The US Securities and Exchange Commission (SEC) on Friday agreed to dismiss a landmark lawsuit that sought to enforce mutual fund liquidity standards.
The SEC initially filed the lawsuit in 2023, charging New York investment firm Pinnacle Advisors, LLC (Pinnacle) with violating the Investment Company Act of 1940 (ICA). The federal lawsuit was filed in the US District Court for the Northern District of New York. The investment firm was accused of violating 17 CFR § 270.22e-4, an ICA-adjacent statute known as the Liquidity Rule, that was adopted by the SEC in 2016.
The Liquidity Rule requires investment companies to hold no more than 15 percent of their assets in illiquid investments. Illiquid investments are assets that cannot be sold within seven days without a significant loss of value. The SEC alleged that Pinnacle kept over 21 percent of its assets in illiquid investments. The SEC further argued that assets had been intentionally misclassified as “less liquid,” which means the asset can be sold within seven days without a drop in value, but the actual settlement of the sale will take more than seven days to complete.
The lawsuit centered around Pinnacle’s NYSA mutual fund. The NYSA fund is extremely small by mutual fund standards, with less than $2 million in total assets at its peak. However, the SEC’s enforcement marked a landmark action as this was the first time the federal government sought to enforce liquidity standards in a mutual fund. Given the fund’s modest assets, the SEC likely pursued this case as a regulatory precedent, which is now moot following Friday’s dismissal.
Friday’s dismissal serves as an early example of the significance of the US Supreme Court’s decision to overturn the Chevron deference doctrine (Chevron) last year. Established in 1984, Chevron required federal courts to defer to the interpretations of agencies when issuing judgments on ambiguous statutes. Under Chevron, courts were required to uphold the agency’s reasonable interpretations if Congress had not directly addressed the central question in a dispute. In June 2024, the Supreme Court overturned Chevron in a 6-3 decision in Loper Bright Enterprises v. Raimondo. In that case, the court ruled that the Administrative Procedure Act (APA) allows courts to exercise “independent judgment” in determining whether an agency’s actions align with the relevant statutory authority. Under the Loper Bright precedent, courts can now decide legal questions by applying their own judgments instead of deferring to agency interpretations.
The new legal framework established in Loper Bright was significant for Pinnacle’s position because the lawsuit involved the interpretation of SEC rules about liquidity classifications. Pinnacle’s initial motion to dismiss charges was denied, but the district court allowed the firm to refile for dismissal so the case could be argued under the new legal standard. The decision in Loper Bright is expected to have significant impacts on the landscape of future legal enforcement of investment activities. Securities regulation often involves interpretation of ambiguous statutory language that agencies have filled in through rulemaking. Without Chevron, the SEC faces increased difficulty defending its regulatory interpretations in court proceedings.
