(Article from Registered Funds Regulatory Update, January 2023)
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In December 2020, the SEC filed a complaint in federal district court against CapWealth, a registered investment advisor, alleging that CapWealth did not properly disclose conflicts of interest to clients when it placed its clients in mutual funds share classes that charged Rule 12b-1 fees. This action is part of the SEC’s ongoing scrutiny and enforcement of investment advisers’ share class selection practices. On November 1, 2022, the federal jury found in favor of CapWealth.
The SEC sought financial penalties against CapWealth, its founder and chief investment officer, and its Managing Director for Wealth Management, claiming that the defendants advised clients to purchase share classes that bore 12b-1 fees when clients were eligible for share classes that did not bear such fees. The SEC estimated that affected advisory clients paid over $450,000 in “avoidable” fees over a three-year period. Further, the SEC alleged that CapWealth’s affiliated broker-dealer received 12b-1 fees from these investments and shared portions of the fees with CapWealth employees who were registered representatives of the broker-dealer.
In response, CapWealth argued that its conflicts disclosure was adequate and that it decreased its advisory fees for clients who paid 12b-1 fees to compensate for the additional cost. CapWealth further noted that 12b-1 fees are
tax-deductible for clients, while advisory fees are not. As such, clients that were placed in a share class that paid 12b-1 fees did not necessarily pay more fees on balance.
A jury rejected the charges against CapWealth on all counts after a four-day trial. The verdict served as a victory for a small group of RIAs that have emphatically resisted the SEC’s efforts to attack adviser share class selection practices.
Verdict Form: SEC v. CapWealth Advisors, LLC (Nov. 1, 2022),
No. 3:20-cv-1064 (M.D. Tenn.).