83 FR 21416 - Form CRS Relationship Summary; Amendments to Form ADV; Required Disclosures in Retail Communications and Restrictions on the Use of Certain Names or Titles
SECURITIES AND EXCHANGE COMMISSION
Federal Register Volume 83, Issue 90 (May 9, 2018)
Page Range
21416-21571
FR Document
2018-08583
The Securities and Exchange Commission (``Commission'') is proposing new and amended rules and forms under both the Investment Advisers Act of 1940 (``Advisers Act'') and the Securities Exchange Act of 1934 (``Exchange Act'') to require registered investment advisers and registered broker-dealers (together, ``firms'') to provide a brief relationship summary to retail investors to inform them about the relationships and services the firm offers, the standard of conduct and the fees and costs associated with those services, specified conflicts of interest, and whether the firm and its financial professionals currently have reportable legal or disciplinary events. Retail investors would receive a relationship summary at the beginning of a relationship with a firm, and would receive updated information following a material change. The relationship summary would be subject to Commission filing and recordkeeping requirements. The Commission also is proposing two rules to reduce investor confusion in the marketplace for firm services, a new rule under the Exchange Act that would restrict broker-dealers and associated natural persons of broker- dealers, when communicating with a retail investor, from using the term ``adviser'' or ``advisor'' in specified circumstances; and new rules under the Exchange Act and Advisers Act that would require broker- dealers and investment advisers, and their associated natural persons and supervised persons, respectively, to disclose, in retail investor communications, the firm's registration status with the Commission and an associated natural person's and/or supervised person's relationship with the firm.
Federal Register, Volume 83 Issue 90 (Wednesday, May 9, 2018)
[Federal Register Volume 83, Number 90 (Wednesday, May 9, 2018)]
[Proposed Rules]
[Pages 21416-21571]
From the Federal Register Online [www.thefederalregister.org]
[FR Doc No: 2018-08583]
[[Page 21415]]
Vol. 83
Wednesday,
No. 90
May 9, 2018
Part III
Securities and Exchange Commission
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17 CFR Parts 240, 249, 275, et al.
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
Federal Register / Vol. 83 , No. 90 / Wednesday, May 9, 2018 /
Proposed Rules
[[Page 21416]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 240, 249, 275 and 279
[Release No. 34-83063; IA-4888; File No. S7-08-18]
RIN 3235-AL27
Form CRS Relationship Summary; Amendments to Form ADV; Required
Disclosures in Retail Communications and Restrictions on the Use of
Certain Names or Titles
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
proposing new and amended rules and forms under both the Investment
Advisers Act of 1940 (``Advisers Act'') and the Securities Exchange Act
of 1934 (``Exchange Act'') to require registered investment advisers
and registered broker-dealers (together, ``firms'') to provide a brief
relationship summary to retail investors to inform them about the
relationships and services the firm offers, the standard of conduct and
the fees and costs associated with those services, specified conflicts
of interest, and whether the firm and its financial professionals
currently have reportable legal or disciplinary events. Retail
investors would receive a relationship summary at the beginning of a
relationship with a firm, and would receive updated information
following a material change. The relationship summary would be subject
to Commission filing and recordkeeping requirements. The Commission
also is proposing two rules to reduce investor confusion in the
marketplace for firm services, a new rule under the Exchange Act that
would restrict broker-dealers and associated natural persons of broker-
dealers, when communicating with a retail investor, from using the term
``adviser'' or ``advisor'' in specified circumstances; and new rules
under the Exchange Act and Advisers Act that would require broker-
dealers and investment advisers, and their associated natural persons
and supervised persons, respectively, to disclose, in retail investor
communications, the firm's registration status with the Commission and
an associated natural person's and/or supervised person's relationship
with the firm.
DATES: Comments should be received on or before August 7, 2018.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's internet comment form (http://www.sec.gov/rules/proposed.shtml); or
Send an email to [email protected]. Please include
File Number S7-08-18 on the subject line.
Paper Comments
Send paper comments to Brent J. Fields, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549.
All submissions should refer to File Number S7-08-18. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method. The Commission will post all comments on the
Commission's internet website (http://www.sec.gov/rules/proposed.shtml). Comments also are available for website viewing and
printing in the Commission's Public Reference Room, 100 F Street NE,
Washington, DC 20549, on official business days between the hours of
10:00 a.m. and 3:00 p.m. All comments received will be posted without
change. Persons submitting comments are cautioned that we do not redact
or edit personal identifying information from comment submissions. You
should submit only information that you wish to make available
publicly. Investors seeking to comment on the relationship summary may
want to submit our short-form tear sheet for providing feedback on the
relationship summary, available at Appendix F.
Studies, memoranda or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at www.sec.gov to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Emily Rowland, Jennifer Songer, Gena
Lai, Roberta Ufford, Jennifer Porter (Branch Chief), and Sara Cortes
(Assistant Director), Investment Adviser Regulation Office at (202)
551-6787 or [email protected], and Benjamin Kalish, Elizabeth Miller,
Parisa Haghshenas (Branch Chief), and Holly Hunter-Ceci (Assistant
Director), Chief Counsel's Office at (202) 551-6825 or [email protected],
Division of Investment Management, Securities and Exchange Commission,
100 F Street NE, Washington, DC 20549.
SUPPLEMENTARY INFORMATION: The Commission is proposing new rule 204-5
under the Investment Advisers Act of 1940 [15 U.S.C. 80b],\1\ and is
proposing to amend Form ADV to add a new Part 3: Form CRS [17 CFR
279.1] under the Advisers Act. The Commission is also proposing to
amend rules 203-1 [17 CFR 275.203-1], 204-1 [17 CFR 275.204-1], and
204-2 [17 CFR 275.204-2] under the Advisers Act. The Commission is
proposing new rule 17a-14 under the Securities Exchange Act of 1934 [17
CFR 240.17a-14],\2\ and new Form CRS [17 CFR 249.640] under the
Exchange Act. The Commission is also proposing to amend rules 17a-3 [17
CFR 240.17a-3] and 17a-4 [17 CFR 240.17a-4] under the Exchange Act. The
Commission is further proposing new rule 15l-2 under the Exchange Act
[17 CFR 240.15l-2], new rule 15l-3 under the Exchange Act [17 CFR
240.15l-3], and new rule 211h-1 under the Advisers Act [17 CFR
275.211h-1].
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\1\ 15 U.S.C. 80b. Unless otherwise noted, when we refer to the
Advisers Act, or any paragraph of the Advisers Act, we are referring
to 15 U.S.C. 80b, at which the Advisers Act is codified, and when we
refer to rules under the Advisers Act, or any paragraph of these
rules, we are referring to Title 17, Part 275 of the Code of Federal
Regulations [17 CFR 275], in which these rules are published.
\2\ 15 U.S.C. 78a. Unless otherwise noted, when we refer to the
Exchange Act, or any paragraph of the Exchange Act, we are referring
to 15 U.S.C. 78a, at which the Exchange Act is codified, and when we
refer to rules under the Exchange Act, or any paragraph of these
rules, we are referring to Title 17, Part 240 of the Code of Federal
Regulations [17 CFR 240], in which these rules are published.
I. Background
II. Form CRS Relationship Summary
A. Presentation and Format
B. Items
1. Introduction
2. Relationships and Services
3. Obligations to the Retail Investor--Standard of Conduct
4. Summary of Fees and Costs
5. Comparisons
6. Conflicts of Interest
7. Additional Information
8. Key Questions
C. Delivery, Updating, and Filing Requirements
1. Filing Requirements
2. Delivery Requirements
3. Updating Requirements
D. Transition Provisions
E. Recordkeeping Amendments
III. Restrictions on the Use of Certain Names and Titles and
Required Disclosures
A. Investor Confusion
B. Restrictions on Certain Uses of ``Adviser'' and ``Advisor''
1. Firms Solely Registered as Broker-Dealers and Associated
Natural Persons
2. Dually Registered Firms and Dual Hatted Financial
Professionals
[[Page 21417]]
C. Alternative Approaches
D. Disclosures About a Firm's Regulatory Status and a Financial
Professional's Association
IV. Economic Analysis
A. Baseline
1. Providers of Financial Services
2. Investor Account Statistics
3. Investor Perceptions About Broker-Dealers and Investment
Advisers
B. Form CRS Relationship Summary
1. Broad Economic Considerations
2. Economic Effects of the Relationship Summary
3. Impact on Efficiency, Competition, and Capital Formation
4. Alternatives to the Proposed Relationship Summary
5. Request for Comments
C. Restrictions on the Use of Certain Names and Titles and
Required Disclosures
1. Broad Economic Considerations
2. Economic Effects of the Proposed Restrictions on the Use of
Certain Titles and Required Disclosures
3. Impact on Efficiency, Competition, and Capital Formation
4. Alternatives to the Proposed Rules
5. Request for Comments
D. Combined Economic Effects of Form CRS Relationship Summary
and Restrictions on the Use of Certain Titles and Required
Disclosures About a Firm's Regulatory Status
V. Paperwork Reduction Act Analysis
A. Form ADV
1. Respondents: Investment Advisers and Exempt Reporting
Advisers
2. Changes in Burden Estimates and New Burden Estimates
3. Total Revised Burden Estimates for Form ADV
B. Rule 204-2 Under the Advisers Act
1. Changes in Burden Estimates and New Burden Estimates
2. Revised Annual Burden Estimates
C. Rule 204-5 Under the Advisers Act
1. Respondents: Investment Advisers
2. Initial and Annual Burdens
D. Form CRS and Rule 17a-14 Under the Exchange Act
1. Respondents: Broker-Dealers
2. Initial and Annual Burdens
E. Recordkeeping Obligations Under Rule 17a-3 of the Exchange
Act
F. Record Retention Obligations Under Rule 17a-4 of the Exchange
Act
1. Changes in Burden Estimates and New Burden Estimates
2. Revised Annual Burden Estimates
G. Rule 151-3 Under the Exchange Act
1. Respondents: Broker-Dealers and Associated Natural Persons
2. Initial and Annual Burdens
H. Rule 211h-1 Under the Advisers Act
1. Respondents: Investment Advisers and Supervised Persons
2. Initial and Annual Burdens
I. Request for Comment
VI. Initial Regulatory Flexibility Analysis
A. Reason for and Objectives of the Proposed Action
1. Proposed Form CRS Relationship Summary
2. Proposed Rules Relating to Restrictions on the Use of Certain
Terms and Required Disclosure of Regulatory Status and a Financial
Professional's Firm Association
B. Legal Basis
C. Small Entities Subject to the Rule and Rule Amendments
1. Investment Advisers
2. Broker-Dealers
D. Projected Reporting, Recordkeeping and Other Compliance
Requirements
1. Initial Preparation of Form CRS Relationship Summary
2. Rule 15l-2 Relating to Restrictions on the Use of Certain
Terms in Names and Titles
3. Rules 15l-3 and 211h-1 Relating to Disclosure of Commission
Registration Status and Financial Professional Association
E. Duplicative, Overlapping, or Conflicting Federal Rules
F. Significant Alternatives
1. Form CRS Relationship Summary
2. Rule 15l-2 Relating to Restrictions on the Use of Certain
Terms in Names and Titles
3. Rule 15l-3 Relating to Disclosure of Commission Registration
Status and Financial Professional Association
G. Solicitation of Comments
VII. Consideration of the Impact on the Economy
VIII. Statutory Authority
IX. Text of Rule and Form
Appendices
Appendix A: Form ADV: General Instructions
Appendix B: [Form ADV, Part 3:] Instructions to Form CRS
Appendix C: Dual Registrant Mock-Up
Appendix D: Broker-Dealer Mock-Up
Appendix E: Investment Adviser Mock-Up
Appendix F: Feedback on the Relationship Summary
I. Background
Individual investors rely on the services of broker-dealers and
investment advisers when making and implementing investment decisions.
Such ``retail investors'' can receive investment advice from a broker-
dealer, an investment adviser, or both, or decide to make their own
investment decisions.\3\ A number of firms are dually registered with
the Commission as broker-dealers and investment advisers, and offer
both types of services.\4\ Broker-dealers, investment advisers and
dually registered firms all provide important services for individuals
who invest in the markets. Studies show that retail investors are
confused about the differences among them.\5\ These differences include
the scope and nature of the services they provide, the fees and costs
associated with those services, conflicts of interest, and the
applicable legal standards and duties to investors.
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\3\ See Staff of the U.S. Securities and Exchange Commission,
Study on Investment Advisers and Broker-Dealers as Required by
Section 913 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Jan. 2011), at 10-11, available at www.sec.gov/news/studies/2011/913studyfinal.pdf (``913 Study''). As discussed below,
we have considered the findings, conclusions and recommendations of
the 913 Study in developing this proposal.
Retail investors also can choose to receive advisory services
from other sources, such as banks, that are not required to be
registered with the Commission.
\4\ Investment advisers also may be registered with one or more
states if, among other things, they have less than a certain amount
of assets under management. See section 203A of the Advisers Act.
References in this release to investment advisers generally refer
only to SEC-registered investment advisers.
\5\ See, e.g., 913 Study, supra note 3. See also Letter from
Barbara Roper, Director of Investor Protection, Consumer Federation
of America, et al., (Sept. 15, 2010) (``CFA Survey'') (submitting
the results of a national opinion survey regarding U.S. investors
and the fiduciary standard conducted by ORC/Infogroup for the
Consumer Federation of America, AARP, the North American Securities
Administrators Association, the Certified Financial Planner Board of
Standards, Inc., the Investment Adviser Association, the Financial
Planning Association and the National Association of Personal
Financial Advisors); Siegel & Gale, LLC/Gelb Consulting Group, Inc.,
Results of Investor Focus Group Interviews About Proposed Brokerage
Account Disclosures (Mar. 5, 2005), available at http://www.sec.gov/rules/proposed/s72599/focusgrp031005.pdf (``Siegel & Gale Study'');
Angela A. Hung, et al., RAND Institute for Civil Justice, Investor
and Industry Perspectives on Investment Advisers and Broker-Dealers
(2008), available at https://www.sec.gov/news/press/2008/2008-1_randiabdreport.pdf (``RAND Study'').
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We recognize the benefits of retail investors having access to
diverse business models and of preserving investor choice among
brokerage services, advisory services, or both. We also believe that
retail investors need clear and sufficient information in order to
understand the differences and key characteristics of each type of
service. Providing this clarity is intended to assist investors in
making an informed choice when choosing an investment firm and
professional, and type of account to help to ensure they receive
services that meet their needs and expectations.
The Commission, as the primary regulator of both broker-dealers and
investment advisers, has considered ways to address this confusion and
preserve investor choice for some time, including through the RAND
study of investor perspectives commissioned in 2006, the 913 Study
conducted in 2010-2011, and a solicitation of data and other relevant
information in 2013.\6\ A number of approaches with a range of formats
have been considered to address this issue, such as a statement by
broker-dealers that an account is a brokerage account and not an
advisory
[[Page 21418]]
account, and encouraging investors to ask questions.\7\ Through these
initiatives, we have heard and considered the views of a wide range of
commenters--financial firms, investors, consumer advocates, academics,
and others. Improving retail investors' understanding of their
different options for investment-related services through better
disclosure is one key area on which commenters have focused. Commenters
have suggested a range of presentations. Some commenters recommended a
short disclosure document that explains the firm's services, fees,
certain conflicts of interest, and the scope and nature of its services
to the retail investor.\8\ Others recommended a longer, more
comprehensive narrative document such as the Form ADV Part 2 brochure
that investment advisers are required to deliver to their clients.\9\
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\6\ See RAND Study, supra note 5; 913 Study, supra note 3;
Duties of Brokers, Dealers, and Investment Advisers, Exchange Act
Release No. 69013 (Mar. 1, 2013) [78 FR 14848 (Mar. 7, 2013)]
(``2013 Request for Data'').
