First of Two IAA Letters on the SEC’s Outsourcing Proposal Filed
January 2, 2023
The IAA submitted a comment letter to the SEC on December 23 reflecting our general views on the recent adviser outsourcing proposal. Our comments were developed with the input of our dedicated member workstream that is focusing on this proposal. We have significant concerns with the proposal and have urged the SEC not to move forward and instead to consider alternative approaches to achieve its goals. We plan to submit a supplemental letter with specific comments and recommendations to improve the proposal should the SEC decide to move forward.
While we understand the SEC’s objectives, we believe that the proposal is unnecessary. As fiduciaries, advisers are responsible today for all aspects of their advisory relationship, regardless of whether any functions or services are outsourced, and must already have programs in place to manage their outsourcing. The SEC has not demonstrated that the existing regulatory framework is lacking or that advisers are unable to meet these obligations so as to justify imposing such a sweeping and prescriptive new rule on advisers.
The SEC has also significantly underestimated the potential costs of the proposal, with little evidence of benefit. It especially underestimates the substantial negative consequences for smaller advisers. And it again fails to consider the cumulative impacts of all its regulations on advisers of all sizes, which the IAA continues to urge it to do.
The proposal is another departure from the historical principles-based approach to the regulation of advisers that has worked well for over 80 years. A principles-based “evergreen” approach is important because it allows advisers to comply with the requirements in a way that makes sense for their particular business. It also ensures that “the buck stops” at the adviser even as financial services evolve because it avoids “whack-a-mole” regulation. The proposal, by contrast, includes broad and prescriptive requirements which may not all be practical or even feasible to satisfy.
One of our main concerns is that the proposal is also framed as an anti-fraud rule, and, because it’s so prescriptive, advisers risk being in non-compliance from technical missteps or minor infractions that don’t result in any harm. They can be found by the SEC to have committed a fraud on their clients without any showing of intent or other misconduct, so are likely to take a conservative and over-inclusive approach to compliance, which will not only increase costs, but could also direct their efforts and resources away from other important compliance functions or even from being able to serve their clients.
There are more tailored ways for the SEC to address concerns it has around adviser outsourcing that would be less onerous and more effective. For example, the SEC could consider providing additional principles-based guidance to assist advisers in tailoring their oversight processes to an ever-evolving landscape.
The IAA makes the following general points in our letter:
- The proposal is unnecessary and unwarranted.
- Investment advisers are fiduciaries to their clients under the Advisers Act, including with respect to outsourced services, and are already required to oversee service providers diligently.
- We strongly object to the SEC’s shift towards prescriptive, and away from principles-based, regulation.
- It is fundamentally unfair to promulgate the prescriptive proposal as an anti-fraud rule, where technical foot-faults and minor infractions could be deemed a fraud on an adviser’s clients.
- The proposal is overbroad and vague.
- The proposal includes elements that are impracticable, if not infeasible.
- The SEC should not try to extend its authority indirectly over service providers over which it has no independent jurisdiction, and it has more effective ways to reach the conduct of service providers it regulates.
- The proposal’s cost-benefit analysis is insufficient and performed in a vacuum. Its assessment of potential benefits is highly theoretical and it vastly underestimates the potential costs to and negative impacts on advisers, their clients, and their service providers. It also fails to consider the cumulative impacts of the proposal for all advisers, and for smaller advisers in particular.
- The SEC has not sufficiently considered the significant and disparate impact of the proposal on smaller advisers.
- The SEC has not considered the interplay of the proposal with other rule proposals or existing rules, or the cumulative impact of its many regulatory initiatives on advisers.
- The SEC has not adequately evaluated the potential impact of the proposal on the service provider landscape. Nor has it sufficiently assessed the potential downstream effects on investors.
- The SEC has not demonstrated that the goals of the proposal cannot be achieved through a more targeted and less onerous approach.