A key component of the SEC’s proposal designed to address investor confusion about their advisory relationships is the Form CRS Relationship Summary – though the proposal’s length is a daunting start. Here’s a look at two of the more critical components for advisors.
Fees and Expenses
An area that is doubtless of particular concern is the one focusing on fees and expenses. This discussion begins on page 57 of the 471-page document, and at the outset the authors explain that they “…are not proposing a requirement that firms personalize the fee disclosure for their retail customers, or provide a comprehensive fee schedule, as some commenters had proposed.”
“Retail customers,” by the way, is generally seen as referring to IRA investors based on other references in the document.
They go on to acknowledge that a personalized fee disclosure “could be expensive and complex for firms to provide in a standardized presentation across all of their accounts and in a way that captures all fees, including embedded fees in various investments (which will vary for each investor depending on their portfolio),” and that in response to that expense, “some firms could choose to reduce the products and services that they offer as a result of the additional costs.” Rather, according to its authors, the proposal is designed to “encourage retail investors to ask financial professionals about their fees and request personalized information about the specific fees and expenses associated with their current or prospective accounts,” including a proposed question “to ask a financial professional is to ‘do the math for me.’”
Nor, though it acknowledges that it has done so in other areas (notably mutual fund fee disclosures), is the SEC proposing to require firms to include examples of how fees could affect a retail investor’s investment returns. By way of explaining its reluctance to do so here, the authors explain that, “Transactional fees, in particular, can vary widely based on a number of circumstances, and it could be potentially misleading to present a typical example showing how sample transaction fees apply to a sample account over time.” They go on to state their belief that “requiring firms to provide an example for each type of account that would show the effect of fees on a sample account could overwhelm investors due to the number and variability of assumptions that would need to incorporated, explained, and understood in order for the example to be meaningful, and would not necessarily promote comparability.”
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Indeed, even if those assumptions were standardized, the SEC says that such examples “might not be useful, or might even be potentially misleading, to the retail investor, whose circumstances may be different from the assumptions used.”
As for third-party payments, the SEC proposal acknowledges the conflicts of interest for firms and financial professionals making investment recommendations for retail investors, and so the SEC includes in its proposal requiring that firms disclose commissions and certain third-party fees related to mutual funds in this section, and certain compensation-related conflicts (e.g., conflicts related to revenue sharing) in the conflicts section of the relationship summary. As for transaction fees, the proposal contemplates mandatory language that a broker-dealer would have to include that says: “The more transactions in your account, the more fees we charge you. We therefore have an incentive to encourage you to engage in transactions.”
Similarly, investment advisers that charge an ongoing asset-based fee for advisory services would be required to address the incentives they have to put their own interests ahead of their retail investors’ interests based on the type of fee charged for investment advisory services with the following statement: “The more assets you have in the advisory account, including cash, the more you will pay us. We therefore have an incentive to increase the assets in your account in order to increase our fees.”
The list of questions the SEC poses for input regarding fees and expenses are, as one might expect, extensive – running from page 77 through 89.
About This Series
This is the second in our ongoing series of posts analyzing the Form CRS. The other installments in the series are: