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The Accountant’s And Attorney’s Guide To New SEC Rules About Financial Advisers

Originally posted on Forbes.com

What Do Accountants And Attorneys Need To Know About New SEC Regulations That Affect Their Clients’ Financial Advisers?

Clients of accountants and attorneys are bound to ask questions about new SEC regulations that affect their relationships with their financial advisers. To prepare you, here’s the background, along with questions you may be asked.  

History

When the U.S. Securities and Exchange Commission (SEC) issued new regulations a few months ago, they didn’t spare any paper. That is an indication of the complexity of the subject of the regulation of financial advisers.

The SEC’s Four 2019 Releases

The SEC issued four important releases on June 5, 2019, highlighting rule making that has been in the works for decades. The lengths of the first two releases will tell you something. The SEC has a lot to say about the topic of who’s who on Wall Street and why Main Street Investors like your clients should care.   

  1. 770-page “Regulation Best Interest: The Broker-Dealer Standard of Care” (final rule)
  2. 564-page Form CRS Relationship Summary; Amendments to FORM ADV” (final rule)
  3. 42-page “Commission Interpretation Regarding Standard of Conduct for Investment Advisers
  4. 28-page Commission Interpretation Regarding the Solely Incidental Prong of the Broker-Dealer Exclusion from the Definition of Investment Adviser

2018 Releases

This follows earlier rule making proposals from April 18, 2018 on the same subjects. These 2018 releases show the thinking, research and survey data that went behind the final adoption of rules in 2019, including focus group studies of investors.

  1. 471-page Form CRS Relationship Summary; Amendments to Form ADV; Required Disclosures in Retail Communications and Restrictions on the use of Certain Names or Titles (proposed rule)
  2. 408-page Regulation Best Interest (proposed rule)
  3. 38-page Proposed Commission Interpretation Regarding Standard of Conduct for Investment Advisers; Request for Comment on Enhancing Investment Adviser Regulation (proposed rule)

Thousands Commented

After the 2018 releases, people who knew about the proposals wanted to share their opinions. Thousands of comment letters made their way to the SEC, on both the Best Interest proposal and the CRS proposal, including a letter from me that you can read here.

What Should Accountants and Attorneys Tell Their Clients About New SEC Regulations and Form CRS?

Financial “Advisers” or Financial “Professionals”?

Financial advisers who work for stand-alone broker-dealers, stand-alone registered investment advisers, and dual registrants (registered as both broker-dealers and investment advisers) will provide their customers/clients a new disclosure document called Form CRS. The term “financial adviser” will no longer be appropriate in describing representatives of broker-dealers, only those who work for registered investment advisers. See Is Your Financial Adviser A Financial ‘Adviser?’ Should You Care?      

New CRS Will Be Written In Succinct Plain English

The CRS is intended to provide “succinct, plain English information” to retail customers (your clients) “about the relationships and services” firms offer. It will help your clients understand “the fees, costs, conflicts of interest and required standard of conduct associated with those relationships and services, and whether the firm and its financial professionals have reportable legal or disciplinary history,” said SEC Chairman Jay Clayton in his June 5, 2019 “Statement at the Open Meeting on Commission Actions to Enhance and Clarify the Obligations Financial Professionals Owe to our Main Street Investors.”  

That’s quite an undertaking, given the fact that most people don’t even know that there are differences between financial professionals.

What To Expect

This is what to expect: Your clients’ financial professionals will provide them with an easy to read two-page (not longer) CRS that follows a mandated question-and-answer format presented in a prescribed order. (Dual registrants are limited to four pages.)  

The SEC’s goal in providing this structure is to enable investors to compare CRS forms from different firms. The stated goal is to “promote consistency and comparability among different relationship summaries.” 

The CRS Is A Summary

The CRS will cover a summary of fees and costs, a description of ways the firm makes money, certain conflicts of interest and standards of conduct. Firms will include disclosures about financial professionals’ compensation.  Firms will also be required to indicate whether any of their financial professionals have reportable disciplinary history. The CRS will link to Investor.gov/CRS, a page on the SEC’s investor education website that will offer educational information about investment advisers, broker-dealers, and individual financial professionals. 

