SEC proposes new due diligence rule under Investment Advisers Act
28 October 2022 US
Image: Andriy Blokhin
The U.S. Securities and Exchange Commission (SEC) has proposed a new rule to prohibit registered investment advisers from outsourcing certain services and functions without conducting due diligence and monitoring of the service providers.
The rule amendments, under the Investment Advisers Act of 1940, would require advisers to satisfy specific due diligence elements before retaining a service provider that will perform certain advisory services or functions, and to subsequently carry out periodic monitoring of the service provider’s performance.
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.
Additionally, the proposal would require advisers to conduct due diligence and monitoring for all third-party recordkeepers and obtain reasonable assurances that the recordkeepers will meet certain standards.
The proposal 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 covered under the rule.
As demand for the asset management industry has grown and clients’ needs have become more complex, many advisers have engaged third-party service providers to perform certain functions or services.
Many of these functions are necessary for an adviser to provide its advisory services in compliance with federal securities laws, says the SEC.
These functions can include providing investment guidelines, portfolio management, models related to investment advice, indexes, or trading services or software.
Outsourcing can benefit advisers and their clients, adds the SEC. However, it warns that clients could be significantly harmed when an adviser outsources a function or service without appropriate adviser oversight.
Commenting on the new proposal, Gary Gensler, SEC chair, says: “Though investment advisers have used third-party service providers for decades, their increasing use has led staff to make several recommendations to ensure advisers that use them continue to meet their obligations to the investing public.
“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. Therefore, [this] proposal specifies requirements for investment advisers designed to ensure that advisers’ outsourcing is consistent with their obligations to clients.”
The rule amendments, under the Investment Advisers Act of 1940, would require advisers to satisfy specific due diligence elements before retaining a service provider that will perform certain advisory services or functions, and to subsequently carry out periodic monitoring of the service provider’s performance.
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.
Additionally, the proposal would require advisers to conduct due diligence and monitoring for all third-party recordkeepers and obtain reasonable assurances that the recordkeepers will meet certain standards.
The proposal 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 covered under the rule.
As demand for the asset management industry has grown and clients’ needs have become more complex, many advisers have engaged third-party service providers to perform certain functions or services.
Many of these functions are necessary for an adviser to provide its advisory services in compliance with federal securities laws, says the SEC.
These functions can include providing investment guidelines, portfolio management, models related to investment advice, indexes, or trading services or software.
Outsourcing can benefit advisers and their clients, adds the SEC. However, it warns that clients could be significantly harmed when an adviser outsources a function or service without appropriate adviser oversight.
Commenting on the new proposal, Gary Gensler, SEC chair, says: “Though investment advisers have used third-party service providers for decades, their increasing use has led staff to make several recommendations to ensure advisers that use them continue to meet their obligations to the investing public.
“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. Therefore, [this] proposal specifies requirements for investment advisers designed to ensure that advisers’ outsourcing is consistent with their obligations to clients.”
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