THIRD IN A SERIES
On June 5, 2019, the Securities and Exchange Commission adopted a rulemaking package that applies to investment advisers and broker-dealers. The package includes two final rules and two interpretations – Regulation Best Interest, Investment Adviser Standard of Conduct Interpretation, Form CRS – Relationship Summary, and Solely Incidental Broker-Dealer Exclusion Interpretation. As described in our April 2018, three-article series, the SEC first proposed a new set of disclosure requirements last year to address confusion among retail investors about brokerage and investment advisory services and the different standards that apply to providers of those services. The final regulatory package made various modifications to those disclosure requirements based on feedback from commenters and investors.
The Regulation Best Interest and Form CRS requirements will be effective 60 days after they are published in the Federal Register, with a transition period for compliance that ends on June 30, 2020. The SEC’s interpretations are immediately effective upon publication in the Federal Register.
This is the third in a series of articles describing the SEC’s rulemaking package. This article provides an overview of the Form CRS – Relationship Summary portion of the package.
Form CRS – Relationship Summary
The SEC created Form CRS for the purpose of informing retail investors about the differences between brokerage and investment advisory firms and their services. According to the SEC, this information will enable investors to make better decisions about engaging and maintaining a relationship with a firm or investment professional. The SEC views Form CRS as a complement to Regulation Best Interest and the Interpretations that were also adopted on June 5.
The Form CRS disclosure requirement applies to both broker-dealers (and their registered representatives) and investment advisers who are registered with the SEC (and their investment adviser representatives). Form CRS is described in the guidance as a “brief relationship summary” that investment advisers and broker-dealers must provide to their retail investors. The Form is designed to provide information regarding: (1) the types of client and customer relationships and services the firm offers, (2) the fees, costs, conflicts of interest, and required standard of conduct associated with those relationships and services, (3) whether the firm and its investment professionals currently have reportable legal or disciplinary history, and (4) how to obtain additional information about the firm.
For purposes of Form CRS, a “retail investor” is defined as “a natural person, or the legal representative of such natural person, who seeks to receive or receives services primarily for personal, family, or household purposes.” This definition is consistent with the definition of a “retail customer” under Regulation Best Interest, but differs in that the relationship summary must be provided regardless of whether there is a recommendation, and covers prospective and existing clients of investment advisers and broker-dealers.
In response to commenters’ requests, the SEC clarified that Form CRS applies to retail investors who seek services for their retirement and non-retirement accounts. However, employer-sponsored retirement plan participants “should not be viewed as ‘seeking or receiving services’ for the purposes of the Form CRS definition of retail investor when they are merely electing among plan features offered by firms and financial professionals retained and supervised by a plan representative…include[ing] a participant’s decision to invest his or her account balance through an in-plan self-directed brokerage account option or to select an in-plan managed account service option, where a plan representative retains and supervises the broker-dealer or investment advisory firm providing such services to the plan.” The final definition of retail investor also does not include most employer-sponsored retirement plans or their plan representatives (such as plan fiduciaries), because “such plans and their representatives are not seeking services primarily for personal, family, or household purposes.”
Presentation and Format
The proposed rule included requirements for the Form’s length, formatting, and content. Under the final rule, the Form may not exceed two pages for investment advisers or broker-dealers. The Form for dually-registered firms may not exceed four pages, if the relationship summary includes the firm’s brokerage and advisory services. Similarly, affiliates offering brokerage or advisory services to retail investors may also provide a single relationship summary.
The Form must be prepared in a question-and-answer format, with standardized questions serving as the headings in a prescribed order. Suggested follow-up questions for retail investors to ask their investment professionals also must be included. Investment advisers and broker-dealers that provide only automated or online services (rather than an individual who can discuss the questions) must answer the questions on their website and provide within the Form a means of accessing the questions and answers.
The SEC also encourages the use of charts, graphs, and other graphics or text features to explain or compare different aspects of a firm’s offerings. The guidance explains that additional narrative language may be required when graphics or text features are used, if the feature is not self-explanatory and responsive to the disclosure topic. In addition, the SEC supports the use of online tools that populate comparative disclosure information based on investor selections when the Form is provided electronically. The instructions to Form CRS include information about the use of electronic and graphical formats to assist firms in the use of electronic media, communications, and tools in the relationship summary.
Form CRS is “principally designed to provide succinct information about (1) relationships and services the firm offers to retail investors, (2) fees and costs that retail investors will pay, conflicts of interest, and the applicable standard of conduct, and (3) disciplinary history.” Thus, the SEC retained some of the content requirements specified in the proposed rule. In some cases, these requirements prescribe language that must be used within the disclosure.
