SEC Proposes Oversight Requirements for Services Outsourced by Investment Advisers

On Oct. 26, 2022, the Securities and Exchange Commission (SEC) proposed a new rule and rule amendments that would prohibit registered investment advisers from outsourcing various services without first conducting due diligence on their service providers and would require that the advisers periodically monitor such service providers. The services covered by the proposal include those 1) that are necessary to provide advisory services under federal securities laws and 2) that if not performed (or negligently performed) would be reasonably likely to cause a material negative impact on the investment adviser’s clients or the investment adviser’s ability to provide investment advisory services (Covered Functions).

Before retaining a service provider, the adviser would be required to conduct due diligence to ensure that the service provider is appropriate, given:

• The nature and scope of the Covered Function
• Risks resulting from the service provider performing the Covered Function and how to mitigate and manage such risk
• The service provider’s competence, capacity and resources
• The service provider’s material subcontractors related to the Covered Function
• The ability to coordinate with the service provider to comply with federal securities law
• The need to provide for an orderly termination of the performance of the Covered Function

The investment adviser would need to periodically review whether a retained service provider is appropriate given the above requirements. The adviser would be required to maintain books and records related to this due diligence and monitoring process and report census-type information on its Form ADV, such as which service providers conduct Covered Functions, the location of the office responsible for such Covered Functions, the date each service provider was first engaged and whether a services provider is a related person of the adviser. If the adviser relies on third-party recordkeepers, the adviser would be required to conduct due diligence and monitoring of that third-party consistent with the above requirements, as well as receive assurances from the third-party recordkeeper regarding its ability to:

• Adopt and implement internal processes for making and/or keeping records that meet the requirements of recordkeeping rules applicable to the books and records of the adviser
• Make and/or keep records that meet the requirements of the recordkeeping rule applicable to the adviser
• Provide access to electronic records
• Ensure the continued availability of records if the third party’s relationship with the adviser or its operations cease

The proposal was published Oct. 26, 2022, and the public comment period will remain open for 60 days thereafter or 30 days after it is published on the Federal Register, whichever period is longer. The press release and full text of the proposal can be found here.