Commonwealth Financial Network is appealing a $93 million court ruling that it didn’t disclose conflicts of interest when recommending certain mutual fund share classes for clients when more affordable options were available.
Commonwealth is moving to appeal the case to the U.S. Court of Appeals in the First Circuit after a Massachusetts federal judge ruled in favor of the Securities and Exchange Commission. (The First Circuit includes Maine, Massachusetts, New Hampshire, Rhode Island and Puerto Rico.)
In a statement to WealthManagement.com, Peggy Ho, senior vice president, general counsel and chief risk officer with the firm, said Commonwealth would “continue vigorously pursuing all available legal avenues” in the case.
“Meanwhile, we remain focused on our mission to offer independent advisors the services and solutions they need to grow their businesses and enhance the experience for their clients,” she said.
The SEC initially filed charges in 2019, accusing Commonwealth of failing to alert mutual fund share class customers that there were cheaper options (with Commonwealth making less profit as a result).
According to the original complaint, Commonwealth has about 2,300 investment advisor representatives, using National Financial Services as its clearing broker. Through that arrangement, reps could recommend mutual fund shares via a No Transaction Fee program and a program including transaction fees.
But Commonwealth and NFS had a revenue-sharing agreement that made the firm more money to put clients in certain mutual fund share classes, according to the original order. At times, those share classes were more expensive for clients than other share classes of the same mutual funds, not including fees.
Between July 2014 and March 2018, Commonwealth received about $58.7 million from client assets invested in NTF mutual fund share classes while receiving $77 million in payments from client assets invested in share classes with transaction fees.
The commission argued Commonwealth knew these affordable options were available. According to the complaint, it even recommended them to certain clients, but it didn’t alert them about the revenue it made from the higher-cost recommendations.
In April 2023, the SEC won a motion for summary judgment (which asks the judge to decide on the case’s merits before trial). In late March, U.S. District Judge Indira Talwani affirmed the decision and ordered Commonwealth to pay nearly $66 million in disgorgement, as well as prejudgment interest totaling $21 million and a civil penalty of $6.5 million, for a total of about $93 million.
The SEC has settled dozens of share-class-related cases with registrants over the years, including through a 2018 self-disclosure initiative that urged firms to self-report share-class violations to avoid higher penalties.
Jury trials on the issue are rare (the Commonwealth case, for example, never reached a jury), and the SEC’s success there is checkered. In March 2022, a jury ruled in favor of the SEC in its case against the Pennsylvania-based Ambassador Advisors for not disclosing share class conflicts (though the judge later “rescinded” the jury’s verdict).
CapWealth Advisors, a Tennessee-based RIA, won its jury trial against the commission in 2022. After the verdict, CapWealth Founder Tim Pagliara told WealthManagement.com the two parties were like “David and Goliath” and called the SEC’s approach “a regulatory abuse of a small business."
