SEC Proposes Requirements for Investment Advisor Outsourcing

The Securities and Exchange Commission (SEC) has released a proposed rule to prohibit investment advisers from outsourcing certain services or functions without first meeting due diligence and ongoing monitoring requirements related to the “covered function”. A covered function is a function or service that is

  • necessary to provide 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 on the adviser’s ability to provide investment advisory services.

The SEC is providing examples of potential covered function categories an adviser may wish to consider in the amendments they are proposing to Form ADV, Section 7.C of Schedule D. Covered functions listed would include: Adviser/Subadviser; Client Services; Cybersecurity; Investment Guideline/Restriction Compliance; Investment Risk; Portfolio Management; Portfolio Accounting; Pricing; Reconciliation; Regulatory Compliance; Trading Desk; Trade Communication and Allocation; and Valuation.

The proposal would also require advisers to obtain reasonable assurances that a third party recordkeeper will meet four standards which address the third party’s ability to

  • adopt and implement internal processes for making and/or keeping records that meet recordkeeping rule requirements applicable to the books and records being maintained on behalf of the adviser;
  • make and/or keep records that meet all of the requirements of the recordkeeping rule applicable to the adviser;
  • provide access to electronic records; and
  • ensure the continued availability of records if the third party’s relationship with the adviser or its operations cease.

Comments should be received on or before 30 days after publication in the Federal Register or December 27, 2022, whichever is later.