Due Diligence for Advisers & Sub-Advisers

Due Diligence for Advisers & Sub-Advisers

In an April 2003 speech by Lori Richards, the then-director of the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations mentioned one area where she believed some less-than-meticulous care has been given: the supervision of service providers and in particular, sub-advisers.

“I doubt anyone questions the need for an adviser, before contracting with a sub-adviser, to conduct an initial due diligence review into the qualifications and suitability of the sub-adviser. What is important in reviewing a potential sub-adviser though, is not just its performance “track record,” but also the compliance controls that the sub-adviser has in place in all areas of its business that will affect clients of the primary adviser. And, after the contract is signed, the adviser needs to perform due diligence on a continuing basis. On a continuing basis, the adviser must concern itself with whether the sub-adviser is, in fact, providing the level of fiduciary care that the adviser itself provides to its clients. One practice that may be effective is for the adviser to conduct compliance audits of the sub-adviser, or for the sub-adviser to provide the adviser with copies of its internal or external compliance audit reports.”

In the time since the speech, the advice about sub-adviser due diligence has only grown in importance.

What makes a registered investment adviser (“RIA”) attractive as a potential sub-adviser? At the top level, this includes key areas such as what differentiates a firm from others; what is the culture – student or master; is there a comprehensive business plan; is there an understanding of the behavior of performance; and how strong is the infrastructure: investment personnel, operations client service, and, what we will focus on in this paper, compliance. Each of these items require a separate due diligence review. If you are an RIA hoping to be hired as a sub-adviser, you need to be prepared to respond to detailed questions and provide evidence that you have memorialized your internal testing. If you are an RIA who is hiring sub-advisers, you need to have in place disciplined policies and procedures around how you will conduct your pre-hire and ongoing due diligence program.


Subscribe to the CSS Blog

CSS frequently publishes blog posts which are written by our team from their observations in the field, at conferences and through experiences with compliance professionals. These posts are designed to further knowledge and share industry best practices. Topics run the gamut, including Form ADV, cybersecurity, MiFID II, position limit monitoring, technology challenges and more. Complete and submit the brief form below to receive notifications when we publish new content.