Morgan Lewis

To help retail investors better understand the services, fees, costs, conflicts of interest, and required standards of conduct that apply to relationships with broker-dealers (Broker-Dealers), federally registered investment advisers (Investment Advisers), and dual registrants (Dual Registrants) (collectively, firms), the US Securities and Exchange Commission (SEC) is requiring firms to deliver a Form CRS customer or client relationship summary (Form CRS) at certain points in the customer or client relationship. This LawFlash provides our initial thoughts on Form CRS and how to start navigating its operational challenges.

WHAT FIRMS ARE SUBJECT TO FORM CRS REQUIREMENTS?

The Form CRS requirements are broad and apply to (1) any Broker-Dealer that offers services to a “retail investor;” (2) any Investment Adviser that enters into advisory contracts with “retail investors;” and (3) Dual Registrants offering services to, or entering into advisory contracts with, “retail investors.”

For purposes of Form CRS, “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.”

Observations: The Form CRS definition of “retail investor” is aligned with the definition under Regulation Best Interest (Reg. BI).[1] However, Reg. BI’s “best interest” obligations are triggered when a Broker-Dealer provides a recommendation to a retail investor, while Form CRS’s requirements are triggered when a retail investor seeks or receives services, which is not clearly laid out in the SEC’s guidance. This is significant because Form CRS encompasses brokerage and advisory services beyond simply recommendations and advice. The obligation to send Form CRS can occur well before a firm makes a recommendation.

What is a personal, family, or household purpose? The SEC clarified in the release adopting Form CRS that “personal, family or household purposes” include “retirement, education and other personal, family or household saving and investing objectives,” but do not include commercial or business purposes.[2]

Observations: A retail investor’s purposes for seeking services may not always be clear. Therefore, firms may want to consider an approach under which they assume that a retail investor is generally seeking services that are in at least some respect for personal, family, or household purposes, and then determine if certain types of relationships with retail investors are clearly excluded from Form CRS’s delivery requirements, recognizing that a retail investor’s purpose for seeking services could change over the course of his or her relationship with a firm.

Is there an exception for high net worth individuals? No. As with Reg. BI, and unlike under the suitability rules of Financial Industry Regulatory Authority (FINRA), which contain a high net worth exception for certain natural persons with $50 million in assets,[3] there is no exception from the Form CRS delivery requirement for retail investors based on high net worth or other factors indicating investor sophistication.

Do the Form CRS delivery requirements apply to employer-sponsored retirement plans? Plan Fiduciaries, No. Plan Participants, Yes. According to the SEC, Form CRS should be delivered to plan participants seeking services for retirement accounts, such as advice about whether to take a distribution, or how to invest distributed assets, but not when plan participants are making “ordinary plan elections that do not involve selecting or retaining a firm to provide brokerage or advisory services.”[4] The SEC clarified that Form CRS does not need to be delivered to workplace retirement plan service providers, such as plan sponsors, trustees, and fiduciaries.

Who is a “legal representative”? As with Reg. BI, the SEC clarified that a “legal representative of a natural person” includes only “non-professional legal representatives,” such as non-professional trustees, executors, conservators, and persons with powers of attorney. This excludes financial services firms and corporate fiduciaries.[5] As the SEC explained, the term “non-professional legal representatives” is intended “to capture persons who are acting on behalf of natural persons and are not regulated financial services professionals retained by natural persons to exercise independent professional judgment.”[6]

Observations: Firms may want to consider whether to develop systems and processes to identify non-professional legal representatives and how best to deliver Form CRS to such persons (e.g., some firms’ onboarding portals initially ask an investor to identify themselves as investors or institutions with appropriate explanation of these terms).

