Commonwealth case sends crystal-clear message

KO blow from the SEC offers pointed lesson: Don’t fight Uncle Sam

In the combat sport of boxing, a trainer throws in the towel not only to concede defeat, but to protect the health of their fighter. At this point, defeat is usually inevitable and the only thing standing in the way of serious injury is the boxer’s ego and pride. Not that they will agree; the best fighters could be on their knees with one functioning arm and still believe they’re going to win.

And so to the recent prizefight in the wealth management world, Commonwealth Financial Network vs. the SEC, which last week delivered a stunning $93 million KO win for the latter to conclude a five-year legal battle.

Commonwealth may now wish it had conceded defeat when it had the chance. Back in 2019, the SEC alleged that the firm, in its role as a registered investment advisor, from July 2014 through December 2018 had failed to disclose material conflicts of interest related to certain revenue-sharing agreements with its clearing firm. In a rare move, Commonwealth’s senior executives refused to back down and went toe to toe with the regulator, opting to litigate the matter rather than settle it. Despite this, InvestmentNews reported just last month that the firm knew defeat was in the cards and was expecting a loss of between $5 million and $24 million. That proved wildly optimistic.

Ultimately, the penalty was broken down to $65.6 million for disgorgement, interest of $21.2 million and a civil penalty of $6.5 million. For context, the Boston-based firm’s net income was close to $56.5 million in 2014 and $119.4 million in 2018, according to the court order. The lesson here: Don’t fight Uncle Sam.

But why did Commonwealth risk more damage by taking on the SEC? Did it really think it could win? Or was it simply too proud to accept a chastening defeat? In addition to the size of the penalty, what makes this case eye-catching is the firm’s stellar reputation. With 2,200 financial advisors across its brokerage and registered investment advisor platform and $296 billion in client assets, it’s a respected institution. Its gross revenue per advisor among independent broker-dealers has won awards. And the firm is built on revered founder Joseph Deitch’s vision of creating an independent broker-dealer without conflicts of interest. Maybe – though this is pure speculation – this clearly articulated ethos is why the firm was so affronted by the SEC’s legal pursuit.

What is clear, however, is that pushing back against the regulator cost Commonwealth at least $69 million more than it had set aside. This will have a chilling effect on other firms caught in the crosshairs of the SEC. Do they really have the stomach and conviction to prolong the fight? Or should they limit the damage and throw in the towel? This case makes one thing crystal clear – you take on Uncle Sam at your peril.