Back in 2019 (before the pandemic) the Securities and Exchange Commission, brought a case against Commonwealth Equity Services, LLC (d/b/a Commonwealth Financial Network), a registered investment adviser and broker-dealer, with failing to disclose material conflicts of interest related to revenue sharing Commonwealth received for certain client investments. The SEC prevailed in federal court, with an entry of summary judgment on liability and a penalty of $93 million. Last week, the First Circuit Court of Appeals overturned the decision and sent it back for remand.
According to the SEC’s 2019 complaint, Commonwealth had a revenue sharing agreement with its clearing broker for trades in their accounts. Under the agreement, Commonwealth received a portion of the money that certain mutual fund companies paid to the clearing broker to be able to sell their funds through the clearing broker’s programs, if Commonwealth invested its clients’ assets in certain share classes of those funds.
Here is the disclosure that the SEC didn’t like:
Additionally, NFS offers an NTF [no transaction fee] program composed of no-load mutual funds. Participating mutual fund sponsors pay a fee to NFS to participate in this program, and a portion of this fee is shared with Commonwealth. None of these additional payments is paid to any advisors who sell these funds. NTF mutual funds maybe purchased within an investment advisory account at no charge to the client. Clients, however, should be aware that funds available through the NTF program may contain higher internal expenses than mutual funds that do not participate in the NTF program and could present a potential conflict of interest because Commonwealth may have an incentive to recommend those products or make investment decisions regarding investments that provide such compensation to Commonwealth.
I think the SEC didn’t like it because it used the world “may” indicating a potential conflict, instead of an actual conflict. Commonwealth ended up changing the language in 2019, I assume as a result of the action.
The District Court agreed with the SEC:
The district court further held that Commonwealth’s disclosures were inadequate as a matter of law. The court reasoned that this was so because over the period from 2014 to 2018 Commonwealth “present[ed] the payments [Commonwealth] receive[d] from the revenue sharing arrangement as a hypothetical rather than disclosing it as a matter of fact,” [page 24]
The anti-fraud provisions of the Section 206 of the Advisers Act have been interpreted to impose a fiduciary duty on investment advisors and includes an obligation to provide ‘full and fair disclosure of all material facts’. Commonwealth argues that the issue of materiality of any omissions in its disclosure is an issue to be best determined by a jury, not summary judgment. The First Circuit agreed with Commonwealth’s argument. The First Circuit stated that the issue of materiality is appropriately resolved as a matter of law by summary judgment citing TSC Industries 426 U.S. at 449 “Only if the established omissions are ‘so obviously important to an investor, that reasonable minds cannot differ on the question of materiality’ is the ultimate issue of materiality appropriately resolved “as a matter of law” by summary judgment.” [Page 31]
In essence, the district court held that, in its view, since all potential conflicts are material, the omissions at issue were material as a matter of law. Applying the correct test of materiality, we hold that a reasonable jury could conclude, on the facts of this case, that additional 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,” Basic Inc., 485 U.S. at 232 [Page 35]
It’s not a total win for Commonwealth. It still faces a jury trial with the SEC having to prove the materiality of what it perceives as an omission by Commonwealth. Perhaps, it finally drop its hatred of “may.”
Sources:
- First Circuit Decision in SEC v. Commonwealth Equity April 1, 2025
- First Circuit Vacates Summary Judgment Award and $93 Million Order in Revenue Sharing Case In Ropes & Gray by R. Daniel O’Connor, Amy D. Roy, Devon Applegate Caton, Sean Adessky
- SEC Charges Investment Adviser for Failing to Disclose Conflicts Arising from Receiving Revenue Sharing On Client Investments
- SEC Complaint