Are any firms excluded from the Form CRS requirements? Yes, clearing and limited purpose underwriting firms. While the Form CRS requirements broadly apply to firms that offer services to retail investors, the SEC specifically stated that the following services by themselves would generally not trigger Form CRS requirements:[7]

  • Broker-Dealers serving solely as principal underwriter to a mutual fund, variable annuity, or variable life insurance contract issuer
  • Clearing and carrying Broker-Dealers that are solely providing services to third party or affiliated introducing Broker-Dealers

The SEC made clear, however, that “[t]o the extent such broker-dealers interact with a retail customer in a different capacity . . . , Form CRS’s obligations would apply in those instances.”[8] In this regard, we note that Form CRS applies to all broker-dealers registered with the SEC under Section 15 of Exchange Act, which would capture Capital Acquisition Brokers (a category of limited purpose broker under FINRA rules) and, arguably, broker-dealers that are notice-registered with the SEC under Section 15(b)(11) of the Exchange Act to transact in security futures products.

Observations: Firms will want to consider whether other services that are not offered directly to retail investors (e.g., investment advisory models and management services provided to another Investment Adviser that uses the models in its own clients’ advisory accounts) would require compliance with Form CRS’s requirements, or whether further clarification on this point from the SEC would be helpful.

DELIVERY, FILING, UPDATING, AND RECORDKEEPING REQUIREMENTS

The Form CRS delivery, filing, updating, and recordkeeping requirements are complex and will require that firms assess their current operations, systems, policies, and procedures to determine whether they can leverage existing structures or whether modifications or new structures are needed.

A. Delivery Requirements

What are the delivery requirements for new and prospective customers and clients?The initial delivery requirements depend on whether the firm is a Broker-Dealer, Investment Adviser, or Dual Registrant.

Required Timing Initial Form CRS Delivery Requirements

Broker-Dealers Investment Advisers Dual Registrants

Earliest of:

A recommendation provided to a “retail investor” of a—Securities transaction, Account type, or Investment strategy involving securities, Placing an order for the retail investor, or Opening a brokerage account for the retail investor

 

Before or at the time of entering into an investment advisory contract with a “retail investor” (i.e., the required timing of Form ADV Part 2 delivery) Before or at the time of the earliest of any of the events in the preceding columns


Observations: Firms will want to consider how best to streamline and automate Form CRS delivery to avoid delivery failures and errors. For example, the initial delivery requirements for Investment Advisers may generally be satisfied by integrating Form CRS into account opening documents and agreements and onboarding process. Note, however, that if Form CRS is delivered in paper format as part of a package of documents, it must be the first document in the package, which could pose challenges.[9]

Whether a Broker-Dealer can satisfy the delivery requirements by including Form CRS in account opening documents will depend on whether the retail investor receives account opening documents before the Broker-Dealer provides a recommendation, places an order, or even discusses the types of the services the Broker-Dealer offers to retail investors. Broker-Dealers that make recommendations and place orders before accounts are formally opened should consider how to deliver Form CRS to retail investors before or at the time of such activities. The SEC specifically declined to mandate a delivery requirement based on first contact or inquiry because there may be instances of first contact where the retail investor is not seeking investment services, but instead is seeking services “such as business interactions for other purposes or social interactions.”[10] Mandating delivery at first contact could create compliance uncertainty.

After initial delivery, at what other times must firms deliver Form CRS?A firm must deliver Form CRS to existing customers or clients before or at the time the firm

  • ·opens a new account that is different from the retail investor’s existing accounts;
  • recommends that the retail investor roll over assets from a retirement account into a new or existing account or investment; or
  • 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 (e.g., a first time investment in a direct-sold mutual fund or variable annuity or adding margin or options trading authorization to an existing account).

The SEC did not explain when a new account would be viewed as “different from the retail investor’s existing accounts,” including whether firms should look to differences in account type (e.g., cash versus margin), program type, account owners, account investment objectives or similar aspects, and did not explain how the requirement applies to master and sub-accounts.

Observations: Many firms will have to implement operational changes to address the ongoing delivery requirements. This will especially impact firms that do not currently deliver new documents or agreements in connection with these events. Firms will want to evaluate their processes for opening accounts, rollovers, and direct investments, and whether systems can be developed to automate Form CRS delivery and recordkeeping to avoid errors.

Firms may also want to consider their current policies and procedures for retirement account rollovers. If a firm does not permit rollover recommendations and limits communications to investment education, a new Form CRS may not need to be delivered in connection with a retirement account rollover. Nonetheless, firms should consider whether Form CRS may be a helpful supplement to their current investment education materials for rollovers.

What delivery requirements apply to existing customers and clients on the Form CRS compliance date? Firms must deliver Form CRS to existing customers who are retail investors within 30 days after the date the firm first files its updated Form CRS with the SEC. Currently, the date firms must first file Form CRS with the SEC is between May 1, 2020, and June 30, 2020.

What methods of delivery are permitted? Form CRS can be delivered in paper or electronic format. If a firm delivers Form CRS electronically, it must follow the SEC’s guidance on electronic delivery,[11] which requires the following:

  1. Notice to the retail investor that Form CRS is available electronically
  2. Access to Form CRS comparable to what would have been provided in paper form that is not so burdensome as to prevent investors from effectively accessing it
  3. Evidence to show delivery (or consent to electronic delivery after receiving certain disclosures)

Firms may also deliver Form CRS in a manner that is consistent with how the retail investor requested guidance about the firm or financial professional (e.g., if the customer requested information by email, the firm can deliver Form CRS by email). If Form CRS is delivered electronically, it must be presented “prominently” as a direct link or in the body of an email or message, and must be “easily accessible” for retail investors.

Form CRS must also be posted prominently on the firm’s public website in a location and format that is easily accessible.

B. Filing Requirements

Investment Advisers must file Form ADV, Part 3 (Form CRS) electronically with the Investment Adviser Registration Depository (IARD) and Broker-Dealers must file Form CRS electronically through the FINRA Central Registration Depository (Web CRD®). Dual registrants must file with both IARD and Web CRD. Filings must be text searchable with machine readable headings. Firms must begin filing Form CRS between May 1, 2020, and June 30, 2020.

Observations: Form CRS is a filing subject to potential liability for false or misleading statements of material fact under Section 207 of the Advisers Act and Section 15(b)(4) of the Exchange Act.

C. Updating Requirements

A firm must update its Form CRS and file it with the SEC within 30 days of any information becoming “materially inaccurate” and must notify existing retail investor clients and customers within 60 days after the updates are required to be made (i.e., within 90 days after any information becomes materially inaccurate). The amended Form CRS should include an attached exhibit highlighting the most recent changes, such as a summary of material changes (i.e., the approach in Item 2 of Form ADV Part 2A) or marked revised text.

Observations: Firms should consider how they will determine when information would be viewed as “materially inaccurate” (a complicated process), requiring an update. Firms should also keep the update requirement in mind when drafting their initial Form CRS and consider maintaining a degree of generality (consistent with full and fair disclosure requirements) to minimize the need for frequent updates. Where information contained in Form CRS is also contained in other documentation, firms will need to ensure that changes are accurately and timely reflected on all such documents.

D. Recordkeeping Requirements

Firms must keep copies of Form CRS and records of each date that Form CRS is provided (in the case of a Broker-Dealer) or given (in the case of an Investment Adviser) to a retail investor, including dates prior to the date the retail investor opens an account or becomes a client.

Observations: Maintaining records of delivery dates prior to account opening or becoming a client will require operational changes for many firms. Note that while the rules speak to delivery of Form CRS, the recordkeeping provisions speak to when Form CRS was provided or given to the retail investor. While these nuances may be innocuous, it is unclear whether examiners would ascribe any meaning to these differences. Firms may wish to consider adding a client acknowledgement of receipt of Form CRS to customer agreements (as is often done with Form ADV Part 2A).

