First Circuit Overturns SEC Judgment Against Commonwealth

Ropes & Gray reports that the First Circuit Court of Appeals vacated a $93 million SEC judgment against Commonwealth Financial Network in the case, Securities and Exchange Commission v. Commonwealth Equity Services, LLC d/b/a Commonwealth Financial Network, on April 1.

The issue was alleged disclosure failures regarding revenue-sharing payments. The three-judge panel criticized the SEC’s evidentiary shortcomings, ruled that materiality and causation issues were not properly resolved on summary judgment, and remanded the case to the District Court for further proceedings.

The case concerns the SEC’s 2019 lawsuit, which alleged that Commonwealth failed to adequately disclose conflicts of interest from revenue-sharing arrangements with its clearing firm, National Financial Services, between 2014 and 2018.

According to the SEC, Commonwealth earned more by recommending higher-cost mutual fund share classes without sufficiently disclosing this conflict. The District Court agreed and found Commonwealth liable for over $93 million in disgorgement, interest, and penalties.

The First Circuit reversed, emphasizing that materiality is a fact-specific inquiry best reserved for a jury unless the significance of the omission is beyond dispute.

The court criticized the District Court for applying a per se rule that all conflicts are material, and for failing to consider the diversity of investor experiences and advisors’ independent decision-making.

It also highlighted flaws in the SEC’s causation evidence, including its failure to show how the omitted details would have influenced investor decisions.

Lawyers should take note of the high evidentiary burden on the SEC in enforcement actions, as this action highlights, particularly in terms of the need for detailed, investor-specific proof of materiality and causation.

The reversal also signals increased judicial scrutiny of disgorgement calculations and reinforces that courts will not assume uniformity among investors in complex advisory relationships. The ruling may set a significant precedent in cases involving fiduciary disclosures and conflicts of interest.