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Regulation and Compliance > Federal Regulation > SEC

Execs Blast SEC’s RIA Outsourcing Rule Plan as ‘Solution in Search of a Problem’

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What You Need to Know

  • Executives at several advisory and fintech firms criticized the new proposed rule by the SEC to prohibit RIAs from outsourcing certain services and functions without conducting due diligence and monitoring of the service providers.
  • Some saw the due diligence requirements as too onerous for advisors.
  • If the proposed rule is implemented, advisers may also be faced with increased costs.

Executives at several advisory and fintech firms on Thursday criticized the new proposed rule by the Securities and Exchange Commission that would impose new due diligence requirements on RIAs seeking certain third-party services.

While a few of them viewed the proposed requirements as onerous, two of them called the proposed rule entirely unnecessary.

“This new rule largely impacts how advisors choose [turnkey asset management platform] partners, though some may apply it to technology partners as well,” Riskalyze CEO Aaron Klein told ThinkAdvisor by email.

“Through that lens, it might even benefit market-leading solutions like Riskalyze,” he conceded.

“That said, this appears to be a solution in search of a problem,” Klein said. “As Commissioner Hester Peirce noted, fiduciary advisors already have a responsibility to their clients that cannot be outsourced and supersedes this rule.

“The most precious thing to an advisor is their client relationships, and I’ve never seen advisors approach decisions with greater care and diligence than who they might pick as their technology and outsourcing partners. It’s too bad we’re layering on micromanaging rules when the fiduciary principle is already accomplishing the objective.”

Although Commonwealth Financial Network was “still reviewing the SEC’s proposal,” Paul Tolley, the firm’s chief compliance officer, said his company has “maintained a comprehensive initial and ongoing due diligence process of its service providers for years.”

Tolley added: “In fact, we have always viewed our due diligence processes as a differentiator in the marketplace and a critical value-add for our affiliated advisors, freeing them up to focus on serving the needs of their clients.”

He explained that “due diligence, done right, requires the dedication of substantial financial resources and the employment of subject matter experts who are well versed in a variety of disciplines, including enterprise risk management, legal, compliance, information security, privacy, accounting, data management and much more.”

Because of that, Tolley said: “The considerable resources and subject matter expertise that will be necessary for smaller or less-sophisticated investment advisers to comply with this rule will likely present significant resource and compliance challenges for many firms.”

James Haynes, Wealth Enhancement Group director of compliance, was also critical of the rule.

“While we support the goal of protecting investors, we don’t see any particular positives in this proposed rule,” Haynes said.

The SEC’s proposed rule “prescribes inflexible due diligence requirements without regard for the disparate impact on smaller advisers,” Haynes said.

“Meeting these prescriptive regulations in addition to an already burdensome regulatory framework may be infeasible for many smaller advisers,” he added. “In my view, the ever-increasing resources needed to ensure compliance with securities regulations crowds out smaller advisers and serves to hasten the continued consolidation of the RIA industry.”

Orion Advisor Solutions was also still reviewing the SEC proposal in detail, Kylee Beach, that firm’s general counsel, pointed out. Her firm will “support our advisor clients as they work to understand the rule [and we] will continue to review the proposed rule and monitor its progression as it advances through the process,” she told ThinkAdvisor.

In the meantime, she said: “Orion encourages all fiduciary advisors to perform appropriate due diligence on their service providers. Our perspective is that outsourced wealthtech can help advisors focus on their clients’ needs and fulfill their fiduciary responsibilities by maximizing their time and leveraging technology to help ensure confidence in the decisions they are making and in the services they are providing to their clients.”

She added: “As always, Orion will continue to partner with firms on their due diligence activities.”

Like Klein, John Gebauer, chief regulatory officer at compliance software company ComplySci, said: “This rule seems to be a solution looking for a problem and promises to generate an interesting comment period.”

After all, Gebauer said: “The proposed rule will have a significant impact on many aspects of the investment advisory industry if adopted as proposed.”

He explained: “From a regulator perspective, it is easy to see that it is beneficial to know as much as possible about the registrants’ operations, including the utilization of service providers and how they fulfill their regulatory and fiduciary obligations, and the risks may be lurking in those details.

“That information, though, can and should be gained through the existing examination and enforcement mechanisms rather than through a burdensome new obligation. In our review of the proposal, we found it striking that the supporting cases cited were just a few cases, some of which were many years old.”

One aspect of the proposal was especially strange to Gebauer, he said: “Normally, the Commission cites a more systemic problem set before establishing a new rule proposal rather than vague statements that they have noticed an increase in wrongdoing. Additionally, the … release is silent on how the proposed rules would mitigate the perceived issues.”

He warned that, if the proposed rule is implemented, “advisers of all sizes will be faced with increased costs to implement an outsource provider management program, provider cost increases due to additional oversight or by in-housing the functions that were previously outsourced.”

Gebauer added: “The industry has built a network of service providers that have created cost and operational efficiencies through innovation and scale. Forcing those outsourced functions back into firms will undoubtedly cost more, and those costs will ultimately be passed on to the advisory clients. The small adviser will feel this burden the most and may even be forced to cease doing business.”

Additionally, he said: “There are many complicated relationships that are unclear in the proposal. For example, take a broker-dealer that allows its representatives to have separately registered investment advisers and provides compliance and operations support to those RIAs. Will the registered representative be in a position to perform due diligence and supervision on their employing broker-dealer?”

Also saying the proposed legislation was a solution “in search of a problem that doesn’t seem to exist [that] would create overly burdensome cost for both providers and advisors” was Blake Wood, CEO of Australian fintech firm Lumiant’s new U.S. division.

“The outsourced technology advisors use by and large doesn’t deliver advice — the advisors themselves do and they are already heavily regulated,” Wood said Friday. “Imagine how stifling a rule like this would be to innovation — small and large in our industry. Technology companies are rolling out updates daily. To tell advice firms they are on the hook for continuous compliance review is excessive.”

The proposed regulation “doesn’t solve a single problem; it only creates them,” he went on to say, adding: “If the SEC wants to review technology, don’t put it on the advisors. None of this helps investors. It’s like adding airbags to airplanes: cost a lot of money, lots of upkeep and won’t save a single life.”

(Pictured: Riskalyze CEO Aaron Klein)


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