A key component of the Securities and Exchange Commission’s proposal designed to address investor confusion about their advisory relationships is the Form CRS Relationship Summary – though the proposal’s length makes for a daunting start.
The document’s title (“Form CRS Relationship Summary; Amendments to Form ADV; Required Disclosures in Retail Communications and Restrictions on the use of Certain Names or Titles”) is as unwieldy as its 471-page length. However, SEC Chairman Clayton has already highlighted the importance of the Form CRS, and since, under the SEC’s proposal, it would be an essential communication tool, it’s worth delving into.
Points of Confusion
The report notes there are studies that show that retail investors are confused about the differences between broker-dealers, investment advisers and dually registered firms, including (but not limited to):
- the scope and nature of the services they provide;
- the fees and costs associated with those services;
- conflicts of interest; and
- the applicable legal standards and duties to investors.
The solution proposed by the SEC comes in two forms: the document already referenced called “Form CRS,” which is a customer or client relationship summary, and rules that “would (i) restrict the use of the terms ‘adviser and ‘advisor’ by broker-dealers and their associated financial professionals, and (ii) require broker-dealers and investment advisers to disclose in retail investor communications the firm’s registration status while also requiring their associated financial professionals to disclose their association with such firm.”
The SEC notes that these would, in turn, “complement” a separate release – the Regulation Best Interest – that the authors say is designed to “enhance existing broker-dealer conduct obligations” by establishing “a standard of conduct for broker-dealers and associated natural persons of broker-dealers to act in the best interest of a retail customer when making a recommendation of a securities transaction or investment strategy involving securities.”
Now, the SEC acknowledges that this Regulation Best Interest “would not make that standard of conduct identical to that of investment advisers, given important differences between investment advisers and broker-dealers.” Rather, they say that these requirements would “help an investor better understand these differences, and distinguish among different firms in the marketplace,” and that – in turn – should “assist the investor in making an informed choice for the services that best suit her particular needs and circumstances.”
So, what would Form CRS require?
- Investment adviser: before or at the time the firm enters into an investment advisory agreement with the retail investor.
- Broker-dealer: at the time the retail investor first engages the firm’s services.
- Dual registrants: at the earlier of entering into an investment advisory agreement with the retail investor or the retail investor engaging the firm’s services.
- As short as practicable (limited to four pages or equivalent limit if in electronic format).
- A mix of tabular and narrative information.
- Eight specific sections covering: (i) introduction; (ii) the relationships and services the firm offers to retail investors; (iii) the standard of conduct applicable to those services; (iv) the fees and costs that retail investors will pay; (v) comparisons of brokerage and investment advisory services (for standalone broker-dealers and investment advisers); (vi) conflicts of interest; (vii) where to find additional information, including whether the firm and its financial professionals currently have reportable legal or disciplinary events and who to contact about complaints; and (viii) key questions for retail investors to ask the firm’s financial professional.
And because what would a good regulation be without definitions, the proposal defines “relationship summary” as a written disclosure statement that firms must provide to retail investors, and a “retail investor” as “a prospective or existing client or customer who is a natural person (an individual), regardless of the individual’s net worth (or financial literacy), including a trust or other similar entity that represents natural persons, even if another person is a trustee or managing agent of the trust.” Oh, and this relationship summary would be in addition to, not in lieu of, current disclosure and reporting requirements for broker-dealers and investment advisers.
In terms of general direction, the SEC proposes:
- Requiring that firms use “plain language,” specifically that firms “use short sentences, active voice, and definite, concrete, everyday words,” and that they would “not be permitted to use legal jargon, highly technical business terms or multiple negatives.”
- That – whether in electronic or paper format – the relationship summary should be no more than four 8½ x 11 inch pages if converted to a PDF, using at least an 11 point font size, and margins of at least 0.75 inches on all sides.
- Shorter (say, a one-page document) was considered, but there was apparently concern that that “might not provide retail investors with enough information to compare firms and types of accounts.”
As for the relationship summary itself, the proposal calls for it to include eight separate items:
- relationships and services the firm provides to retail investors;
- standard of conduct applicable to those services;
- the fees and costs that retail investors will pay;
- comparisons of brokerage and investment advisory services (for standalone broker-dealers and investment advisers);
- conflicts of interest;
- where to find additional information, including whether the firm and its financial professionals currently have reportable legal or disciplinary events and who to contact about complaints; and
- key questions for retail investors to ask the firm’s financial professional.
In the interests of promoting consistency and clarity, firms also would be prohibited from including any information other than what the Instructions and the applicable item require or permit.
Not that it all has to be words. Based on “studies that indicate the effectiveness of graphical presentation for retail investors,” the SEC’s proposal is prescribing the use of graphical formats in specified circumstances. For example, dual registrants would be required to present all of the information required by Items 2 through 4 and Item 6 (above) in a tabular format, comparing advisory services and brokerage services side-by-side, with prescribed headings, while standalone broker-dealers and investment advisers would be required to provide general information about fee types in tabular format, in a separate comparison section. That said, all firms would be permitted to use charts, graphs, tables, and other graphics or text features to explain the information, “so long as the information is responsive to and meets the requirements in the Instructions (including the space limitations).”
For all that clarity, the SEC still has a lot of questions. The list of questions on which they are requesting comments on the relationship summary begins on page 25, and runs (with footnotes) through page 33.
The proposal then turns to each of the eight sections in turn, with not only a conceptual outline as to what each section should address, but some very specific word recommendations to boot. Presumably, the final version would similarly contain specific text requirements as well (“using proscribed wording and bold font”). And, after outlining the potential content, format and presentation for each of the sections, the proposal poses a number of questions relating to each on which the SEC would like input and/or guidance.
About This Series
This is the first in our ongoing series of posts analyzing the Form CRS. The other installments in the series are: