SEC proposes new oversight requirements for certain services outsourced by investment advisers

On October 26, 2022, the Securities and Exchange Commission (SEC) proposed new rule 206(4)-11 and rule amendments under the Advisers Act that prohibit SEC-registered investment advisers from outsourcing certain services or functions to service providers and third-party recordkeepers without meeting minimum due diligence and monitoring requirements. The new requirements are designed to protect investors and ensure that the outsourcing is consistent with investment advisers’ obligations to their clients.

Scope and application of the proposed rule and amendments

The proposed rule would apply to SEC-registered advisers that seek to outsource recordkeeping or functions (covered functions) that (1) are necessary to provide advisory services in compliance with the federal securities laws, and (2) if not performed or performed 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. Clerical, ministerial, utility, and general office functions or services would be explicitly excluded from the proposed rule. The primary requirements for SEC-registered advisers introduced by the proposed rule and amendments include:

• Due diligence before retention of a service provider or third-party recordkeeper:
  
  Prior to retaining a service provider or third-party recordkeeper to perform a covered function or recordkeeping, an advisor must perform due diligence to reasonably determine that the intended outsourcing is appropriate, considering the following factors:
  • Nature and scope of the function;
  • Potential risk, risk mitigation, and risk management relating to performance of the function by the service provider or third-party recordkeeper;
  • Service provider’s or third-party recordkeeper’s competence, capacity, and resources necessary to perform the function;
  • Service provider’s or third-party recordkeeper’s material subcontracting arrangements related to the covered function;
  • Coordination with the service provider or third-party recordkeeper for federal securities law compliance; and
  • Orderly termination of the performance of the function.
• Periodic monitoring of the service provider’s or third-party recordkeeper’s performance
• Periodic reassessment of the selection of the service provider or third-party recordkeeper under the due diligence requirements of the rule
• Maintenance of books and records regarding service provider due diligence and monitoring performed
• Reporting on Form ADV census-type information relating to the service providers
• Obtaining reasonable assurances that the third-party recordkeeper will:
  • Adopt and implement internal processes and/or systems for making and/or keeping records that meet the requirements of the recordkeeping rule applicable to the books and records being maintained on behalf of the adviser;
  • Make and/or keep records that meet all of the requirements of the recordkeeping rule applicable to the adviser;
  • Provide access to electronic records; and
  • Ensure the continued availability of records if the third-party recordkeeper’s relationship with the adviser or its operations cease.

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. If the proposed amendments are adopted, they would have a significant impact on the due diligence and monitoring obligations of SEC-registered advisers.