Skip to main content

Statement on Proposed Rule Regarding Outsourcing by Investment Advisers

Oct. 26, 2022

Thank you, Chair Gensler. Under the Investment Advisers Act of 1940 (“Advisers Act”), an investment adviser owes a fiduciary duty to its clients.[1] The proposing release indicates that, because an adviser cannot waive its fiduciary duty, the “adviser should be overseeing outsourced functions to ensure the adviser’s legal obligations are continuing to be met despite the adviser not performing those functions itself.”[2] Thus, today’s proposal introduces a brand new regulatory regime that prescribes the specific manner in which an investment adviser must oversee its service providers.

Less clear, however, is whether: (1) there is widespread misunderstanding among investment advisers regarding the application of their fiduciary duties to outsourced functions, and (2) there is any observable problem related to investment advisers’ oversight of service providers that necessitates the blanket imposition of specified oversight requirements.

The proposed rule imposes oversight requirements with respect to the outsourcing of “a function or service that is necessary for the investment adviser to provide its investment advisory services in compliance with the Federal securities laws.”[3] According to the proposal, this formulation is “designed to apply in the context of outsourcing core advisory functions.”[4] Tellingly, the observations cited in the proposing release as a basis for proposing this rule do not appear to describe service provider failures that would have been prevented had the rule been in effect.

For example, the release cites an article describing problems encountered by a mutual fund service provider when it temporarily was unable to calculate net asset values (“NAVs”) on approximately 1,200 mutual funds in 2016.[5] However, there is no discussion of whether and to what extent the mutual funds’ investment advisers conducted oversight of the service provider in accordance with their existing obligations, and whether the specified oversight requirements contemplated by the proposed rule would have prevented or mitigated the problem.[6]

The proposing release also cites an enforcement action against investment advisers that used models and volatility guidelines from a third-party subadviser without first confirming that they worked as intended.[7] The settlement order details numerous violations, including failure to verify the proper functioning of the model, misleading disclosure to clients, and misrepresentations to the mutual fund boards that were tasked with overseeing certain of the investment products.[8] In this case, the adviser ignored several existing legal obligations and there is no explanation as to how the overlay of a prescriptive service provider rule would have altered the adviser’s conduct.

The release then discusses two service provider matters that do not appear to involve core advisory functions, including one matter that involves a breach of customer data that resulted from an investment adviser’s hiring of a moving and storage company.[9] However, the matters appear to be included because the proposal would extend the requirement to conduct service provider oversight to third parties that make and/or keep any books and records required to be kept by Rule 204-2 under the Advisers Act.[10] Again, the proposing release is silent as to whether these service provider issues resulted from a failure of proper oversight and how the proposed rule would prevent or mitigate the perceived problems.

Substantively, the proposed rule text is problematic because it creates significant interpretive challenges. The proposing release states that the rule is intended to relate only to core advisory functions, but the definition of a “Covered Function” is a function or service that “is necessary for the investment adviser to provide its investment advisory services in compliance with the Federal securities laws.” Many functions or services that do not relate to an adviser’s investment advisory function nonetheless are necessary for the adviser to provide its investment advisory services in compliance with the federal securities laws.[11] Therefore, under a technical reading of the proposed definition of “Covered Function,” almost any function outsourced by an investment adviser could trigger the numerous oversight functions set forth in the proposed rule.[12] What is a chief compliance officer to do? An already burdensome regulatory regime is made ever more burdensome when the functions that trigger the rule’s requirements are not clearly spelled out.

To add to the confusion, although the Commission has stated that an adviser’s fiduciary duty extends to voting proxies on behalf of its clients,[13] there is not one mention in the proposing release of the use of proxy voting advisory firms by investment advisers. The outsourcing of proxy voting advice presumably would be a “Covered Function” under the rule. However, when the release requests comment on whether various types of specified services or services providers should be identified in the final rule text, proxy voting advisory businesses are noticeably absent.[14] Coupled with the implication that seemingly non-advisory functions – such as moving and storage – may be subject to the requirements of the rule, the glaring absence of any reference to a commonly outsourced advisory function in the proposing release raises additional questions about how the rule would be applied.