\7\ See, e.g., Certain Broker-Dealers Deemed Not to Be
Investment Advisers, Exchange Act Release No. 51523 (Apr. 12, 2005)
[70 FR 20424, 20435 (Apr. 19, 2005)], at n.124 and accompanying text
(``2005 Broker Dealer Release'').
\8\ See, e.g., Comment letters of Sammons Retirement Solutions
(Jun. 4, 2013) and Insured Retirement Institute (Jul. 3, 2013)
(recommending a short summary disclosure document together with a
longer disclosure document similar to Form ADV, to be offered by
both broker-dealers and investment advisers); Comment letter of AARP
(Jul. 25, 2013); Comment letter of American Council of Life Insurers
(Jul. 5, 2013) (incorporating by reference its comment letter, dated
Aug. 30, 2010); Comment letter of Financial Services Institute (Jul.
5, 2013).
\9\ See, e.g., Comment letter of Committee of Annuity Insurers
(Jul. 5, 2013); Comment letter of Edward D. Jones and Co., L.P.
(Jul. 12, 2013); Comment letter of North American Securities
Administrators Association, Inc. (Jul. 5, 2013); Comment letter of
PFS Investments, Inc. (Jul. 5, 2013).
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Similarly, the staff in the 913 Study and the Commission's Investor
Advisory Committee, as part of its recommendation that the Commission
adopt a fiduciary duty for broker-dealers, recommended uniform, simple,
and clear summary disclosures to retail customers about the terms of
their relationships with broker-dealers and investment advisers,
including any material conflicts of interests.\10\ Disclosure has also
been a feature of other regulatory efforts that address investment
advice, including those of the U.S. Department of Labor (``DOL'')
applicable to services provided by broker-dealers and investment
advisers,\11\ and rules applicable to broker-dealers issued by the
Financial Industry Regulatory Authority (``FINRA'').\12\
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\10\ See 913 Study, supra note 3, at 114-117. The 913 Study
contemplated that the general relationship guide would be akin to
Part 2A of Form ADV, which is generally referred to as an investment
adviser's ``brochure'' and is the form investment advisers use to
register with the Commission and states, which is provided to
advisory clients. The 913 Study identified a number of potential
disclosures that the Commission should consider including in such
relationship guide. See also Recommendation of the Investor Advisory
Committee: Broker-Dealer Fiduciary Duty, available at https://www.sec.gov/spotlight/investor-advisory-committee-2012/fiduciary-duty-recommendation-2013.pdf (``Broker-Dealer Fiduciary Duty
Recommendations''). The recommendation of the Investor Advisory
Committee suggested that the disclosure be provided at the start of
the engagement and periodically thereafter, and that it cover basic
information about the nature of the services offered, fees and
compensation, conflicts of interest, and disciplinary record.
\11\ For example, DOL regulations relating to ``reasonable plan
service arrangements'' require firms providing advisory and other
services to workplace retirement plans covered by the Employee
Retirement Income Security Act of 1974 (``ERISA'') and the
prohibited transaction provisions under section 4975 of the Internal
Revenue Code (``Code'') to disclose in writing (among other things)
a description of services and applicable fees. See 29 CFR 2550.408b-
2. See also 29 CFR 2550.408g-1 (regulation requires fiduciary
advisers to plans and individual retirement accounts (``IRAs'')
seeking to rely on the statutory exemption for participant
investment advice to provide certain disclosures, among other
conditions). See also infra Section IV.A.1.c, which further
describes disclosure obligations under DOL regulations and
exemptions, including the DOL's ``Best Interest Contract Exemption''
(the ``BIC Exemption'').
\12\ Disclosure of Services, Conflicts and Duties, FINRA Notice
10-54 (Oct. 2010), available at http://www.finra.org/sites/default/files/NoticeDocument/p122361.pdf (``FINRA Notice 10-54'').
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In 2017, Commission Chairman Clayton continued the discourse on
these issues by outlining a series of questions and welcoming the
public to submit their views on standards of conduct and related
disclosures for investment advisers and broker-dealers. More than 250
commenters responded.\13\ Many commenters recommended enhanced
disclosures in addition to regulations that would raise the standard of
conduct for broker-dealers providing advice.\14\ Some recommended that
both broker-dealers and investment advisers should provide a uniform
disclosure document to retail investors,\15\ while others suggested new
disclosure requirements only for broker-dealers.\16\ Commenters also
noted that investor confusion based on financial professionals' titles
persists, and made a range of suggestions.\17\ Specifically, some
commenters believed that particular titles cause investors to either
form misimpressions about whether the services received are those of an
investment adviser and subject to a fiduciary duty, or these investors
are misled by financial professionals to form such beliefs.\18\
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\13\ Public Comments from Retail Investors and Other Interested
Parties on Standards of Conduct for Investment Advisers and Broker-
Dealers, Chairman Jay Clayton (Jun. 1, 2017), available at https://www.sec.gov/news/public-statement/statement-chairman-clayton-2017-05-31 (``Chairman Clayton's Request for Comment'').
\14\ See, e.g., Comment letter of T. Rowe Price (Oct. 12, 2017)
(``T. Rowe 2017 Letter''); Comment letter of Vanguard (Sept. 29,
2017) (``Vanguard 2017 Letter''); Comment letter of Teachers
Insurance and Annuity Association of America (Sept. 26, 2017)
(``TIAA 2017 Letter''); Comment letter of the Investment Adviser
Association (Aug. 31, 2017) (``IAA 2017 Letter''); Comment letter of
Stifel, Nicolaus & Co. (Jul. 25, 2017) (``Stifel 2017 Letter'');
Comment letter of Bernardi Securities, Inc. (Sept. 11, 2017)
(``Bernardi Securities 2017 Letter''); Comment letter of UBS
Financial Services Inc. (Jul. 21, 2017) (``UBS 2017 Letter'');
Comment letter of SIFMA (Jul 21, 2017) (``SIFMA 2017 Letter'');
Comment letter of the Equity Dealers of America (Sept. 11, 2017)
(``Equity Dealers of America 2017 Letter''); Comment letter of AARP
(Sept. 6, 2017) (``AARP 2017 Letter''); Comment letter of Financial
Services Institute (Oct. 30, 2017); Comment letter of Financial
Services Roundtable (Oct. 17, 2017) (``FSR 2017 Letter''); Comment
letter of Consumer Federation of America (Sept. 14, 2017) (``CFA
2017 Letter'').
\15\ See, e.g., Stifel 2017 Letter; Equity Dealers of America
2017 Letter; Comment letter of Michael Kiley (Jul. 6, 2017) (``Kiley
2017 Letter''); Comment letter of the American Council of Life
Insurers (Oct. 3, 2017) (``ACLI 2017 Letter''); Comment letter of
Allianz Life Insurance Company of North America (Oct. 13, 2017)
(``Allianz 2017 Letter''); AARP 2017 Letter; Comment letter of
Robert Shaw (Jun. 5, 2017) (``Shaw 2017 Letter''); Comment letter of
Alan Syzdek (Jul. 2 2017); Comment letter of Americans for Financial
Reform (Sept. 22, 2017) (``AFR 2017 Letter'').
\16\ See, e.g., SIFMA 2017 Letter; Comment letter of the
Investment Company Institute (Feb. 5, 2018); IAA 2017 Letter;
Comment letter of Fidelity Investments (Aug. 11, 2017) (``Fidelity
2017 Letter''); Vanguard 2017 Letter; T. Rowe 2017 Letter; FSR 2017
Letter; UBS 2017 Letter; TIAA 2017 Letter; Comment letter of Wells
Fargo & Company (Sept. 20, 2017) (``Wells Fargo 2017 Letter'');
Bernardi Securities 2017 Letter; Comment letter of State Farm Mutual
Automobile Insurance Company (Aug. 21, 2017) (``State Farm 2017
Letter''); Comment letter of PFS Investments Inc. (Dec. 10, 2017);
Comment letter of Davis & Harman LLP (Jan. 18, 2018); Comment letter
of LPL Financial LLC (Feb. 22, 2018).
\17\ See, e.g., CFA 2017 Letter; Comment letter of the Public
Investors Arbitration Bar Association (Aug. 11, 2017) (``PIABA 2017
Letter''); IAA 2017 Letter; Comment letter of Pefin (Sept. 13, 2017)
(``Pefin 2017 Letter''); Comment letter of Jackson National Life
Insurance Company (Nov. 1, 2017) (``Jackson 2017 Letter''); Comment
letter of CFA Institute (Jan. 10, 2018); Comment letter of First
Ascent Asset Management (Jan. 10, 2018) (``First Ascent 2018
Letter'').
\18\ See e.g., CFA 2017 Letter; IAA 2017 Letter; Comment letter
of the National Employment Law Project (Oct. 20, 2017) (``National
Employment Law Project 2017 Letter'').
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Many commenters recommended a short disclosure document addressing
the nature and scope of services, fees and material conflicts of
interest.\19\ These suggestions are consistent with our staff's
financial literacy study,\20\
[[Page 21419]]
which found that retail investors favor a summary document and find
these categories of disclosures, plus a financial intermediary's
disciplinary history, to be important in choosing financial
intermediaries.\21\ Regarding investor confusion based on titles,
commenters also recommended, for example, prohibiting the use of
certain terms in titles, and prohibiting a firm not registered as an
investment adviser from holding itself out in a manner that implies it
is an investment adviser.\22\
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\19\ See, e.g., SIFMA 2017 Letter; UBS 2017 Letter; Stifel 2017
Letter; AARP 2017 Letter; Bernardi Securities 2017 Letter; Fidelity
2017 Letter; Allianz 2017 Letter.
\20\ See, e.g., Staff of the Securities and Exchange Commission,
Study Regarding Financial Literacy Among Investors as required by
Section 917 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Aug. 2012), at iv, v, xiv, 37, 73, 121-23 and 131-
32, available at https://www.sec.gov/news/studies/2012/917-financial-literacy-study-part1.pdf (``917 Financial Literacy
Study'').
\21\ See, e.g., 917 Financial Literacy Study, supra note 20, at
iv, x-xiii, xxi, 37, 66-67, 73, 119.
\22\ See, e.g. Comment letter of Mark D. Moss (Jun. 2, 2017);
Comment letter of Gimme Credit (Aug. 8, 2017); PIABA 2017 Letter;
AFL-CIO 2017 Letter; IAA 2017 Letter; Pefin 2017 Letter; Jackson
2017 Letter; AFR 2017 Letter; National Employment Law Project 2017
Letter; First Ascent 2018 Letter.
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We agree that it is important to ensure that retail investors
receive the information they need to understand the services, fees,
conflicts, and disciplinary history of firms and financial
professionals they are considering. Likewise, we believe that we should
reduce the risk that retail investors could be confused or misled about
the financial services they will receive as a result of the titles that
firms and financial professionals use, and mitigate potential harm to
investors as a result of that confusion. We also believe the
information should be reasonably concise. Accordingly, we are proposing
new rules to require broker-dealers and investment advisers to deliver
to retail investors a customer or client relationship summary (``Form
CRS'') that would explain general information about each of these
topics.\23\ Second, we are proposing rules that would (i) restrict the
use of the terms ``adviser'' and ``advisor'' by broker-dealers and
their associated financial professionals, and (ii) require broker-
dealers and investment advisers to disclose in retail investor
communications the firm's registration status while also requiring
their associated financial professionals to disclose their association
with such firm.
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\23\ For investment advisers, Form CRS would be required by Form
ADV Part 3. For broker-dealers, Form CRS would be required by
proposed new rule 17a-14 under the Exchange Act. When we refer to
Form CRS in this release, we are referring to Form CRS for both
broker-dealers and investment advisers.
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Together, these requirements would complement a separate release
that the Commission is proposing concurrently to enhance existing
broker-dealer conduct obligations (``Regulation Best Interest'').\24\
Regulation Best Interest would establish a standard of conduct for
broker-dealers and associated natural persons of broker-dealers to act
in the best interest of a retail customer when making a recommendation
of a securities transaction or investment strategy involving
securities. While Regulation Best Interest would enhance the standard
of conduct owed by broker-dealers to retail customers, it would not
make that standard of conduct identical to that of investment advisers,
given important differences between investment advisers and broker-
dealers. The requirements we are proposing in this release would help
an investor better understand these differences, and distinguish among
different firms in the marketplace, which in turn should assist the
investor in making an informed choice for the services that best suit
her particular needs and circumstances.
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\24\ Regulation Best Interest, Exchange Act Release No. 34-83062
(Apr. 18, 2018) (``Regulation Best Interest Proposal'').
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II. Form CRS Relationship Summary
We are proposing to require registered investment advisers and
registered broker-dealers to deliver a relationship summary to retail
investors. In the case of an investment adviser, initial delivery would
occur before or at the time the firm enters into an investment advisory
agreement with the retail investor; in the case of a broker-dealer,
initial delivery would occur before or at the time the retail investor
first engages the firm's services. Dual registrants would deliver the
relationship summary at the earlier of entering into an investment
advisory agreement with the retail investor or the retail investor
engaging the firm's services.\25\
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\25\ For purposes of the relationship summary, we propose to
define dual registrant as a firm that is dually registered as a
broker-dealer and an investment adviser and offers services to
retail investors as both a broker-dealer and investment adviser.
Proposed General Instruction 9.(b) to Form CRS. Accordingly, a firm
that is registered with the Commission as a broker-dealer and with
one or more states as an investment adviser would be a dual
registrant.
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The relationship summary would be as short as practicable (limited
to four pages or equivalent limit if in electronic format), with a mix
of tabular and narrative information, and contain sections covering:
(i) Introduction; (ii) the relationships and services the firm offers
to retail investors; (iii) the standard of conduct applicable to those
services; (iv) the fees and costs that retail investors will pay; (v)
comparisons of brokerage and investment advisory services (for
standalone broker-dealers and investment advisers); (vi) conflicts of
interest; (vii) where to find additional information, including whether
the firm and its financial professionals currently have reportable
legal or disciplinary events and who to contact about complaints; and
(viii) key questions for retail investors to ask the firm's financial
professional. Form CRS would be required by Form ADV Part 3 and rule
204-5 of the Advisers Act for investment advisers, and by Form CRS and
rule 17a-14 of the Exchange Act for broker-dealers.\26\
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\26\ We propose to amend Form ADV, which investment advisers
must file to register with the Commission and with state securities
regulators, to include a new Part 3: Form CRS that describes the
requirements for the relationship summary, and we propose conforming
technical amendments to the General Instructions of Form ADV. See
proposed amendments to Advisers Act rule 203-1; proposed amendments
to General Instructions to Form ADV. We also propose a rule 17a-14
to require a Form CRS for broker-dealers registered with the
Commission. See Exchange Act proposed rule 17a-14. Advisers use Form
ADV to apply for registration with us (Part 1A) or with state
securities authorities (Part 1B), and must keep it current by filing
periodic amendments as long as they are registered. See Advisers Act
rules 203-1 and 204-1. Form ADV has two parts. Part 1(A and B) of
Form ADV provides regulators with information to process
registrations and to manage their regulatory and examination
programs. Part 2 is a uniform form used by investment advisers
registered with both the Commission and the state securities
authorities. See Instruction 2 of General Instructions to Form ADV.
This release discusses the Commission's proposal of Form ADV Part 3:
Form CRS and related rules applicable to advisers registered with
the Commission. To the extent that state securities authorities
could consider making similar changes that affect advisers
registered with the states, we can forward comments to the North
American Securities Administrators Association (``NASAA'') for
consideration by the state securities authorities.
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We are proposing to define ``relationship summary'' as a written
disclosure statement that firms must provide to retail investors.\27\ A
``retail investor'' would be defined as a prospective or existing
client or customer who is a natural person (an individual).\28\ All
natural persons would be included in the definition, regardless of the
individual's net worth (thus including, e.g., accredited investors,
qualified clients or qualified purchasers).\29\ The definition would
[[Page 21420]]
include a trust or other similar entity that represents natural
persons, even if another person is a trustee or managing agent of the
trust.\30\ We believe that this definition is appropriate because
section 913 of the Dodd-Frank Act defines ``retail customer'' to
include natural persons and legal representatives of natural persons
without distinction based on net worth, and because financial literacy
studies report deficiencies in financial literacy among the general
population.\31\ While studies also report variability in financial
literacy among certain sub-sections of the general population,\32\ we
believe that all individual investors would benefit from clear and
succinct disclosure regarding key aspects of their advisory and
brokerage relationships.
