RIAs Beware: The Pitfalls When Going Straight To The (Out)Source

By Michael E. Pastore, Edmund P. Daley

On October 26, 2022, the Securities and Exchange Commission (SEC) proposed a new rule and amendments under the Investment Advisers Act of 1940 (the “Act”) that would add significant guardrails to the common practice of registered investment advisers (RIAs) using third-party service providers (“Proposed Rule”).  In its press release announcing the Proposed Rule, the SEC acknowledged the benefit to clients of outsourcing certain investment functions or services, while noting that “clients could be significantly harmed when an adviser outsources a function or service without appropriate adviser oversight.”[1]

The key changes that would be implemented by the Proposed Rule are:

  • The establishment of an oversight framework across RIAs that outsource a “covered function”[2]
    • Includes consideration of factors such as nature and scope of the covered function, potential risks, the competence level of the third-party, and any material subcontracting arrangements.
  • Increased due diligence and monitoring, resulting in enhanced oversight of third-party record keepers.
    • RIAs would have to receive reasonable assurance from any third-party that it has the ability to:
      1. adopt and implement processes to meet the same recording keeping rule applicable to the books and records maintained on behalf of the adviser;
      2. make and keep records meeting the recordkeeping requirements applicable to the adviser;
      3. provide access to electronic records; and
      4. ensure the continued available of records past the cessation of the relationship with the adviser.

Public comment on the Proposed Rule will remain open either until December 27, 2022, or 30 after the proposal is published in the Federal Register (whichever is later). 

The Proposed Rule can be found at: https://www.sec.gov/rules/proposed/2022/ia-6176.pdf

A Fact Sheet summarizing the Proposed Rule can be found at: https://www.sec.gov/files/ia-6176-fact-sheet.pdf

 

[2] A “covered function” is “a function or service that is necessary for the adviser to provide its investment advisory services in compliance with the Federal securities laws, and that, 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.”  Proposed Rule 206(4)-11(b).

Subscribe To Viewpoints

Published

    • Viewpoint Topics

  • Litigation & Investigations

    • Professionals

  • Michael E. Pastore
  • Edmund P. Daley

    • Related Practices

  • Financial Institution Litigation

    • Related Industries

  • Financial Services

    • Authors

    Michael E. Pastore

    Special Counsel

    Michael E. Pastore is a Special Counsel who represents banks, financial services, and other companies in litigation and government proceedings involving consumer protection and other laws. He also handles arbitrations and guides clients through government and internal investigations.

    Edmund P. Daley

    Associate

    Edmund P. Daley is an associate in the firm’s Litigation section, focusing on white collar defense and financial services litigation. He represents public and private companies, investors and individuals in all manner of government investigations, enforcement actions and compliance related to financial laws. He is an active member of the firm’s Appellate Practice Group and has experience preparing motions for state and federal court cases, legal opinions and appellate briefs.