Third in a Series

On April 18, the Securities and Exchange Commission issued a proposal package that includes two new rules and one interpretative release. The package consists of three components – Regulation Best Interest, Investment Adviser Standard of Conduct Interpretation, and Form CRS – Relationship Summary. According to the SEC, the proposal is intended to balance investor protections and regulatory requirements with investor access and choice regarding investment services. Each component of the proposal package is available for public comment for 90 days after publication in the Federal Register.

In our first article, Spencer Fane LLP described the Regulation Best Interest proposed by the SEC. Our second article explained the SEC’s interpretative release regarding investment advisers’ conduct standard. This article is the third in our series and describes the Form CRS – Relationship Summary portion of the SEC’s fiduciary proposal.

Form CRS – Relationship Summary

Through a number of initiatives, the SEC found that investors are confused by the differences in type and scope of services, fees, conflicts of interest, and legal obligations and duties associated with the variety of investment services and firms – broker-dealers, investment advisers, or dually-registered entities – available to them. Thus, under the SEC’s proposed rule, investment advisers and broker-dealers would be required to provide clients and prospective clients with a standardized, client relationship summary disclosure (“Form CRS”). In addition, broker-dealers and their registered representatives would be restricted from using the term “adviser” or “advisor” in specific circumstances. The proposed rule also requires that broker-dealers, investment advisers, and their respective registered representatives disclose in client communications the firm’s registration status with the SEC and the representatives’ relationship with the firm. The SEC views these proposed requirements as a complement to the enhanced broker-dealer disclosure obligations under the Regulation Best Interest rule, as well as current investment adviser disclosure obligations through Form ADV, Part 2A.

In the proposal, the SEC describes Form CRS as an additional disclosure that is no more than four pages with a “mix of tabular and narrative information.” The Form would contain the following sections: (1) introduction, (2) description of relationships and services offered, (3) statement of the applicable conduct standard associated with the services, (4) fees and costs, (5) a comparison of brokerage and investment advisory services for firms that are not dually-registered, (6) conflicts of interest, (7) where additional information is available, including whether the firm or its registered representatives have reportable legal or disciplinary events and a contact for complaints, and (8) key questions clients should ask the firm’s representative (or online question and answer in the case of robo-advisers and online-only broker-dealers).

The proposal states that “Form CRS would be required by Form ADV Part 3 and Rule 204-5 of the Investment Advisers Act of 1940 (the “Advisers Act”) for investment advisers, and by Form CRS and Rule 17a-14 of the Securities Exchange Act of 1934 (the “Exchange Act”) for broker-dealers. Firms would be required to electronically file Form CRS and any updates with the SEC for monitoring purposes and so that clients will have access to any firm’s Form.

Regarding delivery of the Form to clients, investment advisers would be required to initially deliver Form CRS to clients before or at the time that the investment adviser and client enter into an investment advisory agreement. A broker-dealer would be required to initially deliver the Form to clients before or at the time the client engages the broker-dealer for services. Firms that are dually-registered would be required to deliver the Form at the earlier of these two events. In any event, the SEC expects firms to deliver Form CRS sufficiently in advance of a client’s final decision to engage the firm so that the client can make an informed decision regarding the engagement. The proposal also requires firms to deliver Form CRS to clients within 30 days, if requested. With respect to existing clients, firms would be required to provide the Form before or at the time (1) a new account is opened that is different from the client’s existing account, or (2) changes are made to a client’s existing account that materially change the nature and scope of the relationship. Similar to current disclosure requirements, the SEC also proposes that firms update Form CRS within 30 days of a material change to the information in the Form.

To further the SEC’s objectives of reducing investor confusion, increasing investor knowledge, and facilitating service comparisons, the SEC explains in the proposal that firms will have limited discretion in the scope and information provided through Form CRS. However, the SEC supports firms using “innovative technology” to create the Form and is requesting comments regarding the format and other features of Form CRS in electronic form.

To help firms understand the SEC’s vision regarding the Form, it published three sample Forms CRS and Instructions with the proposal – one for an investment adviser, one for a broker-dealer, and one for a dually-registered investment adviser and broker-dealer. The SEC believes that “standardizing the [Form CRS] among firms by specifying headings, sequence, and content of the topics; prescribing language for firms to use as applicable; and limiting the length of the [Form] will provide comparative information in a user-friendly manner that helps investors with informed decision-making.” Nevertheless, the SEC is requesting comments on a broad spectrum of issues in connection with the proposal, including filing, delivery, updating, and each of the eight sections of the Form, as described above.

Because Form CRS will be an additional disclosure requirement for investment advisers and broker-dealers, we strongly encourage firms to review the proposal, including the requirements of each section of the Form, to determine the potential impact on business resources and strategies.

As described in the proposal, the SEC believes that “…certain names or titles used by broker-dealers, including ‘financial advisor,’ contributes to investor confusion…” Thus, the SEC proposes that broker-dealers and their registered representatives be prohibited from using as part of their name or title the word “adviser” or “advisor” when communicating with clients or potential clients. The one exception to this restriction is if: (1) the broker-dealer is dually-registered as an investment adviser, (2) the registered representative is a supervised person of the investment adviser, and (3) the representative is providing investment advice on behalf of the investment adviser.

In addition to this limitation, the SEC also proposes that investment advisers, broker-dealers, and their registered representatives “prominently disclose” the firm’s regulatory status and an individual’s association in client communications. In the proposal, the SEC provides specific examples regarding the expected disclosure for each potential regulatory status and association and how it could appear in client communications. The examples include the following: “[Name of Firm]”, an SEC-registered investment adviser,” and “[Name of professional], a [title] of [Name of Firm], an associated person of an SEC-registered broker-dealer.” The SEC believes that these types of disclosures are critical and should not be inconspicuous or placed in fine print. Instead, the disclosures should be “clearly intended to draw attention” and “be presented in the body of the communication…not in a footnote.” For radio or television (or presumably website), the SEC proposes that the disclosures be presented through a voice overlay or on-screen text.

The SEC views these additional limitations and requirements regarding terminology and status as complementing its Form CRS proposal. Similar to the SEC’s Regulation Best Interest, we expect a significant number of comments in connection with the SEC’s Form CRS proposal before a final rule is issued. Whether the final rule will result in reducing investor confusion and enhancing informed decision-making, or simply result in “more disclosure,” is yet to be determined.