The U.S. Court of Appeals for the First Circuit has vacated a $93 million judgment entered by the U.S. District Court for the District of Massachusetts against a registered investment adviser (Adviser).1 In its April 1 decision in SEC v. Commonwealth Equity Services, the First Circuit set aside both the district court’s grant of summary judgment in favor of the U.S. Securities and Exchange Commission (SEC) and the associated disgorgement award, remanding the case for further proceedings. The decision turned on two key issues: (1) the standard for determining whether information is material; and (2) the proper method for calculating disgorgement.
Key Legal Points
- The determination of whether a fact is “material” is typically a mixed question of law and fact that should be determined by a jury, taking into account the total mix of information available to investors.
- Disgorgement may only be ordered in an amount that is a reasonable approximation of profits causally connected to the underlying violation, generally deducting any legitimate expenses prior to calculation.
Procedural Background
The Adviser, a dually registered broker-dealer and investment adviser, offers advisory services through a network of investment adviser representatives. These representatives are affiliated with the Adviser but operate independent advisory businesses in their own names. To buy and sell mutual funds to advisory clients, the representatives utilize a platform of available funds provided to them by the Adviser. The platform pays the Adviser 80% of the gross revenue it receives from the sales of mutual funds on the platform by the representatives (revenue-sharing program).
Because the Adviser is a registered investment adviser, it is required to file public disclosure on Form ADV. Among other things, Form ADV requires an investment adviser to make full disclosure of all material conflicts of interest that could affect the advisory relationship by providing sufficiently specific facts so that the client is able to understand the conflicts and can give informed consent. In particular, Form ADV requires an adviser to describe arrangements in which someone other than a client gives an economic benefit to the adviser for providing advisory services, explain the conflicts of interest arising out of that relationship, and describe how those conflicts are addressed.
The Adviser modified its Form ADV disclosure over time with respect to the conflicts of interest arising from the revenue-sharing program. The SEC alleged that the Adviser failed to adequately disclose these conflicts in violation of Section 206(2) of the Investment Advisers Act of 1940 (Advisers Act) and failed to adopt and implement written policies and procedures to ensure that it identified and disclosed the conflicts in violation of Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder. The SEC and the Adviser both filed motions for summary judgment, and the district court granted the SEC’s motion for summary judgment with respect to the Adviser’s liability for inadequate disclosure.2 As a result, the district court entered final judgment against the Adviser, ordering disgorgement of $65 million in revenue-sharing income plus $21 million in prejudgment interest.3 The Adviser appealed the order to the First Circuit.
Materiality Cannot Be Resolved as a Matter of Law Where Material Facts Are in Dispute
The Adviser argued on appeal that the district court should have denied the SEC’s motion for summary judgment, as a court should only grant summary judgment if there “is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.”4 The district court held that the conflicts of interest associated with the revenue-sharing program between the Adviser and the mutual fund platform were per se material and that the Adviser’s disclosures about those conflicts were inadequate as a matter of law.
As the First Circuit pointed out, however, a fact is only material if “there is a substantial likelihood that a reasonable shareholder would consider it important”5 and such determinations are “typically left to the jury.”6 The First Circuit explicitly rejected the district court’s use of a “per se materiality” rule, noting that even the SEC did not argue that it was entitled to summary judgment by application of any such per se rule. In doing so, the First Circuit reiterated that only when omissions “are so obviously important to an investor, that reasonable minds cannot differ on the question of materiality” is the issue “appropriately resolved … by summary judgment.”7
Importantly, the First Circuit held that, given the facts asserted by the SEC, a reasonable jury could conclude that additional disclosures with more precise descriptions, added to the already disclosed conflict of interest, would not have significantly altered the total mix of information available to investors. The First Circuit stated that it was not obvious that the facts the SEC argued were omitted from the Adviser’s conflict-of-interest disclosure would have changed the investors’ perceptions. As a result, the First Circuit reversed the district court’s grant of summary judgment to the SEC.
Disgorgement Must Be Limited to Net Profits Causally Connected to the Violations
The First Circuit vacated the district court’s disgorgement award and stated that, on remand, the district court must consider whether the SEC has adequately established a causal connection between the Adviser’s profits and its alleged violations, as well as whether the Adviser is entitled to deduct its expenses from any disgorgement awarded. The First Circuit stated that disgorgement may only be ordered in matters where the SEC can demonstrate “a reasonable approximation of profits causally connected to the … violation.”8
The First Circuit held that the SEC did not adequately show either reasonable approximation or causal connection to support the district court’s disgorgement award. In particular, the First Circuit rejected the district court’s justification that disgorgement was appropriate because “at least some” clients would have moved money to lower-cost funds had the conflict been disclosed.9 The First Circuit stated that reasonable approximation, while not exact, requires more analysis and connection than the SEC provided in this case, to move from “a few” investors to “every” investor.10
The First Circuit also stated that, on remand, the district court must assess whether the Adviser is entitled to deduct any of its expenses from the disgorgement awarded. The First Circuit stated that generally, legitimate expenses must be deducted before ordering disgorgement with limited exceptions for some expenses that are determined inequitable.11
Takeaways
- Investment advisers that are involved in an SEC examination or enforcement inquiry should ensure that any materiality assessment considers whether the statement or omission significantly alters the “total mix” of information available to investors as required by well-established precedent.
- Additionally, investment advisers should carefully evaluate SEC disgorgement calculations to determine whether they are a reasonable approximation of illicit gains and have a causal connection to any alleged harm to investors. Investment advisers should also be sure that all legitimate business expenses are deducted from any disgorgement calculation as required by the U.S. Supreme Court in Liu v. SEC.
1 SEC v. Commonwealth Equity Services, No. 24-1427, 2025 U.S. App. LEXIS 7541 (1st Cir. April 1, 2025).
2 SEC v. Commonwealth Equity Services, Civil Action No. 1:19-cv-11655-IT, 2023 U.S. Dist. LEXIS 61489 (D. Mass. April 7, 2023).
3 SEC v. Commonwealth Equity Services, Civil Action No. 1:19-cv-11655-IT, 2024 U.S. Dist. LEXIS 59361 (D. Mass. March 29, 2024). The district court also issued a civil monetary penalty in the amount of $6.5 million.
5 Commonwealth, supra n.1 at *32-33 (quoting TSC Industries v. Northway, 426 U.S. 438 (1976)).
6 Id. at *33 (quoting SEC v. Lemelson, 57 F.4th 17, 25 (1st Cir. 2023)). The First Circuit also highlighted that the U.S. Supreme Court’s decision in SEC v. Jarkesy held that the Seventh Amendment right to a jury trial applies to SEC securities enforcement actions of its administrative orders, and that any encroachment on the right to a jury trial should be highly scrutinized. See id. at *37 (citing Jarkesy, 603 U.S. 109 (2024)).
7 Id. at *33 (quoting TSC Industries).
8 Id. (quoting SEC v. Navellier & Associates, 108 F.4th 19 (1st Cir. 2024)). The First Circuit noted that the causal connection required is between the amount by which a defendant was unjustly enriched and the amount they can be required to disgorge.
11 See Liu v. SEC, 591 U.S. 71, 91-92 (2020).
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