The Securities and Exchange Commission on Wednesday advanced by a 3-2 vote a new rule
proposal (new rule 206(4)-11 and rule amendments under the Advisers Act) that would
establish due diligence and monitoring requirements for SEC registered advisers that hire
outside providers to perform certain services.
Essentially, the SEC’s proposed new oversight rule would prohibit advisers from outsourcing
certain services and functions without conducting due diligence and monitoring of the service
providers.
The SEC had “observed an increase in advisers outsourcing and issues related to the
outsourcing and advisers’ oversight. 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, Chairman Gensler said. Thus, today’s proposal specifies requirements for investment
advisers designed to ensure that advisers’ outsourcing is consistent with their obligations to
clients.”
The rule would apply to services or functions that are “necessary to provide advisory services in
compliance with the federal securities laws” and, if not performed properly or 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,” according to the proposal.
Clerical, ministerial, utility, and general office functions or services would be explicitly excluded
from the proposed rule. Examples of “covered” functions could include the providing of
investment guidelines, portfolio management, modeling, indexes, and trading services or
software.
As part of the due diligence requirements, advisers would have to address potential risks
resulting from a service provider performing a covered function, including how to mitigate and
manage such risks, as well as review the provider’s relevant fourth party arrangements.
The proposed rules appear to merely reinforce existing obligations covered by an investment
adviser’s duty of care but significantly expand the due diligence obligations under existing third-
party due diligence policies by considering a long list of enumerated factors as well as obtain
“reasonable assurances” that the recordkeepers will meet certain standards. Finally, the
proposed rule, would require advisers to maintain books and records related to the new rule’s
oversight obligations and to report “census-type” information about the service providers
defined in the rule.
The public comment period will remain open for 60 days after October 26, 2022, or 30 days
after publication in the Federal Register, whichever period is longer.
We believe that if the proposed rule and amendments are adopted, they would have a
significant impact on the due diligence and monitoring obligations of SEC-registered advisers.