SEC Charges Adviser and Fund Trustees in First Case Enforcing Liquidity Rule

Who may be interested: Investment Advisers, Mutual Fund Boards, Compliance staff

Quick Take: The SEC charged a registered investment adviser, two of the adviser’s officers, and two independent trustees of a mutual fund managed by the adviser with violations of Rule 22e-4 (Liquidity Rule). 

In its first action enforcing the Liquidity Rule, the SEC announced charges alleging that an adviser, certain of its officers, and independent trustees of a mutual fund it advised, aided and abetted violations of the Liquidity Rule by the fund. 

The Liquidity Rule, adopted in 2016, restricts a mutual fund from acquiring an illiquid investment if immediately after the acquisition, the fund would have invested more than 15% of its net assets in illiquid investments. In addition, the Liquidity Rule requires a fund that holds more than 15% of net assets in illiquid investments to take certain actions, including, reporting of such holdings in illiquid investments to the board of directors and the SEC. The Liquidity Rule also requires a fund to adopt a liquidity risk management program (LRMP) to assess its liquidity risk. 

According to the SEC complaint, the fund in this case held approximately 21 to 26% of its net assets in illiquid investments from June 2019 to June 2020. The complaint states that in administering the fund’s LRMP, the adviser classified the fund’s largest illiquid investment as “less liquid,” rather than “illiquid,” ignoring restrictions on the transferability of the investment, the absence of a market for the investment, and the advice of auditors and fund counsel as to its liquidity status. In doing so, the complaint states, the fund did not comply with the requirements of the Liquidity Rule addressing holdings in illiquid investments, nor did the adviser or its officers take corrective action to reduce the fund’s illiquid investments or make the required filings with the SEC. The SEC alleged that the adviser’s officers also misled the SEC’s Division of Investment Management as to the basis for classifying the investment as “less liquid.”

The SEC complaint stated that the two independent trustees of the fund aided and abetted the alleged violations by recklessly failing to exercise reasonable oversight of the LRMP. The complaint stated that the trustees were “keenly aware” that the investment was restricted and illiquid.

The SEC complaint seeks permanent injunctions and civil monetary penalties against the adviser, its officers, and the independent trustees. The fund is now a liquidating trust and was not charged.

Without admitting or denying the findings, a third trustee settled charges that he caused and willfully counseled the fund’s violations, and he agreed to a six-month suspension, a civil penalty of $20,000, and a cease-and-desist order. Also, without admitting or denying findings, an affiliate of the adviser settled related charges relating to Form ADV disclosures, its policies and procedures, and delivery of information to clients. The affiliate agreed to a cease-and-desist order, a censure, and disgorgement and civil penalties totaling approximately $476,000.

The SEC’s complaint can be found here.

The SEC’s settlement orders with the third trustee and the adviser’s affiliate can be found here and here, respectively.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm or its clients, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.