SEC Adopts Form CRS (Client Relationship Summary) for Advisers and Broker-Dealers

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On a June 5, 2019, the SEC adopted Form CRS (“relationship summary”), along with new and amended rules and forms, to improve retail investors’ understanding of the different investment-related services provided by registered broker-dealers, registered investment advisers and dually registered firms (each, a “firm”).

At the same meeting, the SEC also adopted Regulation Best Interest and published two interpretive releases regarding (i) the standard of conduct for investment advisers under the Advisers Act and (ii) the “solely incidental” prong of the broker-dealer exclusion in the Advisers Act Section 202(a)(11)(C). Regulation Best Interest and the two interpretive releases are covered in separate Ropes & Gray Alerts.

The Form CRS rulemaking (the “CRS Release”) is described in detail below.

Overview

The CRS Release adopted Advisers Act Rule 204-5 and Exchange Act Rule 17a-14, which will require a firm to deliver to retail investors its current Form CRS. A firm that does not have any retail investors to whom the firm would be required to deliver a Form CRS is not required to prepare or to file a Form CRS.

In a Form CRS, a firm is required to describe the nature and scope of services provided by the firm, the types of fees customers will incur, the conflicts of interest faced by the firm, and the firm’s disciplinary history.

Form CRS has been streamlined compared to the form that the SEC proposed in 2018. A firm’s Form CRS cannot exceed two pages (or the equivalent, if provided in electronic format). If a dual registrant – i.e., a dually registered firm that offers services to retail investors as both a broker-dealer and an investment adviser – decides to provide a combined Form CRS, the combined form cannot exceed four pages.1

Firms must file their initial Form CRS and post their Form CRS prominently on their websites no later than June 30, 2020.

The Appendix to this Alert describes the mechanics of filing, delivering, amending and otherwise satisfying the legal requirements with respect to a firm’s Form CRS. This includes a summary of the required contents of the streamlined Form CRS.

Who is a Retail Investor?

The CRS Release defines “retail investor” 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 revised from the definition proposed by the SEC in 2018, which included “a trust or other similar entity that represents natural persons, even if another person is a trustee or managing agent of the trust.” The 2018 definition introduced some confusion among industry observers regarding the breadth of the definition, which could be read to include a private fund and its investors. The adopted definition, by narrowing the types of representatives (of natural persons) who can be deemed retail investors, reduces without eliminating this confusion. From the revisions to the definition and from the discussion in the CRS Release, it does not appear that the SEC intended to include private funds and their investors within the adopted definition of retail investor.

The CRS Release narrows the types of representatives who can be deemed retail investors by clarifying that a “legal representative” of a natural person, as used in the definition “retail investor,” includes only “non-professional” legal representatives, such as a non-professional trustee representing a natural person’s assets (as well as analogous representatives such as executors, conservators and persons holding a power of attorney for a natural person). The CRS Release states that the term “non-professional legal representative” is intended to include persons who are acting on behalf of a natural person and “who are not regulated financial services professionals retained . . . to exercise independent professional judgment.” Thus, natural persons who participate in a wrap fee program, where the investment adviser sponsor of the program exercises its independent judgment on behalf of the program’s participants, should be deemed retail investors only with respect to the investment adviser (and affiliated firms, if any) sponsoring the wrap fee program. On the other hand, a family office that is not required to register as an investment adviser by operation of Rule 202(a)(11)(G)-1 under the Advisers Act could be a retail investor. Other fact patterns may present greater uncertainty.

Consistent with the 2018 proposal, the adopted retail investor definition captures natural persons without regard to a natural person’s assets or net worth. The CRS Release states that “all individual investors would benefit from clear and succinct disclosure regarding key aspects of available brokerage and advisory relationships.” It follows that even an ultra-high net worth natural person can be a retail investor if the person is unrepresented or the person’s legal representative is a non-professional legal representative. This underscores that a natural person’s status as a retail investor may depend on the type of representative who stands between the investor and a firm. Consequently, for an institutional manager seeking to determine whether it has a Form CRS delivery obligation to a natural person who might be deemed a retail investor client, the analysis will focus on whether a regulated financial services professional exercising independent professional judgment stands between the institutional manager and the natural person.

