SEC readies limit on outsourcing despite pushback on new rules

Oct. 26 vote may settle clawback, reporting issues; pushback on regulatory agenda unlikely to stop new limit on outsourcing

SEC commissioners – who can now count the SEC inspector general and Congressional Democrats among those suggesting it should dial back its ambitious regulatory agenda – will meet Wednesday to decide whether to confirm two more sets of rules and introduce a third rule.

During the Oct. 26 meeting commissioners will get the opportunity to finally resolve a clawback proposal that was five years late when it was introduced and hasn’t gotten any more timely in the seven years since.

They will also get the chance, despite complaints about the impact of the aggressive SEC regulatory agenda on fund boards and fund advisers trying to keep up, to add another new rule to an already long list by proposing a regulation setting minimum standards of oversight on fund advisers outsourcing critical services to third-party service providers.

“Service providers often play critical roles within our financial sector,” SEC Chair Gary Gensler said during a Jan. 24 speech that focused mainly on issues related to the cybersecurity rule the SEC would propose a few weeks later.

Security may have been the SEC’s initial concern, but it has been looking into regulation of many different types of service provider in the months since then, including questions about the regulation of specific functions such as swap execution facilities, clearing houses and other narrow-function services.

It put out a request for comment in June on questions about whether the information provided by index providers or other data services qualifies as investment advice and should be regulated as such.

The cybersecurity rule proposal included frameworks to help fund advisers verify an outsourcer’s security preparations, or create a set of security policies, but not to verify those policies are being followed, whether they involve security or any one of a dozen other critical outsourced functions.

Third-party services “go far beyond the cloud,” Gensler said, to include fund administration, index providers, custodian services, data analytics, trading, order management, pricing and other data services.

“Many of these entities may not be registered with the SEC,” he said.


Outsourcing is one more item on a long, long list

The SEC’s ambitious regulatory agenda and the record number of regulatory changes it has already proposed this year have stretched the resources of the agency to the point that many members of staff wonder if they will be able to fully digest and incorporate all the public comments into workable documents, according to a report published Oct. 13 by the SEC Office of the Inspector General.

A Sept. 13 letter to Gensler from Congressional Democrats, including members of the Senate Banking Committee that oversees the SEC, suggested rule changes would be more effective and more easily accepted if the SEC were to extend the comment period on new rules to allow more time for analysis and discussion.

“It is critical that, as the SEC moves through the rulemaking processes, there is adequate time to evaluate each individual rule as well as how those rules interact with existing and other proposed rules,” according to the letter, which was published Oct. 20 by Politico.

“The pace has been aggressive,” according to Cynthia Plouché, an independent director of the Northern Trust and MassMutual Funds who was recently elected chair of the Independent Directors Council (IDC).

SEC Commissioner Hester Peirce wrote in June that the typical 30-day comment period allowed for a new rule is not enough for analysis and response, especially for organizations forced to deal with a chain of several-hundred-page-long proposals rather than just one at a time.

“We are clearly supportive of good and effective regulation,” agreed Thomas Kim, president of the IDC. “The quantity and the pace of various regulatory proposals can be a concern.”


Final resolution?

New or not, the outsourcing proposal will have the advantage of being less controversial than the

incentive-pay clawback rule that will finally come up for a vote.

The clawback rule, which if adopted as proposed would require companies to develop policies for recovering executive compensation under certain conditions, was introduced in 2015, then re-opened for comment and discussion in 2021. Its appearance in a list of final-stage regulations being voted on by commissioners in an open meeting means it is likely to be approved this year, though it was intended to fulfill requirements of the Dodd-Frank Act, which was passed in 2010.

Both the other two proposals, which will be managed and implemented by the SEC’s Division of Investment Management (DIM), focus specifically on issues relevant to fund boards and fund advisers.

The most immediate impact is likely to come from the tailored-shareholder-report rule requiring that open-end fund advisers send shareholders semi-annual reports that are “concise and visually engaging” and focus on performance data of interest to retail investors as an alternative to a prospectus designed primarily for the use of professional investors or advisers.

The rule would also require that fund advisers include information about fees, costs and risk in marketing materials aimed at potential investors and make information about fees more prominent and easier to interpret in reports intended for shareholders.

Portions of the rule dovetail with the heavy emphasis on disclosure to investors that runs through many of the rules proposed by the SEC under Gensler – though this particular rule was proposed in November, 2020, as the administration of previous SEC Chair Jay Clayton neared its end.

Disclosure of fee information also dovetails with the Gensler-era regulatory agenda, especially as articulated by DIM director William Birdthistle, who raised the hackles of fund directors by suggesting problems in both the level at which fees are set and the process for setting them.


Rules up for vote, SEC open meeting 10/26
  • Listing Standards for Recovery of Erroneously Awarded Compensation
    • RIN: 3235-AK99
    • Proposed: 7/14/2015
    • Final resolution: 10/00/2022
  • Tailored Shareholder Reports for Mutual Funds and Exchange-Traded Funds; Fee Information in Investment Company Advertisements
    • RIN: 3235-AM52
    • Proposed: 11/5/2020
    • Final resolution: 10/00/2022
  • Outsourcing by Investment Advisers
    • RIN: 3235-AM95
    • Proposed: 10/00/2022
    • Final resolution: