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The SEC Proposes New Oversight Requirements for Third Parties

The Securities and Exchange Commission (SEC) unveiled protective new proposals in October 2022 which would affect all investment firms that outsource certain functions or services to third party contractors.
Sumit Mahajan, CAIA, FRM
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The Securities and Exchange Commission (SEC) unveiled protective new proposals in October 2022 which would affect all investment firms that outsource certain functions or services to third party contractors.

The proposals are designed to reduce the risk of disruption or service standards lowering as a result of outsourced arrangements, and to require investment advisors (RIAs) to carry out due diligence on such parties as well as have the capability to monitor the performance of third party outsourced tasks in future.

As the nature of fund management is so changeable, it is practical for significant aspects of the RIA business needs to be outsourced, from IT, HR, marketing and software platforms, where industry specialists can fulfil that role extremely well, helping to manage costs while also having the ability to adhere to relevant regulatory obligations.

The new proposal covers two important factors that must be considered when outsourcing: Is the third party resilient both financially and practically day to day, and does its ESG values match those of the firm, ensuring a cohesive working relationship that provides a continuity of reliable and successful service arrangement?

Gary Gensler, Chair of the SEC was clear on who will benefit from such new regulation of outsourcing, when he highlighted RIAs’, “obligations to the investing public.” He acknowledged that 3rd party outsourcing has been widespread “for decades” but clarified that the fact that these arrangements are still on the increase does not “change an advisor’s core obligations to its clients.”

Specific due diligence to meet reasonable assurances will be required from the regulated firm through this proposal if an outsourced firm is to be retained, and in addition new monitoring of the provider’s ongoing performance will be required. Clearly the viability and financial position of any third party must be reliable and ascertained before any contract is entered into. Recordkeeping will also need to be checked to ensure that if anything were to go wrong, data security would remain intact and data breach risk can be mitigated.

ESG values and policies are becoming increasingly important and are covered under this proposal. Advisors want to share a similar cultural outlook with any third party and maintain practices and attitudes that are on a par with their own regarding diversity, inclusion and core values. These might be as simple as the number of holidays employees are entitled to or how transparently non-discriminatory interviewing processes are. Such issues can help contribute to a rewarding and successful business relationship.

Portfolio BI is well positioned to work alongside regulated entities, bringing their own financial resilience and sector specific expertise to regulated firms. As a specialist operation, we understand the obligations to the regulator and work with our clients to ensure they have visibility of their data operations to report to the regulator.

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