Overview of Form CRS
Form CRS (Customer Relationship Summary) is a disclosure document that investment advisers and broker-dealers are required to file and distribute to retail investors. Its purpose is to provide investors with information about the nature of their relationship with their financial service provider. Items that must be covered by the Form include the types of services the firm offers, the fees and costs associated with the services, the investment authority of the firm, and how disputes with the firm are handled.
The Form CRS was first required in June 2019, implementing new rules from the Securities and Exchange Commission (SEC) under Regulation Best Interest. It is intended to be a short-form document that is clear and concise enough for retail investors to quickly read and understand.
The Form CRS is not meant to replace other disclosures (such as ADV, Part 2, general firm material) but to supplement them with key information.
Broker-dealers, registered investment advisers (RIAs), and dual-registrants have a "Form CRS obligation" and must meet the following requirements:
For broker-dealers, the SEC’s new rule requires the firm to deliver the form to customers before opening an account. If a form isn’t provided prior to the opening of an account but is provided to a customer thereafter, delivery is considered to have occurred upon receipt. If a contract isn’t a firm’s formal contract with their customer for the service particular to that contract, or if a contract is entered into over a period of time, the Form must still be delivered at the time the account is opened.
Broker-dealers may also have to provide the Form CRS upon account transfer , upon opening another type of brokerage account, or upon renewal of services or rollover of a retirement account.
For RIAs and dual registrants, the SEC’s new rule governs when they must provide the form. For financial planning services that involve limited investment activities, Form CRS delivery must occur no later than the time the investor enters into a written agreement, the firm starts services, or sends the investor the bill for those services. For investment advice services that don’t involve financial planning and disburse securities transactions, Form CRS delivery must occur simultaneously with the client agreement, starting services, or the issuance of a bill. For investment advice services involved in a financial planning capacity but that also involve regular securities market transactions, delivery must occur about the same time as the delivery of the client agreement or starting services. For advisory contracts where services are based on a blended fee schedule that includes both a financial planning service and a securities market transaction, Form CRS delivery must occur either simultaneously or not more than 48 hours before the client schedules a conference or about the time the client enters into the advisory contract.
RIAs and dual registrants are also able to provide clients with their form at a later time if they confirm that the customer has its form within 30 days and three business days of receiving confirmation.
Regulation Best Interest went into effect on June 30, 2020, and affected firms apply until June 30, 2020.
The Regulatory History of Form CRS
The concept of obtaining client concise disclosure responsive to the growing complexity of financial services has been considered by regulators for many years. For example, in 2013, the Securities and Exchange Commission ("SEC") issued a staff report required by the Jumpstart Our Business Startups Act of 2012 regarding "Disclosure Effectiveness," which recognized the challenge for investors to obtain all of the relevant information about competing firms in order to make informed investment choices. Since that time, each year the SEC has listed disclosure reform as a significant regulatory area of focus in its annual examination priorities.
Similarly, the Financial Industry Regulatory Authority ("FINRA") has long recognized the need for and the use of targeted disclosure. In 2006, FINRA renamed the simplified disclosure form of the NASD Form U4 to Form U4 to reflect the change to uniformity among the self regulatory organizations. FINRA also adopted FINRA Rule 2210, which sets forth the general standards for communications with the public and previously required "script" approval for communications intended to be delivered to more than 25 retail investors within a certain time period. In later years, this rule has been amended to allow for an expedited review process if certain information has been submitted in advance.
In the future, firms should expect a continued review of their marketing and advertising materials regarding the use of digital media and formats. The SEC has already approved amendments to Form ADV that affect the delivery of ADV Part 2A (the Brochure) electronically. The SEC has also approved, among others, proposals to amend rules to simplify and modernize the reporting and disclosure requirements for investment advisers registered with the Agency.
The final rule adopting Form CRS was jointly issued by the SEC and the FINRA. It requires that broker dealers and investment advisers deliver a standard customer or client relationship summary ("Form CRS") to retail investors who open a new account. It also requires the delivery of a brief relationship summary covering brief key information about the firm’s fees, costs, education, performance, conflicts of interest and legal and disciplinary history. Form CRS must be made available to customers on the firm’s website, as well as on FINRA’s website. Similar to Form ADV, a Form CRS must be updated annually and disclosed whenever there is a material change. Form CRS also must be maintained in the firm’s books and records.
Given the reach of the SEC and FINRA, the need for a uniform concise disclosure document studied for many years, and the increasing complexity of financial services products being offered, the launch of Form CRS is a long awaited milestone years in the making.
