SEC proposes new requirements for advisors that outsource services to third parties

Securities Agency Rule-Making & Guidance Third-Party Investment Advisers Act

On October 26, the SEC proposed new oversight requirements for outsourced investment advisory services. The proposed rule, issued under the Investment Advisers Act of 1940, would prohibit registered investment advisers from outsourcing certain services and functions without conducting due diligence prior to engaging a third-party service provider. The proposed rule would apply to advisors that outsource certain “covered functions,” including services or functions necessary for providing advisory services in compliance with federal securities laws that—if not performed or negligently performed—would result in material harm to clients. Under the proposed rule, advisors would also be required to periodically monitor a third party’s performance and reassess whether it is appropriate to continue to outsource its services and functions. Additionally, the SEC is proposing corresponding amendments so that it may collect “census-type information” about third-party service providers, as well as amendments that would require advisors to maintain books and records related to the proposed rule’s oversight obligations.

SEC Chairman Gary Gensler released a statement supporting the proposed amendments. “[T]hese rules, if adopted, would better protect investors by requiring that investment advisers take steps to continue to meet their fiduciary and other legal obligations regardless of whether they are providing services in-house or through outsourcing, whether through third parties or affiliates,” Gensler said, explaining that the increased use of third-party service providers “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.”

Commissioner Hester M. Peirce criticized the proposed rule, with Peirce claiming the proposal “may end up abrogating fiduciary duty and replacing it with [a] predefined approach to best interest—one not responsive to unique facts and circumstances.” She also expressed concerns related to the proposal’s potential impact on smaller advisors that may face disproportionate competitive challenges. Commissioner Mark T. Uyeda also dissented, expressing concerns over whether “there is any observable problem related to investment advisers’ oversight of service providers that necessitates the blanket imposition of specified oversight requirements.”