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First Leaside founder David Phillips was alleged by OSC to have committed fraud.Fernando Morales/The Globe and Mail

Angry victims of failed investment firm First Leaside Wealth Management Inc. have filed a lawsuit against the Ontario Securities Commission, alleging its staff were motivated by "personal animus and feelings of ill will" toward First Leaside when they shut down the firm in 2011.

The lawsuit, filed in December in Ontario Superior Court on behalf of more than 160 investors, argues the OSC should not have shut down First Leaside because it was still viable, and alleges OSC staff were looking for excuses to "justify" closure of the company.

The lawsuit argues the shutdown led to a rapid liquidation of First Leaside's assets, which raised only a tiny fraction of the over $300-million originally invested with the firm.

"As a direct and foreseeable consequence of the defendants' negligence and bad faith, First Leaside failed and the plaintiffs lost all the money they invested," it says.

Lawyer Tim Gleason of Toronto law firm Dewart Gleason LLP, who is representing the investors, said he could not comment on the case. The OSC also said it could not comment.

Similar lawsuits in Canada have rarely succeeded because regulators are normally immune from liability if they act "in good faith," creating a high hurdle for investors to prove negligence or other wrongdoing.

Veteran securities lawyer Phil Anisman, who is not involved in the First Leaside case, said courts have rejected most attempts to sue various boards and tribunals if they act in good faith. Plaintiffs need evidence of willful wrongdoing or reckless negligence.

"It's tough to sue the OSC for causing damage to investors by fulfilling its mandate," he said. "The protection given to them is very broad, and the purpose is obvious – it's to ensure that the commission and its staff don't feel constrained in pursuing their statutory mandate to protect investors and the marketplace."

The Supreme Court of Canada helped define when a regulator's decisions cross the line to negligence in a 2004 decision on a lawsuit filed against the Barreau du Québec, which regulates lawyers in the province. The top court said the Barreau had failed to act appropriately on a disciplinary case for years despite many complaints about a lawyer, and the "virtually complete absence of the diligence" amounted to "gross carelessness and serious negligence."

Toronto litigator Linda Fuerst, a partner with Lenczner Slaght Royce Smith Griffin LLP and a former senior enforcement counsel at the OSC, said the Ontario Securities Act makes suits against the regulator very difficult, and as a result, they are exceedingly rare.

"It's a pretty high standard," she said, adding plaintiffs would have to prove the regulator's actions went far beyond merely being sloppy or incompetent.

Although lawsuits have rarely succeeded, the Manitoba Securities Commission and the Manitoba government agreed in 2008 to pay $2.75-million as part of a $12-million settlement of a class-action lawsuit filed by shareholders of Winnipeg-based Crocus Investment Fund. Investors alleged the regulator ignored warnings about problems at the fund. The government admitted no wrongdoing in the settlement.

The First Leaside lawsuit alleges the OSC was biased against the firm because a senior First Leaside official helped lead an investment industry committee in 2009 that challenged new investment firm rules proposed by the Investment Industry Regulatory Organization of Canada, which regulates brokerage firms.

The lawsuit alleges the OSC's investigation of First Leaside began in November, 2009, and "was not commenced for any bona fide purpose, but rather, was a reprisal" for the firm's role in challenging the IIROC rules, which it says the OSC supported.

It also alleges regulators were looking for "a pretext for immediately closing down First Leaside" because "they had developed personal animus and fillings of ill will towards First Leaside and its principals."

Uxbridge, Ont.-based First Leaside was ordered by the OSC to stop raising funds in November, 2011, and filed for court protection within months, leaving more than 1,000 investors in the lurch.

The OSC later accused founder David Phillips and senior salesman John Wilson of fraud, saying the two men should not have sold $19-million of fund units in 2011 without telling investors about a report by Grant Thornton Ltd., completed in August that year, that raised questions about the firm's viability.

Mr. Phillips testified during a hearing that he was "stunned" when the OSC shut down his firm because he felt it was viable and improving. He is not one of the investors suing the OSC.

Some investors criticized the OSC for not ordering the firm to distribute the Grant Thornton report after August, 2011, or for failing to close the company sooner.