For example, the final rule requires that Form CRS include a standardized introductory paragraph, as well as a link to the SEC’s investor education website page that provides educational materials about broker-dealers and investment advisers (i.e., Investor.gov/CRS). The introduction must also explain that brokerage and advisory services and fees differ and that it is important for investors to understand the differences.
Relationships and Services
Firms must state whether they offer brokerage services, investment advisory services, or both. In addition, they must summarize the principal services, accounts, or investments made available to investors, as well as any material limitations on those services. Specifically, all firms are required to address the following topics in the description of their services: (1) monitoring, (2) investment authority, (3) limited investment offerings, and (4) account minimums and other requirements.
The SEC also requires that firms include three suggested questions for retail investors to ask their investment professional. The content of the specific questions depends on whether the firm is a dually-registered investment adviser and broker-dealer. All firms are also required to include in the summary three additional questions to help investors understand a financial professional’s investment methodology, experience, and qualifications.
The SEC modified the proposed rule’s required discussion of fees, costs, conflicts of interest, and standard of conduct. While Form CRS will still include a summary of fees and costs, a description of ways the firm makes money, certain conflicts of interest, and standards of conduct, the SEC decided to integrate these sections into one item on the Form. Nevertheless, this information will appear as separate, consecutive sections so that each topic is distinct for investors. To distinguish firm-level from investment professional-level conflicts, firms are also now required to disclose in a separate section how its investment professionals are compensated and the conflicts of interest those payments create. As in other sections of the Form, the SEC requires that firms use certain headings, text, and questions in connection with these disclosures to encourage retail investors to discuss and understand the information.
Firms must indicate under a separate heading whether they, or any of their investment professionals, have reportable disciplinary history. This section also must explain where an investor can conduct further research on these events.
An additional information section at the end of the relationship summary will explain where the retail investor can find more information about the firm’s brokerage or investment advisory services, as well as certain contact information. The additional information will also include information about how to report complaints to the firm and the SEC.
Filing, Delivery, Updating
Form CRS must be filed with the SEC and delivered to retail investors. Firms that are registered with the SEC prior to June 30, 2020, must file Form CRS with the SEC beginning on May 1, 2020, and by no later than June 30, 2020. On and after June 30, 2020, investment advisers and broker-dealers with a pending SEC registration must file their Form CRS with their registration application. The relationship summary will be accessible through the SEC’s public website, as well as the firm’s website.
Consistent with the proposed rule, investment advisers must initially deliver the Form to their new and prospective retail investors before, or at the time that, the investment adviser and client enter into an investment advisory agreement. The final rule modified the delivery requirement for broker-dealers, however, so that they must deliver Form CRS to new and prospective retail investors before or at the earliest of: (1) a recommendation of an account type, a securities transaction, or an investment strategy involving securities, (2) placing an order for the retail investor, or (3) the opening of a brokerage account for the retail investor. Dually-registered firms (and affiliated broker-dealers and investment advisers that jointly offer their services) must deliver the Form at the earlier of these delivery events.
With respect to existing clients, investment advisers and broker-dealers are required to provide Form CRS within 30 days after the date by which the firm is required to file the Form with the SEC. After such initial delivery, the firm must deliver the most recent version of the Form to an existing retail investor if the investment adviser or broker-dealer: (1) opens a new account that is different from the client’s existing account, (2) recommends that the client roll over assets from a retirement account into a new or existing account or investment, or (3) recommends or provides a new brokerage or investment advisory service or investment that does not necessarily involve the opening of a new account and would not be held in an existing account.
Investment advisers and broker-dealers may use electronic delivery (consistent with existing guidance) to provide Form CRS (and any updates) to their retail investors. However, firms must provide a free paper copy of the relationship summary upon request.
As under the proposed rule, broker-dealers and investment advisers are required to update their Form CRS within 30 days whenever the relationship summary becomes materially inaccurate. Firms are also still required to provide a current relationship summary to retail investors within 30 days upon request. Firms are allowed to communicate Form updates to existing clients within 60 days after the updates are required to be made.
Updates must be highlighted for clients. For example, firms may mark the revised text or include a summary of the material changes as an exhibit to the updated relationship summary.
In some cases, firms can use their own wording or methods to satisfy the disclosure requirements. In other cases, however, they will be required to provide information in a specific manner using prescribed language, questions, and/or headings. To ensure compliance with the requirements, investment advisers and broker-dealers should thoroughly review the final rule in conjunction with the Form ADV Instructions and Form CRS Instructions that the SEC also issued.