Key Form CRS Delivery Requirements
The SEC proposes to require broker-dealers and investment advisers to deliver Form CRS to any retail investor that is or "believes it might be" a retail investor. In other words, Form CRS must be delivered to both customers and clients. A retail investor includes any natural person who "seeks" services offered by broker-dealers or investment advisers and any natural person (or the legal representative thereof) legal representative of such a retail investor. Retail investors does not include any natural person or legal representative thereof with assets under management attributable to them of at least $10 million at the time of Form CRS delivery. The SEC has proposed a number of approaches, including the following, for determining when an individual "believes" the can "might be" a retail investor: (i) an investment adviser’s representation of eligibility for advisory services given through a in-person meeting or a concluded discussion regarding eligible advisory services, (ii) a client’s representation of eligibility received through a in-person meeting or communications specifically regarding a client’s consideration of the firm’s investment advisory services, (iii) the receipt of form financial information by an investment adviser that reasonably suggests a person is a retail investor, (iv) a broker-dealer sending leaflets to prospective clients that describe eligible products and topics related to those products, (v) a broker-dealer receiving inquiries or requests for materials for topics that the firm only sells to retail investors, and (vi) generalized materials designed or intended for a mass audience published by a firm that discusses how an investor might be affected by a change in interest rates.
Form CRS generally must be delivered to retail investors prior to or contemporaneously with "the time [the firm] enters into a contract with a retail investor to provide a covered service to that retail investor, or before [the firm] offers or sells securities." The SEC includes the following guidelines for "the time" of delivery: (i) for an investment adviser that delivers Form CRS to a prospective retail client who later becomes a new retail client, delivery must generally be at least 48 hours prior. If delivered less than 48 hours but prior to entering into a contract with the retail client to provide a service under 17 CFR 275.204-3 (the investment adviser brochure rule), generally, an investment adviser must provide the retail client with a contract to review or execute; (ii) for an investment adviser that delivers Form CRS to a new retail investor in connection with a change in services (such as transitioning investment strategies) or addition of services, the brochure must be delivered prior to or at the time of the change or addition; (iii) a broker-dealer performing due diligence on an offering or participating in a private placement or non-public offering must provide Form CRS to its customers that are retail investors prior to, or at the same time, the delivery of the prospectus. If the prospectus is or may be expected to be delivered less than 48 hours prior to its receipt, the broker-dealer may send Form CRS to existing brokerage customers prior to the receipt of the prospectus; (iv) for well-known seasoned issuers that have a Schedule E or F or eligibility requirements, the brochure is required to be delivered "contemporaneously" with the delivery of the prospectus and (v) in addition to the timing requirements imposed on broker-dealers, broker-dealers are not required to deliver Form CRS to customers who have granted discretionary authority to execute trades on their behalf. Disclosure of this discretionary authority must be provided on the Form CRS.
Tips and Challenges with Form CRS
The most common compliance challenge for Form CRS delivery requirements under Regulation Best Interest seems to be the failure to mail Form CRS to existing clients. Many firms have given their clients and customers the choice between e-delivery of all documents, paper delivery of all documents or a combination of both. If an existing client had already opted into electronic delivery, sending an electronic version of Form CRS would not have appeared to be an issue. However, what was missed by most firms was the requirement that, regardless of whether a client chooses to receive documents in electronic or paper format, the firm has a legal obligation to ensure that the Form CRS, in paper or electronic format, is sent or made available to all existing retail customers/investors . Another issue many firms ran into was using a firm specific URL or hyperlink in an email to provide Form CRS to its clients who have elected electronic delivery, but not including the required disclosure for the web-based Form CRS that explains that the retail investor in a new account can request to review a paper copy of the firm’s Form CRS.
In order to overcome these and other issues, firms should consider implementing a compliance checklist at least quarterly to ensure the firm’s supervisory procedures on Form CRS are followed. Also consider including random sampling of 5-10 clients over each quarter to which the firm can send a paper copy of the firm’s Form CRS to ensure that such delivery is done. Lastly, each firm should consider conducting annual refresher training to its supervised persons on Form CRS.
