INVESTMENT ADVISERS—SEC proposes new oversight requirements for investment advisers - 27 October 2022

SEC Chair Gensler supports the new oversight requirements but Commissioner Peirce questions the necessity of a rulemaking that reconfirms the “incontrovertible fact” that an adviser’s fiduciary duty is not terminated by outsourcing.

The SEC has proposed a new rule and rule amendments under the Investment Advisers Act of 1940 which will prohibit registered investment advisers from outsourcing certain services or functions without first meeting minimum requirements.

According to the SEC’s press release, the proposed rule would require that advisers conduct due diligence prior to engaging a service provider for certain services or functions and would require that advisers “periodically monitor the performance and reassess the retention of the service provider in accordance with due diligence requirements to reasonably determine that it is appropriate to continue to outsource those services or functions to that service provider.”

The SEC’s fact sheet explains that the new proposed rule 206(4)-11 would establish an oversight framework across SEC-registered advisers that outsource a “covered function.” A “covered function” is defined as a function or service that:

1. Is necessary to provide advisory services in compliance with 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.

SEC Chair Gary Gensler released a statement saying that he believes that the rule 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.” Chair Gensler stated that he is pleased to support the proposal and he looks forward to the public’s feedback on all elements of the proposal.

SEC Commissioner Hester M. Peirce released a statement reacting to the proposed rule in which she stated that she could have “supported Commission guidance highlighting the importance of an adviser’s ongoing obligations to its clients when it has engaged a service provider,” but she “cannot support repackaging existing fiduciary obligations into a new set of prescriptions for investment advisers.” The Commissioner also questioned what problem the proposal is trying to correct and asked why the sudden urgency for a rulemaking that reconfirms “the incontrovertible fact that outsourcing does not terminate an adviser’s fiduciary duty.” Commissioner Peirce also stated that prescriptive regulations like this one will favor big firms and incumbents but will create disproportionate competitive challenges for small service providers.

The proposal is on SEC.gov and will be published in the Federal Register. The public comment period will remain open for 60 days after the date of issuance and publication on SEC.gov or 30 days after the date of publication in the Federal Register, whichever period is longer.

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