FORMAT AND STYLE REQUIREMENTS

According to the SEC, Form CRS is “designed to be a short and accessible disclosure for retail investors that helps them to compare information about firms’ brokerage and/or investment advisory offerings and promotes effective communication between firms and their retail investors.”[12] The SEC intends that “through the use of layered disclosure, [Form CRS] will facilitate investors’ access to additional, more detailed, information.”[13]

Certain elements of Form CRS are prescribed, such as page limits, ordering of topics, headings, and certain disclosures and “conversation starters,” but the SEC has left each firm with some flexibility to develop and customize its Form CRS to better reflect the firm and its business, as well as to be reader friendly and accessible to retail investors. As firms prepare Form CRS (consistent with the format and style requirements discussed below) they will want to consider how best to leverage this flexibility. Firms also should consider how Form CRS might interact with, and complement, their existing disclosures and those developed in connection with Regulation Best Interest (as applicable).

A. Length

In paper format:

  • Broker-Dealers’ and Investment Advisers’ Form CRS may not exceed two pages
  • A Dual-Registrant is limited to four pages if brokerage and investment advisory services are covered in one Form CRS, or two pages each if covered in separate Forms CRS
  • Firms with affiliates can include multiple affiliates in one Form CRS, or prepare separate Forms CRS for each affiliate

Firms must use “reasonable” paper size, font size, and margins. The SEC noted that it believes 8½” x 11” paper size, at least 11-point font size, and a minimum of 0.75” margins could be considered reasonable, but that other parameters could also be considered reasonable.[14] The Form CRS instructions also require firms to include white space and other design elements and graphics to make Form CRS easier to read.

In electronic format, Form CRS may not exceed the equivalent of two or four pages as applicable.

Observations: Mark Twain said, “I didn’t have time to write a short letter, so I wrote a long one instead.” Crafting a reader friendly Form CRS that includes all of the required content, prescribed language, white space and other design elements, and fits within the two- or four-page limits will be no easy task. Firms will likely need to devote significant time and resources and, where feasible, consider whether to establish a multidisciplinary working group (with personnel from business, legal, compliance, marketing, communications, investor relations, technology, web design, and others as applicable) for initial drafting and later updates.

B. Plain English and Fair Disclosure

Form CRS must be written in “plain English” and should be concise and direct, taking into account retail investors’ financial experience. In particular, firms are encouraged to

  1. use short sentences and paragraphs;
  2. use definite, concrete, everyday words;
  3. use active voice;
  4. avoid legal jargon or highly technical business terms, unless clearly explained;
  5. avoid multiple negatives; and
  6. use “you,” “us,” “our firm,” etc., as if speaking to the retail investor.

The SEC has developed a “Plain English Handbook,” which it encourages firms to consider reviewing in drafting Form CRS.

Information and disclosures in Form CRS must also be consistent with full and fair disclosure and specifically must

  1. be true and not omit any material facts so that the disclosures are not misleading;
  2. be factual and provide balanced descriptions; and
  3. not include unsubstantiated claims, vague and imprecise “boilerplate” explanations, or disproportionate emphasis on investments or activities that are not offered to retail investors.

    Observations: Form CRS (including any linked information) is generally subject to the antifraud rules under both the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940.[15] Firms should be mindful in crafting Form CRS to avoid unintentionally tripping over these rules.

    We also urge firms to consider reviewing existing disclosures and disclosures developed in connection with Reg. BI to ensure consistency across all client communications, as well as to determine where linking or cross-referencing other disclosures in Form CRS may be appropriate to ensure full and fair disclosure.

    Additionally, firms may want to consider developing processes or work streams to ensure that disclosures remain consistent as updates are made over time.

    C. Graphical and Digital Formats

With the goal of making Form CRS more visibly appealing and accessible to retail investors, and to enhance understanding of the information in Form CRS, the Form CRS instructions encourage firms to use graphical and digital formats, including

  • charts;
  • graphs;
  • ·other graphics;
  • text features;
  • text colors;
  • graphical cues, such as dual-column charts to compare elements;
  • ·online tools that populate information in comparison boxes based on investor selections,
  • access to video or audio messages or other information (by hyperlink, web address, Quick Response Code or other method);
  • mouse-over windows;
  • pop-up boxes;
  • chat functionality;
  • fee calculators; and
  • ·other forms of electronic media, communications, or tools.

