On 26 October 2022, the Securities and Exchange Commission ("SEC") released proposed new rules (and a Fact Sheet) introducing an oversight framework for SEC registered Investment Advisers outsourcing certain “covered functions” to service providers.
Covered functions
A covered function is a function or service that
- is necessary to provide advisory services in compliance with the 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 proposed rule adds that clerical, ministerial, utility, and general office functions or services would be excluded.
Proposals
Before appointing a service provider to perform a covered function, investment advisers would be required to establish, through due diligence, that outsourcing would be appropriate by considering:
- Nature and scope of the covered function;
- Potential risks resulting from the service provider performing the covered function, including how to mitigate and manage such risks;
- Service provider’s competence, capacity, and resources necessary to perform the covered function;
- Service provider’s material subcontracting arrangements related to the covered function;
- Coordination with the service provider for Federal securities law compliance; and
- Orderly termination of the performance of the covered function.
Additionally, investment advisers would be required to monitor performance periodically and reassess the selection of the service provider.
Link to Form ADV
An adviser would have to retain due diligence and monitoring records, as well as report information on service providers on their Form ADV.
Third-party record keepers
In addition to the above rules, investment advisers would also be required to obtain assurances that third-party record keepers meet four standards:
- Adopt and implement internal processes and/or systems for making and/or keeping records that meet the requirements of the recordkeeping rule 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.
Investment adviser should be aware that although the proposed rule does not require additional explicit written policies and procedures, advisers would be required under existing rules to have policies and procedures designed to prevent violations should the proposed rule become effective.
Next steps
The proposed rule is opened to public comments for 60 days from its publication or 30 days after being published in the Federal Register, whichever is longer.
How Apex can help
Contact Apex Compliance Services - for assistance with SEC compliance support, including:
- Form ADV
- Compliance Programs
- Policies and Procedures
- ESG Compliance
- Managed Due Diligence
- Vendor and Service Provider Due Diligence