Conversation Starters

A rather unusual new requirement in my view is to include a series of mandated questions (with no answers) that the SEC calls “conversation starters.” The intention is to help retail investors “dialogue with their financial professionals about their individual circumstances.”  

Type Of Firm

The first question depends on the type of firm the client is interviewing, but the rest are identical for all firms, whether they are stand-alone broker-dealers, investment advisers, or dually registered firms.  

Here is question 1 (from CRS Item 2): For a stand-alone broker-dealer: “Given my financial situation, should I choose a brokerage service? Why or why not?” For an investment adviser: “Given my financial situation, should I choose an investment advisory service? Why or why not?” For a dual registrant: “Given my financial situation, should I choose an investment advisory service? Should I choose a brokerage service? Should I choose both types of services? Why or why not?”

Remaining Questions

The remaining questions are identical irrespective of the type of firm.

Question 2: “How will you choose investments to recommend to me?”

Question 3: “What is your relevant experience, including your licenses, education and other qualifications? What do these qualifications mean?” 

Question 4: “Help me understand how . . . fees and costs might affect my investments. If I give you $10,000 to invest, how much will go to fees and costs, and how much will be invested for me?”

Question 5: “How might your conflicts of interest affect me, and how will you address them?”

I like this question in particular, but it takes some knowledge to make sense of it. The rationale behind it is this: The question “underscores for retail investors [your clients] that investment advisers and broker-dealers have conflicts that may create incentives to put their interests ahead of the interests of their retail clients and customers,” according to the SEC.

What’s a potential conflict? Proprietary products, third-party payments, revenue sharing, principal trading, the payment of fees to someone to refer clients.  

Question 6: “As a financial professional, do you have any disciplinary history? For what type of conduct?”

Question 7: “Who is my primary contact person? Is he or she a representative of an investment adviser or a broker-dealer? Who can I talk to if I have concerns about how this person is treating me?”

How these questions will be answered by the financial professional presenting the CRS will vary person-to-person. Firms will be training their representatives. It remains to be seen how Main Street investors will react.

Did The SEC Create A New Standard Of Care?

Is there a new standard? 

“[R]egardless of whether a retail investor chooses a broker-dealer or an investment adviser (or both), the retail investor will be entitled to a recommendation (from a broker-dealer) or advice (from an investment adviser) that is in the best interest of the retail investor and that does not place the interests of the firm or the financial professional ahead of the interests of the retail investor,” quoting from the SEC’s June 5, 2019 Fact Sheet

The use of the term, “best interest” for both investment advisers and brokers can raise a question on the part of retail investors about whether the SEC changed the legal standards of care that apply to brokers vs. investment advisers. 

Investment Advisers Are Fiduciaries

Before the issuance of the new rules, a fiduciary standard of care, the highest under the law, was required of registered investment advisers. That has not changed.

“An adviser’s fiduciary duty is imposed under the Advisers Act in recognition of the nature of the relationship between an adviser and its client—a relationship of trust and confidence. The adviser’s fiduciary duty is principles-based and applies to the entire relationship between the adviser and its client. The fiduciary duty follows the contours of the relationship between the adviser and its client, and the adviser and its client may shape that relationship by agreement, provided that there is full and fair disclosure and informed consent.” See, SEC’s Fiduciary Interpretation

“An investment adviser’s fiduciary duty under the Advisers Act comprises a duty of care and a duty of loyalty,” quoting from the SEC’s Fiduciary Interpretation issued June 5, 2019. This requires an adviser to “adopt the principal’s goals, objectives, or ends.” 

Using the term, “best interest” does not change that higher fiduciary requirement for investment advisers. 

“[T]he [registered investment] adviser must, at all times, serve the best interest of its client and not subordinate its client’s interest to its own. In other words, the investment adviser cannot place its own interests ahead of the interests of its client. This combination of care and loyalty obligations has been characterized as requiring the investment adviser to act in the ‘best interest’ of its client at all times.” See, SEC’s Fiduciary Interpretation

Brokers Are Not Fiduciaries

The SEC considered increasing the standard of care for brokers to that of the higher fiduciary that applies to registered investment advisers, but did not. However, the SEC did create a new standard for broker-dealers, that of “best interest” as defined in Regulation Best Interest, which replaces “suitability.”

