QuestionsQuestions (SEC MEMORANDUM CIRCULAR NO. 5, S. 2014)
The Circular prescribes the principles and standards that broker dealers must observe in their outsourcing arrangements with service providers, and it applies specifically to the outsourcing of functions by broker dealers (Section 1).
A broker dealer may outsource only its back office functions. It must not outsource material activities and any activity involving interaction/direct contact with clients for buying/selling securities or solicitation, except as permitted by law (Section 3).
“Material activities” are activities requiring a Commission license (e.g., buying/selling securities as broker/dealer or acting as salesman/associated person) and other activities of such importance that any weakness/failure significantly affects statutory compliance. It matters because outsourcing of material activities is prohibited (Section 2 and Section 3).
Clearing and settlement activities may only be outsourced to service providers authorized by the Commission to conduct such activities (Section 3).
The outsourcing broker dealer, its management and officers retain full legal liability and accountability to the Commission and the relevant self-regulatory organization, as if the outsourced activity were performed by the broker dealer itself (Section 5).
Broker dealers must perform suitable due diligence to assess the service provider’s ability and capacity, financial condition, and risk management practices (Section 4).
Broker dealers must assess the appropriateness of the foreign provider and conduct enhanced due diligence focusing on: ability to monitor performance; ability to maintain confidentiality of customer/proprietary information; ability to execute contingency plans and exit strategies; and analysis of economic/social/political conditions that might affect performance (Section 4).
Broker dealers must monitor performance by establishing standards and measures to identify non-compliance/unsatisfactory performance, including annual reviews of processes, performance, and compliance with the outsourcing contract (Section 4).
The broker dealer must terminate the outsourcing contract in case of such failure and report the failure and remedial measures to the Commission (Section 4).
It must be legally binding and include (among others) limitations/conditions on subcontracting; confidentiality; responsibilities and warranties; IT security/data protection; IP ownership; service provider liability; obligation to provide records/info/assistance; dispute resolution and choice of law; business continuity; and termination provisions including exit strategies (Section 6).
Because outsourcing must not compromise proprietary/customer information and system integrity. Service providers must have procedures to protect proprietary and customer-related information/software; prevent unauthorized access or tampering/destruction of data; and maintain up-to-date emergency/disaster recovery plans (Section 7).
Broker dealers must ensure service providers protect confidential customer and proprietary information. If confidential information is transferred, the broker dealer must notify clients or secure consent when required by law/regulation, and notify the Commission, including ensuring confidentiality safeguards (Section 8).
The Commission, broker dealer, and auditors can access service provider records related to outsourced activities. For foreign service providers, originals or certified true copies must be maintained within the Philippine jurisdiction and accessible to the Commission (with allowance for microfilm/electronic form subject to SRC requirements). Additionally, if service providers prepare/maintain records, they must file the written undertaking under the SRC Books and Records rules (Section 9).
Broker dealers must promptly notify the Commission of any outsourcing arrangement (including changes/termination) within 10 days from execution/amendment/termination, submit a signed copy of the contract, a compliance certification, and an amended Written Supervisory Procedure incorporating safeguards. They must also notify within 10 days of any third-party contractual arrangements not falling under outsourcing but supplementing employee/organizational structure (Section 10).
Violations by the broker dealer or other registered person are penalized under Section 54 of the SRC. The broker dealer has the duty to terminate the outsourcing contract for non-compliance, and the Commission may also take action against an unregistered person acting as a service provider who violates laws/regulations (Section 11).
Within 6 months from effectivity, broker dealers must submit a list of all existing outsourcing contracts with details to show compliance. For contracts not compliant, broker dealers may either preterminate them or renegotiate/amend them to comply (Section 12).