What the SEC's Proposed Vendor Due Diligence Rule Means for RIAs
In line with an ongoing trend to establish cybersecurity protocols for registered investment advisers (RIAs), the Securities and Exchange Commission (SEC) voted on a proposal to address vendor due diligence and security.
As the financial services industry adapts to changing market conditions and an increasingly digital business landscape, the need to incorporate new tools and services to meet demand efficiently has also grown. The proposed rule expands the definition of a vendor, focusing not only on software and cloud solutions, but also on service providers such as consultants, law firms, and accounting firms.
Under the Investment Advisers Act of 1940, the proposed SEC vendor due diligence rule prohibits RIAs from outsourcing certain services or functions without first meeting minimum due diligence requirements.
"When an investment adviser outsources work to third parties, it may lower the adviser’s costs, but it does not change an adviser’s core obligations to its clients. Thus, today’s proposal specifies requirements for investment advisers designed to ensure that advisers’ outsourcing is consistent with their obligations to clients."
Key elements of the proposal
SEC Chairman Gary Gensler said the organization had “observed an increase in advisers outsourcing and issues related to the outsourcing and advisers’ oversight.”
The proposed SEC outsourcing rule and amendments would apply the following requirements:
- Reasonably identify and determine thorough due diligence before outsourcing a covered function to a service provider
- Periodically monitor performance and reassess whether due diligence requirements are being met, to determine whether the relationship should continue
The proposal also includes amending the RIA registration form, Form ADV to provide more specific information about service providers and their functions, allowing for greater transparency and oversight.
Proposed vendor requirements
The proposed rule imposes further RIA due diligence and monitoring provisions on third-party vendors that provide recordkeeping functions.
Conducting due diligence will be mandatory to assure that vendors meet four standards:
- Adopt and implement internal procedures for producing and retaining records maintained on behalf of the adviser to comply with the recordkeeping rule
- Produce and/or retain records that comply with recordkeeping rule requirements applicable to the adviser
- Allow access to digital records
- Ensure accessibility to digital records even after the vendor’s contract terminates or if the vendor goes out of business
Addressing SEC third-party due diligence requirements with potential vendors and reassessing existing service provider relationships enable necessary policy adjustments, agreements, and risk management.
How financial firms can prepare
So, what does this mean for RIAs and firms? Working with vendors is a critical part of doing business — but they must be trusted to access, handle and transmit highly sensitive information.
A vendor risk management solution simplifies the vendor risk assessment process by automating the most resource-intensive parts of third-party risk evaluation and management, including:
- Flexibility to create any relevant assessment questionnaire
- Automating the time-consuming process of grading vendor assessments and adjusting contract clauses to match
- Maintain auditable tracking of remediation plans and validation documentation
- Real-time reporting for cross-functional visibility
- Customization of assessments and rules to meet each firm’s unique needs
- Ongoing monitoring and remediation
As the vendor ecosystem expands and security threats evolve, firms should be proactive in their due diligence process. Performing annual reassessments, armed with a modern vendor risk management solution will help RIAs stay secure and compliant.
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Scalable for organizations of all sizes, the Smarsh platform provides customers with compliance built on confidence. It enables them to strategically future-proof as new communication channels are adopted, and to realize more insight and value from the data in their archive. Customers strengthen their compliance and e-discovery initiatives and benefit from the productive use of email, social media, mobile/text messaging, instant messaging and collaboration, web, and voice channels.
Smarsh serves a global client base that spans the top banks in North America and Europe, along with leading brokerage firms, insurers, and registered investment advisors. Smarsh also enables state and local government agencies to meet their public records and e-discovery requirements. For more information, visit www.smarsh.com.
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