SEC Dismisses Charge Against Fund for Breaching Liquidity Limit
Commentary by Andrew Lom
The SEC dismissed its first-ever case against an investment adviser of a mutual fund, as well as several of its trustees, for investments in illiquid assets that exceeded the amount allowed under the "Liquidity Rule." (See previous coverage.)
In the Complaint, filed in May 2023 with the US District Court, Northern District of New York, the SEC alleged that after investing more than 15 percent of the mutual fund’s net assets in restricted shares of a medical device company, the mutual fund failed to take steps to bring its position under the 15 percent threshold required by ICA Rule 22e-4 (a/k/a the "Liquidity Rule").
On July 11, 2023, the defendants moved to dismiss the Complaint. The defendants argued that: (i) the Liquidity Rule exceeded the SEC's statutory authority under the Investment Company Act; (ii) the Rule failed to provide fair notice of what constituted a violation; (iii) the trustees had no duty to classify individual assets under the Rule; and (iv) the SEC's own adopting release stated that liquidity classifications were subjective and not the responsibility of fund boards.
On March 27, 2025, the Court denied the motions to dismiss but granted the defendants leave to refile within thirty days to address the Supreme Court's decision in Loper Bright Enterprises v. Raimondo (June 28, 2024) (a decision that rejected the Chevron deference). The defendants refiled their motions to dismiss on April 28, 2025, arguing that the Liquidity Rule was invalid under Loper Bright and that the SEC had improperly expanded its authority without clear congressional authorization. On July 11, 2025, the parties stipulated to dismiss the litigation with prejudice.
The SEC stated that its decision to seek dismissal did not necessarily reflect its position in any other case.
Commentary
The SEC’s choice to dismiss this case now is part of a larger trend by the SEC in favor of increased retail participation in a broader range of potentially illiquid assets that, despite their illiquidity risks, could offer the benefits of diversification and enhanced returns and that generally support the SEC’s goals with respect to capital formation. That trend is separate from any merits argued in this case in response to Loper or regarding the scope of the SEC’s statutory authority.