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SEC Announces First Enforcement Action Under Fund Liquidity Rule

May 16, 2023

The SEC has charged a fund’s investment adviser, two officers of both the adviser and the fund, and two of the fund’s independent trustees in connection with violations by the fund of the Investment Company Act liquidity rule. The rule limits a fund’s illiquid investments to 15% of the fund’s net assets. In this case, the SEC found that the fund held between 21 and 26% of its net assets in illiquid investments. The fund’s largest illiquid investment was classified by the adviser and its officers as “less liquid” rather than illiquid, against the advice of the fund’s counsel and auditors. The complaint alleges that the fund’s counsel and auditors resigned as a result of this issue.

The complaint also discusses the liquidity classification process and how restrictions and limitations on the transfer of the shares were ignored. The complaint alleges that the adviser’s officers and one of the independent trustees who separately agreed to settle SEC charges misled the staff of the SEC’s Division of Investment Management regarding the basis for the fund’s liquidity classifications. It is unusual for the SEC to take action against fund directors, but in this situation, the SEC noted in the related press release that “the fund’s board had oversight responsibilities regarding the fund’s Liquidity Risk Management Program, and [the trustees], who knew that the shares were restricted and illiquid, aided and abetted the fund’s violation by recklessly failing to exercise reasonable oversight of the fund’s program.”

See SEC v. Pinnacle Advisors, LLC et al., and Press Release: SEC Charges Investment Adviser and Fund Trustees with Liquidity Rule Violations (May 5, 2023).

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