Fact-Specific Materiality of Adviser Conflicts and Disgorgement Limits under the Advisers Act

Introduction

The case of Securities and Exchange Commission v. Commonwealth Equity Services, LLC (1st Cir. Apr. 1, 2025) challenges summary judgment in a civil enforcement action brought by the SEC under Sections 206(2) & (4) of the Investment Advisers Act of 1940 and Rule 206(4)-7. Commonwealth, an SEC-registered investment adviser and broker-dealer, operated a network of some 2,300 independent representatives. From 2014 to 2018, Commonwealth shared revenue received from its clearing broker, National Financial Services (“NFS”), with its parent company, generating approximately $189 million. The SEC alleged that Commonwealth failed to disclose material conflicts of interest arising from these revenue-sharing arrangements and sought summary judgment on liability, disgorgement of profits, prejudgment interest, and a civil penalty. Commonwealth appealed from the district court’s grant of partial summary judgment to the SEC, the disgorgement order of roughly $65.6 million, prejudgment interest of $21.2 million, and a $6.5 million civil penalty.

Summary of the Judgment

The First Circuit vacated the district court’s summary judgment for the SEC and its disgorgement order, holding:

Materiality of omitted conflict-of-interest disclosures cannot be decided as a matter of law; a jury must assess whether the omitted information “‘significantly altered the total mix of information’” available to clients (quoting TSC Industries v. Northway).
The district court erred in applying a per se rule that all conflicts are material without conducting the required fact-specific inquiry.
Disgorgement must be tied to profits “causally connected” to wrongdoing and qualify as a “reasonable approximation” of unjust enrichment. The SEC’s “at least some” causal standard was too broad.
Under Liu v. SEC, legitimate business expenses must ordinarily be deducted from any disgorgement award unless the entire profit derives from wrongful activity and the expenses are “inequitable.”
The case was remanded for trial on liability issues and for a new disgorgement analysis if liability is proved.

Analysis

Precedents Cited

Basic Inc. v. Levinson (1988): Endorsed the TSC Industries materiality standard in securities-fraud contexts.
TSC Industries, Inc. v. Northway, Inc. (1976): Held that an omitted fact is material if disclosure would “significantly alter the total mix of information” available to a reasonable investor; materiality is typically a jury question.
SEC v. Jarkesy (2024): Reaffirmed the Seventh Amendment jury-trial right in SEC enforcement actions and emphasized legal vs. equitable remedies distinctions.
Liu v. SEC (2020): Directed that disgorgement awards must represent a defendant’s net unjust enrichment by deducting legitimate expenses unless the entire profit was obtained by wrongdoing and ordinary business costs are “inequitable.”

Legal Reasoning

The First Circuit’s opinion rests on two pillars:

Materiality as a Fact-Specific Inquiry: The district court wrongly applied a blanket rule that all potential conflicts of interest are material as a matter of law. Instead, under TSC Industries and Basic, materiality depends on whether omission of a fact would have substantially altered the “total mix” of information that a reasonable client—or, here, the client’s sophisticated representative—used in making investment decisions. Disputed evidence regarding how Commonwealth’s independent representatives weighed cost, transaction fees, product recommendations, and publicly available prospectus data gives rise to genuine material-fact disputes unsuitable for summary judgment.
Disgorgement Must Track Causation and Net Profits: Disgorgement is equitable relief and must reflect only those profits unjustly gained because of the violation. The SEC’s broad assumption that “at least some” clients would have moved assets to lower-cost share classes if fully informed fails to provide the required “reasonable approximation” of causal profit. Moreover, under Liu, legitimate business expenses—such as clearing, advisory support, and compliance costs—should be deducted unless they are so directly tied to the wrongful conduct or “inequitable” as to forfeit deduction.

Impact

This decision carries significant implications for investment-adviser enforcement and disclosure practice:

Reinforces Materiality Jury Role: Defendants in Advisers Act cases can resist summary judgment on disclosure claims by showing divergent client or intermediary practices and emphasizing fact-specific cost-benefit analyses by investors or advisors.
Heightens Disclosure Precision: Advisers must tailor brochure disclosures to clients’ decision processes and cannot rely on boilerplate conflict language alone. They should consider how independent advisors interpret disclosures when crafting Form ADV updates.
Limits on Disgorgement Calculations: The SEC must present rigorous expert evidence tying specific profit streams to specific disclosure failures. Disgorgement remedies will require granular expense accounting and causation analysis, reducing risk of overbroad awards.
Jury Trial Rights Upheld: Confirms that SEC enforcement defendants retain Seventh Amendment rights to jury trials on liability and disgorgement issues.

Complex Concepts Simplified

Materiality: A fact is “material” if a reasonable investor would consider it important in making an investment decision. Courts generally leave this judgment to juries unless the importance is so obvious that reasonable minds cannot differ.
Summary Judgment: A pretrial ruling that ends a case—or part of it—when there is no genuine dispute over facts essential to the outcome. If reasonable inferences from undisputed evidence conflict, the issue must go to trial.
Disgorgement: An equitable remedy requiring a wrongdoer to return profits obtained through unlawful conduct. It must be a fair approximation of the profits causally linked to the violation, less legitimate business expenses.
Causation in Disgorgement: The SEC must show that the specific revenues it seeks to recover stem from the very acts that violated the Advisers Act—“but-for” the disclosure failure, those profits would not have been earned.
Expense Deduction: Under Liu v. SEC, courts must subtract ordinary costs of running the business from any disgorgement award unless those expenses are themselves inequitable or entirely derivative of the wrongdoing.

Conclusion

SEC v. Commonwealth Equity Services clarifies that in Advisers Act enforcement:

Conflict-of-interest disclosures are not per se material; materiality must be decided by a jury after fact-specific inquiry.
Disgorgement must be tied to profits causally connected to the violation and reflect only net, unjust gains.
Legitimate business expenses ordinarily offset disgorgement awards unless they are inequitable or wholly wrongful.

By vacating summary judgment and the disgorgement order, the First Circuit has reaffirmed due process protections in SEC enforcement, strengthened the role of juries in disclosure and disclosure-remedy cases, and demanded rigorous linkage between misstatements or omissions, actual harm or gain, and ultimate equitable relief.