SEC Sues Commonwealth over Revenue-Sharing from Fidelity Unit
The Securities and Exchange Commission on Thursday sued independent broker-dealer Commonwealth Financial Network for failing to disclose to customers conflicts involving payments from a Fidelity Investments unit for steering customers to certain mutual funds.
Commonwealth received almost $136 million from mid-2014 through the end of 2018 from National Financial Services, the clearing broker and custodian for its managed fund account programs, for selling certain funds that paid NFS to be on its sales platform. NFS is owned by Fidelity.
“These revenue sharing amounts that Commonwealth received from NFS were sufficient to create meaningful incentives to invest clients’ assets in share classes and mutual funds that were more expensive for clients, and more profitable for Commonwealth,” the SEC said in its complaint filed in U.S. District Court in Boston.
Commonwealth breached its fiduciary duty by failing to tell clients of less expensive share class investments, of funds whose sales did not lead to revenue-sharing and of the fact that revenue-sharing applied not only to funds on NFS’s “no transaction fee” platform that generally had higher internal expenses but also to some on its regular transaction-fee platform, according to the lawsuit.
“Commonwealth Financial Network vehemently denies the allegations and believes they are categorically without merit,” company spokeswoman Jacquelyn Marchand said in an e-mailed statement. “We are confident we have operated both appropriately and justly, and will vigorously defend our actions in this matter.”
Commonwealth, which has 2,300 independent advisors, did not receive revenue sharing on client investments in Fidelity mutual funds, which it can purchase for its clients without a transaction fee, according to the complaint.
The independent broker-dealer discussed conflicts of interest in some of its website and regulatory disclosures, but did so misleadingly by describing them as ‘‘potential,” the SEC complaint said. Commonwealth acknowledged that it ‘may’ have incentives to select more expensive investments based on its compensation, but “in reality, Commonwealth had an actual conflict that did create those incentives,” it said.
To illustrate the firm’s share-class conflict, the SEC said Commonwealth collected about $515,000 from NFS in 2016 for $174 million of client assets invested in the “Class D” share class of an unidentified no-transaction-fee fund. The share class paid Commonwealth .30% of each client’s investment, while two other classes of the same fund had lower or no revenue-sharing and lower expense ratios.
NFS’s contracts with Commonwealth required the independent broker-dealer to disclose “receipt or prospective receipt of compensation or other payments on balances or positions in mutual funds” that would incline it to favor those types of investments, according to the complaint.
The lawsuit characterized NFS as “a relevant entity,” but did not name the firm or Fidelity as defendants.
A Fidelity spokeswoman declined to comment.
The lawsuit seeks disgorgement of Commonwealth’s “unjust enrichment” and a civil penalty.
In March, the SEC ordered the Massachusetts-based independent broker to pay $1.64 million in disgorgement and interest to customers for failing to disclose receipt of 12b-1 and other fees from fund companies. The sanction evolved from an SEC project encouraging self-disclosure of illegal fund sales practices and overcharges.
The Financial Industry Regulatory Authority last month said it has obtained $89 million from 56 broker-dealers since 2015 in a similar self-disclosure effort aimed at accelerating reimbursements to charitable and retirement accounts that were overcharged for fund purchases.