On June 28, the Securities and Exchange Commission (SEC) proposed a rule that would require registered investment advisers to adopt and implement written business continuity and transition plans. This rule proposal was generated, in part, by the SEC’s observation that advisers have addressed operational risk management in a broad variety of ways, and the SEC has noted weaknesses in some advisers’ business continuity plans with respect to consideration of widespread disruptions, alternate locations, vendor relationships, telecommunications and technology, communications plans, and review and testing.
The proposed rule is designed to ensure that investment advisers have written policies in place that are “reasonably designed” to address operational and other risks related to a significant disruption in the adviser’s business in order to minimize any potential negative impact on clients and investors. An adviser’s operations could be affected by severe market events, as well as, for example, such occurrences as a natural disaster, cyberattack or the departure of essential employees, any of which could cause a disruption or even termination of an adviser’s business. The proposed changes would also require that advisers review the adequacy and effectiveness of their plans at least annually and retain certain related records.
The proposed rule is part of the SEC’s overarching objective of protecting investors from any harm resulting from material service disruptions within the asset management industry. In the proposed rule, the SEC expressed the view that “an adviser’s fiduciary duty obligates it to take steps to protect client interests from being placed at risk as a result of the adviser’s inability to provide advisory services and, thus, it would be fraudulent and deceptive for an adviser to hold itself out as providing advisory services unless it has taken such steps.” These business continuity and transition plans would include policies and procedures related to both the continuity of the adviser’s business after a significant disruption and the transition of the business should the investment adviser be unable to continue providing services to clients. In such an instance, “an adviser and its personnel may be unable to provide services to the adviser’s clients and continue its operations while affected by the disruption, which could result in client harm.” A firm’s unexpected closure or winding down during a time of stress will necessarily bring operational risks, which the rule proposal states can impact “an adviser’s ability to safeguard client assets.”
The content of an adviser’s business continuity plan would be based on risks associated with its operations and would seek to address such issues as maintenance of critical operations and systems, and the protection, backup and recovery of data; prearranged alternate physical location (or locations) of the adviser’s offices and/or employees; communications with clients, employees, service providers and regulators; identification and assessment of third-party service providers critical to the operation of the adviser; and a plan of transition that accounts for the possible winding down of the adviser’s business or the transition of the adviser’s business to others in the event the adviser is unable to continue providing advisory services.
With respect to transition planning, the SEC outlined several elements that an adviser’s plan must address, including policies and procedures intended to safeguard, transfer and/or distribute client assets during transition; policies and procedures facilitating the prompt generation of any client-specific information necessary to transition each client account; information regarding the corporate governance structure of the adviser; the identification of any material financial resources available to the adviser; and an assessment of the applicable law and contractual obligations governing the adviser and its clients, including pooled investment vehicles, implicated by the adviser’s transition.
While the SEC prescribed certain elements to be addressed in an adviser’s business continuity and transition plan, it also recognized that each adviser’s plan will differ depending on the specific nature of each, as “business models and operations vary significantly among advisers.”
In regard to recordkeeping, the SEC proposed that advisers be required to maintain copies of all written business continuity and transition plans that either are in effect or were in effect at any time during the past five years after the compliance date. Advisers would also need to keep records documenting the annual review of the plans.
The SEC is accepting comment on the proposed rule until Sept. 6, and the SEC has specifically asked for comment on several matters, including (i) whether advisers should be obligated to report to the SEC regarding the annual review of their business continuity and transition plan, (ii) whether advisers should be required to report to the SEC incidents in which they rely on their business continuity and transition plan and (iii) whether advisers should be required to provide disclosure to their clients about their business continuity and transition plan.