SEC Proposes New Rule to Monitor Outsourced Investment Advisory Services

The SEC proposed a new rule establishing minimum standards that investment advisers would be required to meet prior to outsourcing certain services or functions. The SEC also proposed amending Form ADV and the recordkeeping rules to impose further requirements as to the outsourcing of "covered functions."

Proposed Rule

Under the proposal, the SEC would implement baseline due diligence requirements and monitoring obligations for advisers that outsource covered functions to a third-party service provider. A covered function is defined as a function that (i) is critical to the adviser's ability to conduct business operations in compliance with federal securities laws and, (ii) if performed incorrectly, would cause material harm to investors or hinder the adviser's ability to fulfill its obligations. The proposal would also require advisers to provide reasonable justification for outsourcing the service to a particular third-party and periodically monitor performance by the third-party service provider.

The adviser would be required to keep records on the third-party agreement. Additionally, the SEC proposed revising Form ADV to require information on the third-party service provider, the function that is being outsourced and the risks involved.

Commissioner Statements

SEC Chair Gary Gensler, Commissioner Jaime Lizárraga and Commissioner Caroline A. Crenshaw each supported the proposal. Ms. Crenshaw also asked market participants to consider and comment on (i) whether the proposed rule is consistent with similar industry standards and (ii) whether the proposal require any additional disclosures beyond what is already included.

Commissioner Hester M. Peirce criticized the proposal, calling it a "repackaging [of] existing fiduciary obligations into a new set of prescriptions for investment advisers." She, along with Commissioner Mark T. Uyeda, who also dissented, said the proposal may have a disproportionate impact on smaller advisers.