Implications for Noncompliance
The consequences of not fulfilling Form CRS delivery requirements are not hypothetical. For example, in In the Matter of Haven Act, LLC, the Commission took action against a firm that did not deliver a 2003 version of the majority of its clients its Form CRS and instead directed the clients to an out-of-date link on the same firm’s website. In that matter, the Commission: (i) imposed an industry wide bar for the firm and its principals from working at any firm that provides investment services and advised the principals to retain counsel; (ii) prohibited the firm from registration – including renewing its registration – for 3 years; (iii) ordered the firm to pay the investors $2,781,508.95, which included $178,558.06 for attorney’s fees; and (iv) ordered the firm to pay a civil penalty of $100,000. Enforcement action or penalties imposed for non-compliance with Form CRS delivery requirement include: Enforcement action In re. 1 Globex Fund GMG Ltd, SEC Release #81781 (July 14, 2017) (Charging papers allege that CEO of 1 Globex Fund GMG one of the 1 Globex funds misrepresented to investors that the funds were registered with the SEC when they were not and failed to deliver each investor a written disclosure (and/or Terms and conditions) electronically or upon request as to the firm’s relationship to FCM (and or broker-dealer affiliate); opinion of counsel advised 1 Globex Funds GMG that an industry practice has developed that requires firms to at least direct investors to a firm’s website to make a Form CRS available to them) In re. FABK, SEC Release #82604 (November 6, 2018) (FABK was an investment adviser registered with the State of Nevada. It provided investment advisory services to clients. May – December 2015 – FABK submitted two brochures on the IAPD and uploaded an alternative fee schedule to its alternative fee schedule and brochure); Failing to deliver a Form ADV and provide all relevant information; Failing to deliver a factual and specific disclosure about material conflicts of interest. In the Matter of Havens Act, SEC Release #81677 (July 14, 2017) (Charging papers alleged that CEO of Haven Act misrepresented to investors that the funds were registered with the SEC when they were not and failed to deliver each investor a written disclosure (and/or Terms and conditions) electronically or upon request as to the firm’s relationship to FCM (and or broker-dealer affiliate); opinion of counsel also advised 1 Globex Funds GMG that firm is required to provide every client a copy of the firm’s brochure from the IAPD website, available to clients or by request and/or directing investors to the firm’s website, as a registered investment adviser, that provides a link to the IAPD website. In re. Financial Designs, Inc., SEC Release #78751 (December 8, 2015) (Deceptive conduct under Commission authority to take action against former owner of firm; owner offered to repay the amounts received but did not) In re. Hopkins Investment Management LLC, SEC Release #78515 (November 4, 2015) (Deceptive conduct under Commission authority to take action against former owner of firm; owner offered to repay the amounts received but did not) SEC v. Caritas, 12 Civ. 8207 (MHD) (S.D.N.Y.) (February 11, 2015) (Court affirmed lower court recommendation regarding appointing a receiver to avoid the delays associated with enforcement proceeding where the firm ceased all business and converted to a private investment fund.) SEC v. Marquis Properties Management & Securities, Inc., No. 08 Civ. 0658 (S.D.N.Y. 2011) (Court enforced CCO PBW; adopted magistrate’s report allowing civil fines against CEO/CCO, where the firm repeatedly failed to amended its Form ADV since 2005, despite repeated warnings from SEC staff) In re.: W. Mass. Capital Corp., No. C97-30129 (D. Mass.) (Bank failed to amend its registration under the new rule requiring it to be registered as a bank broker dealer. The bank could be subject to both criminal and civil penalties for selling securities in contravention of Section 15(a) of the Exchange Act. The former President signed a conciliation award entered by FINRA admitting to violating his duties under rule 7210 and accepting a permanent bar from association for supervising trading and market making activities.
Preparing Form CRS: Best Practices
The Form CRS should be completed with an emphasis on providing information to a client in a way that will assist the client in making an informed decision about a firm. Confusion over the potential uses of Form CRS as client specific communications versus general communications may be overstated. Firms should carefully address what information is essential to be included in a client specific cover letter that contains the specific Form CRS information applicable to the particular client. For instance, creating a cover letter that directs each client to its specific Form CRS is probably not going to be beneficial to a client that may not even notice it is there. Further, we would expect that some firms may decide to provide a client specific delivery cover sheet solely as a means of delivering the Form CRS to a client electronically .
Including client specific information in the body text of Form CRS, such as the specific account opening, fees, products and services related to that client will be critical to ensuring that a client properly understands the applicable disclosure before entering into a relationship with a firm. Furthermore, it will be important for many financial institutions to review their supervisory procedures to ensure that they do not conflict with or are at odds with Form CRS and that any required supervision corresponds with what customers receive as a client specific cover letter or related communication. While reasonable supervisory requirements are permissible under FINRA Rule 3110, if those requirements are impractical or impermissible under the Form CRS delivery rules, they should be reconsidered.