Form CRS encourages the use of links or other means of accessing other online information referenced in the Form CRS.

Observations: Although the SEC stated that it is encouraging rather than requiring firms to use these elements, encouraged practices can often become de facto practices over time or during the course of regulatory examinations. Firms may want to consider how best to use these elements to enhance Form CRS and its usability for retail investors.

When incorporating these elements, firms must consider the page length and other content limitations. In some cases, firms may decide to include these features in Form CRS itself, but in other cases these features may be better suited as supplemental materials that support the Form CRS disclosures, but are not included in the two- to four-page limits. In deciding what should be included in Form CRS, firms should heed the guidance by the SEC that while layered disclosure is anticipated, supplemental materials incorporated by reference will not, by themselves, satisfy disclosure requirements.

Firms must also be attentive to the volume of supplemental materials in order to avoid overwhelming investors with disclosures or creating disclosures that will need to be updated and monitored for consistency over time. Thus, coordination between a firm’s legal, communications, and compliance teams will be imperative.

CONTENT REQUIREMENTS

Form CRS requires firms to complete the following five sections:

  1. Introduction
  2. Relationships and Services
  3. Fees, Costs, Conflicts, and Standards of Conduct
  4. Disciplinary History
  5. Additional Information

Please see our schematic disclosure templates for Investment Advisers and Broker-Dealers, with instructions for each section, prescribed language, and annotations on SEC’s views on the requirements and best practices. We will update this LawFlash with a template for Dual Registrants at a later date.

As noted in the schematics, several sections include so-called “conversation starters” that are intended to spark discussions between retail investors and financial professionals.

Observations: In general, firms should review and catalog existing disclosures and client communications to determine what can be leveraged to develop Form CRS. We note that many of Form CRS’s disclosures are similar and consistent with disclosures that the US Department of Labor (DOL) has required firms to complete, including Service Provider Fee Disclosures and disclosures many firms prepared (or were in the process of preparing) to satisfy the since-vacated Best Interest Contract Exemption. Leveraging these disclosure and work streams may be helpful here. Firms should also consider developing this disclosure in conjunction with disclosures newly required under Reg. BI.

With respect to “conversation starters,” firms should develop training programs for financial professionals and consider whether to develop scripts for financial professionals to use.

TITLING RESTRICTIONS

Along with the Form CRS rule proposal, the SEC proposed a rule that would have prohibited Broker-Dealers and their financial professionals from using the titles “Advisor” and “Adviser,” unless dually registered as an investment adviser. Though final Form CRS did not include the titling rule, the SEC stated in the release for final Reg. BI that the SEC presumes a broker-dealer’s use of such titles would violate Reg. BI’s disclosure obligation, subject to certain limited circumstances in which the Broker-Dealer provides advisory services in other capacities (e.g., as a municipal bond advisor).[16]

CORRECTING FORM CRS ERRORS

The SEC did not prescribe procedures for correcting substantive or delivery errors related to Form CRS.

Observations: Firms may want to consider requesting additional guidance on how to correct errors related to Form CRS (as well as the new disclosure requirements under Reg. BI). Given the complexity of the delivery requirements, and the potential for errors in the disclosures themselves (particularly in cross-referenced or linked documents with additional information), a correction methodology for good faith errors would be beneficial and consistent with other regulatory disclosure regimes (e.g., Department of Labor Service Provider Fee Disclosures).

