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Compliance and Regulatory Alerts  |  11-07-22

Newly Proposed SEC Rule Would Impose New Requirements on IAs to Oversee Outsourced Providers

Under a proposed new rule, the SEC would require investment advisers to conduct due diligence and monitor “covered services” outsourced to third-party providers. The proposal would also amend Form ADV to include recordkeeping requirements as to the outsourcing of these "covered functions." The Commission said it recognizes that investment advisers are increasingly relying on outsourced sources to perform many functions in support of advisory services and, as a result, “more needs to be done to protect investors.” A Fact Sheet accompanying the proposal helps to break it down. Here’s what you need to know.

“Covered Functions”

The proposed new rule defines “covered functions” as those (i) necessary to the provision of advisory services and to comply with the securities laws, and (ii) that might cause a material negative impact on an adviser’s clients “if not performed or performed negligently.” Covered services may include, for example, third parties that provide portfolio management services, models related to investment advice, indexes, and trading services or software. (The proposal makes exceptions for “clerical, ministerial, utility, and general office functions or services.”)  

Due Diligence

Under the due diligence obligation in the proposed rule, the adviser must determine that the service provider would be appropriate to perform the covered function. Due diligence considerations include: the nature and scope of the covered function; potential risks and how to mitigate them; whether the service provider has the “competence, capacity, and resources necessary” to provide the service; any material subcontracting arrangements; any compliance coordination with the service provider; and issues that may arise in the event of a termination by the provider concerning the covered function. Ongoing due diligence would require that the adviser monitor the provider’s performance and keep books and records of these preliminary and ongoing oversight efforts.

Third-Party Record Keepers

The proposed rule adds special requirements when the service being provided is for advisor recordkeeping. Under this circumstance, the adviser must “obtain reasonable assurances” (i) that the service provider’s systems and processes satisfy the advisers’ obligation as to the recordkeeping rule; (ii) that the recordkeeping rule itself is being complied with (that the records are being created); (iii) that access to electronic records are provided; and (iv) that records are continually available even if the relationship with the provider ceases.

The proposal is open for comment for 60 days.

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Bates supports firms navigating compliance with SEC rules. We work with your firm to address investment adviser concerns and to support efforts to conform to oversight, monitoring, recordkeeping and disclosure requirements. Our compliance team includes senior compliance staff and former regulators with expertise in the development of policies, procedures, supervisory and compliance processes, and best practices to enhance compliance and supervisory systems.

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