With respect to participants in 401(k) plans and other workplace retirement plans,2 the CRS Release clarifies that the definition of retail investor includes a natural person who is seeking to select or retain a firm for brokerage or advisory services for the person’s workplace retirement account (this includes but is not limited to IRAs and individual accounts in workplace retirement plans). However, according to the CRS Release, participants in 401(k) plans and other workplace retirement plans are not retail investors for purposes of a Form CRS delivery obligation when participants are making ordinary plan elections that do not involve seeking to select or retain a firm for brokerage or advisory services.

Observations

  1. Narrowing “Retail Investor” Definition. A firm that does not have any retail investors to whom the firm would be required to deliver a Form CRS is not required to prepare or to file a Form CRS. Therefore, we expect that many of our clients that are registered investment advisers to institutional separate accounts, private funds and registered funds will be able to interpret the revised definition of “retail investor” to avoid Form CRS entirely.

  2. Disclosure Streamlining. To its credit, the SEC recognized that the SEC website is a better place for the abundance of educational and scripted disclosure that the SEC proposed in 2018. Therefore, the new requirement in Form CRS – to include an introductory paragraph with a link to the SEC’s investor education website – also is a commendable change.

    In turn, this approach allows for a streamlined, two-page Form CRS that relies more heavily on layered disclosure and a notice-and-access electronic delivery regime. It follows that Form CRS is consistent with other SEC disclosure initiatives and appears to suit retail investors’ preferences.3

    Some caution is justified regarding the ultimate utility of Form CRS. In this vein, the CRS Release stated that “to help ensure that [Form CRS] fulfills its intended purpose, we have directed our staff to review a sample of relationship summaries that are filed with the Commission beginning after June 30, 2020 . . . and to provide the Commission with the results of this review.” The staff’s conclusions will be of interest to confirm or improve Form CRS’s utility.

  3. Guidance Relevant to Form ADV. The CRS Release provides some useful guidance to investment advisers required to make an off-cycle amendment to a Form ADV. Form ADV’s instructions require an investment adviser to amend Part 1A, 1B, 2A and 2B (as applicable) of its Form ADV “promptly” upon the occurrence of certain specified events, but the SEC has never provided guidance regarding the meaning of “promptly.” An investment adviser’s Form CRS is required to be filed (as new Part 3 of its Form ADV) by the Investment Adviser Registration Depository (“IARD”) (as it files its Form ADV Parts 1A and 2A).

    The CRS Release provides that an investment adviser is required to amend and file its Form CRS within 30 days whenever any information in the Form CRS “becomes materially inaccurate,” by filing the amendment with the SEC by IARD. Discussing the 30-day period, in the CRS Release, the SEC stated that, “[b]ased on our experience with other similar filings, we believe the proposed [30-day] approach is consistent with the current requirements for investment advisers to update the Form ADV Part 2A brochure.” This is a helpful express statement about the SEC’s expectations regarding the timing of an amendment to a now-in-force Form ADV that is required to be made “promptly.”

* * *

The Appendix to this Alert describes the mechanics of filing, delivering, amending and otherwise satisfying the legal requirements with respect to a firm’s Form CRS. This includes a summary of the required contents of the streamlined Form CRS.

  1. Dual registrants also have the flexibility to prepare separate Forms CRS, neither exceeding two pages, for its brokerage services and for its investment advisory services. Affiliated broker-dealer and investment adviser firms have the same flexibility to prepare a single combined Form CRS of up to four pages.
  2. The CRS Release clarifies that workplace retirement plans also include “any arrangement available at a workplace that provides retirement benefits or allows saving for retirement, including, for example, any 401(k) plan or other plan that meets requirements for qualification under [IRC] section 401(a), deferred compensation plans of state and local governments and tax-exempt organizations described by Code section 457, and annuity contracts and custodial accounts described by [IRC] section 403(b).”
  3. See e.g., Securities Act Rule 498 (layered disclosure); 1940 Act Rule 30e-3 (notice-and-access electronic delivery).

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