a fiduciary duty.

[914] Clarke was not a fiduciary to Weir or Blackwood. He breached his contract with each, and

NBFL breached its duty in two other ways: in its failure to properly supervise Clarke and in the

manner in which it dumped the Enervision shares of Blackwood.

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[915] NBFL’s conduct of its litigation against Weir and Blackwood has been outrageous. It

promised to settle, then reneged, and waged an aggressive, no-holds-barred, defence of their claim,

especially respecting liability.

[916] The punitive damage claim of Weir and Blackwood must be proportional. It must act as a

deterrent to similar conduct in future. It must be more than a slap-on-the-wrist. The conduct proven

at trial gives the investment industry a black eye, but more important it will create mistrust of an

important institution.

[917] The quantum of this punitive judgment award is based upon the abusive and disingenuous

treatment of Weir and Blackwood after the margin calls. The bullying and threats, followed by the

litigation, followed by the acknowledgment of wrongdoing in March 2003 and advance of

settlement, followed by nine years of contesting vigorously the Weir / Blackwood claim is abusive

conduct of an exceptional nature.

[918] NBFL acknowledged in 2003 in affidavits, filed in respect of motions contesting its

pleadings, that it had independentlyinvestigated the conduct of Clarke and others, such that theyhad

overwhelming evidence of a stock manipulation scheme in which Clarke played an important part.

NBFL had the best access to the records that proved Clarke’s involvement in the scheme, and its

effects on NBFL’s clients It made an advance to Weir on an eventual settlement with him at the

same time that it commenced the Main Action.

[919] It represented that it would settle when it had recovered a contribution from the others,

whom, it represented to Weir, should share in the wrongful conduct against Weir. There was no

justification for it to have contest Weir’s claim, at least with respect to liability, for the next nine

years.

[920] At trial, NBFL presented no evidence to rebut any of the oral testimony of Weir or

McLaughlin-Weir. In its post-trial brief, it acknowledged that it had failed to supervise Clarke’s

conduct in respect of his 540 account, while maintaining that the Dunlop Clients had failed to prove

that Clarke’s market making was illegal.

[921] NBFL’s actions speak louder than its submissions. There was no justification, on the

evidence before the Court, for NBFL to contest Weir’s claim after 2003, except as to quantum.

[922] The question is not whether punitive damages should be awarded, but rather the quantum.

As pointed by Justice Binnie in Whiten, beginning at para 111, the quantum has to be in the context

of the purpose of punitive damages (retribution, deterrence, denunciation).

[923] NBFL’s conduct in contesting the Weir / Blackwood claim after March 2003, when it

acknowledged its liability to him, was intentional. It persisted in an outrageous manner over a

lengthy period of time (9 years).

[924] The vulnerability of the Plaintiffs and consequential abuse of power by the Defendant

reflectedasubstantial powerimbalance. Manyother“outside”investorsdroppedout ofthelitigation

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between 2001 and the commencement of trial 11 years later. NBFL has benefited from the fact that

many could not stay in the arena with it.

[925] The quantum of the damage award has to be proportionate with to the need for deterrence.

The Defendant is a substantial national institution. An important portion of its business involves

investments by its clients in the Canadian securities market. It is a factor, even if of limited

importance, that the quantum of the punitive damage claim recognize that a smaller award would

have less deterrence on it than a less substantial corporation.

[926] Applying these factors to the purpose of punitive damages, I award Weir and Blackwood

jointly punitive damages in the amount of $200,000.00.

I.3

Barthe

[927] Counsel for the Barthe estate submits that the calculation of damages in this claim is the

easiest. Based on the Court’s assessment of the evidence respecting liability, I agree.

[928] Barthemadetwo investments in KHIafterClarkebecameinvolvedinthestockmanipulation

scheme. However, as the Court found, the evidence appears to show that Barthe paid the last two

installments on the private placement after he became aware of the stock manipulation scheme and

he knew or should have known, that Clarke was a party to that scheme.

[929] Barthe advanced to Clarke 1.7-million dollars in August 2000 to purchase shares. Clarke

purchased 259,000 KHI shares.

[930] The loss to Barthe in the value of the KHI shares was 1.7 million dollars, less the amount

recovered by his sale of those shares after the collapse of NBFL. The Court awards 1.7-million

dollars less the amount recovered from the sale of the 259,000 KHI shares after the collapse of KHI

plus interest at the prejudgment interest rate referred to earlier in this decision of 2.615% per year,

compounded monthly, not in advance, from September 1, 2000 to the date of judgment.

[931] WithrespecttoNBFL’sargumentregardingmitigation, unlikethecircumstancesofDunham

and Weir / Blackwood, the quantity of KHI shares held by Barthe was so significant, and the public

market so thin, that it is not reasonable to expect that if Barthe had attempted to sell into the market

after January 19, 2001 that he would have recovered anything for the shares. It is more likely that

placing those shares into the market would have caused an earlier collapse in the public price of the

KHI shares.

I.4.

Calvin Wadden’s Third Party Liability to NBFL

[932] Wadden is not liable to NBFL for any of its liability to Dunham.

[933] Wadden was an active participant in the stock manipulation scheme in January 2001, when

Clarke did everything he could to prevent the Weirs / Blackwood from following through on their

instructions to him to sell the KHI shares if they dropped below $5.00. He is jointly liable to Clarke

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for the actual net loss to Weir and Blackwood in the value of their KHI shares. He is not liable for

the punitive damages claim, which is based on NBFL’s conduct of litigation, nor the $100,000.00

promissory note (the advance by NBFL respecting the manner in which NBFL conducted its margin

call for the Enervision shares).

[934] I have already determined that at the time Clarke was purchasing shares for Barthe, which

included shares of Wadden, Wadden was an active participant in the stock manipulation scheme.

He is jointly liable to NBFL for its liability to the Barthe Estate respecting this Court’s award to the

Barthe Estate.

1.5

Costs

[935] Counsel disagreeon whetherthe Court should hearfurtherfrom them before awardingcosts.

Counsel for Dunham and Weir/Blackwood seek solicitor-client costs.

[936] While theCourt recognizes thatits findingrespectingthe conduct of NBFLtowardsthe Weir

familyand Dunham, on its face, could support a substantial costs award, the Court declines to award

costs without further submissions. These submissions would include, in the Dunham and Weir

matters, factual information with respect to actual solicitor - client costs.

[937] In any event, costs in respect of the Barthe and Wadden claims, NBFL’s third party claims,

and the Wadden claim against BMO, require submissions.

[938] The Court will received submissions on how those submissions should be received, by

conference call or by a motion in chambers, or otherwise.

J.