Close Close
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards
SEC building in Washington

Regulation and Compliance > Federal Regulation > SEC

New SEC Plan Says RIAs Must Vet Third-Party Services

Your article was successfully shared with the contacts you provided.

What You Need to Know

  • The SEC's proposed due diligence requirements could cover services like portfolio management and trading software.
  • The rule excludes services such as clerical, ministerial, utility and general office services.
  • The Investment Adviser Association says the rule is overly burdensome, especially for small firms.

The Securities and Exchange Commission Wednesday proposed a new rule to prohibit registered investment advisors from outsourcing certain services and functions without conducting due diligence and monitoring of the service providers.

“Though investment advisers have used third-party service providers for decades, their increasing use has led staff to make several recommendations to ensure advisers that use them continue to meet their obligations to the investing public,” SEC Chairman Gary Gensler said Wednesday during the open meeting.

“When an investment adviser outsources work to third parties, it may lower the adviser’s costs, but it does not change an adviser’s core obligations to its clients,” he explained.

The proposal would require advisors to satisfy specific due diligence elements “before retaining a service provider that will perform certain advisory services or functions, and to subsequently carry out periodic monitoring of the service provider’s performance.”

Karen Barr, president and CEO of the Investment Adviser Association in Washington, told ThinkAdvisor Wednesday in an email that IAA’s initial review of the SEC’s proposed new oversight requirements for services outsourced by investment advisors is that they “are overly burdensome and prescriptive and fail to recognize how little leverage firms have over many service providers.”

The proposal, Barr added, “is also not adequately tailored to the range of firms it covers, including smaller advisers. It is also apparent that the SEC again has not appropriately considered the cumulative impact of its wave of new proposals on advisory firms of all sizes, nor has it provided sufficient time for meaningful feedback on these sweeping changes.”

IAA noted that while it’s unclear from the 232-page rule which “covered” outsourced services the SEC is targeting, the agency’s plan explicitly excludes services and functions such as clerical, ministerial, utility and general office functions or services.

The new proposed rule would establish an oversight framework across SEC-registered advisors that outsource a “covered function,” that is, a function or service that:

  • is necessary to provide advisory services in compliance with the federal securities laws, and
  • if not performed or performed negligently, would be reasonably likely to cause a material negative impact on the adviser’s clients or on the adviser’s ability to provide investment advisory services. 

These functions, the agency said, can include providing investment guidelines, portfolio management, models related to investment advice, indexes or trading services or software.

“Outsourcing can benefit advisers and their clients, but clients could be significantly harmed when an adviser outsources a function or service without appropriate adviser oversight,” the SEC said.

The SEC explained that its plan would require advisors “to satisfy specific due diligence elements before retaining a service provider that will perform certain advisory services or functions, and to subsequently carry out periodic monitoring of the service provider’s performance.”

Commissioner Peirce Balks

SEC Commissioner Hester Peirce, a Republican, voted against the plan.

“What precisely is the problem this proposal is trying to correct?” Peirce complained. “The release tells us that some advisers are operating under the misimpression that outsourcing certain functions somehow absolves them of their responsibilities as fiduciaries with respect to those functions. Why this sudden urgency to propose a rulemaking reconfirming the incontrovertible fact that outsourcing does not terminate an adviser’s fiduciary duty?”

Peirce continued: “Has there been a surge of enforcement actions against advisers for service provider-related failures or infractions? Are our examiners seeing advisers running from their fiduciary obligations with respect to outsourced functions? Are we aware of widespread investor harm due to advisers not overseeing their service providers?”

She added: “If the answer to any of these questions is yes, the release does not tell us so. The actual number of advisers who think that they are off the hook when it comes to outsourced services likely is negligible and, even if it is not, we do not need new rules to hold them to account.”

New Requirements

The SEC’s plan specifies requirements for investment advisors “designed to ensure that advisors’ outsourcing is consistent with their obligations to clients.”

The proposal includes:

  • New requirements for advisers to conduct due diligence before outsourcing and to periodically monitor service providers’ performance and reassess whether to retain them;
  • Related requirements for advisers to make and/or keep books and records related to the due diligence and monitoring requirements;
  • Amendments to the adviser registration form, Form ADV, to collect census-type information about advisers’ use of service providers; and
  • A requirement for advisers to conduct due diligence and monitoring for third-party recordkeepers, along with a requirement to obtain reasonable assurances that the third party will meet certain standards.

The proposal will be published in the Federal Register and will be open for a 60-day comment period after the date of issuance and publication on or 30 days after the date of publication in the Federal Register, whichever period is longer.


© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.