United States: SEC Proposes New Requirements for Adviser Oversight of Service Providers

By: Megan W. Clement

On October 26, 2022, the Securities and Exchange Commission (the “SEC”) proposed new rule 206(4)-11 and related amendments under the Advisers Act, which would require registered investment advisers to meet certain requirements when outsourcing “covered functions” to service providers.  Citing increasing use of third-party service providers, SEC Chair Gary Gensler noted that the proposals are designed to ensure that outsourcing is consistent with the obligations advisers have to their clients. A related fact sheet and the SEC’s press release can be found here and here.

Specifically, the proposals would require advisers to:

  • Perform due diligence on a service provider before retaining it to perform a “covered function”;
  • Monitor a service provider’s performance and reassess the selection of the service provider to perform the “covered function”; and
  • Maintain books and records relating to its due diligence and monitoring activities.

The proposals also would require advisers to conduct due diligence on and monitor third-party recordkeepers, as if the third-party recordkeeper were a “service provider” performing a “covered function”.  Advisers also would be required to obtain “reasonable assurances” that the recordkeeper will meet specific standards.    

“Covered functions” are defined as services or functions that are (1) 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 its ability to provide investment advisory services. 

The proposals are broad with potentially far-reaching implications.  For example, a “covered function” could include the engagement of an index provider to create or lease an index for the adviser to follow as a strategy for its advisory clients.  The proposals do not distinguish between third-party and affiliated service providers, so an adviser’s oversight responsibilities would also extend to affiliated service providers. Similarly, the proposals also do not include an exception for sub-advisers or other service providers subject to other federal securities laws.

Comments to the proposals are due the later of December 27, 2022 or 30 days after publication in the Federal Register.

Please stay tuned, additional details to come in our upcoming client alert.

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