‘We do not negotiate with regulatory thugs’: RIA strikes back at SEC over 12b-1 fee charges

CapWealth Advisors plans to fight charges brought this week by the Securities and Exchange Commission (SEC), which claimed that the $1.1bn Franklin, Tennessee-based RIA didn’t properly disclose conflicts of interest related to 12b-1 fees it received from clients’ mutual fund investments.

‘We do not negotiate with regulatory thugs that harass our clients,’ CapWealth founder and principal Tim Pagliara told Citywire, adding that his firm looks forward to its day in court.

The SEC claims that from at least June 2015 until June 2018, CapWealth, as well as Pagliara and advisor Tim Murphy, failed to adequately disclose conflicts in their selection of mutual fund share classes that charged 12b-1 fees. The regulator said that lower-cost share classes of the same funds were available to affected clients, who paid hundreds of thousands of dollars in ‘avoidable’ fees.

The fees in question are marketing and distribution fees an asset manager attaches to a mutual fund and pays to a broker-dealer which sells its products.

‘Principle is important, my integrity is not negotiable, and I will not settle with them,’ Pagliara, a 38-year industry veteran, said. ‘I will take this all the way to a jury trial, and it will be adjudicated by a jury of my peers, and that’s the only way I’m going to accept it.’

The SEC, which on Tuesday filed its complaint against CapWealth with the US District Court for the Middle District of Tennessee, declined to comment on the matter.

According to the complaint, the 12b-1 fees were paid to CWIS, an affiliated broker-dealer under common ownership and control with CapWealth, which in turn paid some of the fees directly to Murphy as compensation, and indirectly to Pagliara, through his majority stake in CapWealth’s holding company.

The regulator is seeking financial penalties against CapWealth, Pagliara, 63, and Murphy, 61, as well as repayment of ill-gotten gains plus prejudgment interest from Pagliara and Murphy.

Pagliara called the SEC ‘bullies’ and criticized the regulator for honing in on alleged misconduct from as far back as five years ago and only as recently as two years ago. He said the agency is more concerned with ‘bragging’ about what they’ve recovered for individual investors rather than making the industry more accessible to ‘smaller’ investors.

CapWealth had shut down its affiliated broker-dealer, CWIS, before the SEC even announced its Share Class Selection Disclosure Initiative in February of 2018, Pagliara said. He said he hasn’t collected 12b-1 fees since the first quarter of 2018, which really came from business conducted at the end of 2017.

‘This is like a retrospective action,’ Pagliara said. ‘They’re asking for injunctive relief to keep me from doing something I’m not even licensed to do anyway. I don’t have a federal license; I shut it down. I don’t sell anything by commission, I don’t collect any 12b-1 fees, I don’t do anything other than pure advisory work. It’s one of those cases where you just get harassed.’

Knock knock

Pagliara, who founded CapWealth in 2009, said that neither his firm nor any of its individual employees ever had a regulatory issue. He said that the SEC’s charges stemmed from the agency’s ‘normal audit’ of CapWealth, which commenced in September 2019, rather than any client complaints.

‘There was one individual on the audit, after they’d been there, like, three days, who looked at me and said, “I have some really bad news for you. You didn’t self-report violations based upon our rulemaking on our 12b-1 initiative,” Pagliara said. ‘He slipped this Office of Compliance Inspections and Examinations (OCIE) bulletin across the desk to me. I looked at him and I said, “I didn’t report anything, because I didn’t do anything wrong.”

Pagliara said that the firm’s disclosures are ‘the very same’ disclosures that OCIE reviewed and approved in its 2011 inspection and examination.

‘They have a template, where they have pre-determined that there is an inherent conflict of interest collecting 12b-1 fees, when there is a lower share class available, and it’s just not true,’ Pagliara continued.

He argued that the mere receipt of 12b-1 fees does not create a conflict of interest, but that the issue is when an advisor financially benefits to a client’s detriment. He said that was not the case with CapWealth and that the firm had provided the SEC thousands of pages of documents and a ‘detailed analysis’ of each of the firm’s accounts.

‘We discounted our advisory fee to account for what we would pick up in 12b-1 reimbursements for the clients that had mutual funds, and it was a very, very small portion of our business anyway,’ Pagliara said.

For the 2016-2018 period, for instance, Pagliara said that 12b-1 fees accounted for 2.6% of CapWealth’s entire revenue and that this revenue did not increase the firm’s income due to the discounted advisory fees. He said the 12b-1 fees were ‘irrelevant’ to clients because they paid no more than 1% in total fees regardless.

Yet Bill Singer, a veteran securities attorney who runs the Broke and Broker blog, says that the 12b-1 fee issue with CapWealth is merely one of disclosure. In these kinds of cases, he said the SEC is simply ticking off boxes on a checklist.

‘Their allegation is that the disclosure was, at best, half-assed because CapWealth said the 12b-1 fees were paid to principals, but we now see it was paid to a non-principal,’ Singer said, referring to advisor Tim Murphy’s alleged receipt of 12b-1 fees. ‘Does that strike me as a ticky tacky complaint given what we’re going through with the pandemic and what the economy looks like and the age of this thing? Absolutely.’

‘We did nothing’

In response to the SEC’s notice of intent to bring an enforcement action against the firm, CapWealth on June 15 sent the regulator a Wells submission outlining its defense.

The firm essentially argued that it ‘did not benefit in any way’ from its receipt of 12b-1 fees, that its clients did not suffer any financial detriment and, therefore, that the firm had ‘no conflict of interest it had a legal duty to disclose.’

Nonetheless, the firm claimed that its clients were ‘well-aware’ from communications with CapWealth’s advisors that their advisory fee was being discounted by the approximate amount of 12b-1 fees that CapWealth would receive.

CapWealth said that ‘it — not its clients — absorbed the cost of the 12b-1 fees through a discount of its standard advisory fee.’

According to documents reviewed by Citywire, the firm in September rejected a settlement proposal in which it would have disgorged more than $450k in 12b-1 fees collected during the relevant period and paid a $200k penalty to the SEC.

Pagliara said he has already spent $1m on attorneys’ fees this year related to the SEC’s investigation.

He acknowledged that there have been ‘some abuses in the system’ regarding fee disclosures, but insists that CapWealth wasn’t a part of it.

‘We did nothing — but no matter what we’ve told them, no matter what we’ve tried to do, they’ve been locked on us like a laser beam,’ Pagliara said.

This article originally appeared on CItyWire.


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