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\27\ Proposed General Instruction 9.(d) to Form CRS.
\28\ Proposed General Instruction 9.(e) to Form CRS.
\29\ Advisers Act proposed rule 204-5(d)(2) and Exchange Act
proposed rule 17a-14(e)(2); proposed General Instruction 9.(e) to
Form CRS. We recognize that the definition of ``retail investor''
would differ from that of ``retail customer,'' as used in Regulation
Best Interest. ``Retail customer'' for broker-dealers under
Regulation Best Interest would be defined as ``a person, or the
legal representative of such person, who: (1) Receives a
recommendation of any securities transaction or investment strategy
involving securities from a broker, dealer or a natural person who
is an associated person of a broker or dealer, and (2) uses the
recommendation primarily for personal, family, or household
purposes.'' Regulation Best Interest Proposal, supra note 24,
section II.C.4. We believe it is beneficial to require firms to
provide a relationship summary to all natural persons to facilitate
their understanding of account choices, regardless of whether they
will receive investment advice primarily for personal, family, or
household purposes. The relationship summary is intended for an
earlier stage in the relationship between an investor and a
financial professional, potentially before discussing the investment
purposes of the investor. In contrast, Regulation Best Interest
focuses on recommendations to ``retail customers'' who have chosen
to engage the services of a broker-dealer after receiving the
relationship summary.
\30\ Advisers Act proposed rule 204-5(d)(2) and Exchange Act
proposed rule 17a-14(e)(2); proposed General Instruction 9.(e) to
Form CRS.
\31\ See Federal Research Division, Library of Congress,
Financial Literacy Among Retail Investors in the United States (Dec.
30, 2011), available at https://www.sec.gov/news/studies/2012/917-financial-literacy-study-part2.pdf (``Library of Congress Report'').
The Library of Congress Report is incorporated by reference into the
917 Financial Literacy Study, supra note 20, at Appendix 1.
\32\ See, e.g., 917 Financial Literacy Study, supra note 20, at
viii (``In addition, surveys demonstrate that certain subgroups,
including women, African-Americans, Hispanics, the oldest segment of
the elderly population, and those who are poorly educated, have an
even greater lack of investment knowledge than the average general
population.''); Library of Congress Report, supra note 31, at 1.
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As discussed further below, the relationship summary would be in
addition to, and not in lieu of, current disclosure and reporting
requirements for broker-dealers and investment advisers.\33\ The
relationship summary would alert retail investors to important
information for them to consider when choosing a firm and a financial
professional, and would prompt retail investors to ask informed
questions. In addition, the content of the relationship summary would
facilitate comparisons across firms that offer the same or
substantially similar services. We are promoting these goals through
specifying much of the content and presentation of Form CRS in the
form's instructions (``Instructions''); while firms will be required to
include firm-specific information in Form CRS, they will have limited
discretion in the scope and presentation of that information. We are
proposing that firms electronically file the relationship summary and
any updates with the Commission, and therefore such filings would be
subject to section 207 of the Advisers Act \34\ and section 18 of the
Exchange Act.\35\ Investment advisers would file on the Investment
Adviser Registration Depository (``IARD''), broker-dealers would file
on the Commission's Electronic Data Gathering, Analysis and Retrieval
System (``EDGAR''), and dual registrants would file on both IARD and
EDGAR.
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\33\ See infra Section II.C.
\34\ 15 U.S.C. 80b-7.
\35\ 15 U.S.C. 78r.
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To aid firms in understanding the type of disclosures we propose to
require, we have created mock-ups of a relationship summary for an
investment advisory firm, a brokerage firm, and a dual registrant, and
have included them as Appendices C-E to this release. The mock
relationship summaries are for illustrative purposes only, reflect the
business models of hypothetical firms, and are not intended to imply
that they reflect a ``typical'' firm. They do not provide a safe harbor
and, depending on the circumstances of a particular firm, a
relationship summary that merely copies the mock-ups may not provide
sufficient or accurate information about the firm, including for
purposes of meeting the firm's obligations under the antifraud
provisions of the federal securities laws. Investors seeking to comment
on the relationship summary may want to submit our short-form tear
sheet for providing feedback on the relationship summary, available at
Appendix F. Below we request comments on all requirements of the
relationship summary, including format, content, method of filing,
method of delivery, updating, and other aspects as discussed below.
We preliminarily believe that providing this information before or
at the time a retail investor enters into an investment advisory
agreement or first engages a brokerage firm's services, as well as at
certain points during the relationship (e.g., switching or adding
account types), as further discussed below, is appropriate and in the
public interest and will improve investor protection, and will deter
potentially misleading sales practices by helping retail investors to
make a more informed choice among the types of firms and services
available to them.\36\
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\36\ See Exchange Act section 15(l)(2) and Advisers Act section
211(h)(2) (providing that the Commission shall examine and, where
appropriate, promulgate rules prohibiting or restricting certain
sales practices, among other things, for brokers, dealers, and
investment advisers that the Commission deems contrary to the public
interest and the protection of investors).
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A. Presentation and Format
We are proposing requirements designed to make the relationship
summary short and easy to read. We believe that the required disclosure
provides an overview of information that would help retail investors
when choosing a firm, financial professional, and account type. The
proposed formatting requirements would help retail investors, many of
whom may not be sophisticated in legal or financial matters, to
understand the information in the relationship summary and be in a
better position to ask informed questions. The proposal is also
informed by our experience with the mutual fund summary prospectus,
which has illustrated the benefits of highlighting certain information
in summary form, coupled with layered disclosure and disclosure
designed to facilitate comparisons across investments.\37\ We encourage
firms to use innovative technology to create a relationship summary
that is user-friendly, concise, easy-to-read, and more interactive than
paper, and request comment below on ways to do so. The relationship
summary would be provided to retail investors in addition to, and not
in lieu of, any other required disclosures.\38\
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\37\ In a previous study, Commission staff found that most of
the retail investors agreed that it was important to read a summary
prospectus prior to investing in a mutual fund, and a majority of
the retail investors surveyed on the mutual fund summary prospectus
panel agreed that the actual summary prospectus they reviewed
highlighted important information, was well-organized, written using
words that they understood, clear and concise, and user friendly,
and agreed that summary prospectuses contain the `right amount' of
information. 917 Financial Literacy Study, supra note 20, at xvii
and xix.
\38\ See Proposed General Instruction 3 to Form CRS. Broker-
dealers and investment advisers have disclosure and reporting
obligations under state and federal law, and broker-dealers are also
subject to disclosure obligations under the rules of self-regulatory
organizations. Delivery of the relationship summary would not
necessarily satisfy a firm's other disclosure obligations.
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As noted in the General Instructions, the requirements of the
relationship summary are designed to promote effective communication
between the firm and its retail investors.\39\ First, as several
commenters have recommended, we propose requiring that firms use
``plain language'' principles for the organization, wording, and design
of the entire relationship summary, taking into consideration retail
investors' level of financial sophistication.\40\ Specifically,
[[Page 21421]]
firms would be required to be concise and direct and to use short
sentences, active voice, and definite, concrete, everyday words.\41\
Firms would not be permitted to use legal jargon, highly technical
business terms or multiple negatives.\42\ Firms should write the
relationship summary as if addressing the retail investor, using
``you,'' ``us,'' or ``our firm.'' \43\
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\39\ Proposed General Instruction 2 to Form CRS.
\40\ Proposed General Instruction 2 to Form CRS. See, e.g.,
PIABA 2017 Letter; State Farm 2017 Letter; Fidelity 2017 Letter;
Comment letter of BlackRock (Aug. 7, 2017); Comment letter of the
Investor Advisory Committee (Aug. 24, 2017); CFA 2017 Letter; AFR
2017 Letter; ACLI 2017 Letter; FSR 2017 Letter.
\41\ Proposed General Instruction 2 to Form CRS.
\42\ Proposed General Instruction 2 to Form CRS.
\43\ Proposed General Instruction 2 to Form CRS.
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Second, we are proposing to require that, whether in electronic or
paper format, the relationship summary should be no more than four 8\1/
2\ x 11 inch pages if converted to Portable Document Format (``PDF''),
using at least an 11 point font size, and margins of at least 0.75
inches on all sides.\44\ For example, if delivered directly in the text
of an email or in a mobile viewing format on the firm's website, the
content of the relationship summary should not exceed this four-page
PDF-equivalent length. This approach is consistent with our experience
and commenters' suggestion that brief disclosure is more effective than
a long-form narrative to focus retail investors on relevant
information, and with suggestions from commenters who advocated for a
clear, concise disclosure.\45\ If delivered in paper, the paper size,
font, and margin requirements would also encourage a clear presentation
for retail investors, for example, by presenting important disclosures
in a readable font-size and eliminating fine print.\46\ Recognizing,
however, that many firms deliver disclosures in electronic format and
employ a variety of technologies to interact with prospective and
existing retail investors, the Commission is requesting comment on
formatting and other features of the relationship summary in electronic
form.
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\44\ Proposed General Instruction 1.(c) to Form CRS.
\45\ See, e.g., Shaw 2017 Letter; SIFMA 2017 Letter; AFL-CIO
2017 Letter; AARP 2017 Letter; CFA 2017 Letter; AFR 2017 Letter;
TIAA 2017 Letter; Vanguard 2017 Letter; ACLI 2017 Letter; FSR 2017
Letter; Allianz 2017 Letter.
\46\ See, e.g., 917 Financial Literacy Study, supra note 20, at
xiii and 32.
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In the past, the Commission has declined to impose page limits on
disclosures required by the Investment Company Act of 1940
(``Investment Company Act''), including the summary prospectus,
expressing concern that page limits could constrain appropriate
disclosure and lead funds to omit material information about fund
offerings.\47\ The proposed relationship summary is intended to serve
different purposes than the summary prospectus, including to provide a
general overview of firms that could prompt a more detailed,
individualized, and open conversation between the retail investor and
his or her financial professional. The Commission preliminarily
believes that the utility and effectiveness of the relationship summary
lie in its brevity and conciseness; accordingly, we believe a page
limit (or equivalent limit if in electronic format) is appropriate.
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\47\ See Enhanced Disclosure and New Prospectus Delivery Option
for Registered Open-End Management Investment Companies, Investment
Company Act Release No. 28584 (Jan. 13, 2009) [74 FR 4546 (Jan. 26,
2009)], at 24 (``Enhanced Mutual Fund Disclosure Adopting
Release'').
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Brief disclosure would also facilitate a layered approach to
disclosure in which firms would include certain information in the
relationship summary, along with references and links to other
disclosure where interested investors can find additional
information.\48\ The proposed relationship summary also would encourage
retail investors to seek additional information in other ways,
including through suggested questions for retail investors to ask their
financial professional, as discussed further below.\49\ These
requirements are intended to create a concise summary that points out
relevant areas for retail investors to focus on as they consider
financial services, and the cross references and suggested questions
facilitate investors' ability to choose to seek additional information.
In addition, providing retail investors with a relationship summary
containing specified information about the firm in a standardized
format should aid retail investors' ability to compare firms at a
higher level. The suggested questions and cross references to more
information would enable them to more easily find and compare these
details about the firms.
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\48\ Firms would be required to include cross-references to
where investors could find additional information, such as in the
Form ADV Part 2 brochure and brochure supplement for investment
advisers or on the firm's website or in the account opening
agreement for broker-dealers. For electronic versions of the
relationship summary, we would require firms to use hyperlinks to
the cross-referenced document if it is available online. See
proposed Items 7.E.1. and 7.E.2. of Form CRS; proposed General
Instruction 1.(g) to Form CRS.
\49\ See proposed Item 8 of Form CRS.
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We considered requiring more detailed disclosure for broker-dealers
similar to many items in the Form ADV brochure that advisers currently
must deliver to clients. This longer disclosure would provide, for
example, more information about fee amounts for specific accounts and
products and more detailed descriptions of a wider range of conflicts
of interest. We believe, however, that brief disclosure that focuses on
the proposed topics would be more effective in capturing the attention
of retail investors, encouraging them to explore certain key areas
further, including by asking questions, and allowing them to make a
quick comparison among a number of options.\50\ We also encourage the
use of methods, such as embedded hyperlinks, to direct retail investors
to additional disclosures.
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\50\ See, e.g., 917 Financial Literacy Study, supra note 20, at
23-24 (citing CFA 2012 Letter, at 4-5).
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Alternatively, we considered shorter disclosure, such as a one-page
document (or equivalent length if in electronic format) that would
provide either a much abbreviated general description of a firm's
services, fees, and conflicts, or a list of suggested questions for
retail investors to discuss with their financial professional. We are
concerned, however, that these approaches might not provide retail
investors with enough information to compare firms and types of
accounts. In addition, we are concerned that providing only a list of
questions, without sufficient background information for investors to
know why the question is important to ask, could make it less likely
that investors would ask the questions or have an informed
conversation. Only providing questions also would not ensure a
standardized minimum of information that retail investors would receive
across firms and therefore would not facilitate comparing firms or
account types.
The relationship summary would require eight separate items
covering: (i) Introduction; (ii) relationships and services the firm
provides to retail investors; (iii) standard of conduct applicable to
those services; (iv) the fees and costs that retail investors will pay;
(v) comparisons of brokerage and investment advisory services (for
standalone broker-dealers and investment advisers); \51\ (vi) conflicts
of
[[Page 21422]]
interest; (vii) where to find additional information, including whether
the firm and its financial professionals currently have reportable
legal or disciplinary events and who to contact about complaints; and
(viii) key questions for retail investors to ask the firm's financial
professional.\52\ In order to promote comparison across firms, we would
require firms to present this information under prescribed headings in
the same order.\53\ Firms also would be prohibited from including any
information other than what the Instructions and the applicable item
require or permit.\54\ We believe that allowing only the required and
specified permitted information would promote consistency of
information presented to investors, allow retail investors to focus on
information that we believe would be particularly helpful in deciding
among firms, and help retail investors to decide what further
information is needed. It would also encourage impartial information by
preventing firms from adding information commonly used in marketing
materials, such as performance.\55\
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\51\ For purposes of the relationship summary, we propose to
define a standalone investment adviser as a registered investment
adviser that offers services to retail investors and (i) is not
dually registered as a broker-dealer or (ii) is dually registered as
a broker-dealer but does not offer services to retail investors as a
broker-dealer. We propose to define a standalone broker-dealer as a
registered broker-dealer that offers services to retail investors
and (i) is not dually registered as an investment adviser or (ii) is
dually registered as an investment adviser but does not offer
services to retail investors as an investment adviser. Proposed
General Instruction 9.(f) to Form CRS. We are including certain dual
registrants in these proposed definitions because we understand that
dual registrants do not always offer both brokerage and advisory
accounts to retail investors. For example, some dual registrants
offer advisory accounts to retail investors, but offer brokerage
broker-dealer services only to institutions (e.g., for their
underwriting services).
\52\ See proposed Items 1-8 of Form CRS.
\53\ Proposed General Instruction 1.(b) and (e) to Form CRS. See
also e.g., proposed Items 2.A., 3.A., 4.A., 5.A. and 5.B., 6.A.,
7.A., and 8 of Form CRS.
\54\ Proposed General Instruction 1.(d) to Form CRS.
\55\ Although performance disclosure is a subject on which the
Commission focuses, including to promote accuracy, consistency, and
comparability, such disclosure is not the subject of this
initiative.
