Compliance October 26, 2022

SEC Proposal Calls for Vetting of Outsourced Services by Advisers

The SEC says the new rule proposals are responding to the growing trend in use of third-party vendors by financial advisers. An adviser association calls them ‘overly burdensome.’

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The Securities and Exchange Commission (SEC) on Wednesday proposed new rules requiring that financial planning and wealth management advisers vet and monitor vendors they use to outsource a broad array of client-related services.

The SEC said that, while advisers have always used third-party services for their work, the increased use of outsourcing to lower the costs of business requires increased regulation.

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“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,” SEC chair Gary Gensler said in a statement.

The rule comes amid continued growth in advisers’ using outsourcing in their everyday work with clients. About 32% of RIAs said they use outsourcing for services, up from 27% two years ago, according to a September survey of 550 advisers by a division of the Chicago-based Northern Trust.

The Investment Adviser Association (IAA), which represents financial advisers in Washington, called the new rules “overly burdensome” and said the SEC does not recognize “how little leverage firms have over many service providers.”

“The SEC again has not appropriately considered the cumulative impact of its wave of new proposals on advisory firms of all sizes, nor has it provided sufficient time for meaningful feedback on these sweeping changes,” Karen Barr, president and CEO of the IAA, said in an emailed statement.

The new rule broadly applies to what the SEC calls “covered functions,” or outsourced services that could cause a “material negative impact” on clients. The regulator also said it applies to services that are required for the adviser to provide to comply with Federal securities laws.

In a 232-page report, the SEC said the determination of what obligations should be given due diligence would depend on the “facts and circumstances.” It gave examples such as third-parties providing custom indexes, investment risk software or services, portfolio management or trading services or software, and investment advisory services.

“An 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,” the SEC said.

There will be a public comment period on the proposal of at least 60 days, the SEC said.

Compliance October 26, 2022

The SEC Adopts Rules on Shareholder Reporting, Fund Advertisements

The rules adopted by the SEC update requirements for mutual fund and ETF shareholder reports and promote transparent fee and expense presentations in investment company advertisements.

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The U.S. Securities and Exchange Commission voted today to adopt significant changes to its mutual find and exchange-traded fund advertisement disclosure framework.

The new rule and form amendments will require mutual funds and ETFs to transmit “concise and visually engaging shareholder reports” to promote transparent and balanced presentations of fees and expenses in investment company advertisements.

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“Retail investors are typically non-professional investors buying and selling securities, mutual funds, or ETFs through traditional or online brokerage accounts,” says Syed Farooq, director, assurance, in a blog published by tax consulting and advisory firm Cohen & Co. “They usually do not have the time or sufficient background to understand all of the complex information captured in voluminous annual and semi-annual shareholder reports or fund prospectuses.”

Farooq says that with an increased entry of new Millennial and Gen Z investors, the need for “simplicity, clarity and transparency has never been greater.” The rules will “help drive improved decision-making ability for retail investors, management, boards and external service providers,” he adds.

According to the SEC, funds will be required to provide shareholder reports that highlight key information, such as fund expenses, performance, and portfolio holdings. The instructions for the reports will encourage the use of graphics and text features to make them more effective.

Funds will be required to tag the information in their reports in a structured data format. The rule amendments also require funds to make certain information that may be more relevant to investors and financial professionals who desire more in-depth information available online and available for delivery free of charge to investors on request, the SEC says. That information will no longer appear in fund’s shareholder reports but will remain available to investors on a website identified in the shareholder report and must be filed semi-annually with the SEC.

“Shareholder reports are amongst the most important documents that fund investors receive. These reports, however, often are more than 100 pages in length. As a result, a retail investor looking to understand the performance, fees, and other operations of a mutual fund or exchange-traded fund may need to sift through extensive financial information,” says SEC Chair Gary Gensler. “Today’s final rules will require fund companies to share a concise set of materials that get to the heart of the matter. Further, today’s final rules are designed to promote transparent and balanced presentations of fees and expenses in investment company advertisements.”

The SEC has also adopted amendments to investment company advertising rules that require fee and expense presentations in registered investment and business development company advertisements and sales literature be consistent with relevant prospectus fee table presentations and be reasonably current. The amendments also address representations of fees and expenses that could be materially misleading.

The amendments become effective 60 days after publication in the Federal Register, though the SEC is providing an 18-month transition period after the effective date to provide mutual funds and ETFs with adequate time to adjust their shareholder report and transmission practices.

The SEC is also providing an 18-month transition period after the effective date to comply with the final amendments to the advertising rules.

The rules amendments that address representations of fees and expenses that could be materially misleading will apply on the effective date.

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