First Circuit Vacates Summary Judgment Award and $93 Million Order in Revenue Sharing Case

On April 1, 2025, the United States Court of Appeals for the First Circuit overturned a $93 million judgment issued against Commonwealth Financial Network (“Commonwealth”) nearly one year ago in a case by the Securities and Exchange Commission (“SEC”) concerning alleged failures to adequately disclose revenue sharing payments.¹ A three-judge panel has remanded the case to the District Court for the District of Massachusetts taking the SEC to task for its lack of evidence that the alleged omissions regarding details on conflicts were material to investors and asking the District Court to “consider and address the numerous shortcomings in the SEC’s causation evidence.”²

Background

The SEC sued Commonwealth in 2019, alleging that from at least July 2014 through December 2018, the company breached its fiduciary duty to its advisory clients by failing to adequately disclose conflicts of interest involving a revenue sharing program involving mutual fund shares sold through National Financial Services (“NFS”), its clearing firm.

Specifically, the SEC alleged that Commonwealth failed to disclose to clients that certain mutual fund share classes generated millions of dollars for the firm, while other, allegedly cheaper share classes would have generated much less, or no, additional revenue. The SEC alleged that Commonwealth’s failures to disclose were “egregious,” including that “Commonwealth had agreements with NFS to receive portions of the fees received by NFS’ [No Transaction Fee and Transaction Fee] programs… and that Commonwealth failed to make robust disclosures regarding the revenue it generated from the higher-cost shares.”³ The Appeals Court noted that in various disclosures over the relevant period, Commonwealth did tell investors that Commonwealth and the individual advisors’ receipt of “commissions, fees, payments, and other compensation may present a potential conflict of interest because Commonwealth or [the] advisor may have an incentive to recommend those products . . . that provide such compensation . . . .”⁴ The District Court, however, ruled that the disclosures were insufficient and that it was “was well-settled that potential conflicts of interest are material facts that investors would consider important in making investment decisions [i.e., material].”⁵

The District Court found that Commonwealth was liable for disgorgement of $65.6 million, interest of $21.2 million and a civil penalty of $6.5 million, finding that “at least some” clients would have made different decisions if they had known about the higher fees.⁶

SEC’s Failure to Submit Issues of Materiality to a Jury

The First Circuit agreed with Commonwealth’s argument that the question of whether the alleged omission of certain statements was material constituted an issue best left to a jury. The First Circuit asserted that the issue of materiality is appropriately resolved as a matter of law by summary judgment “[o]nly if the established omissions are ‘so obviously important to an investor, that reasonable minds cannot differ on the question of materiality.’”⁷

The First Circuit faulted the District Court for failing to engage in a “fact-specific inquiry” with respect to the alleged omissions and instead resting on a generalized per se conclusion that it was “indisputable” that the potential conflicts of interest were material. The First Circuit asserted that the District Court effectively held that (1) all potential conflicts are material; and that (2) therefore, all omissions at issue were material as a matter of law – a determination the First Circuit stated was made in error. The Court reasoned that due to the nature in which Commonwealth’s investors “differed in many categories of ways” (despite the SEC arguing that they were “identically situated”), and the myriad factors used by Commonwealth’s advisors to recommend investments, there were “material issues of fact as to the importance of price, Commonwealth’s influence over the funds selected, and about the significance of the allegedly deficient disclosures, themselves.”⁸

Shortcomings in the SEC’s Causation Evidence

The First Circuit ultimately concluded that the issue of materiality was best left to a jury due to the numerous causation issues underpinning the SEC’s theory. As the Court explained, the District Court’s failure to engage in a fact-specific inquiry ignored analysis of critical causation issues at play. For one, the First Circuit disagreed with the District Court’s acceptance that all of Commonwealth’s 319,000 investors (served by 2,300 different representatives) were identically situated and took issue with the fact that the SEC had failed to solicit any testimony from Commonwealth clients or representatives describing the particular significance they attributed to the omitted information.⁹ In addition, Commonwealth’s own representatives testified that they are not always necessarily looking for the lowest-cost share class for their clients (and that it therefore does not follow that simply because a share class was the lowest cost available, that this was material to the representatives and their clients).¹⁰

The First Circuit noted that clients are not making investment decisions purely through Commonwealth’s pre-constructed portfolios but are instead making them through representatives—representatives who are “themselves sophisticated and independent members of the financial industry,” such that it was “not obvious whether the omitted facts would have changed the investors’ decisions.”¹¹ These representatives testified that they conduct independent research to determine the best share class for a client, and at least one testified that he never even used Commonwealth’s pre-constructed portfolios.¹² As a result, the First Circuit held that “a reasonable jury could conclude…that additional conflict of interest disclosures with more precise descriptions, added to the already-disclosed conflicts of interest, would not have so ‘significantly altered the ‘total mix’ of information made available’ [and] that summary judgment was inappropriate.”¹³

In reconsidering these factors, the First Circuit directed the District Court to consider and address “the numerous shortcomings in the SEC’s causation evidence” including (1) the criticisms raised by Commonwealth’s experts as to the representativeness of the sample used by the SEC’s expert to calculate the number of lower-cost, alternative share classes; (2) countervailing evidence of causation in statements from Commonwealth representatives; and (3) the inadequately supported assumptions made by the SEC as to the materiality of the omissions.¹⁴

Disgorgement Award Error

In addition to vacating the liability judgment, the First Circuit also vacated the disgorgement award. The First Circuit concluded that the District Court made fundamental legal errors in the disgorgement calculations, asserting that the SEC “has not adequately shown either reasonable approximation or causal connection sufficient to support the court’s disgorgement award.”¹⁵ Moreover, the First Circuit criticized the District Court for failing to deduct Commonwealth’s expenses in the disgorgement calculation.¹⁶

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The First Circuit’s decision demonstrates that the SEC needs to provide more direct proof of the materiality of an alleged omission related to a conflict of interest rather than to simply show an omission occurred. Moreover, the court made clear that high-level approximations of ill-gotten gain will not suffice. The SEC needs to provide evidence of a causal connection and a more concrete analysis related to disgorgement calculations including consideration of expenses. Here, the First Circuit concluded that a reasonable jury could find that additional disclosures “with more precise descriptions, added to the already-disclosed conflicts of interest” may not have “so significantly altered the total mix of information made available.”¹⁷ Importantly, the materiality determination is a “fact-specific inquiry,” and a court must analyze the actual decision-making process, and what factors were considered, in order to make a determination as to whether the omitted information would have been “material” to a reasonable investor.