SEC Alert! Commissioner Hester M. Peirce on Proposed rule 206(4)-11: I cannot support repackaging existing fiduciary obligations into a new set of prescriptions for investment advisers.


Thank you Chair Gensler. Investment advisers are fiduciaries to their clients, so why are we giving them step-by-step instructions on how to do their jobs? If we think Congress got it wrong—that investment advisers cannot, absent regulatory handholding, serve their clients faithfully—then we should tell Congress. The approach we are taking—incrementally displacing their judgment with our own—is neither statutorily grounded nor protective of investors. I could have supported Commission guidance highlighting the importance of an adviser’s ongoing obligations to its clients when it has engaged a service provider. I cannot support repackaging existing fiduciary obligations into a new set of prescriptions for investment advisers.

Proposed rule 206(4)-11, among other things, would establish due diligence and monitoring obligations for advisers that outsource “covered functions” to a service provider. What precisely is the problem this proposal is trying to correct? The release tells us that some advisers are operating under the misimpression that outsourcing certain functions somehow absolves them of their responsibilities as fiduciaries with respect to those functions.

Why this sudden urgency to propose a rulemaking reconfirming the incontrovertible fact that outsourcing does not terminate an adviser’s fiduciary duty? Has there been a surge of enforcement actions against advisers for service provider-related failures or infractions? Are our examiners seeing advisers running from their fiduciary obligations with respect to outsourced functions? Are we aware of widespread investor harm due to advisers not overseeing their service providers? If the answer to any of these questions is yes, the release does not tell us so.

The actual number of advisers who think that they are off the hook when it comes to outsourced services likely is negligible and, even if it is not, we do not need new rules to hold them to account. As the Commission states quite clearly in this release, “[a]n adviser remains liable for its obligations, including under the Advisers Act, the other Federal securities laws and any contract entered into with the client, even if the adviser outsources functions.”[1] SEC compliance staff has made many similar public pronouncements. In 2009 for instance, exams staff reminded industry that “when a service provider is utilized, the adviser still retains its fiduciary responsibilities for the delegated services.”[2] The fiduciary duty that attaches to an adviser is intrinsic to the role. While the scope of that duty will be interpreted within the context of the agreed-upon relationship with the client, the adviser cannot wish it away by deciding to contract out services to a third party.

Reducing the fiduciary duty to a set of prescriptions could undermine investor protection. Standing alone, the fiduciary duty requires one to act in the client’s best interest at all times. If the rule intends to define what constitutes the client’s best interest, the definition quite naturally will lead to exclusion of other alternatives. The rule thus may end up abrogating fiduciary duty and replacing it with our predefined approach to best interest—one not responsive to unique facts and circumstances.

Even were I in favor of specific requirements regarding outsourcing, I would have concerns about promulgating them under section 206(4) of the Investment Adviser Act, which makes it unlawful “to engage in any act, practice, or course of business which is fraudulent, deceptive, or manipulative.” Section 206(4) authorizes the Commission to “define, and prescribe means reasonably designed to prevent, such acts, practices, and courses of business as are fraudulent, deceptive, or manipulative.” While the release states that it is being adopted as a “means reasonably designed to prevent fraudulent, deceptive, or manipulative acts, practices, or courses of business,” the release also seems to suggest that departing from the proposed requirements would itself be deceptive.[3] An adviser need not engage in a fraudulent, deceptive, or manipulative act, practice, or course of business to fall afoul of the rule, but any resulting enforcement charges likely will include section 206(4), which could lead people to believe that the adviser has engaged in much more nefarious conduct. This proposal is not the first to take such an approach, but I hope commenters nevertheless think about the collateral consequences advisers will face if their due diligence or monitoring is deemed inadequate and thus unlawful under section 206(4). Would adopting this type of rule under section 206(4) serve to confuse investors given that more serious conduct also could be charged under that section?

Another concern that gets only passing mention is the likely effect these changes would have on smaller advisers.[4] Small advisers are already stretched, and their compliance resources are limited. Adding another regulatory checklist to the compliance officer’s clipboard will only make it harder for small firms to hire high-quality compliance personnel. Costs charged by service providers who will indirectly be subject to the rule’s requirements will inevitably go up. Small advisers will have little leverage in negotiating contracts with service providers.

Some advisers may determine that they can no longer afford to engage service providers and will be forced to bring contracted services back in-house. Advisers contract out services for a variety of reasons, including to benefit from cost efficiencies and to secure for investors superior service. Forcing strapped smaller advisers to DIY functions perhaps better performed by third parties is a recipe for investor harm, not investor protection. Other small advisers may consolidate in pursuit of economies of scale. With each new regulatory burden, we make it harder for small advisers to compete. If we insist on pursuing this regulatory initiative, we should carve out smaller advisers.

Because prescriptive regulations like this one inevitably favor big firms and incumbents, small service providers will face disproportionate competitive challenges. Larger service providers—especially those that offer multiple services—will have a distinct advantage over their smaller competitors who may not be able to provide “one stop shopping.” Advisers will face less risk of second-guessing by the Commission if they pick service providers that everybody else is using. Tilting the regulatory field in favor of large providers raises barriers to entry and limits the opportunities for enterprising new firms trying to break into the business.

Although I cannot support today’s proposal, I am no less grateful for the work, unflagging professionalism, and dedication of the Commission staff, including especially in the Divisions of Investment Management and Economic and Risk Analysis and Office of General Counsel. Even when, as here, I am not enthusiastic about the substance, I enjoy the process of engaging with you. I look forward to hearing what the commenting public has to say about this proposal, if they can find the time, in between commenting on the multitude of other Commission proposals, to share their wisdom.

Reddit Post