SEC proposed oversight requirements for RIA service providers

On Oct. 26, 2022, the Securities and Exchange Commission (SEC) proposed a new rule under the Investment Advisers Act of 1940 (Advisers Act) in relation to registered investment advisers (adviser) outsourcing certain services or functions. Included in the proposed rule were related amendments to the investment advisor registration form to collect census-type information about the service providers as well as related amendments to the Advisers Act books and records rule. The rule aims to reduce any harm to the investing public that can arise from an adviser outsourcing services without proper oversight.

The proposed rule would require advisers to:

• Conduct due diligence prior to engaging a service provider to perform “covered functions;”
• Periodically monitor the performance and reassess the retention of the service provider in accordance with due diligence requirements; and
• Make and/or keep books and records to conduct due diligence and monitoring of service providers.

Under the proposed rule, a covered function is a function or service that:

• Is necessary for the adviser to provide its investment advisory services in compliance with federal securities laws; and
• If not performed or performed negligently would be reasonably likely to cause a material negative impact on the adviser’s clients or the adviser’s ability to provide investment advisory services.

The SEC provided examples of potential covered function categories:

• Adviser/subadviser
• Client services
• Cybersecurity
• Investment guideline/restriction
• Compliance
• Investment risk
• Portfolio management (excluding adviser/subadviser)
• Portfolio accounting
• Pricing
• Reconciliation
• Regulatory compliance
• Trading desk
• Trade communication and allocation
• Valuation

Prior to engaging a third-party service provider to perform a covered function, advisers will be required to determine through due diligence if it would be appropriate to outsource a function to that service provider by assessing six elements.

1. The nature and scope of the services
2. Potential risks resulting from the service provider performing the covered function, including how to mitigate and manage such risks
3. The service provider’s competence, capacity and resources necessary to perform the covered function
4. The service provider’s subcontracting arrangements related to the covered function
5. Coordination with the service provider for federal securities law compliance
6. The orderly termination of the provision of the covered function by the service provider

The proposed rule also requires the adviser to periodically monitor the service provider’s performance and reassess the selection of said service provider. The adviser would need to maintain books and records in relation to the oversight obligation and report census-type information under the rule. Comments on the proposal are due to the SEC by Dec. 27, 2022.

This new oversight requirement aims to add additional oversight to aid the investing public to ensure that proper due diligence and monitoring is completed when outsourced services are being used. The use of outsourced services does not change the obligation of the adviser to their clients, and these rules will aim to ensure sufficient assessment is completed.

Information included above was sourced from the SEC website.