How this new best interest standard will be applied is still to be seen. As Jamie Hopkins, Director of Retirement Research at Carson Wealth, wrote “this rule presented a perfect opportunity to firm up what “best interest” means, but the SEC declined to do so.” See, SEC Brings Increased Confusion For Investors With New ‘Best Interest’ Rule.

A Moment In Time? Or At All Times?

There are key differences between the best interest standard that will apply to broker-dealers and the fiduciary standard that applies to registered investment advisers. The differences are reflective of differences in the two business models.

“For example, an investment adviser’s fiduciary duty generally includes a duty to provide ongoing advice and monitoring, while Regulation Best Interest imposes no such duty and instead requires that a broker-dealer act in the retail customer’s best interest at the time a recommendation is made.”

We do know, however, that the broker’s “best interest” standard applies at the moment in time of a recommendation or transaction-by-transaction but does not apply on an ongoing basis. In addition, brokers generally have no duty to monitor the account. 

In contrast, the investment adviser’s fiduciary duty applies to the entire relationship between the investment adviser and client; the investment adviser must act in clients’ best interest “at all times.”  

Timing For Clients Of Investment Advisers

Investment advisers are required to give the CRS to potential clients before or at the time the firm enters into an investment advisory contract with them.  Existing clients will receive their CRS in June 2020. The firm has to file the CRS with the SEC online (through IARD), where Form ADV Parts 1 and 2 are now filed. The CRS will be called ADV Part 3. 

Timing For Customers Of Broker-Dealers

Customers of broker-dealers, will receive a CRS “before or at the earliest of: (i) a recommendation of an account type, a securities transaction, or an investment strategy involving securities; (ii) placing an order for the retail investor; or (iii) the opening of a brokerage account for the retail investor.” Broker-dealers will file their CRS’s with the SEC through Web CRD.

Timing For Customers Of Dually Registered Firms

Dual registrants must deliver the relationship summary at the earlier of the delivery requirements for the investment adviser or broker-dealer. Dual registrants will file both through Web CRD and IARD.

What’s Next?

The key date is June 30, 2020. By then, your clients will be receiving a Form CRS from their financial professionals, whether they work for broker-dealers or investment advisers. At that time, broker-dealers will also be required to comply with Regulation Best Interest. 

Why Are These Developments Important To You As A Trusted Adviser?  

As their clients’ trusted advisers, accountants and attorneys need to be prepared to answer questions that likely will arise out of these new rules. For example:

  1. What is this new CRS disclosure document and why am I getting a copy? 
  2. Why did the SEC adopt this new requirement?  
  3. Should I bother reading the CRS and comparing the CRS’s of different firms? 
  4. What should I make of my financial professional’s answers to the conversation starters? How do I know they are correct? Should I record the answers?
  5. Do these new rules change my relationship with my financial professional? 
  6. Under what circumstances should I change my financial professional given the information in the CRS?   
  7. Should I change financial professionals if I learn they have disciplinary disclosures? 
  8. What do I make of the conflicts of interest they tell me about? How do I judge whether I can live with them, such as getting paid more if I buy certain financial products? 
  9. Should I change financial professionals if I learn the services they provide are not what I understood them to be? For example, what if I thought I was getting ongoing monitoring and I found out that I was getting “recommendations” instead, with no ongoing monitoring?

These and many more questions are coming as these new rules have a chance to sink into the fabric of financial advice. I’ll do additional posts on this topic in the future.    

Video Resources

Videos of Jay Clayton, SEC Chairman designed to assist with “selecting a financial professional who can help you with investing.”

Further Reading

Commission Interpretation Regarding Standard of Conduct for Investment Advisers

SEC Adopts Rules and Interpretations to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships with Financial Professionals

Form CRS Relationship Summary; Amendments to Form ADV; Required Disclosures in Retail Communications and Restrictions on the use of Certain Names or Titles