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SEC Loses Legal Battle Against Tennessee RIA

After three years in a legal battle with the Securities and Exchange Commission, CapWealth Advisors found favor from a jury in Tennessee’s middle district.

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After three years in a legal battle with the Securities and Exchange Commission, CapWealth Advisors found favor from a jury in Tennessee’s middle district.

The jury found that the $1.3 billion registered investment advisor’s collection of 12b-1 fees on sales of certain mutual fund share classes did not violate its fiduciary duty.

Chief District Judge Waverly Crenshaw, Jr., entered that verdict as an official judgement last week.

In December 2020, the SEC charged CapWealth Advisors LLC, its principal, Timothy J. Pagliara, and an advisory representative, Timothy R. Murphy, in connection with their mutual fund share class selection practices.

The SEC’s complaint alleged that, from at least June 2015 until June 2018, CapWealth, Pagliara and Murphy, failed to adequately disclose conflicts of interest arising from their selection of mutual fund share classes that charged 12b-1 fees, instead of lower-cost share classes of the same funds that were also available to clients.

According to the complaint, those 12b-1 fees were paid to 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.

In addition, the complaint alleges that CapWealth, Pagliara and Murphy breached their duty to seek best execution for their clients’ mutual fund share class purchases by causing certain advisory clients to invest in fund share classes that charged 12b-1 fees when share classes of the same funds that presented a more favorable value for the clients were available.

Following the official judgement, Pagliara blasted the SEC for “regulatory abuse of a small business.”

CapWealth had argued during the case that it had lowered advisory fees for clients who paid 12b-1 fees to negate the added expense and that such fees were tax-deductible for the client in question, which made the fees an ordinary and necessary business expense inside a mutual fund, while advisory fees are not.  As a result, they argued, the client would be better off placed in a more expensive share class.

“It is a tenet of our fiduciary responsibility that you have to take into account taxes,” explained Pagliara.

It is a common practice among those pursued by the SEC to simply settle with the agency, with the vast majority of actions being settled rather than argued in court. Pagliara previously stated that his decision to fight the SEC in court was because, “We do not negotiate with regulatory thugs that harass our clients.”

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