Finally, the economic analysis fails to account for the substantial burden that would likely be placed on smaller advisers. While the release discusses potential differences in costs that complying with the rule would impose on larger advisers as compared to smaller advisers, the release fails to consider other outcomes that might further disproportionately impact smaller advisers. One possibility is that the burdensome nature of the service provider oversight requirements could cause certain service providers to cease doing business with smaller advisers altogether.

The lack of attention to the impact of this rule on smaller advisers is further evidenced by the absence of a staggered compliance date. At a minimum, any new rule imposing significant new compliance burdens on investment advisers should afford smaller advisers a longer time period to come into compliance with the rule. I had similar concerns with respect to the lack of a staggered compliance date in the recently-adopted broker-dealer recordkeeping rule.[15] I strongly encourage commenters to consider whether smaller advisers will be disproportionately affected by this proposed rule and – if so – include in comment letters ideas as to what the dividing line should be between smaller advisers and larger advisers for purposes of implementing a staggered compliance date in any future final rule.

There may be a role for enhanced procedures for oversight of specified functions performed by third parties for investment advisers, but the breadth of this proposal goes too far. It also seems premature when the Commission has yet to identify a path forward on index providers.[16] Perhaps the best role of this proposal is to serve somewhat akin to a concept release on what constitutes “core advisory functions.” Although I am unable to support this proposal, I thank the staff in the Divisions of Investment Management and Economic and Risk Analysis, as well as the Office of the General Counsel, for their efforts. I will look forward to the public comments.

[1] See SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963). See also Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Investment Advisers Act Release No. 5248 (June 5, 2019) [84 FR 33669 (July 12, 2019)].

[2] See Outsourcing by Investment Advisers, Investment Advisers Act Release No. 6176 (Oct. 26, 2022), available at

[3] Id.

[4] Id.

[5] See Armental, Maria, BNY Mellon to Pay $3 Million to Resolve Massachusetts Probe Over Glitch, The Wall Street Journal (Mar. 21, 2016), available at

[6] The release also does not address that – unlike other types of advisory clients - mutual funds are required by the Investment Company Act of 1940 (“Investment Company Act”) to have independent boards of directors that oversee the funds’ operations. See, e.g., 15 U.S. Code § 80a–10. In addition, Rule 38a-1 under the Investment Company Act requires mutual fund boards to approve the compliance policies and procedures of a fund’s investment adviser and certain enumerated service providers. See 17 CFR § 270.38a-1.

[7] See In the Matter of Aegon USA Investment Management, LLC, et al, Investment Advisers Act Release No. 4996 (Aug. 27, 2018) (settled order), available at

[8] Id. According to the settled order, the primary adviser’s employees recognized that “we run the risk of the [the subadviser’s analyst] making an error, which is easy to do.” Id.

[9] See Morgan Stanley Smith Barney LLC, Investment Advisers Act Release No. 6138 (Sept. 20, 2022) (settled order), available at The other matter is the failure of certain investment advisers to produce records to evidence the delivery of firm brochures due to the use of third-party client relationship managers to perform that function.

[10] See 17 CFR § 275.204-2.

[11] For example, Rule 204-3 under the Advisers Act requires an adviser to deliver a firm brochure to clients or prospective clients. See 17 CFR § 275.204-3. While the delivery of firm brochures is not a core advisory function, it is nevertheless a function that is necessary for an adviser to provide its investment advisory services in compliance with the federal securities laws.

[12] The proposing release exacerbates these interpretive problems by citing to an enforcement action involving moving and storage functions as an example of service provider oversight failures that justify the rule.

[13] See Proxy Voting by Investment Advisers, Release No. IA-2106 (Jan. 31, 2003) [68 FR 6585, 6586 (Feb. 7, 2003)], available at

[14] See Outsourcing by Investment Advisers, supra note 2.

[15] See Electronic Recordkeeping Requirements for Broker-Dealers, Security-Based Swap Dealers, and Major Security-Based Swap Participants, Release No. 34-96034 (Oct. 12, 2022), available at

[16] See Request for Comment on Certain Information Providers Acting as Investment Advisers, Investment Advisers Release No. 6050 (Jun. 15, 2022) [87 FR 37254 (Jun. 22, 2022)], available at The proposing release indicates that “we are continuing to consider all of the comments received.” See Outsourcing by Investment Advisers, supra note 2.

Return to Top