Commonwealth hit with new SEC case over disclosure failures

A self-reporting program aimed at scrutinizing 12b-1 fees collected by RIAs didn’t shield one of the largest participating firms from an SEC case involving other revenue sharing.

Commonwealth Financial Network’s RIA failed to disclose conflicts of interest related to more than $100 million in revenue sharing from mutual funds over 4 and ½ years, the regulator said Aug. 1. The firm had agreed to pay $1.6 million in March to settle the SEC’s other case.

The latest one involves the nation’s fourth largest independent broker-dealer with more than $1.4 billion in revenue in 2018 and one of the industry’s biggest clearing firms, Fidelity Clearing & Custody Solutions’ National Financial Services. It also reveals details of the firms’ relationship.

The SEC's settlements with Commonwealth and 78 other RIA affiliates of broker-dealers had prompted the firm to make a “kitchen sink” of disclosures in its Form ADV, Chief Compliance Officer Paul Tolley said in May. The regulator alleges it still hasn’t done enough.

Commonwealth “has not adopted a reasonably designed, and enforced, written policy for identifying material conflicts of interest,” according to the SEC’s civil complaint, which it filed in the U.S. District Court in Massachusetts.

The complaint also alleges Commonwealth hasn’t implemented policies and procedures designed to prevent violations of the Advisers Act and its own rules around “ensuring the disclosure of ‘any form of compensation,’ including the revenue sharing arrangement with NFS.”

Commonwealth has built a reputation for having the highest job satisfaction for financial advisors — as well as garnering fewer regulatory cases than other large firms. The firm intends to fight the SEC’s new case, spokeswoman Jacquelyn Marchand said in an email statement.

“While the enforcement action proposed by the [SEC] is a pending legal matter, Commonwealth Financial Network vehemently denies the allegations and believes they are categorically without merit,” Marchand said. “We are confident we have operated both appropriately and justly and will vigorously defend our actions in this matter.”

• Independent BDs
• Commonwealth Financial Network
• Northwestern Mutual
• IBD Elite
• Fee-based compensation
• RIAs

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The SEC listed the Fidelity NFS unit — which has some 200 broker-dealer clients — as a relevant entity rather than as a defendant. The custodian and clearing firm declined to comment on the case.

NFS and Commonwealth share a portion of the recurring fees NFS collected from mutual funds in exchange for access to Commonwealth’s $80-billion asset Preferred Portfolio Services advisory program, according to the complaint. Such arrangements are common among BDs.

BD-affiliated advisors don’t receive any part of the revenue-sharing payments at Commonwealth or other firms. However, between July 2014 and December 2018, Commonwealth didn’t fully spell out to clients how the firm stood to benefit from their mutual fund investments, the SEC says.

The firm failed to explain its vested interest in making recommendations among the various share classes of mutual funds, according to the SEC. Even an amended Form ADV disclosure about no-transaction-fee funds in March 2017 “was still deficient and misleading,” the regulator says.

“Commonwealth described the conflict as merely ‘potential’ and acknowledged only that Commonwealth ‘may’ have incentives to select more expensive investments based on its compensation,” the complaint states. “In reality, Commonwealth had an actual conflict that did create those incentives.”

In addition, the complaint continues, the firm didn’t state it had an incentive to place clients in higher-cost share classes that came with greater revenue sharing. Among funds that did have transaction fees, Commonwealth failed to disclose any revenue sharing, according to the SEC.

The case also outlines the differences in expenses relating to some sample share classes, noting that some no-transaction-fee products came with higher internal costs that benefited Commonwealth. The firm failed to disclose this conflict, according to the complaint.

It wasn’t immediately clear whether the revenue-sharing investigation stemmed from information Commonwealth provided to the regulator under the RIA self-reporting program. Representatives for the SEC declined to comment beyond the complaint and a press release announcing it.

Tolley, the Commonwealth CCO, said on a panel at FINRA’s annual conference earlier this year that the company’s Form ADV “makes us sound terrible” after adding language about revenue sharing the firm wouldn’t even have considered using two to five years ago. He cited the 12b-1 cases.

“The reality is that we need to disclose that information,” Tolley said in the panel on conflicts of interest. The firm is “going to err in the most extreme way” on the side of spelling them out, he added.