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For certain items, firms will have some flexibility in how they
include the required information.\56\ For others, we are requiring
firms to use prescribed wording, as discussed in the following
sections. Firms may not include disclosure in the relationship summary
other than disclosure that is required or permitted by the
Instructions. We believe that this approach balances the need to
provide firms flexibility in making the presentation of information
consistent with their particular business model while ensuring that all
investors receive certain information regardless of the firm. The
information in the relationship summary must accurately reflect the
characteristics of the particular firm and the services that it offers.
Accordingly, all information in the relationship summary must be true
and may not omit any material facts necessary to make the required
disclosures not misleading.\57\ If a statement is inapplicable to a
firm's business or would be misleading to a reasonable retail investor,
the firm may omit or modify that statement.\58\
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\56\ See, e.g., proposed General Instruction 1.(f) to Form CRS
(``You may use charts, graphs, tables, and other graphics or text
features to explain the required information, so long as the
information (i) is responsive to and meets the requirements in these
instructions (including space limitations); (ii) is not inaccurate
or misleading; and (iii) does not, because of the nature, quantity,
or manner of presentation, obscure or impede understanding of the
information that must be included. When using interactive graphics
or tools, you may include instructions on their use and
interpretation.''); proposed Items 2.B., 2.C., and 6.B. of Form CRS.
\57\ Firms should keep in mind the applicability of the
antifraud provisions of the federal securities laws, including
section 206 of the Advisers Act, section 17(a) of the Securities
Act, and section 10(b) of the Exchange Act and rule 10b-5
thereunder, in preparing the relationship summary.
\58\ See proposed General Instruction 3 to Form CRS. Firms may
omit or modify prescribed wording or other statements required to be
part of the relationship summary if such statements are inapplicable
to a firm's business or would be misleading to a reasonable retail
investor.
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Based on studies that indicate the effectiveness of graphical
presentation for retail investors,\59\ we are prescribing the use of
graphical formats in specified circumstances. For example, dual
registrants would be required to present all of the information
required by Items 2 through 4 and Item 6 in a tabular format,\60\
comparing advisory services and brokerage services side-by-side, with
prescribed headings.\61\ Similarly, standalone broker-dealers and
investment advisers would be required to provide general information
about fee types in tabular format, in a separate comparison
section.\62\ All firms would be permitted to use charts, graphs,
tables, and other graphics or text features to explain the information,
so long as the information is responsive to and meets the requirements
in the Instructions (including the space limitations).\63\ The use of a
graphical presentation would be prohibited if it is inaccurate or
misleading or, because of its nature, quantity, or manner of
presentation, obscures or impedes understanding of the information that
is required to be included. Firms that choose to use interactive
graphics or tools may include Instructions on their use and
interpretation.\64\ We believe that standardizing the relationship
summaries among firms by specifying the headings, sequence, and content
of the topics; prescribing language for firms to use as applicable; and
limiting the length of the relationship summary will provide
comparative information in a user-friendly manner that helps retail
investors with informed decision-making.\65\
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\59\ See 917 Financial Literacy Study, supra note 20, at iv, xx,
21-22; see also Benbasat & Dexter, infra note 592.
\60\ Empirical evidence suggests that visualization improves
individual perception of information (see Hattie, infra note 591)
and that tabular reports may lead to better decision making (see
Benbasat & Dexter, infra note 592).
\61\ Dual registrants must present the information in Items 2
through 4 and Item 6 in a tabular format, comparing advisory
services and brokerage services side-by-side. In the column
discussing brokerage services, firms must include the heading
``Broker-Dealer Services'' and the sub-heading ``Brokerage
Accounts.'' In the column discussing investment advisory services,
firms must include the heading ``Investment Adviser Services'' and
the sub-heading ``Advisory Accounts.'' See proposed General
Instruction 1.(e) to Form CRS.
\62\ Standalone broker-dealers and investment advisers would be
required to include the sub-heading ``You can receive advice in
either type of account, but you may prefer paying:'' and present
prescribed information comparing a transaction-based fee and an
asset-based fee in side-by-side columns, in a tabular format. See
proposed Items 5.A.4. and 5.B.6. of Form CRS.
\63\ Proposed General Instruction 1.(f) to Form CRS.
\64\ Id.
\65\ Empirical evidence suggests that users are better able to
make coherent, rational decisions when they have comparative,
standardized disclosure that allows them to assess relevant trade-
offs. See infra note 593 and accompanying text.
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We request comment on the following for the relationship summary.
Should firms only be required to deliver the relationship
summary to retail investors? Or should they be required to deliver one
to other types of investors, too, such as individuals representing sole
proprietorships or other small businesses, or institutional investors
that are not natural persons, including workplace retirement plans and
funds? Would such investors have the need for the information in the
relationship summary to facilitate a choice among different firms,
financial professionals, and account types? Or would these investors
rely directly on the more detailed disclosures in the Form ADV Part 2
brochure or pursuant to Regulation Best Interest?
Should retail investors be defined for purposes of Form
CRS to include all natural persons, as proposed? Should we instead
exclude certain categories of natural persons based on their net worth
or income level, such as accredited investors,\66\ qualified
clients,\67\ or
[[Page 21423]]
qualified purchasers? \68\ If we did exclude certain categories of
natural persons based on their net worth, what threshold should we use
for measuring net worth? Should we exclude certain categories of
natural persons for other reasons?
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\66\ Accredited investors include natural persons who (i) have a
net worth over $1 million, either individually or together with a
spouse (excluding the value of the primary residence); (ii) had an
individual income greater than $200,000 (or $300,000 together with a
spouse) in each of the two most recent years, and has a reasonable
expectation of reaching the same income level in the current year;
or (iii) for purposes of a securities offering of a particular
issuer, are directors, executive officers, or general partners of
that issuer. Accredited investors also include non-natural persons,
such as, banks, broker-dealers, insurance companies, investment
companies registered under the Investment Company Act of 1940, and
certain partnerships, corporations, nonprofit entities, retirement
plans, and trusts. 17 CFR 230.501.
\67\ A qualified client is a client that meets one or more of
the following criteria: (i) Is a natural person or company that has
at least $1 million in assets under management with the adviser
immediately after entering into an investment advisory contract with
the adviser; (ii) the adviser reasonably believes the natural person
has a net worth (together with assets held jointly with a spouse) of
more than $2.1 million immediately prior to entering into an
advisory contract (excluding the value of the primary residence);
(iii) the adviser reasonably believes the natural person or company
is a ``qualified purchaser'' as defined in section 2(a)(51)(A) of
the Investment Company Act at the time an advisory contract is
entered into; (iv) is an executive officer, director, trustee,
general partner, or person serving in a similar capacity, of the
adviser; or (v) is an employee of the adviser who participates in
the investment activities of the adviser, and has performed
investment activities for at least twelve months. The dollar
thresholds under the definition of qualified client are subject to
inflation adjustments every five years. 17 CFR 275.205-3(d)(1);
Order Approving Adjustment for Inflation of the Dollar Amount Tests
in Rule 205-3 under the Investment Advisers Act of 1940, Investment
Advisers Act Release No. 4421 (Jun. 14, 2016) [81 FR 39985 (Jun. 20,
2016)].
\68\ The term ``qualified purchaser'' has been defined for
purposes of the Investment Company Act and for the Securities Act.
Under the Investment Company Act, the term ``qualified purchaser''
includes any natural persons who or certain family-owned companies
that own not less than $5 million in investments; certain trusts;
and any person, acting for its own account or the accounts of other
qualified purchasers, who in the aggregate owns and invests on a
discretionary basis, not less than $25 million in investments. 15
U.S.C. 80a-2(a)(51)(A).
For purposes of section 18(b)(3) of the Securities Act, the
term ``qualified purchaser'' means any person to whom securities are
offered or sold pursuant to a Tier 2 offering as defined in
Regulation A. 17 CFR 230.256. Tier 2 offerings generally may be sold
only to (i) accredited investors; (ii) natural persons for whom the
aggregate purchase price to be paid by the purchaser for the
securities is no more than 10% of the purchaser's annual income or
net worth; or (iii) non-natural persons for which the aggregate
purchase price to be paid by the purchaser for the securities is no
more than 10% of its revenue or net assets for the most recently
completed fiscal year. 17 CFR 230.251.
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Should we conform the definition of retail investor to the
definition of retail customer as proposed in Regulation Best Interest,
which would include non-natural persons who use the recommendation
primarily for personal, family, or household purposes? Should the
definition of retail investor include trusts or similar entities that
represent natural persons, as proposed? Are there other persons or
entities that should be covered? Should we expand the definition to
cover plan participants in workplace retirement plans who receive
services from a broker-dealer or investment adviser for their
individual accounts within a plan?
Should we include any additional definitions of terms or
phrases in the relationship summary? Should we omit any definitions we
have proposed for the relationship summary? Should any of the proposed
definitions be changed? If so, why?
Will the length and presentation proposed for the
relationship summary be effective for retail investors? Are there other
approaches we should consider? What are the benefits and drawbacks of
shorter or longer disclosure for retail investors relative to the
proposed approach?
We are proposing that the relationship summary discuss all
of the firm's advisory and brokerage services in one relationship
summary. Should we instead permit firms to prepare a separate
relationship summary for different business lines or different programs
or types of accounts and/or services that a broker-dealer or investment
adviser offers? If we adopt such an approach, how could we modify the
requirements to allow for comparison among account options within and
across firms? For example, should we require that each such separate
summary refer to the other summaries and include hyperlinks or other
electronic features if presented on a firm's website? Should we require
the use of hyperlinks that direct the investor directly to specific
disclosure (i.e., a ``deep link'') or a more general landing page? How
would delivery obligations be formulated to ensure that retail
investors receive sufficient but still user-friendly information?
In the alternative, should we permit or require firms to
prepare one relationship summary for the entire affiliated group or
firm complex, i.e., to summarize the services offered to retail
investors of all affiliated companies together in a single relationship
summary? What factors should dictate whether affiliates should be
permitted or required to prepare a single relationship summary? For
example, should we base any permissive instruction or requirement on
whether the affiliates typically market services of multiple investment
advisers and broker-dealer entities together? What about investment
advisers and broker-dealers that are not affiliates but have
partnership agreements, are part of one wrap fee program,\69\ or other
arrangements? Should they be required or permitted to cross-reference
to other firms?
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\69\ A wrap fee program would be defined as an advisory program
under which a specified fee or fees not based directly upon
transactions in a retail investor's account is charged for
investment advisory services and the execution of retail investor
transactions. Proposed General Instruction 9.(g) to Form CRS. See
infra note 173.
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Should we permit the relationship summary, or any part of
it, to substitute for other disclosure obligations that broker-dealers
or investment advisers have, if the disclosure obligations overlap? If
so, for what disclosures could the relationship summary substitute? If
not, why not?
Does the proposal sufficiently encourage electronic design
and delivery? Are there other ways we can modify the requirements to
make clear that paper-based delivery is not the only permissible or
desired delivery format?
With respect to firms that use paper delivery to meet
investor preferences, are the proposed presentation and content
requirements appropriate for a relationship summary provided in paper
or in PDF (e.g., 11 point font, and have margins of at least 0.75
inches on all sides)? Would they be helpful in encouraging relationship
summaries that address retail investors' preferences for concise and
user-friendly information? If not, what requirements would improve the
document's utility and accessibility for retail investors? In
particular, are there any areas where requiring the use of a specific
check-the-box approach, bullet points, tables, charts, graphs or other
graphics or text features would be helpful in presenting any of the
information or making it more engaging to retail investors? Should we
include different requirements for font size, margins and paper size?
Should we restrict certain types or sizes of font, color choices or the
use of footnotes?
Are there special technical specifications we should
consider for other forms of electronic or online delivery on phones,
tablets and other devices, and for information conveyed via videos,
interactive graphics, or tools and calculators? Are the Instructions to
the relationship summary sufficiently flexible to permit delivery on
phones, tablets and other devices and to accommodate information
conveyed via videos, interactive graphics, or tools and calculators?
Should we require that firms make the relationship summary available by
specific forms of electronic delivery or certain electronic devices?
How can the Commission encourage investment advisers and broker-dealers
to make fuller use of innovative technology to enable more interactive,
user-friendly relationship summary disclosure, while still creating a
short, easy-to-read relationship summary that includes the proposed
content? Are there potential tools that the Commission should encourage
or require firms to use in order to make
[[Page 21424]]
their disclosures more interactive and understandable? For instance,
should we permit or require a firm to use pop-ups or hovers to provide
retail investors with additional information required or permitted by
the relationship summary, without retail investors having to scroll to
find the information in another section of the relationship summary?
Would this tool be useful for firms to use, for example, in the
Introduction section of the relationship summary, so that a retail
investor could access upfront additional information about the terms
used (advisory and brokerage accounts) that is presented in other
sections of the relationship summary? Instead of requiring and
permitting hyperlinks in certain circumstances (e.g., to link to an
adviser's Form ADV or a fee schedule), are there other technological
tools that would better help an investor find information that is
cross-referenced in the relationship summary? Should we permit or
require other technologies (such as QR codes \70\) in addition to or in
lieu of hyperlinks to connect to such information?
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\70\ A QR code is a two-dimensional barcode capable of encoding
information such as a website address, text information, or contact
information. These codes are becoming increasingly popular in print
materials and can be read using the camera on a smartphone.
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Would retail investors be more likely to read a firm's
relationship summary if we required or permitted firms to use certain
design elements--such as larger font sizes or greater use of white
space, colors, or visuals? Could this be accomplished while still
providing retail investors with the information we are proposing to
require in a short and easy-to-read relationship summary?
We are proposing that the firm use plain language
principles and the Instructions refer to the SEC's Plain English
Handbook. Should we modify any of these principles? Should the
Instructions refer to any other principles to promote understandable
wording?
Do firms commonly market to non-English speakers or
provide information--including marketing materials--in languages other
than English? To what extent would firms expect to deliver a
relationship summary in a language other than English? Should we
propose requirements to prepare relationship summaries in languages
other than English? For example, should we require that firms prepare,
file, and deliver a relationship summary in any language in which they
disseminate marketing materials? Are there concerns with translating
the relationship summary without also having to translate the firm's
other disclosures? If so, what are those concerns?
Should we limit the relationship summary to four pages (or
equivalent limit if in electronic format), as proposed? Is this enough
space for firms to provide meaningful information? Should we instead
eliminate page limits (and their equivalent for electronic format) or
increase the amount of permitted pages or their equivalent? Are there
particular items that may require longer responses than others? If so,
how should the Commission take these into account in considering page
limits? For example, if commenters believe the use of graphics will be
more effective to communicate fees, should we permit a greater number
of pages to account for the use of graphics? Conversely, will retail
investors read four pages? Should the page limit be shorter, such as
one to three pages? If so, what information in the proposed
requirements should we omit? Should we have different page limits for
dual registrants than for firms that offer only brokerage or only
advisory services? If we do require shorter disclosure, what
information should firms be required to provide regardless of the
length?
Are there too few or too many items that would be required
in the relationship summary? Are there other items that we should also
require or proposed items that we should delete? Do commenters agree
that we should only permit the items required by the relationship
summary? Is there other information that we should permit, but not
require, firms to include? If so, what items are those?
Do commenters agree that all items should be presented in
the same order under the same heading to promote comparability across
firms? Why or why not? If the items are not listed in the same order,
could retail investors still easily compare firm relationship
summaries? Does the prescribed order work, or should we consider a
different order? Is there information that we should always require to
appear on the first page or at the beginning of an electronic
relationship summary? Are there any specifications we should include to
enhance comparability for electronic delivery of the relationship
summary in various forms?
Should we, as proposed, prescribe headings for each item
or allow firms to choose their own headings? Should we require or
permit a different style of headings, such as a question and answer
format or other wording to encourage retail investors to continue
reading?
Should we permit firms to include additional disclosure
with the relationship summary, such as a comprehensive fee table, or
other disclosures? Would the inclusion of additional disclosures affect
whether retail investors would view the relationship summary? What are
the benefits and drawbacks of such an approach?
