Weekly RoundUp
November 3, 2022

SEC Proposes New Rule Addressing Outsourcing by Investment Advisers

In This Weekly Roundup Issue. The U.S. Securities and Exchange Commission (SEC) proposed a new rule addressing outsourcing by investment advisers; the SEC adopted amendments to modernize fund shareholder reports and promote transparent fee- and expense-related information in fund advertisements; and the SEC adopted final rules requiring the disclosure and recovery of erroneously awarded incentive-based compensation. These and other developments are discussed in more detail below.

Regulatory Developments

SEC Proposes New Rule Addressing Outsourcing by Investment Advisers

On October 26, the SEC proposed a new rule 206(4)-11 and related amendments addressing investment advisers’ outsourcing of certain services or functions to third-party service providers. The new rule would establish an oversight framework applicable to a service or function that (1) is necessary to provide advisory services in compliance with the federal securities laws, and (2) if not performed, or performed negligently, would be reasonably likely to cause a material negative impact on the adviser’s clients or on the adviser’s ability to provide investment advisory services (each, a “covered function” and collectively, the “covered functions”). If an investment adviser seeks to obtain a third-party service provider to perform a covered function, the adviser would be required to perform due diligence to determine that outsourcing the covered function would be appropriate considering a number of factors outlined in a fact sheet. The new rule would also require the adviser to periodically monitor the service provider’s performance and to reassess the selection of the service provider. The new rule also contains various recordkeeping requirements and standards.

The public comment period will remain open for the longer of 60 days after the date of issuance and publication on sec.gov or 30 days after publication in the Federal Register.

“Though investment advisers have used third-party service providers for decades, their increasing use has led staff to make several recommendations to ensure advisers that use them continue to meet their obligations to the investing public.”
- SEC Chair Gary Gensler

SEC Adopts Amendments to Modernize Fund Shareholder Reports and Promote Transparent Fee- and Expense-Related Information in Fund Advertisements

On October 26, the SEC voted to require mutual funds and exchange-traded funds to provide concise shareholder reports, balanced fee presentations, and expenses relating to investment company advertisements.

The new rule imposes a variety of requirements on how funds display and disseminate information, including requiring funds to provide concise reports that highlight key information. Additionally, funds must make information available online, provide for free delivery, and are encouraged to use graphic and text features to more effectively convey information.

The SEC is providing an 18-month transition period after publication in the Federal Register to allow funds to adjust to the new requirements. The SEC also adopted amendments that require certain advertisements be consistent with relevant prospectus fee table presentations and impose requirements to address misleading information. The amendments affecting misleading information will become effective 60 days after publication in the Federal Register; the SEC is providing an 18-month transition period after publication in the Federal Register to allow funds to adjust to the new advertising requirements.

SEC Adopts Final Rules Requiring Disclosure and Recovery of Erroneously Awarded Incentive-Based Compensation

On October 26, the SEC adopted final rules implementing Section 10D of the Securities Exchange Act of 1934 (Exchange Act), which was added by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The SEC originally proposed these rules in 2015, and reopened the comment period in October 2021 and again in June 2022. New Exchange Act Rule 10D-1 will require U.S. national stock exchanges, including the NYSE and Nasdaq, to propose and adopt new listing standards that will require listed companies to adopt and comply with policies that provide for the recovery of incentive-based compensation received by current or former executive officers based on any misstated financial reporting measure if the company is required to prepare an accounting restatement.

Read the client alert for a summary of what companies should be doing now and other considerations.

FINRA Focused on Registered Reps Named as Beneficiaries and Trustees for Customer Accounts

FINRA recently highlighted Rule 3241 in the 2023 Regulatory Element Learning Plan. Rule 3241 became effective in early February 2021 and prohibits a registered person from being named as a beneficiary, executor, or trustee or having a power of attorney or similar position of trust for or on behalf of a customer unless certain requirements are satisfied.

Read the client alert to learn more about the rule and key considerations.

SEC Revamps Broker-Dealer Recordkeeping Requirements; “Audit Trail” Alternative Replaces “Worm” Format

The SEC recently adopted new recordkeeping requirements for broker-dealers and “SBS entities” (security-based swap dealers and major security based swap participants). Most notably, the SEC will no longer require broker-dealers to maintain records in “write once, read many” or “WORM” format. Instead, broker-dealers will be able to utilize a new “audit trail” alternative for their electronic recordkeeping systems.

Read the client alert to learn about the new audit trail alternative, the use of cloud service providers, and what’s next.

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William McCurdy