United States: SEC Proposes Simplified Relationship Summary For Broker-Dealers And Investment Advisers To Use With Retail Investors

This alert is one in a series of Client Alerts on recent SEC proposals regarding regulation of broker-dealers and investment advisers.

In the third release comprising part of the package of proposed rules and forms related to broker-dealers’ and investment advisers’ standards of conduct, the Securities and Exchange Commission (the SEC or the “Commission”) proposed a new disclosure document to be used by registered broker-dealers, registered investment advisers, and dual registrants. The new client relationship summary, or “Form CRS,” would provide certain basic disclosures to retail investors at the account opening stage. Form CRS would be an additive disclosure; it is not designed to replace existing disclosures provided to clients or potential clients, or filings made with the Commission. It would be supplemented by disclosures, made on a periodic basis or at the point-of-sale, as might be required to ensure that retail investors are fully informed of material conflicts of interest and other relevant information.

Form CRS is designed to inform retail investors–that is, natural persons regardless of net worth and trusts benefitting natural persons–about a firm’s relationships and the services it offers, the standard of conduct to which it is subject, fees and costs associated with its services, conflicts of interest related to such services, and whether the firm and its financial professionals currently have reportable legal or disciplinary events. According to the SEC, there are benefits of preserving investor choice among brokerage services and advisory services, and the disclosure in Form CRS should preserve such choice by helping investors understand the key differences among investment firms and professionals.

In short, according to a recent speech by Dalia Blass, director of the SEC’s Division of Investment Management, the staff’s intent in developing proposed Form CRS was to help investors “understand what type of investment professional they are dealing with, how they differ, and why it matters.”

Proposed Form CRS

Proposed Form CRS complements the SEC’s recent proposal of a new standard of conduct for registered broker-dealers when dealing with retail investors and its recent interpretive guidance regarding the investment adviser standard of care. While proposed Regulation Best Interest would heighten the standard of conduct applicable to broker-dealers, that standard would still differ from the fiduciary standard applicable to registered investment advisers. Form CRS, according to the SEC, “would help an investor better understand these differences” in a “reasonably concise” format.

Form CRS would be limited to no more than four pages (or the electronic equivalent). In certain sections, prescribed wording would be required, and the use of certain information, such as performance data, would be prohibited. The Commission contemplates, however, that the brief disclosure will “facilitate a layered approach to disclosure” that would, among other things, require Form CRS to include references and links (in electronic format) to other disclosures including, among others, an investment adviser’s Form ADV filed with the SEC or the account opening agreement for a broker-dealer.

Form CRS itself would include only eight sections covering prescribed information in a stylized format:

  • a title and an introduction that briefly explains the type of accounts and services the firm offers;
  • information about the relationships between the firm and retail investors and the account services provided by the firm to its retail clients, including, as applicable: brokerage services, advisory services, and services provided by affiliates of the firm;
  • a prescribed description of the legal standard of conduct applicable to the firm’s relationship with retail investors;
  • a summary of specified fees and costs that retail investors will incur in connection with services rendered by the firm, and a description of the firm’s incentives to place its own interests in front of those of its retail investors;
  • a comparison of the fees, services, standards of conduct, and incentives applicable to stand-alone broker-dealers and investment advisers;
  • a summary of conflicts of interest related to financial incentives for recommending or selling proprietary products or products offered by third parties, from revenue-sharing arrangements, or from principal trading opportunities;
  • disclosure directing investors to where they can find additional information about the firm’s disciplinary events, services, fees, and conflicts of interest; and
  • a list of required questions that retail investors might want to ask their financial professionals.

The SEC noted that current disclosure documents result in varying disclosures to retail investors, but that “all retail investors would benefit from a short summary that focuses on certain key aspects of [a] firm and its services.”

For investment advisers, Form CRS would be required by new Form ADV Part 3; for broker-dealers, Form CRS would be required by proposed new rule 17a-14 under the Securities Exchange Act of 1934 (the “Exchange Act”). Investment advisers would file Form CRS on the Investment Adviser Registration Depository, and broker-dealers would file on the Commission’s Electronic Data Gathering, Analysis and Retrieval System (EDGAR). Accordingly, such filings would be subject to section 207 of the Investment Advisers Act of 1940 and section 18 of the Exchange Act, respectively.

Our Take

Proposed Form CRS is designed to help retail investors understand and compare key differences between broker-dealers and investment advisers and the types of accounts and services they provide. Through prescribing specific wording and limiting length, however, the proposed Form could limit the ability of a broker-dealer or investment adviser to adequately describe the very differences the Commission seeks to highlight, and may require investors to find this information in other “layers” of disclosure.

Retail investors have consistently asked to receive disclosure that is useful and meaningful to them. Proposed Form CRS tries to address that request by requiring all investment advisers and broker-dealers that do business with retail investors to fit information into a single format. The Form, as currently proposed, may have the unintended effect of resulting in less informative and enlightening disclosure than sought. Hopefully, commenters on the proposal will address this point and the final version of the Form will elicit disclosure that is both useful and illuminating to retail investors.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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