For registered investment advisers across the country, a new rule proposed by the Securities and Exchange Commission (SEC) would prohibit RIAs from outsourcing certain services and functions without first conducting due diligence and monitoring of the service providers. The rule would impact the way RIAs outsource certain functions or services to third-party providers to reach compliance.
Functions such as providing investment guidelines, portfolio management, models related to investment advice, indexes, or trading services or software are among those included on the chopping block. The increased demand in the asset management industry is a major reason why so many RIAs have turned to third-party providers to perform these necessary compliant functions and services.
Using third parties is not a new practice and has been taking place for decades. However, because of this surge in demand and an influx of complex clients, clients could be significantly harmed when/if an adviser outsources a function or service without appropriate adviser oversight. Therefore, the proposed rule is designed to ensure that advisers’ outsourcing is consistent with their obligations to clients.
Most specifically, the rule would require:
- New requirements for advisers to conduct due diligence before outsourcing;
- periodic monitoring of service providers’ performance and reassessing whether to retain them;
- maintenance of books and records related to the due diligence and monitoring requirements;
- updates to Form ADV, to collect information about advisers’ use of service providers; and
- due diligence and monitoring for all third-party recordkeepers and obtain reasonable assurances that the recordkeepers will meet certain standards.
The rule would apply to advisers that outsource certain “covered functions,” which include those services or functions that are necessary for providing advisory services in compliance with the Federal securities laws and that if not performed or performed negligently would result in a material adverse impact to clients. While it’s unclear from the 232-page proposal exactly which 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.
To learn more about the rule proposal, click here.