NEXT STEPS

Given the current compliance deadline of June 30, 2020, firms have little time to make the operational changes and technology builds needed to comply with the Form CRS requirements. We suggest considering the following next steps as firms begin to develop Form CRS compliance processes:

  1. Assemble your team. Consider the disciplines needed to achieve optimal results. In our experience, firms that combine input from business, marketing, communications, investor relations, legal, compliance, and other personnel have well-thought-out disclosures. Your DOL Fiduciary Rule teams may provide helpful insight and experience when it comes to implementation.
  2. Review Form CRS delivery, filing, recordkeeping, updating, and content requirements. Make sure you and your team have a good grasp of all of the elements of Form CRS’s delivery and content requirements.
  3. Review existing disclosures and delivery, filing, recordkeeping, and updating systems. Consider what can be leveraged from what is already in place, what needs to be modified, and how best to maintain consistency across all layers of disclosure and communication you have with retail investors.
  4. Consider requesting additional guidance from the SEC on requirements that are unclear or difficult to operationalize. If you have questions or think clarification may yield better, more efficient results, consider asking the SEC for additional guidance, whether directly or through trusted counsel.
  5. Draft your Form CRS disclosures. Keep the big picture in mind—Form CRS is intended to help retail investors better understand and compare firms and their services. Try not to draft yourself into a corner by providing too many specifics that will require frequent updating and monitoring for consistency across your firm’s other disclosures and communications. At the same time, make sure you provide balanced, full, and fair disclosures that are not misleading to investors. And don’t forget to draft and edit with the goal of “plain English” disclosure.
  6. Make any changes to systems, policies, and procedures for delivering, filing, and updating Form CRS and keeping records. Certain Form CRS delivery, filing, updating, and recordkeeping requirements are likely to require firms to develop new compliance structures. Technology lead times will be challenging here. Consider alerting upper management of the technological needs in order to ensure that Form CRS implementation timetables will be given adequate resources and priority.
  7. Train your financial professionals so that they can appropriately handle retail investor questions regarding Form CRS, including with respect to conversation starters. Financial professional training will be important to ensuring timely delivery of Form CRS (to the extent not automated) and to help financial professionals address retail investor questions about the information disclosed in Form CRS, including those raised in response to “conversation starters”. Firms may want to consider providing financial professionals with scripts to facilitate these discussions.
  8. We are here to help. Our team is here to help you and your team navigate these changes. We are happy to share or experiences and market insight as practices develop, as well as communicate any questions or concerns to the SEC as needed.

[1] For our analysis of Reg. BI, please see our LawFlash, “In Focus: What Regulation Best Interest Means for Broker-Dealers.”

[2] Form Customer Relationship Summary (CRS); Amendments to Form ADV, SEC Release Nos. 34-86032, IA-5247, File No. S7-08-18 (Jun. 5, 2019) (to be codified at 17 CFR pt. 200, 240, 249, 275, and 279), available here. at 192-3 (CRS Release).

[3] See, e.g., FINRA Rule 2111 provides certain exceptions when Broker-Dealers deal with institutional accounts that can include persons with $50 million or more in assets. See also FINRA Rule 4512(c), which defines an institutional account.

[4] CRS Release at 198.

[5] Id. at 195.

[6] Id. at 195.

[7] Id. at 224-225.

[8] Id. at 225.

[9] Id. at 213.

[10] Id. at 218.

[11] See, e.g., Use of Electronic Media by Broker-Dealers, Transfer Agents, and Investment Advisers for Delivery of Information; Additional Examples Under the Securities Act of 1933, Securities Exchange Act of 1934, and Investment Company Act of 1940, Exchange Act Release No. 37812 (May 9, 1996), 61 Fed. Reg. 24644 (May 15, 1996). The SEC did not acknowledge the Electronic Signatures in Global and National Commerce Act signed into law in 2000, which preempts other laws with some exceptions. However, the SEC did note that, “[r]ecognizing the growth of different forms of electronic media, other technological developments, and the passage of time since these releases were issued, the Commission plans to revisit its existing guidance regarding electronic delivery.”

CRS Release at 207.

[12] Id. at 29.

[13] Id. at 327.

[14] Id. at 48.

[15] Id. at 58-59.

[16] Regulation Best Interest: The Broker-Dealer Standard of Conduct, SEC Release No. 34-86031, File No. S7-07-18 (Jun. 5, 2019) (to be codified at 17 CFR pt. 240), at 148.

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