Should we generally permit firms to use charts, graphs,
tables, and/or other graphics or text features to explain the
information required by the relationship summary (so long as any such
feature meets requirements as specified in the Instructions), as
proposed? Should we permit firms to choose the graphical presentation
that they will use? Are there specific graphical presentations that we
should require? Should we permit other mediums of presentation, such as
the use of video presentations?
Do any elements of the proposed presentation requirements
impose unnecessary costs or compliance challenges? Please provide
specific data. Are there any changes to the proposal that could lower
those costs? Please provide examples.
Are the mock relationship summaries useful and
illustrative of the proposed form requirements? Do they appropriately
show the level of detail that firms might provide?
With respect to each item for which we prescribe wording in the
relationship summary, we request the following comment on each of those
required disclosures:
Does the narrative style work for the prescribed wording
or are there other presentation formats that we should require? Should
the Commission instead require more prescribed wording? Conversely, is
there prescribed wording we have proposed that we should modify or
replace with a more general instruction that allows firms to use their
own description?
B. Items
1. Introduction
We are proposing that the beginning of the relationship summary
contain a title highlighting the types of investment services and
accounts the firm offers to retail investors, specifically ``Which Type
of Account is Right for You--Brokerage, Investment Advisory or Both?''
for dual registrants and ``Is a[n] [Brokerage/Investment Advisory]
Account Right for You?'' for standalone brokerage firms or investment
advisory firms, respectively.\71\ A firm also would be required to
include its name, whether it is registered with the Commission as a
broker-dealer, investment adviser, or
[[Page 21425]]
both, and date of the relationship summary prominently on the first
page or beginning of the electronic disclosure (this information could
be included in the header or footer).\72\
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\71\ Proposed Items 1.B., 1.C. and 1.D. of Form CRS.
\72\ Proposed Item 1.A. of Form CRS. The disclosure of
Commission registration would make the relationship summary
consistent with proposed rules 15l-3 of the Exchange Act and 211h-1
of the Advisers Act, which would require that a broker-dealer and a
registered investment adviser prominently disclose that it is
registered with the Commission as a broker-dealer or investment
adviser, respectively, in print or electronic retail investor
communications.
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An introductory paragraph would briefly explain the types of
accounts (brokerage accounts and/or investment advisory accounts) and
services the firm offers. Using prescribed wording, all firms would be
required to state: ``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.'' In a new paragraph and using
prescribed wording and bold font, a standalone broker-dealer would be
required to state: ``We are a broker-dealer and provide brokerage
accounts and services rather than advisory accounts and services.''
\73\ Likewise, a standalone investment adviser would be required to
state in bold font: ``We are an investment adviser and provide advisory
accounts and services rather than brokerage accounts and services.''
\74\ Dual registrants would include a similar statement in bold font
that discusses both types of services, specifically: ``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.'' \75\ Finally, all firms would be required to include:
``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 [ ].'' \76\
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\73\ Proposed Item 1.B. of Form CRS.
\74\ Proposed Item 1.C. of Form CRS.
\75\ Proposed Item 1.D. of Form CRS.
\76\ Proposed Items 1.B.--1.D. of Form CRS.
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The proposed introductory paragraph sets up a key theme of the
relationship summary--helping retail investors to understand and make
choices among account types and services. For example, some retail
investors want to receive periodic recommendations while others prefer
ongoing advice and monitoring. Some retail investors wish to pursue
their own investment ideas and direct their own transactions, while
others seek to delegate investment discretion to the firm. Emphasizing
that there are different types of accounts and services from which a
retail investor may choose would help the retail investor make an
informed choice about whether the firm provides services that are the
right fit for his or her needs and help the retail investor to choose
the right firm or account type. Although the disclosures are
intentionally simplified and generalized, we believe they would help
retail investors to obtain more detailed information.
We request comment generally on the proposed requirement for firms
to include specific information in the introduction.
In addition to the title, firm name and SEC registration
status, and date, is there other information that we should require at
the beginning of the relationship summary? Should we instead require a
cover page? Are the titles we proposed in the Instructions appropriate?
What alternatives should we consider? Should we allow firms to select
their own title for the relationship summary?
Should we require firms to include the prescribed wording,
as proposed, or should we allow more flexibility in the words they use?
Should we modify the prescribed wording? Does the proposed wording
capture the range of business models among investment advisers and
broker-dealers? Would the prescribed wording require a firm to provide
any inaccurate information given that firm's circumstances? Instead of
the proposed prescriptive wording, should the Commission permit or
require a more open-ended narrative?
Is there additional information we should require in the
introduction?
Should we require that standalone brokerage and investment
advisory firms include a statement that the retail investor may instead
prefer investment advisory or brokerage services, respectively? Why or
why not?
2. Relationships and Services
After the introduction, the proposed relationship summary would
provide information about the relationships between the firm and retail
investors and the investment advisory account services and/or brokerage
account services the firm provides to retail investors.\77\ The section
would begin with the heading ``Relationships and Services'' for a
standalone broker-dealer or investment adviser.\78\ A dual registrant
would use the heading ``Types of Relationships and Services,'' followed
by this statement: ``Our accounts and services fall into two
categories.'' \79\ Each firm would discuss specific information about
the nature, scope, and duration of its relationships and services,
including the types of accounts and services the firm offers, how often
it offers investment advice, and whether the firm monitors the account.
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\77\ Proposed Item 2 of Form CRS.
\78\ Proposed Item 2.A. of Form CRS.
\79\ Id.
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This item requires firms to provide specific information with a mix
of prescribed wording and short narrative statements. As discussed
above, if a prescribed statement is not applicable to the firm's
business or would be misleading to a reasonable retail investor, the
firm would be permitted to omit or modify that statement.\80\ We have
designed these requirements to provide retail investors with
consistent, concise, and meaningful information about the services they
would receive from a firm and help them to ask relevant questions,
compare firms' services against each other, and make more informed
choices about the services they choose.
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\80\ See supra note 58 and accompanying text.
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We considered an approach whereby firms would be required to
complete a prescribed checklist of common characteristics of brokerage
and advisory accounts, indicating which characteristics applied to
their accounts and services. This approach could improve comparability
among firms. We are concerned, however, that this approach would not be
sufficiently flexible to accommodate the variety of business models and
services that broker-dealers and advisers provide, and that a mix of
prescribed wording and narrative format would help investors better
understand the firm's services. We believe that our proposed approach
provides enough information to help retail investors understand and
choose between investment advisory accounts and brokerage accounts
without overwhelming them with too much information.
Brokerage Account Services. We propose requiring broker-dealers to
summarize the principal brokerage services that they provide to retail
investors.\81\ First, broker-dealers would include the following
wording to explain the transaction-based nature of their fees (emphasis
required): ``If you open a brokerage account, you will pay us a
transaction-based fee, generally referred to as a commission, every
time you buy or sell an investment.'' \82\ Even though a separate
section of the relationship summary would discuss a firm's fees, we
believe it is important for broker-dealers to explain transaction-based
fees at the beginning of the
[[Page 21426]]
disclosure because these types of fees are typically a critical
distinction between brokerage and investment advisory accounts.\83\
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\81\ Proposed Item 2.B. of Form CRS.
\82\ Proposed Item 2.B.1. of Form CRS.
\83\ See infra note 126 (discussing our use of the term
``transaction-based fees'' in the relationship summary).
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Next, broker-dealers that offer accounts in which they offer
recommendations to retail investors would state that the retail
investor may select investments or the broker-dealer may recommend
investments for the retail investor's account, but that the retail
investor will make the ultimate investment decision regarding the
investment strategy and the purchase or sale of investments.\84\
Broker-dealers that offer accounts in which they do not offer
recommendations to retail investors (e.g., execution-only brokerage
services) would state that the retail investor will select the
investments and make the ultimate investment decision regarding the
investment strategy and the purchase or sale of investments.\85\
Starting with a clear description of the services provided in a
brokerage account by a broker-dealer--including the retail investor's
choice of receiving recommendations or self-directing his or her
investments, and the fact that the retail investor will make the
ultimate investment decision--would help address confusion about the
services that broker-dealers offer to retail investors.\86\ This
language also highlights differences from the services that investment
advisers would describe, discussed below.
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\84\ Proposed Item 2.B.2. of Form CRS.
\85\ Id.
\86\ We believe that retail investors have the ultimate
investment decision for their investment strategy and the purchase
or sale of investments, even if the broker-dealer has temporary or
limited discretion over retail investors' accounts. See Regulation
Best Interest Proposal, supra note 24, at section II.F.
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Next, we propose requiring broker-dealers to state if they offer
additional services to retail investors, including, for example: (a)
Assistance with developing or executing the retail investor's
investment strategy (e.g., the broker-dealer discusses the retail
investor's investment goals or designs with the retail investor a
strategy to achieve the retail investor's investment goals); or (b)
monitoring the performance of the retail investor's account.\87\ They
would also state that a retail investor might pay more for these
additional services, if applicable.\88\ Broker-dealers that offer
performance monitoring as part of the standard brokerage account
services would indicate how frequently they monitor the
performance.\89\ While broker-dealers do not undertake to provide
investment strategy and performance monitoring services when they give
recommendations, we recognize that many broker-dealers offer these
services to retail investors as part of their account agreement. We
believe that retail investors would benefit from disclosure that such
services exist, and that broker-dealers might charge higher fees for
these services. Broker-dealers would also be required to briefly
describe any regular communications they have with retail investors,
such as providing account statements, giving an overview of
transactions during a period, or evaluating the account's
performance.\90\ Firms would include the frequency (e.g., at least
quarterly) and the method (e.g., by email, phone or in person) of the
communications.\91\
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\87\ Proposed Item 2.B.3. of Form CRS.
\88\ Id.
\89\ Id. Broker-dealers that monitor the performance of the
retail investor's account, as market and customer conditions demand
(rather than on a specific time schedule), could state so.
\90\ Id.
\91\ Id. We are proposing the same requirement for investment
advisers, described below. See infra note 102 and accompanying text.
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Finally, broker-dealers would be required to include the following
if they significantly limit the types of investments available to
retail investors in any accounts: ``We offer a limited selection of
investments. Other firms could offer a wider range of choices, some of
which might have lower costs.'' \92\ A broker-dealer would
significantly limit the types of investments if, for example, the firm
only offers one type of asset (e.g., mutual funds, exchange-traded
funds, or variable annuities), the firm only offers mutual funds or
other investments sponsored or managed by the firm or its affiliate
(i.e., proprietary products), or the firm only offers a small choice of
investments.\93\ In addition, if the limitations only apply to some of
the accounts the firm offers, such as, for example, limiting the types
of investments for retail investors within different asset tiers, then
the firm would have to identify those accounts.\94\
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\92\ Proposed Item 2.B.4. of Form CRS.
\93\ Id.
\94\ Id.
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Limitations on investments offered could have a significant effect
on investor choice and performance of the account over time. In
particular, firms that offer proprietary products exclusively preclude
investor access to competing products that could offer lower fees or
result in better performance over time. As a result, retail investors
should understand these limitations before they enter into a
relationship with a firm.
Advisory Account Services. We propose requiring investment advisers
that offer investment advisory accounts to retail investors to
summarize the principal investment advisory services provided to retail
investors.\95\ First, investment advisers would be required to state
the type(s) of fee they receive as compensation if a retail investor
opens an investment advisory account.\96\ For example, an investment
adviser would state if it charges an on-going asset-based fee based on
the value of the cash and investments in the advisory account, a fixed
fee, or some other fee arrangement. A standalone adviser would also
state how frequently it assesses the fee.\97\ Similar to the
requirement for broker-dealers,\98\ we are proposing to require a
statement about how investment advisers charge fees up-front because of
the importance that investors understand how they will pay for services
and to highlight this critical distinction between brokerage and
advisory accounts. We are proposing to require that firms describe
additional fees associated with these services in the discussion of
fees and costs. Because the fees charged by each investment adviser may
differ, we are not prescribing specific wording and instead are
allowing firms flexibility in choosing the exact wording to use for
this disclosure. Advisers would, however, emphasize the type of fee in
bold and italicized font.\99\
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\95\ Proposed Item 2.C. of Form CRS.
\96\ Proposed Item 2.C.1. of Form CRS. The relationship summary
would refer to ``account advisory services'' and ``opening an
account'' to simplify the explanations for retail investors. When an
investment adviser provides investment advisory services, the client
may have a custodial account with another firm, such as a broker-
dealer or bank. A dual registrant may maintain custody for an
advisory client's assets as broker-dealer. We are not proposing to
require that firms include these nuances in the discussion of
relationships and services.
\97\ Id.
\98\ See supra note 82 and accompanying text.
\99\ Proposed Item 2.C.1 of Form CRS.
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Next, investment advisers would state that they offer advice on a
regular basis, or, if they do not offer advice on a regular basis, they
would state how frequently they offer advice.\100\ They would also
state the services they offer to retail investors including, for
example, (a) assistance with developing the retail investor's
investment strategy (e.g., the investment adviser discusses the retail
investor's investment goals or designs with the retail investor a
strategy to achieve the retail investor's investment goals), or (b) how
frequently
[[Page 21427]]
they monitor the retail investor's accounts.\101\ Similar to broker-
dealers, advisers would include the frequency (e.g., at least
quarterly) and the method (e.g., by email, phone or in person) of the
communications.\102\ We believe that the regularity of advice and other
services that investment advisers commonly provide, including, as
applicable--discussions with the retail investor, designing a strategy
to achieve investment goals, monitoring, and reporting on performance--
are key aspects of services that advisers commonly provide.\103\ As
discussed above with respect to broker-dealers, these services can
distinguish advisory accounts from brokerage accounts and therefore the
disclosure will help retail investors determine which type of account
best suits their needs.
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\100\ Proposed Item 2.C.2. of Form CRS.
\101\ Id.
\102\ Id.
\103\ An agreement for advisory services typically defines the
scope and specific types of services provided.
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Additionally, investment advisers would state if they offer
advisory accounts for which they exercise investment discretion (i.e.,
discretionary accounts), accounts for which they do not exercise
investment discretion (i.e., non-discretionary accounts), or both.\104\
For purposes of this Item in the relationship summary, investment
advisers generally should use the same definition of ``discretionary
authority'' as in Form ADV, which is the authority to decide which
securities to purchase and sell for the client, or the authority to
decide which investment advisers to retain on behalf of the
client.\105\ If an investment adviser offers a discretionary account,
the relationship summary would state that a discretionary advisory
account allows the firm to buy and sell investments in the retail
investor's account, without asking the retail investor in advance. For
a non-discretionary advisory account, the relationship summary would
state that the firm gives advice and the retail investor decides what
investments to buy and sell.\106\
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\104\ Proposed Item 2.C.3. of Form CRS. Investment advisers
would be required to emphasize the type of account (discretionary
and non-discretionary) in bold and italicized font.
\105\ Term 12 of Glossary of Terms to Form ADV.
\106\ Proposed Item 2.C.3. of Form CRS.
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We believe it is important for retail investors considering an
advisory account to understand the difference between discretionary
services and non-discretionary services, as that distinction would
affect the degree of control the retail investor would provide to the
adviser. Discretionary advice is also a common feature of many
investment advisory accounts,\107\ so explaining discretion would
benefit a retail investor in choosing between brokerage and investment
advisory services, as well as between different types of advisory
accounts.
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\107\ In 1992, only approximately three percent of SEC-
registered advisers had discretionary authority over client assets;
as of March 31, 2018, according to data collected on Form ADV, 91
percent of SEC-registered advisers have that authority.
---------------------------------------------------------------------------
Finally, as we are proposing for broker-dealers, investment
advisers that significantly limit the types of investments available to
retail investors in any accounts would include the same statement that
broker-dealers would be required to include, and if such limits only
apply to certain accounts, the investment adviser would identify those
accounts, for the same reasons discussed above.\108\
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\108\ Proposed Item 2.C.4. of Form CRS. The required statement
would be ``Our investment advice will cover a limited selection of
investments. Other firms could provide advice on a wider range of
choices, some of which might have lower costs.'' Also consistent
with the requirements for broker-dealers, such limitations could
include, for example, only offering a selection of mutual funds,
equities, or proprietary products.
