The Securities and Exchange Commission has charged a Franklin, Tenn.-based firm, its principal and an advisory representative with violating their fiduciary duty to clients by steering them into expensive mutual funds.
According to the SEC complaint, from June 2015 until June 2018 and several years preceding that, CapWealth Advisors LLC, Timothy J. Pagliara, 63, and advisory representative Timothy R. Murphy, 61, 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.
The SEC complaint said CapWealth’s affiliated broker-dealer, CapWealth Investment Services (CWIS), received 12b-1 fees from these investments and shared portions of the fees with Pagliara and Murphy, who were registered representatives of CWIS. Pagliara, the SEC said, instructed the broker-dealer to send the 12b-1 fees from his clients’ accounts to CWIS, of which Pagliara was the majority owner and through which he received compensation from his advisory and brokerage roles. Murphy also received 12b-1 fees from his clients’ mutual fund investments as a portion of the compensation he received, the complaint alleged.
The SEC said CapWealth, Pagliara and Murphy invested, recommended or held advisory clients’ assets in mutual fund share classes that charged 12b-1 fees, even though clients were eligible to invest in or convert to share classes of the same funds without 12b-1 fees. As a result, CWIS received 12b-1 fees that were later passed on to Pagliara and Murphy.
Pagliara, the SEC said, incurred a collective total of more than $228,000 in avoidable 12b-1 fees between June 2015 and June 2018, and the advisory clients of Murphy incurred more than $223,000 in avoidable 12b-1 fees.
The complaint noted that during the period of the alleged violation, Pagliara and Murphy understood that advisory clients, as a general matter, could avoid 12b-1 fees by investing in class I shares and other lower-cost share classes of a fund, when such a share class was available to their clients. But investments were made without giving clients full and fair disclosures concerning the conflicts of interest stemming from CapWealth’s, Pagliara’s and Murphy’s share class selection practices for clients, the complaint said.
Further, the complaint said Pagliara admitted to not disclosing any conflict of interest arising from his share class selection practices because he did not believe that there was a conflict of interest. Also, Murphy made misleading statements to certain clients’ inquiries about the selection practices, the complaint said.
The complaint said CapWealth also failed to adopt and implement written policies and procedures designed to prevent these violations. The firm had the same deficient disclosures about 12b-1 fees from at least July 2014 until June 2018, it said. The complaint further said CapWealth was eligible to self-report to the SEC pursuant to the Division of Enforcement's Share Class Selection Disclosure Initiative but did not do so.
The SEC seeks financial penalties against CapWealth, Pagliara and Murphy, as well as disgorgement of ill-gotten gains plus prejudgment interest from Pagliara and Murphy.