SEC Charges Investment Adviser and Fund Trustees with First Liquidity Rule Enforcement Action
As the SEC's swing of enforcement actions continues, the Division of Enforcement has recently announced charges against a mutual fund, its associated investment adviser, and multiple trustees of the fund for “aiding and abetting Liquidity Rule violations.” This is the first time the SEC has charged a firm with violations of the Liquidity Rule since its initial inception in 2016. The charges announced are against investment adviser Pinnacle Advisors, LLC, two officers of Pinnacle Advisors and the mutual fund, Robert Cuculich and Benjamin Quilty, and two of the mutual fund's independent trustees, Mark Wadach and Lawton Williamson. Along with these initial charges, the SEC also charged a third trustee, Joseph Masella. Masella agreed to settle charges that he “caused and willfully counseled the fund's violations.”
A Liquidity Complaint
In their complaint, the SEC alleges that, from June 2019 to June 2020, the mutual fund held ~21 - ~26 percent of its net assets in illiquid investments. This amounts directly violates the liquidity rule, which prevents mutual funds from investing more than 15 percent of net assets in illiquid investments. The SEC alleges that Pinnacle Advisors and its officers, Cuculich and Quilty, classified the fund's largest illiquid investment as a “less liquid” investment. This classification ignored restrictions, transfer limitations, and disregarded the specific advice of fund counsel and auditors. The SEC continues, alleging that both Pinnacle Advisors and its officers “did not present the fund's board with a plan to reduce the fund's illiquid investments to 15 percent or lower or make the required filings with the SEC”, despite the requirements of the Liquidity Rule. Specifically, mentioning Cuculich, Quilty, and Masella, the SEC alleges these individuals knowingly misled the SEC's Division of Investment Management about the fund's liquidity classifications. Following the complaints mentioning Pinnacle Advisors, Cuculich, Quilty, and Masella, the SEC continues by stating that the fund's board of trustees had specific oversight responsibilities surrounding the fund's Liquidity Risk Management Program. The complaint continues by alleging that Wadach and Williamson, who knew as trustees that the fund's shares were restricted and illiquid, “aided and abetted the fund's violation by recklessly failing to exercise reasonable oversight of the fund's program.” Citing trustee duties, Associate Regional Director in the SEC's New York Regional Office Sheldon Pollock stated, “Trustees must exercise oversight on behalf of shareholder interests, and the Commission will hold trustees accountable when they fail to fulfill the most basic requirements under the applicable rules.' The SEC also announced charges against a direct affiliate of Pinnacle Advisors, Pinnacle Investments, LLC. These charges allege Pinnacle Investments, LLC made “false and misleading statements in its Form ADV regarding reviews of advisory client accounts and failing to disclose certain conflicts of interests, adopt and implement related policies and procedures, and deliver to clients required information about advisory personnel.”
The Final Verdict
Following the SEC's complaint seeking permanent injunctions and civil monetary penalties for the respondents, the fund is now a liquidating trust and is not separately charged. Without admitting or denying the SEC's findings, Joseph Masella consented to the SEC's order requiring him to cease and desist from violations of the Liquidity Rule and pay a civil penalty of $20,000. Masella was also suspended from association with any investment adviser, registered investment company, and others for six months. Similarly, without admitting or denying the SEC's findings, Pinnacle Investments consented to the SEC's order requiring it to cease and desist from violations of multiple provisions of the Investment Advisers Act of 1940, a censure, and disgorgement and a civil penalty of ~$476,000 in total.
Takeaway and Conclusion
We mentioned at the beginning of this blog that this enforcement action was the first of its kind but that certainly does not mean it will be the last one. Advisers with mutual funds investing in illiquid investments should review the Liquidity Rule to ensure that they are compliant with even the finer details of the Rule. Trustees should also ensure they understand their role regarding the Liquidity Rule. If you are unsure of the Liquidity Rule's role in your business, FinTech Law can help. Don't hesitate to reach out to our team to help you manage and amplify your compliance program and business.