The SEC Sued a Wealth Manager Over 12b-1 Fees. He Fought Back—and Won.

Three years and $1.5 million.

That’s how much time and money advisor Tim Pagliara has spent fighting allegations brought by the Securities and Exchange Commission that he and the firm he founded failed to disclose conflicts of interest related to 12b-1 fees. After a lengthy legal battle that culminated in a trial in federal court, a jury last week found that the SEC failed to prove its allegations against Pagliara, CapWealth Advisors, and the firm’s managing director of wealth management, Timothy Murphy.

“It was bittersweet,” Pagliara tells Barron’s Advisor. “I felt vindicated. But I also feel there was something dreadfully wrong about their process.”

An SEC spokesman declined to comment beyond public filings.

The loss represented a setback for the SEC, which in recent years has been scrutinizing advisors’ disclosures to clients around 12b-1 fees and mutual fund share class selection. A 12b-1 fee is a recurring fee paid out of mutual fund assets to cover marketing and can reduce a client’s return. The SEC has collected tens of millions of dollars in fines and penalties from wealth managers.

The SEC began investigating CapWealth’s practices and use of 12b-1 fees in 2019, according to Pagliara. In 2020, the regulator filed a civil lawsuit in a federal court in Tennessee against the firm, Pagliara, and Murphy. The SEC alleged that over a three-year period they failed to adequately disclose conflicts of interest arising from their selection of mutual fund share classes that charged 12b-1 fees to clients when lower-cost share classes of the same funds were available. The SEC said 12b-1 fees were paid to an affiliated broker-dealer under common ownership 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 SEC said clients allegedly paid more than $430,000 in unnecessary fees.

CapWealth Advisors, Pagliara and Murphy denied the allegations and chose to litigate the case. They argued that they had disclosed the fees, acted in the best interests of their clients, and discounted their standard advisory fee to offset the costs of 12b-1 fees.

“I had no choice but to fight for my integrity,” Pagliara says. “They wanted me to admit that I had defrauded my clients.”

Pagliara had established a broker-dealer in 2009, the same year he launched CapWealth, but disbanded it in 2018 because of changes in the mutual fund industry and what was available through RIA custodians, he says. Pagliara adds that his average annual fee for advisory clients is 0.75 percent of assets under management.

He says he’s pleased to put the legal battle behind him but notes he won’t be able to recoup his legal fees. 

CapWealth, which is based in Franklin, Tenn., had approximately $1.4 billion in assets, according to its form ADV filed with the SEC. Pagliara has worked as an advisor for 36 years and has been ranked among Barron’s Top 1,200 Advisors. He says he lost no clients during the legal tussle with the SEC, but it slowed his growth rate as the charges were a disclosable event on his regulatory record, and the trial took time away from his business.

“I’ve climbed Kilimanjaro 12 times,” he says. “I learned a lot about perseverance. But I never thought that the highest mountain I would ever climb was a battle with my regulator that lasted three years.”