Now that the Securities and Exchange Commission has made poring over client relationship summaries (Form CRS) a 2020 examination priority, advisors should be doubling down on how they describe their conflicts of interest and compensation in the mandated disclosure for retail clients.
That’s according to veteran securities attorney and compliance expert Kelli A. Haugh, managing director for Foreside, a broker-dealer consultancy based in Del Ray, Fla.
“The purpose of Form CRS is to reduce confusion for retail investors regarding advisory and brokerage services and to help them decide whether to establish an investment advisory relationship, engage a particular firm or financial professional, or terminate or switch a relationship or specific service,” Haugh said in a blog the Investment Adviser Association sent to all of its members earlier this month.
In fact, “advisers should evaluate conflicts as perceived from a retail investor’s perspective, even if the firm believes the conflicts are mitigated,” Haugh said.
The heat is on. Advisor firms must file the new disclosure with the SEC or Finra by June 30, 2020 and must deliver the disclosure to their existing retail investor clients by July 30, 2020. However, firms must start delivering Form CRS to new and prospective clients before, or at the time of, entering into a new investment contract.
In short, the brief, standardized format of Form CRS (two or four pages total depending on firm type) is designed to help retail investors readily size up a firm and investment professional and compare and contrast him or her to competitors with different types of registrations.
For instance, according to Haugh, dual registrants must provide a side-by-side comparison of the services provided in advisory accounts versus services provided in brokerage accounts and must inform prospective retail investors that:
There are different ways you can get help with your investments. You should carefully consider which types of accounts and services are right for you.
Depending on your needs and investment objectives, we can provide you with services in a brokerage account, investment advisory account, or both at the same time. This document gives you a summary of the types of services we provide and how you pay. Please ask us for more information. There are some suggested questions on page [ ].
“Advisers should inventory all conflicts of interest arising from the type of advisory fee charged (such as, asset-based fees, performance-based fees, wrap fees), as well as compensation derived from proprietary products, third-parties in connection with the recommendation or sale of certain investments, revenue sharing arrangements, and principal trading,” Haugh said.
Advisors should also review each supervised person’s compensation structure and disclose any conflicts of interest these structures create, she said.
Advisors also need to include in their summaries whether their financial professionals are compensated based on the amount of client assets they service, the time and complexity required to meet a client’s needs, the products sold, product sales commissions, or revenue the firm earns from the financial professional’s advisory services or recommendations.
Since there is supposed to be consistency between advisors’ Form ADV and Form CRS, firms should review them side-by-side to ensure there is consistency, Haugh said. This review should include disclosures of additional compensation that a supervised person receives for providing investment advisory services, including sales awards and other prizes, as well as bonuses based on the number of sales, client referrals, or new accounts. This additional compensation must be explained on Form CRS.
Advice that bears repeating: “Advisers should evaluate conflicts as perceived from a retail investor’s perspective, even if the firm believes the conflicts are mitigated,” Haugh said.
For example, a firm may not consider asset-based fees to create conflicts of interest, particularly where neither the firm nor any of its associated persons earn any additional compensation. However, as the SEC pointed out in Form CRS instructions, asset-based fees can present a conflict because they incentivize firms to encourage clients to invest additional funds in their accounts.
“Importantly, language regarding how conflicts will be mitigated or minimized is not permitted in Form CRS since the purpose of the summary is to highlight for investors that conflicts of interest exist,” Haugh said.
To help retail investors compare and contrast working with different types of firms and zero in on firms’ potential conflicts, the SEC is also mandating standard “Conversation Starters.”
The questions that clients are encouraged to ask their financial advisor are:
- Given my financial situation, why should I choose an advisory account? Why should I choose a brokerage account?
- Do the math for me. How much would I pay per year for an advisory account? How much for a typical brokerage account? What would make those fees more or less? What services will I receive for those fees?
- What additional costs should I expect in connection with my account?
- Tell me how you and your firm make money in connection with my account. Do you or your firm receive any payments from anyone besides me in connection with my investments?
- What are the most common conflicts of interest in your advisory and brokerage accounts? Explain how you will address those conflicts when providing services to my account.
- How will you choose investments to recommend for my account?
- How often will you monitor my account’s performance and offer investment advice?
- Do you or your firm have a disciplinary history? For what type of conduct?
- What is your relevant experience, including your licenses, education and other qualifications? Please explain what the abbreviations in your licenses are and what they mean.
- Who is the primary contact person for my account, and is he or she a representative of an investment adviser or a broker-dealer? What can you tell me about his or her legal obligations to me? If I have concerns about how this person is treating me, who can I talk to?
How firms and advisors answer the questions will no doubt be carefully examined by SEC and Finra regulators.