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Affiliate Services. We recognize that many investment advisers and
broker-dealers that are not dual registrants nonetheless have
affiliates that are broker-dealers or investment advisers,
respectively. Often, these standalone firms offer their affiliates'
services to retail investors. For example, an affiliated sub-adviser
also may manage a portion of a retail investor's portfolio or an
investment adviser may effect trades for client accounts through an
affiliated broker-dealer. We would allow these firms to state that they
offer retail investors their affiliates' brokerage or advisory
services, as applicable.\109\ We believe that the inclusion of this
disclosure could make clear the choice investors have within affiliated
firms and give financial professionals an opportunity to discuss these
services.
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\109\ Proposed Item 2.D. of Form CRS. This disclosure only
applies in the context of an affiliate of the firm. This is not
intended to describe disclosure of a financial professional's
outside business activities, such as an outside investment advisory
business of a broker-dealer registered representative.
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We request comment generally on the proposed requirement for firms
to include specific information about the relationships and services
offered in their advisory and brokerage accounts.
Would the proposed summary of relationships and services
help retail investors to make informed choices about whether investment
advisory or brokerage services better suit their needs? If not, how
should we revise it?
Would the proposed requirements result in disclosure that
is clear, concise, and meaningful to retail investors? Would this
information help retail investors to better understand the general
differences in the services that investment advisers and broker-dealers
provide? Are there other differences in the services provided by
investment advisers and broker-dealers that we should require firms to
discuss in this section? If so, should we permit or require information
about those differences in the summary of services? Are there any
common misconceptions about services provided by broker-dealers,
investment advisers, or dual registrants that the relationship summary
should specifically seek to clarify or correct?
Would more or less information about a firm's services be
helpful for retail investors? Are there any elements of the proposed
requirements that firms should or should not include? If so, why?
Should any of the required disclosures be included in a different
section of the relationship summary? Is the proposed order of the
information appropriate, or should it be modified? If so, how should it
be modified? Should we allow firms the flexibility to present this
information in a different order if doing so makes their relationships
and services more understandable to retail investors?
Is the proposed heading and the introductory wording for
firms clear and useful to retail investors? Are there alternative
headings we should consider?
Does the mix of prescribing wording for some information
and requiring brief narratives for other information strike the right
balance between having similar, neutral wording to promote comparisons
and permitting firms to conform the language to reflect the services
they offer? Should the Commission instead require more prescribed
wording in this Item? Conversely, is there prescribed wording we have
proposed that we should modify or replace with a more general
instruction that allows firms to use their own description?
Does the prescribed wording we are proposing capture the
range of business models of investment advisers and broker-dealers?
Would the prescribed wording require any firm to state something
inaccurate in the relationship summary? Should we instead provide more
flexibility to change the prescribed wording?
Should we require broker-dealers to include prescribed
wording about transaction-based fees and investment advisers to state
the type of fee for an advisory account at the beginning of this
[[Page 21428]]
section, or should fees only be discussed in the fee section?
How should broker-dealers describe execution-only
accounts, sometimes referred to as ``discount'' brokerage, and accounts
in which they provide recommendations concerning securities, sometimes
referred to as ``full-service'' brokerage? Should we, as proposed,
require that broker-dealers offering recommendations to retail
investors state that the retail investor may select investments or the
broker-dealer may recommend investments, but the retail investor will
make the ultimate investment decision? Should we also, as proposed,
require that broker-dealers only offering discount brokerage accounts
to retail investors state that the retail investor will select the
investments and make the ultimate investment decision? Should we
require prescribed language about these accounts, or should we permit a
brief narrative as proposed? Should firms be permitted or required to
use the terms ``full-service'' accounts and ``discount'' brokerage
accounts, or other terms, so long as they are likely to be understood?
Do investors understand the meanings of these terms?
Should investment advisers that provide investment
advisory services be required to discuss both discretionary and non-
discretionary account services, regardless of whether they offer both
discretionary and non-discretionary accounts? Should they instead be
permitted to describe only the service they offer? Do firms offer
accounts that involve limited discretionary services that would not be
covered in the proposed discussions of discretionary and non-
discretionary accounts? If so, how should the requirements be changed
to reflect these accounts? Should we also require investment advisers
to state that they offer advice on a regular basis, or, if not on a
regular basis, state how frequently they offer advice? Should we
require the disclosure of any additional information about the advice
an investment adviser provides?
We are proposing to require firms to disclose if they
offer certain additional services, such as assistance with developing
or executing the retail investor's investment strategy, and performance
monitoring, and to briefly describe any regular communications they
have with retail investors. Are there services in addition to those in
the Instructions that broker-dealers and investment advisers also
should disclose? Should we require disclosure of the same types of
additional services for both broker-dealers and investment advisers?
We understand that, to some extent, all firms limit the
investments offered to retail investors. Would other disclosures
regarding a firm's product offering limitations be helpful to
investors, in addition to the proposed disclosures for firms that
significantly limit the types of investments that are available? Why or
why not? Should we, for example, require firms that only offer
proprietary investments to also state that the only investments
available to a retail investor are investments that the firm or its
affiliates issue, sponsor, or manage? How feasible would this
disclosure be for a firm that has several account types? Should we
consider other alternatives?
Is it clear what we mean by ``significantly limit'' with
regard to the requirement to disclose limitations on investment
choices? Should we provide additional examples or more prescriptive
instructions regarding when firms must disclose such limitations? Are
there other ways a firm may significantly limit the types of
investments that should be captured by this instruction?
Should we permit firms to prepare different relationship
summaries for different types of services and lines of business,
particularly where the firm offers a broad array of accounts and
services? Would separate relationship summaries still promote
comparability across firms and the ability to understand the
differences between advisory and brokerage services?
Would the proposed summary of services allow retail
investors to easily compare the services provided by different firms?
If not, what changes to the requirements should we make to increase
comparability?
Would other disclosures about a firm's services be more
helpful for retail investors? Should we permit or require firms to
describe services they offer to retail investors, in addition to
brokerage and advisory services, such as insurance services? Would such
disclosure about other services give retail investors a more complete
overview of a firm's offerings, or would it detract from the other
disclosures, for example, by overwhelming the more important
information about a firm's brokerage and advisory services?
Should we require firms to include more details about the
specific services provided for each type of advisory account or
brokerage account that they offer? Should the relationship summary help
investors to choose among a variety of account options that the firm
offers, rather than providing more summary information about the
advisory and brokerage services that are offered?
Some dual registrants have implemented a default
relationship for retail investors, where, for example, the firm will
act as a broker-dealer with respect to the account unless specifically
stated otherwise. Should we require these firms to disclose that they
are acting as a broker-dealer (or investment adviser, as applicable)
with respect to the account unless the firm specifically states
otherwise?
Should we, as proposed, allow firms with affiliated
broker-dealers or investment advisers to state that they offer retail
investors additional brokerage or advisory services, as applicable,
through their affiliates? Should we require such statements, if
applicable? Should we permit or require firms to expand on the
different types of services available to their retail investors through
the firm's affiliates? Should affiliates be required or permitted to
use a single relationship summary that describes the services of all
affiliates? If not, why not? What are the advantages and disadvantages
to the retail investor?
Should we also permit or require disclosure regarding a
firm's relationships with other third parties, such as where the
registered representatives of a broker-dealer are also investment
adviser representatives of an unaffiliated investment adviser or where
an investment adviser uses a single unaffiliated broker-dealer to
provide execution and custody and generally does not consider execution
through other firms?
Should we require investment advisers and broker-dealers
to disclose whether they have a minimum account size and state that
minimum (or range of minimums) if the account minimum varies by
account? If applicable, should we require disclosure that the selection
of investments or services is limited by account size? Would this help
investors understand whether they are eligible for certain accounts or
certain services and understand the ways in which their investment
choices may be limited? Are there any drawbacks to requiring such
disclosure?
So-called robo-advisers and online broker-dealers
represent a fast-growing trend within the brokerage and investment
advisory industries. They employ a wide range of business models. For
example, differences among robo-advisers and online broker-dealers
include: The degree of reliance on computer algorithms (as opposed to
individualized human judgment) to generate financial advice; the level
of human interaction between the client or customer and firm personnel;
and the use of the internet to communicate with
[[Page 21429]]
clients and customers. Are the Instructions pertaining to relationships
and services sufficient and appropriate to capture the business models
of robo-advisers and online broker-dealers? For example, would it be
appropriate to require or permit descriptions regarding the degree of
human involvement in the oversight and management of individual client
accounts, how computer algorithms are used in generating investment
advice, and the availability of financial professionals to answer
retail investors' questions? Do the requirements with respect to the
content and delivery of the relationship summary, as further discussed
below, allow retail investors to make informed decisions about entering
into a relationship with a robo-adviser, other type of investment
adviser, or broker-dealer?
3. Obligations to the Retail Investor--Standard of Conduct
Following the relationships and services section, the relationship
summary would include a brief section, using prescribed wording, to
describe the firm's legal standard of conduct to the retail
investor.\110\ The section would begin with the heading ``Our
Obligations to You'' and the following language: ``We must abide by
certain laws and regulations in our interactions with you.'' Firms
would then use prescribed wording describing the standard of conduct
applicable to investment advisers and/or broker-dealers.\111\ As with
certain other sections of the relationship summary, dual registrants
would provide this information in tabular format to facilitate
comparison.
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\110\ Proposed Item 3.A. of Form CRS.
\111\ Proposed General Instruction 1.(e) to Form CRS.
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We understand that the standard of conduct that applies to firms
and financial professionals has been a source of investor
confusion.\112\ For example, the 913 Study noted that retail investors
were not clear about the specific legal duties of broker-dealers and
investment advisers.\113\ We believe that providing a brief overview of
the standards of conduct to which broker-dealers and investment
advisers must adhere, including the differences between the standards
of care of broker-dealers and investment advisers, could help alleviate
this confusion. We further believe that providing this overview, in
combination with the key question about the financial professional's
legal obligations discussed below, would encourage a conversation
between the retail investor and the financial professional about
applicable legal obligations.\114\ We also believe that prescribing
language is appropriate to promote consistency in communicating these
standards to retail investors.\115\
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\112\ See, e.g., Siegel & Gale Study, supra note 5; and RAND
Study, supra note 5. See also CFA Survey, supra note 5.
\113\ See 913 Study, supra note 3, at v. See also Rand Study,
supra note 5.
\114\ See infra at Section II.B.8. Similarly, certain DOL
regulations already obligate firms and financial professionals to
acknowledge fiduciary status when they provide certain advisory type
services to workplace retirement plans subject to ERISA and to IRAs.
See, e.g., 29 CFR 2550.408g-1(b)(7)(i)(G) (regulation under
statutory exemption for participant advice requires fiduciary
advisers to plans and IRAs seeking exemptive relief to provide
advice and receive compensation to acknowledge fiduciary status); 29
CFR 2550.408b-2(c)(1)(iv)(B) (regulation under statutory exemption
for reasonable service arrangements requires certain ERISA-covered
plan service providers to state, if applicable, that the service
provider will provide or reasonably expects to provide services as a
``fiduciary'' as defined by ERISA). Similarly, the DOL's BIC
Exemption, see infra note 504, would require an investment advice
fiduciary that seeks to rely on that exemption to receive
compensation in connection with investment recommendations to state
in writing that it is acting as a fiduciary under ERISA or the Code.
\115\ As noted above, if a prescribed statement is inapplicable
to a firm's business or would be misleading to a reasonable retail
investor, the firm may omit or modify that statement, as further
discussed below. Proposed General Instruction 3 to Form CRS. See
supra note 58.
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Broker-Dealers. We are proposing a required description of the
standard of conduct for broker-dealers based on the proposed standards
in Regulation Best Interest, as well as existing obligations of broker-
dealers when they provide services to customers. First, a broker-dealer
that provides recommendations subject to Regulation Best Interest \116\
would include the following wording: ``We must act in your best
interest and not place our interests ahead of yours when we recommend
an investment or an investment strategy involving securities.'' \117\
Execution-only broker-dealers and other broker-dealers that do not
provide such recommendations would not be required to include this
sentence. We believe retail investors receiving recommendations that
are subject to Regulation Best Interest would benefit from
understanding the new obligation.
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\116\ Regulation Best Interest Proposal, supra note 24.
\117\ Proposed Item 3.B.1. of Form CRS. This wording assumes
Commission adoption of Regulation Best Interest. As noted above (see
supra note 29 and accompanying text), the proposed definition of
``retail customer,'' to whom Regulation Best Interest would apply,
differs from the proposed definition of ``retail investor'' under
Form CRS. The relationship summary is intended for a broader range
of investors than the intended focus of Regulation Best Interest.
Accordingly, the proposed Regulation Best Interest standard may not
apply to the recommendations of all retail investors receiving the
relationship summary from broker-dealers. The Instructions for
proposed Item 3.B.1 recognizes this possibility and seeks to ensure
that broker-dealers provide accurate disclosure to their retail
investors, even if the broker-dealer is not providing a
recommendation subject to Regulation Best Interest.
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Second, all broker-dealers providing services to retail investors
would state, ``When we provide any service to you, we must treat you
fairly and comply with a number of specific obligations.'' This would
inform retail investors that broker-dealers have a duty of fair dealing
under the federal securities laws and self-regulatory organization
rules, as well as other obligations and standards to which they must
adhere.\118\
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\118\ See Report of the Special Study of Securities Markets of
the Securities and Exchange Commission, H.R. Doc. No. 88-95, at 238
(1st Sess. 1963); In the Matters of Richard N. Cea, et al., Exchange
Act Release No. 8662 (Aug. 6, 1969), at 18 (``Release 8662'')
(involving excessive trading and recommendations of speculative
securities without a reasonable basis); In the Matter of Mac Robbins
& Co. Inc., Exchange Act Release No. 6846 (Jul. 11, 1962). See also
FINRA Rule 2111.01 (Suitability) (``Implicit in all member and
associated person relationships with customers and others is the
fundamental responsibility for fair dealing. Sales efforts must
therefore be undertaken only on a basis that can be judged as being
within the ethical standards of [FINRA's] Rules, with particular
emphasis on the requirement to deal fairly with the public. The
suitability rule is fundamental to fair dealing and is intended to
promote ethical sales practices and high standards of professional
conduct''); see also FINRA Rule 2010 (Standards of Commercial Honor
and Principles of Trade) (requiring a member, in the conduct of its
business, to observe high standards of commercial honor and just and
equitable principles of trade).
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Finally, broker-dealers would be required to state, ``Unless we
agree otherwise, we are not required to monitor your portfolio or
investments on an ongoing basis.'' This sentence reflects that neither
Regulation Best Interest nor existing broker-dealer standards oblige
the broker-dealer to monitor the performance of retail investor's
accounts,\119\ while making clear that broker-dealers could agree to
provide monitoring as an additional service. We are proposing this
wording because we believe that the episodic, rather than ongoing,
nature of broker-dealers' standard of conduct in Regulation Best
Interest is a distinction from investment advisers' obligations to
clients that retail investors should be
[[Page 21430]]
aware of from the outset of a relationship.
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\119\ References to ``monitoring'' relate to monitoring the
performance of a portfolio or investments, and are not intended to
alter or diminish broker-dealers' current supervisory obligations
under the Exchange Act and detailed self-regulatory organization
rules, including the establishment of policies and procedures
reasonably designed to prevent and detect violations of, and to
achieve compliance with, the federal securities laws and
regulations, as well as applicable self-regulatory rules. See
section 15(b)(4)(E) of the Exchange Act; FINRA Rule 3110.
