RIA CapWealth Wins Legal Battle With SEC Over 12b-1 Disclosures

CapWealth went up against an SEC staff of eight attorneys, jury experts and two paralegals, and won a rare victory related to share class disclosure conflicts.'This is David and Goliath,' the firm's founder said.

A Franklin, Tenn.–based registered investment advisor prevailed in a jury trial brought by the Securities and Exchange Commission accusing the firm of not disclosing conflicts of interest stemming from 12b-1 fees.

CapWealth Advisors was found not guilty after a trial that began in federal court in Tennessee’s Middle District last week. The SEC first filed its complaint against the RIA in late 2020, arguing the firm failed to inform clients their investments were placed in certain mutual fund share classes when more affordable options were available. 

CapWealth founder Tim Pagliara told WealthManagement.com in February 2021 that he intended to fight the accusations in a jury trial, if necessary.

In an interview following the verdict, Pagliara said he’d been appreciative of the judge, federal court staff and his own attorney, saying he’d faced off against an SEC staff of eight attorneys, jury experts and two paralegals, compared with his single attorney and paralegal. He called the SEC’s actions “a regulatory abuse of a small business.”

“This is David and Goliath,” he said. “That’s all it was.”

On Tuesday, the jury voted in favor of CapWealth on all counts, responding “no” to charges that Pagliara and CapWealth “engaged in conduct that operated as a fraud or deceit,” and that the firm “did not adopt and implement written policies and procedures reasonably designed to prevent” violations of the Investment Advisers Act, according to a verdict form dated Nov. 1.

Many firms over the past several years opted into the SEC’s Division of Enforcement’s Share Class Selection Disclosure Initiative, which launched in February 2018 to encourage firms to self-report mutual fund share class violations in order to avoid being charged and possibly paying higher penalties. That initiative returned nearly $140 million to clients. After the self-reporting period ended, the SEC began charging firms for nondisclosure, with most deciding to settle with the regulator. 

The CapWealth trial marked one of the few occasions where such charges reached a jury trial. In March, a jury decided in favor of the SEC in its case against Ambassador Advisors, finding that the Pennsylvania-based firm breached its fiduciary duty by failing to disclose share class conflicts. While the jury decided in the SEC’s favor, the judge later “rescinded” the jury’s verdict.

The SEC argued that a portion of CapWealth’s raised 12b-1 fees had gone to the firm’s managing director, as well as other brokers; while Pagliara didn’t directly receive such fees, some of his share of generated fees went to the parent company, a trend that allegedly continued after CapWealth began offering share classes with different fee structures. 

Pagliara previously told WealthManagement.com the allegations were “absurd,” arguing the SEC misunderstood the services CapWealth provided for clients, and argued that the SEC had spoken to more than a dozen of his clients, none of whom had raised concerns. He also called the commission’s self-disclosure initiative intimidating to advisors and an exploitative example of the regulator’s power.

The SEC declined to comment “beyond public filings,” including whether it planned to appeal the verdict, according to a spokesperson. Pagliara believed he would prevail should the SEC pursue an appeal, calling the verdict a “pretty-clear cut” victory. 

However, he questioned whether “the average firm” would have even pursued a jury trial, saying his own personal wealth made that decision easier. He also hoped to work with elected officials to raise awareness of what he called “an abuse of power and colossal waste of taxpayer money.”

“It’s bittersweet, because you think your government’s looking out for your best interest, and you find there are these regulators who don’t care about the truth,” he said. “They care about winning."