The SEC has announced the first case enforcing its 2016 liquidity rule and one of the very few in which it charged independent trustees for their role in a violation.
Pinnacle Advisors LLC agreed to a censure and penalties and disgorgement totaling $476,00 to settle and SEC complaint charging that the company knowingly violated the SEC liquidity rule that forbids mutual funds from putting more than 15% of their holdings in illiquid investments.
During the 12 months between June 2019 and June 2020 the company held between 21% and 26% of its investments in illiquid assets, according to a May 5 press release from the SEC that accused independent trustees Mark Wadach and Lawton “Charlie” Williamson and two officers of Pinnacle Advisors and the fund it advised with aiding and abetting liquidity rule violations. A third trustee Joseph Masella, agreed to a $20,000 payment to settle charges that he caused and willfully counseled the fund’s violations, according to the SEC.
The complaint alleges that company officers Robert Cuculich and Benjamin Quilty classified the fund’s largest illiquid investment as “less liquid” despite the restrictions on transfer and absence of a market for the shares, against the advice of fund counsel and auditors, according to the SEC, which also accuses Cuculich, Quilty and Miasella of misleading the Division of Investment Management about the basis for its liquidity classifications.
In addition to the problems with the liquidity classification, Pinnacle Advisors and its officers failed to offer the fund’s board a plan to reduce illiquid investments to 15% of net assets or less as required by the liquidity rule, according to the SEC.
The SEC accused the two independent trustees of aiding and abetting the fund’s violation by “recklessly failing to exercise reasonable oversight of the fund’s program” despite knowing that sales of the “less liquid” investment was restricted and that the asset should be classed as illiquid.
The SEC singled Masella out for censure in a second complaint that alleged he told company officers the “less liquid” classification was justified based on “the portfolio manager’s purported belief that he could sell the shares in seven calendar days.” The complaint said that advice demonstrated Masella’s failure to exercise oversight of the fund’s liquidity risk management program because he knew or should have known about restrictions on the fund’s largest illiquid asset – 84,332 shares of a private company the fund bought in private-placement transactions between 2007 and 2009, which totalled 23.45% of fund assets as of June 1. 2019.
The company sent two letters to the Division of Investment Management in June of 2019 justifying the “less liquid” classification by misstating the salability of the shares and the existence of potential buyers and other pertinent facts, according to the SEC.
The fund is now a liquidating trust and has not been separately charged.
“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,” Sheldon L. Pollock, Associate Regional Director in the SEC’s New York Regional Office said in the May 5 release.
Pinnacle Investments LLC is an East Syracuse, NY-based broker dealer and investment adviser with approximately $814mn under management as of Dec. 2022, according to the SEC complaint against the company.
In addition to violation of liquidity rules, the SEC complaint also accuses Pinnacle of violating antifraud, compliance and reporting provisions of the Advisers act between 2015 and October 2022 by making false and misleading statements in its Form ADV brochure describing reviews of advisory accounts, failed to disclose conflicts of interest with outside business activities and compensation arrangements and failed to adopt policies designed to prevent such violations.