A federal appeals court sided with Commonwealth Financial Network in its appeal of sanctions imposed by the Securities and Exchange Commission, reports Advisor Hub.
The case dates back to 2019, when the SEC alleged that Massachusetts-based Commonwealth had breached its fiduciary duty.in its mutual fund revenue sharing practices. Commonwealth was ordered to pay $93.3 million, including more than $65 million in disgorgement, $21 million in prejudgment interest and a $6.5 million civil penalty
But the penalty was reversed in a unanimous opinion by a three-judge panel of the U.S. First Circuit Court of Appeals, which sent the case back to the trial court that approved the penalty last year in a summary judgment.
The appellate court panel said the trial court must “consider and address the numerous shortcomings in the SEC’s causation evidence.”
According to the SEC, Commonwealth failed to tell clients between 2014 and 2018 that it received as much as $136 million in payments from Fidelity’s National Financial Services for selling funds that paid NFS to be on its platform.
A federal judge in Massachusetts agreed with the SEC in finding that the payments created a material customer conflict and that clients were placed into revenue sharing funds without knowing that cheaper alternatives were available.
But in an opinion authored by Circuit Judge Sandra Lynch, the appeals court noted the role that “sophisticated” advisors played in helping Commonwealth clients make investment decisions, suggesting that the investors had not needed to rely exclusively on the firm’s disclosures in order to make their decisions..
“[W]e 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,’” Lynch wrote, quoting a precedential case.
The appeals court overturned Commonwealth’s liability in the case and told the trial court to also recalculate the disgorgement since it had failed to factor in Commonwealth’s expenses.
Lynch said the district court made fundamental legal errors regarding whether the SEC proved a causal relationship between Commonwealth’s profits and alleged violations.
“[C]lients made their investment decisions through their representatives rather than Commonwealth’s recommendations or pre-constructed portfolios,” Lynch wrote. “These representatives were themselves sophisticated and independent members of the financial industry who recommended to their clients the funds and share classes to be purchased.”
A spokesperson for the SEC declined to comment.
Commonwealth filed its appeal over what it called a “draconian” judgment, arguing that the SEC never established a causal link between client harm and its allegedly inadequate investment disclosures. With regards to the disgorgement figure, Commonwealth stated, “The SEC’s disgorgement request here was staggering in its magnitude and audacity.”.
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