SEC regulatory lawyers will want to note the recent filing of the 2022 Investor Advocate Report. The Investor Advocate is an advisory arm of the SEC looking out for the interests of retail investors, but it doesn’t engage in SEC rulemaking. A few things in the Report jump out. First, a statement that suggests the Investor Advocate wants to see more before weighing in on the effectiveness of Regulation Best Interest. Also, the Report includes a table of certain potentially problematic products, practices and trends broken down by regulator: These include performance claims and social media (SEC); Finfuencers and Reassigned Advisory Accounts (NASAA) and Financial Literacy Declines (FINRA). Here is a link to the full report: FY22 OIAD SAR Activities Report (sec.gov)
Category Archives: Compliance
SEC proposes service provider oversight requirements for investment advisers
On October 26, 2022, the Securities and Exchange Commission (SEC) proposed new Rule 206(4)-11 under the Investment Advisers Act of 1940 (Advisers Act), which would prohibit SEC-registered investment advisers from outsourcing certain services or functions to service providers without meeting minimum requirements. At the same time, the SEC also proposed certain related amendments to Rule 204-2 under the Advisers Act and Form ADV.
Proposed Rule 206(4)-11 (Proposed Rule) would require investment advisers to conduct due diligence prior to engaging a service provider to perform certain services or functions. It would further require advisers to periodically monitor the performance and reassess the retention of the service provider in accordance with due diligence requirements to reasonably determine that it is appropriate to continue to outsource those services or functions to that service provider.
New SEC Proposal on Adviser Oversight
The SEC today proposed a rule that could have a significant impact on advisers that outsource certain advisory or trading functions to third parties.
The new rule would require advisers to conduct initial due diligence and ongoing monitoring of service providers to whom covered functions are outsourced. SEC-registered advisers would have to reasonably identify and determine through due diligence that it would be appropriate to outsource the covered function, and that it would be appropriate to select that service provider, by complying with six specific elements. These elements address: (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; and (6) The orderly termination of the provision of the covered function by the service provider.
Marketing Rule and “Promoter” Agreements — What Advisers Should Consider
Advisers paying third parties for client referrals (“promoters”) must determine whether they will need agreements with such promoters in order to comply with the new Marketing Rule and to ensure that any such agreements allow them to ensure compliance with the Marketing Rule’s disclosure, oversight and disqualification provisions pertaining to the use of paid testimonials and endorsements.
Among other things, advisers will want to consider the following with respect to agreements with promoters:
- Restrictions on the materials the promoter may use to promote the adviser’s services
- Processes for pre-approval of any materials to be used by the promote to promote the adviser’s services
- The Imposition of disclosure requirements for any marketing materials to be used by the promoter to ensure compliance with the Marketing Rule
- The right of the adviser to conduct ongoing due diligence on the promoter’s compliance with the Marketing Rule including the right to inspect books and records
- Inclusion of representations and warranties to be made by the promoter to ensure that it and its personnel are not disqualified from referring clients to the adviser
Fiduciary Obligations for Legacies
Many advisers incorrectly believe they automatically have no fiduciary obligations with respect to legacy investments that clients bring into the advisory relationship.
However, in the absence of an explicit understanding to the contrary, this is not true. By default, advisers still owe a fiduciary duty of care with respect to such investments (i.e., to conduct a reasonable investigation into such investments and to determine if they are suitable for the client) as they do for other investments they proactively recommend.
Advisers that do not wish to undertake the responsibility of conducting due diligence on and to make suitability determinations with respect to such legacy investments must take steps to clarify these points in their advisory agreements with clients.