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After the description of the standard of conduct, broker-dealers
would be required to state: ``Our interests can conflict with your
interests.'' If the broker-dealer provides to retail investors
recommendations that are subject to Regulation Best Interest, it would
also include the language, ``When we provide recommendations, we must
eliminate these conflicts or tell you about them and in some cases
reduce them.'' \120\ These statements reflect proposed requirements in
Regulation Best Interest that broker-dealer would need to establish,
maintain, and enforce reasonably designed policies and procedures
relating to material conflicts of interest, including those arising
from financial incentives, associated with recommendations to retail
customers. While we are not using the exact words of the proposed
standard, we believe that this information, in combination with the
conflicts section below, can make the retail investor aware that
conflicts exist and that the broker-dealer has obligations regarding
disclosure, mitigation, or elimination of conflicts when the broker-
dealer is subject to Regulation Best Interest. We believe this could
help prompt a conversation between retail investors and their financial
professionals about both the conflicts the firm and financial
professional have and what steps the firm takes to reduce the
conflicts.\121\
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\120\ Proposed Item 3.B.2. of Form CRS. This wording assumes
Commission adoption of the Regulation Best Interest.
\121\ See discussion of the proposed conflicts of interest
disclosure in the relationship summary, infra Section II.B.6.
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Investment Advisers. We propose to require that investment advisers
state the standard of conduct that applies to them as an investment
adviser by including the following wording: ``We are held to a
fiduciary standard that covers our entire investment advisory
relationship with you.'' In addition, unless the investment adviser
does not provide ongoing advice (for example, provides only a one-time
financial plan), the investment adviser would also state, ``For
example, we are required to monitor your portfolio, investment strategy
and investments on an ongoing basis.'' \122\ While we are not proposing
to include a specific definition of fiduciary, we believe that the
proposed wording that the relationship covers the ``entire investment
advisory relationship'' and wording regarding the ongoing duty to
monitor would provide retail investors with information about aspects
of the fiduciary duty that can help the retail investor understand the
standard.\123\ Additionally, as with the proposed standard of conduct
disclosure for broker-dealers, we believe that the ongoing, as opposed
to episodic, nature of investment advisers' standard of conduct is a
distinction from broker-dealers' typical obligations when providing
recommendations that retail investors should be aware of from the
outset of a relationship.
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\122\ Proposed Item 3.C.1. of Form CRS.
\123\ We are concurrently publishing for comment a proposed
interpretation of the standard of conduct for investment advisers
under the Advisers Act. See Proposed Commission Interpretation
Regarding Standard of Conduct for Investment Advisers; Request for
Comment on Enhancing Investment Adviser Regulation, Investment
Advisers Act Release No. IA-4889 (Apr. 18, 2018) (``Fiduciary Duty
Interpretive Release'').
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After the description of the standard of conduct, investment
advisers would then be required to state, ``Our interests can conflict
with your interests. We must eliminate these conflicts or tell you
about them in a way you can understand, so that you can decide whether
or not to agree to them.'' As with broker-dealers, we believe that this
information, in combination with the conflicts section below, can make
retail investors aware that conflicts exist and that investment
advisers, as part of their fiduciary duty, have obligations regarding
conflicts.\124\ We believe this could help prompt a conversation
between retail investors and their financial professionals about both
the conflicts the firm and financial professional have and what steps
the firm takes to reduce the conflicts.
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\124\ See, e.g., General Instruction 3 to Form ADV, Part 2.
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We request comment generally on the proposed standard of conduct
descriptions, and in particular on the following issues:
Should we require, as proposed, that all firms include a
brief prescribed statement about the legal standards of conduct that
apply to them under the federal securities laws, including the new
standard proposed in Regulation Best Interest and an investment
adviser's fiduciary duty? Is such disclosure likely to be meaningful to
retail investors? Does the prescribed wording capture what retail
investors should or want to understand about broker-dealers' and
investment advisers' standards of conduct? Would the prescribed wording
require any firm to provide any inaccurate information? Are there
modifications to the proposed wording or alternative wording that would
make the legal standards more clear in a succinct way? Should we
require or permit additional information, and if so, what?
Alternatively, would a briefer statement be appropriate? Are there any
common misconceptions about broker-dealers' and investment advisers'
standard of conduct that the relationship summary should specifically
seek to clarify or correct?
Should we require or permit broker-dealers to include
additional detail about the best interest standard proposed in
Regulation Best Interest or their duty of fair dealing? Would this or
other disclosure provide retail investors with useful information?
Should we provide flexibility in how broker-dealers describe the best
interest standard or duty of fair dealing?
We are proposing to require that broker-dealers state that
they must comply with a number of specific obligations when providing
any service to customers. Should we permit or require more detailed
disclosure about these obligations? For example, should we permit or
require broker-dealers to disclose their obligations to make sure that
the prices a customer receives when a trade is executed are fair and
reasonable, and to make sure that the commissions and fees the customer
pays are not excessive?
Should we require disclosure that further describes the
investment adviser fiduciary standard, including any additional details
described in the proposed interpretation? If so, what wording should we
require? Should we provide flexibility in describing the fiduciary
standard?
For dual registrants, would the side-by-side descriptions
of the standards of conduct for broker-dealers and investment advisers
assist retail investors in understanding the differences between these
standards? Are there modifications we can make to the wording or the
presentation to facilitate this comparison?
Should we permit or require firms to disclose additional
information about the legal differences between broker-dealers and
investment advisers, such as explaining that broker-dealers are subject
to regulation by self-regulatory organizations in addition to the SEC?
Should we permit or require firms to disclose the differences in
licensing requirements for financial professionals of broker-dealers
and investment advisers, such as the frequency of licensing or
qualifications examinations? Would such disclosure about financial
professionals fit within this section of the relationship summary that
focuses on the firm? What information would be most relevant to retail
investors?
[[Page 21431]]
We understand that state laws and other regulations,\125\
also may require broker-dealers and advisers to affirmatively
acknowledge fiduciary status. Should we provide firms flexibility to
include language in a relationship summary consistent with or to
satisfy these other regulatory requirements? Would such flexibility
enhance or potentially reduce the effectiveness of the relationship
summary?
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\125\ See. e.g., supra note 114.
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4. Summary of Fees and Costs
We are proposing to require broker-dealers and investment advisers
to include an overview of specified types of fees and expenses that
retail investors will pay in connection with their brokerage and
investment advisory accounts. This section would include a description
of the principal type of fees that the firm will charge retail
investors as compensation for the firm's advisory or brokerage
services, including whether the firm's fees vary and are negotiable,
and the key factors that would help a reasonable retail investor
understand the fees that he or she is likely to pay.\126\ Investment
advisers that provide advice to retail investors about investing in
``wrap fee programs'' would include an overview of the fees associated
with those wrap fee programs.\127\ Both broker-dealers and investment
advisers would state that some investments impose fees that will reduce
the value of a retail investor's investment over time, and would
provide examples relevant to the firm's business.\128\ In addition,
each firm would include the incentives it and its financial
professionals have to put their own interests ahead of their retail
investors' interests based on the account fee structure,\129\ and would
state that depending on an investor's investment strategy, retail
investors may prefer paying a different type of fee in certain
specified circumstances.\130\ Having a clear, simple explanation of the
fees a retail investor would pay firms for advisory accounts versus
brokerage accounts, and the incentives that such fees create, would
help the retail investor to understand the types of fees that they will
pay and make a more informed choice about which account is right for
them. As with other sections of the relationship summary, dual
registrants would provide this information in tabular format to
facilitate comparison.\131\
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\126\ Proposed Item 4 of Form CRS. A broker-dealer would
describe transaction-based fees as its principal type of fee, using
prescribed wording. See proposed Item 4.B.1 of Form CRS. We use the
term ``transaction-based fees'' in the relationship summary for
plain language purposes to refer generally to broker-dealer
compensation such as commissions, mark-ups, mark-downs, sales loads
or similar fees, including 12b-1 fees, tied to specific
transactions. An investment adviser would summarize the principal
fees and costs that align with the type of fee(s) the adviser
reports in response to Item 5.E. of Form ADV Part 1A that are
applicable to retail investors. See proposed Item 4.C. of Form CRS.
Investment advisers and associated persons that receive compensation
in connection with the purchase or sale of securities should
carefully consider the applicability of the broker-dealer
registration requirements of the Exchange Act.
\127\ Proposed Items 4.C.3., 4.C.7., 4.C.9. and 4.C.10. of Form
CRS.
\128\ Proposed Items 4.B.2.b. and 4.C.4. of Form CRS.
\129\ Proposed Items 4.B.5. and 4.C.8. of Form CRS.
\130\ Proposed Items 4.B.6. and 4.C.10. of Form CRS. Dual
registrants would make these disclosures under the heading ``Fees
and Costs,'' whereas standalone investment advisers and broker-
dealers would make certain of these disclosures under the heading
``Fees and Costs,'' and certain of these disclosures under the
heading, as applicable ``Compare with Brokerage Accounts'' or
``Compare with Advisory Accounts,'' as described below. Proposed
Items 5.A.4. and 5.B.6. of Form CRS.
\131\ Proposed General Instruction 1.(e) to Form CRS.
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Fees and costs are important to retail investors,\132\ but many
retail investors are uncertain about the fees they will pay.\133\ Many
commenters have stressed the importance of clear fee disclosure to
retail investors, including disclosure about differences between
advisory and brokerage fees.\134\ Accordingly, the proposed
relationship summary is intended to provide investors greater clarity
concerning certain categories of fees they should expect to pay, how
the types of fees affect the incentives of the firm and their financial
professionals, and certain other fees and expenses that will reduce the
value of the retail investor's investment. The proposed relationship
summary would focus on certain general types of fees, rather than
describe all fees or provide a comprehensive schedule of fees.
Specifically, the proposal would highlight certain differences in how
broker-dealers and investment advisers charge for their services.
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\132\ See 917 Financial Literacy Study, supra note 20, at iv
(``With respect to financial intermediaries, investors consider
information about fees, disciplinary history, investment strategy,
conflicts of interest to be absolutely essential.'').
\133\ See Rand Study, supra note 5, at xix (``In fact, focus-
group participants with investments acknowledged uncertainty about
the fees they pay for their investments, and survey responses also
indicate confusion about the fees.''). In addition, we have brought
enforcement actions against advisers providing inaccurate disclosure
of all of the fees and costs that retail investors pay. See, e.g.,
In the Matter of Robert W. Baird & Co. Inc., Investment Advisers Act
Release No. 4526 (Sept. 8, 2016) (settled action) (``In re Robert W.
Baird''); In the Matter of Raymond James & Associates, Inc.,
Investment Advisers Act Release No. 4525 (Sept. 8, 2016) (settled
action) (``In re Raymond James''); In the Matter of Barclays Capital
Inc., Investment Advisers Act Release No. 3929 (Sep. 23, 2014)
(settled action) (``Release 3929'').
\134\ See, e.g., Kiley 2017 Letter (recommending that investors
receive disclosures about the differences in advisory and brokerage
fees, and brokers' specific fee and commission structure); Stifel
2017 Letter (recommending that firms explain the differences between
brokerage and advisory accounts with the goal of improving
understanding of a firm's different service models, compensation
arrangements, and conflicts of interests); Equity Dealers of America
2017 Letter (recommending disclosure of aspects of advisory and
brokerage accounts, including the type of fees charged, to
facilitate investors' selection of an account type); Wells Fargo
2017 Letter; ACLI 2017 Letter; FSR 2017 Letter; SIFMA 2017 Letter;
UBS 2017 Letter; Comment letter of the Investment Company Institute
(Aug. 7, 2017) (``ICI 2017 Letter''); State Farm 2017 Letter; IAA
2017 Letter; Bernardi Securities 2017 Letter; Fidelity 2017 Letter;
Vanguard 2017 Letter.
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We are not proposing a requirement that firms personalize the fee
disclosure for their retail customers, or provide a comprehensive fee
schedule, as some commenters had proposed.\135\ A personalized fee
disclosure could be expensive and complex for firms to provide in a
standardized presentation across all of their accounts and in a way
that captures all fees, including embedded fees in various investments
(which will vary for each investor depending on their portfolio). Many
firms likely would seek to implement systems to automate the disclosure
for each of their existing and prospective retail investors, and if
such systems were expensive, some firms could choose to reduce the
products and services that they offer as a result of the additional
costs. Our proposal would encourage retail investors to ask financial
professionals about their fees and request personalized information
about the specific fees and expenses associated with their current or
prospective accounts. As further discussed in Section II.B.8 below, one
of the proposed questions for a retail investor to ask a financial
professional is to ``do the math for me,'' and specifically encourages
retail investors to ask about the amount that they would pay per year
for the account, what would make the fees more or less, and the
services included in those fees.\136\ Additionally, the beginning of
the Fees and Costs section of the relationship summary would state:
``Please ask your financial professional to give you personalized
information on fees and
[[Page 21432]]
costs that you will pay.'' \137\ We believe that financial
professionals are well positioned to provide individualized fee
information to their retail investors upon request. During the account
opening process, for example, generally the relevant financial
professional would have access to personalized information about the
retail investor's account and can put together personalized fee
information estimates during the process.
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\135\ See, e.g., Comment letter of Mark J. Flannery, BankAmerica
Professor of Finance, University of Florida (Jul. 27, 2017)
(``Flannery 2017 Letter''); Pefin 2017 Letter (recommending that
clients should receive information on a quarterly basis on fees
charged to their account, the calculation used to determine fees,
and a breakdown of the charges by category).
\136\ See infra Section II.B.8.; infra notes 299-303 and
accompanying text; proposed Item 8 of Form CRS.
\137\ Proposed Item 4.A. of Form CRS.
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Likewise, we believe that requiring a comprehensive fee schedule in
the relationship summary also could be more complex than a retail
investor would find useful for an overview disclosure such as this.
However, we believe our proposed layered disclosure would achieve
similar results in a less costly and complex manner. The relationship
summary would provide required information about fees, and a later
section titled ``Additional Information'' would provide references and
links to other disclosures where interested investors can find more
detailed information.\138\ As discussed below, investment advisers
would be required to direct retail investors to additional information
in the firm's Form ADV Part 2 brochure and any brochure supplement
provided by a financial professional to the retail investor.\139\ An
adviser's Form ADV Part 2 contains more detailed information about the
firm's fees. Broker-dealers would likewise be required to direct retail
investors to additional information at BrokerCheck, the firm's website,
and the retail investor's account agreement.\140\ Up-to-date fee
disclosures may appear on broker-dealers' websites or in the retail
investors' account agreements, if applicable, where we understand
broker-dealers typically provide information about fees, including, in
some cases, comprehensive fee schedules.\141\
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\138\ Proposed Item 7 of Form CRS.
\139\ Proposed Item 7.E.2. of Form CRS. Investment advisers that
do not have a public firm website or do not maintain their current
Form ADV brochure on its public website would be required to include
a link to adviserinfo.sec.gov. Advisers that do not have a public
firm website would also be required to include a toll-free telephone
number where retail investors can request up-to-date information.
\140\ Proposed Item 7.E.1. of Form CRS. Broker-dealers that do
not have a public firm website would be required to include a toll-
free telephone number where retail investors can request up-to-date
information.
\141\ Under Regulation Best Interest, broker-dealers would also
be required to disclose the material facts relating to the scope and
terms of the relationship, which would include disclosure of fees
and charges that apply to a customer's transactions, holdings and
accounts. Regulation Best Interest Proposal, supra note 24, at
section II.D.1.a.
