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CapWealth 12b-1 Case vs. SEC Moves Closer to Jury Trial

The Securities and Exchange Commission’s charges against a Tennessee-based RIA for allegedly not disclosing 12b-1 fee conflicts of interest moved one step closer to a jury trial this week, after a federal judge denied summary judgment appeals from both sides.

The SEC first filed a complaint against Franklin, Tenn.–based RIA CapWealth Advisors in late 2020, claiming the firm failed to tell clients they were investing their funds in certain mutual fund share classes that resulted in higher fees, when more affordable options were available. 

The commission has made similar cases against many other firms in recent years. Most end up settling with the regulator. CapWealth Advisors co-founder Tim Pagliara pledged to fight the accusations all the way to a jury trial, if necessary.

In response to the SEC motion for a decision on the case, U.S. District Judge Waverly Crenshaw ruled the regulator did not show CapWealth made any “material misstatement or omission.” During depositions, Pagliara argued that clients kept in 12b-1 funds were either granted advisory fee discounts or were kept in those share classes because the investments and fees were more tax-efficient.

“The SEC has not rebutted defendants’ testimony. It has presented evidence that certain CapWealth clients who incurred 12b-1 fees were charged CapWealth’s standard advisory fee,” Crenshaw wrote. “But it has not demonstrated that any one of them in particular did not benefit from the tax efficiency strategy outlined by Mr. Pagliara in his deposition.”

Likewise, the judge found CapWealth had not demonstrated a need for an immediate judgment in its favor, arguing that there were still “genuine issues of material fact” in dispute.

“Defendants’ argument that no conflict existed relies heavily on the credibility of their own testimony … which is a matter for the jury to consider,” the judge wrote. “The same applies to defendants’ argument that if a conflict existed they adequately disclosed it.”

According to Pagliara, the judge has ordered the parties back into mediation, but he expects a jury trial will begin as scheduled on June 14.

“I think we’re going to win,” he told “The SEC didn’t know the law, and they don’t understand the economic benefits that were transferred to clients with the strategy that we employed, and I think it’s been an abuse of power on their part.”

The SEC offered amnesty for registered firms to disclose share class conflicts in 2018. After that window, the regulator began charging firms for nondisclosure and a breach of fiduciary duty. Most end up settling without denying wrongdoing and paying a small fine. 

It’s rare that the charges reach a jury trial, but it has happened. In March, a jury decided in the SEC’s favor in a trial against Ambassador Advisors, finding that the Pennsylvania-based firm breached its fiduciary duty with the more expensive funds. Shortly thereafter, the trial judge “rescinded” the jury’s verdict, arguing the judgment was “entered prematurely in error.”

In a previous interview, Pagliara said most RIAs feel they have no choice but to settle.

The problem is nobody’s got the resources to fight them and it becomes too easy to settle,” he said. “They don’t have the money to fight and they don’t investigate.”

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