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We are also not proposing to require firms to include examples of
how fees could affect a retail investor's investment returns. We
recognize that the Commission has required firms to disclose examples
showing the effects of fees and other costs in certain contexts. For
example, we have required mutual funds to provide in their summary
prospectuses an example that is intended to help investors compare the
cost of investing in the mutual fund with the cost of investing in
other mutual funds.\142\ While we continue to believe that examples of
the effect of fees on returns could be helpful to retail investors,
they could also fail to capture the effect of a firm's fees on a
particular retail investor's account. Transactional fees, in
particular, can vary widely based on a number of circumstances, and it
could be potentially misleading to present a typical example showing
how sample transaction fees apply to a sample account over time. We
believe requiring firms to provide an example for each type of account
that would show the effect of fees on a sample account could overwhelm
investors due to the number and variability of assumptions that would
need to incorporated, explained, and understood in order for the
example to be meaningful, and would not necessarily promote
comparability. If the assumptions were standardized, such examples
might not be useful, or might even be potentially misleading, to the
retail investor, whose circumstances may be different from the
assumptions used.
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\142\ See Item 3 of Mutual Fund Summary Prospectus; Enhanced
Mutual Fund Disclosure Adopting Release, supra note 47, at section
III.A.3.b (``The fee table and example are designed to help
investors understand the costs of investing in a fund and compare
those costs with the costs of other funds.'').
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Some commenters suggested requiring that a firm disclose the types
of compensation firms and their financial professionals receive,
including from third parties, in connection with providing investment
recommendations.\143\ A few commenters suggested requiring disclosure
of how much the firm and its financial professionals receive in fees,
including commissions and fees from third parties.\144\ We agree with
commenters that it is important to make investors aware of such fees
and compensation because they create conflicts of interest for firms
and financial professionals making investment recommendations for
retail investors. We are proposing to require that firms disclose
commissions and certain third-party fees related to mutual funds in
this section, and certain compensation-related conflicts (e.g.,
conflicts related to revenue sharing) in the conflicts section of the
relationship summary, as discussed in Section II.B.6 below.
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\143\ See, e.g., SIFMA 2017 Letter; UBS 2017 Letter; ICI 2017
Letter; State Farm 2017 Letter; Bernardi Securities 2017 Letter;
Fidelity 2017 Letter.
\144\ See, e.g., Flannery 2017 Letter; Pefin 2017 Letter.
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Heading. To emphasize the importance of fees, all firms would be
required to include the following statement at the beginning of this
section under the heading ``Fees and Costs'': ``Fees and costs affect
the value of your account over time. Please ask your financial
professional to give you personalized information on the fees and costs
that you will pay.'' \145\ We are proposing this precise wording
because we believe it is applicable to retail investors regardless of
any differences among the accounts and their fees. Understanding that
fees and costs affect investment value over time would help retail
investors to understand why they should review and understand this
information. This introductory language also would highlight that
retail investors could get more personalized information from the
firm's financial professionals.
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\145\ Proposed Item 4.A. of Form CRS.
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Brokerage Account Fees and Costs. Broker-dealers would be required
to summarize the principal fees and costs that retail investors will
incur.\146\ First, we are proposing prescribed language that describes
the transactional nature of many brokerage fees.\147\ We are proposing
different wording for dual registrants than for standalone broker-
dealers to facilitate the side-by-side comparison with the description
of the advisory fee in the dual registrant's relationship summary.
Specifically, dual registrants that offer retail investors both
investment advisory accounts and brokerage accounts would include the
following wording to assist with the side-by-side comparison with
investment advisers: ``Transaction-based fees. You will pay us a fee
every time you buy or sell an investment. This fee, commonly referred
to as a commission, is based on the specific transaction and not the
value of your account.'' \148\ A standalone broker-dealer
[[Page 21433]]
would include the following: ``The fee you pay is based on the specific
transaction and not the value of your account.'' \149\
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\146\ Proposed Item 4.B. of Form CRS.
\147\ As discussed above, we use the term ``transaction-based
fees'' to refer to broker-dealer compensation such as commissions,
mark-ups, mark-downs, sales loads or similar fees, including 12b-1
fees, tied to specific transactions. See supra note 126.
\148\ Proposed Item 4.B.1. of Form CRS. As discussed further
below, dual registrants would include a parallel statement regarding
their investment advisory account fees. Proposed Item 4.C.1. of Form
CRS.
\149\ Proposed Item 4.B.1. of Form CRS. As discussed above,
standalone broker-dealers would be required to include wording that
a transaction-based fee is generally referred to as a commission in
the Relationships and Services section of the relationship summary.
See proposed Item 2.B.1. of Form CRS.
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In addition, both standalone and dual registrant broker-dealers
would include the following (emphasis required): ``With stocks or
exchange-traded funds, this fee is usually a separate commission. With
other investments, such as bonds, this fee might be part of the price
you pay for the investment (called a ``mark-up'' or ``mark down'').
With mutual funds, this fee (typically called a ``load'') reduces the
value of your investment.'' \150\ Because of the importance of these
transaction-based fees to brokerage services, as well as the variety of
forms that such fees can take, we believe it will benefit investors to
have specific examples to illustrate transaction-based fees with
standardized, concise wording. We are proposing to require the example
of mutual fund loads because they are common indirect fees associated
with investments that compensate the broker-dealer.
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\150\ Proposed Item 4.B.2.a. of Form CRS.
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We are not proposing to require broker-dealers to provide the range
of their transaction-based fees. We understand that these fees vary
widely based on the specific circumstances of a transaction. For
example, a broker-dealer that transacts in only one type of security--
such as equities--can have a wide range of transaction fees for such
securities, depending on factors such as the size of the transaction,
the type of investment purchased, the type of account and services
provided, and how retail investors place their orders (for example,
online, telephone or with the assistance of a financial professional).
A broker-dealer that transacts in multiple types of securities--for
example, equities and real estate investment trusts (REITs)--could have
an even wider range of transaction fees. Given this variability, and
our intent that the relationship summary be short and that it be
provided in addition to, and not in lieu of, other disclosure, we
believe that requiring firms to provide a range of transaction-based
fees in the relationship summary could be confusing or provide limited
benefit to retail investors.
Following the examples of transaction-based fees, broker-dealers
would be required to state that some investments impose additional fees
that will reduce the value of retail investors' investments over time,
and provide examples of such investments that they offer to retail
investors.\151\ Mutual funds, variable annuities and exchange-traded
funds are common examples, as well as any other investment that incurs
fund management, 12b-1, custodial or transfer agent fees, or any other
fees and expenses that reduce the value of the investment over
time.\152\ Broker-dealers also would be required to state that a retail
investor could be required to pay fees when certain investments are
sold, for example, surrender charges for selling variable
annuities.\153\ We believe that it is important to highlight for
investors the costs associated with particular investments in addition
to describing the transaction-based fee for brokerage services. Retail
investors may not appreciate that they will bear costs for some
investments in addition to the transaction-based brokerage fee they pay
to their financial professional or firm.\154\ In addition, the
investment fees and expenses we are proposing to require that firms
disclose are ones that we believe are among the most common and can
have a substantial impact on an investor's return from a particular
investment.
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\151\ Proposed Item 4.B.2.b. of Form CRS. Investment advisers
would also be required to make this disclosure. See proposed Item
4.C.4. of Form CRS.
\152\ We acknowledge that some fees, such as 12b-1 fees, could
be a broker-dealer's principal fee for their brokerage services and
are also fees that reduce the return on an investment. In such a
case, the broker-dealer would describe transaction-based fees as its
principal fees and costs pursuant to proposed Item 4.B.1, and would
also describe these fees as additional fees that will reduce the
return on an investor's investments pursuant to proposed Item
4.B.2.b. of Form CRS.
\153\ Proposed Item 4.B.2.b. of Form CRS. Investment advisers
would also be required to make this disclosure. See proposed Item
4.C.4. of Form CRS.
\154\ See, e.g., Enhanced Disclosure and New Prospectus Delivery
Option For Registered Open-End Management Investment Companies,
Investment Company Act Release No. 28064 (Nov. 21, 2007) [72 FR
67790 (Nov. 30, 2007)], at n.49 and accompanying text (``In recent
years, we have taken significant steps to address concerns that
investors do not understand that they pay ongoing costs every year
when they invest in mutual funds, including requiring disclosure of
ongoing costs in shareholder reports.'').
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Requiring the disclosure of these investment fees and expenses,
sometimes described as ``indirect fees,'' follows commenters'
recommendations that investment advisers and broker-dealers disclose
certain indirect costs to retail investors.\155\ We are not proposing a
requirement that firms disclose the amount or range of mutual fund fees
or other third-party fees that retail investors may pay related to
their underlying investments, as a few commenters recommended.\156\
These expenses vary so greatly that attempts to quantify them or
describe their range likely would not be useful to retail investors or
would provide limited benefit to retail investors given that the
relationship summary is designed to be short disclosure provided in
addition to, and not in lieu of, other disclosures.\157\ Instead, we
intend that our proposed summary disclosure would effectively highlight
these costs in a simple, understandable way.
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\155\ See, e.g., State Farm 2017 Letter; Bernardi Securities
2017 Letter; Pefin 2017 Letter; Flannery 2017 Letter; Comment letter
of Dan Keppel (Jun. 5, 2017); Comment letter of Edward H. Weyler
(Jun. 8, 2017).
\156\ See Flannery 2017 Letter; Pefin 2017 Letter.
\157\ See Amendments to Form ADV, Investment Advisers Act
Release No. 3060 (Jul. 28, 2010) [75 FR 49233 (Aug. 12, 2010)]
(``Brochure Adopting Release''); Amendments to Form ADV, Investment
Advisers Act Release No. 2711 (Mar. 3, 2008) [73 FR 13958 (Mar. 14,
2008)] (``2008 Brochure Proposing Release'').
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Additionally, broker-dealers would be required to state whether or
not the fees they charge retail investors for their brokerage accounts
vary and are negotiable, including a description of the key factors
that they believe would help a reasonable retail investor understand
the fee that he or she is likely to pay for the firm's services.\158\
Such factors could include, for example, how much the retail investor
buys or sells, what type of investment the retail investor buys or
sells, and what kind of account the retail investor has with the
broker-dealer. We believe investors would benefit from knowing at
account opening whether they have the ability to negotiate the fees
they pay.
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\158\ Proposed Item 4.B.3. of Form CRS.
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Broker-dealers would next be required to state, if applicable, that
a retail investor will also pay other fees in addition to the firm's
transaction-based fee, and to list those fees, including account
maintenance fees, account inactivity fees, and custodian fees.\159\ We
believe that it is important to highlight for investors the fees
associated with an account that they will pay in addition to the
principal type of fee that the firm charges retail investors for their
brokerage account because these fees are common and they can have an
impact on a retail investor's return.
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\159\ Proposed Item 4.B.4. of Form CRS.
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Broker-dealers would then be required to disclose certain specified
incentives they have to put their own interests ahead of retail
investors' interests based on charging transaction-based fees for
brokerage accounts.\160\
[[Page 21434]]
They would be required to include the following: ``The more
transactions in your account, the more fees we charge you. We therefore
have an incentive to encourage you to engage in transactions.'' \161\
We believe this information would help retail investors understand how
the fee structures for brokerage accounts could affect their
investments and the incentives that firms and financial professionals
have to place their interests ahead of retail investors' interests by
encouraging retail investors to engage in transactions to increase
their fees.\162\ We are proposing to prescribe wording because we
believe these particular incentives and considerations generally apply
to most brokers that offer retail investors brokerage accounts, and
using uniform wording would promote consistency. We believe that retail
investors would benefit from understanding these incentives when they
are considering broker-dealers. Additionally, we believe this
disclosure would reinforce a key theme of the relationship summary,
which is choice across account types and services.
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\160\ Proposed Item 4.B.5. of Form CRS.
\161\ Id.
\162\ Pursuant to the federal securities laws, broker-dealers
can violate the federal antifraud provisions by engaging in
excessive trading that amounts to churning, switching, or unsuitable
recommendations. Churning occurs when a broker-dealer, exercising
control over the volume and frequency of trading in a customer
account, abuses the customer's confidence for personal gain by
initiating transactions that are excessive in view of the character
of the account and the customer's investment objectives. Excessive
trading is an excessive level of trading unjustified in light of the
customer's investment objectives. See Mihara v. Dean Witter & Co.,
Inc., 619 F.2d 814, 821 (9th Cir. 1980); Carras v. Burns, 516 F.2d
251, 258 (4th Cir. 1975). See also Regulation Best Interest
Proposal, supra note 24, at section II.D.2.c.
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Finally, dual registrants would be required to include the
following with respect to brokerage services: ``From a cost
perspective, you may prefer a transaction-based fee if you do not trade
often or if you plan to buy and hold investments for longer periods of
time.'' \163\ We believe that these factors--cost, trading frequency,
and the desire to ``buy and hold''--are important for retail investors
to consider when determining whether to use brokerage services or
advisory services.\164\ We are proposing to prescribe the wording
because we believe these factors reflect common circumstances in which
a brokerage account could be more cost-effective for a retail investor
than an advisory account, and using uniform wording would promote
consistency. We believe this disclosure, in conjunction with the
corresponding disclosure regarding advisory accounts that would appear
next to it, would help retail investors to compare the two services and
make an informed choice about the account type that is the right fit
for them based on their goals and preferences.
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\163\ Proposed Item 4.B.6. of Form CRS.
\164\ See e.g., Comment letter of The Capital Group Companies,
Inc. (Mar. 12, 2018) (discussing considerations for buy and hold
investors choosing among commission-based and fee-based
arrangements). Standalone broker-dealers and standalone investment
advisers would also be required to include similar wording under the
headings ``Compare with Typical Advisory Accounts'' and ``Compare
with Typical Brokerage Accounts,'' as applicable. See proposed Items
5.B.5 and 5.A.4 of Form CRS. Dual-registrants, standalone broker-
dealers, and standalone investment advisers would also be required
to include a statement that retail investors may prefer an asset-
based fee in certain circumstances, and that an asset-based fee may
cost more than a transaction-based fee. See proposed Items 4.C.10,
5.B.5 and 5.A.4 of Form CRS.
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Investment Advisory Account Fees and Costs. Investment advisers
that offer advisory accounts to retail investors would be required to
summarize the principal fees and costs that retail investors will
incur.\165\ Dual registrants that charge ongoing asset-based fees for
their advisory services would state the following: ``Asset-based fees.
You will pay an on-going fee [at the end of each quarter] based on the
value of the cash and investments in your advisory account.'' \166\
replacing, as needed, the bracketed wording with how often they assess
the fee. If the dual registrant charges another type of fee for
advisory services, it would briefly describe that fee and how often it
is assessed.\167\ Standalone investment advisers would state the
following: ``The amount paid to our firm and your financial
professional generally does not vary based on the type of investments
we select on your behalf.'' \168\ Standalone investment advisers that
charge an ongoing asset-based fee would also state ``The asset-based
fee reduces the value of your account and will be deducted from your
account.'' \169\ Standalone investment advisers that charge another
type of fee would succinctly describe how the fee is assessed and the
impact it has on the value of the retail investor's account.\170\
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\165\ Proposed Item 4.C. of Form CRS. An investment adviser
would summarize the principal fees and costs that align with the
type of fee(s) the adviser reports in response to Item 5.E. of Form
ADV Part 1A that are applicable to retail investors.
\166\ Proposed Item 4.C.1. of Form CRS.
\167\ Id. Some investment advisers report on Form ADV Item 5.E
that they receive ``commissions.'' These ``commissions'' may include
deferred sales loads, including fees for marketing and service, as
well as commissions as understood in the broker-dealer context. As a
form of deferred sales load, all payments of ongoing sales charges
to intermediaries would constitute transaction-based compensation.
Intermediaries receiving those payments should consider whether they
need to register as broker-dealers under section 15 of the Exchange
Act.
\168\ Proposed Item 4.C.2. of Form CRS. We recognize that, in
some cases, the amount paid to the advisory firm and the financial
professional can vary based on the type of investment selected
(e.g., advisory firms and financial professionals may recommend
certain mutual funds that pay the adviser or the financial
professional 12b-1 fees out of fund assets).
\169\ Id.
\170\ Proposed Item 4.C.2. of Form CRS. Investment advisers that
offer retail investors advisory accounts sometimes charge fees that
are not ongoing, asset based fees. A financial planner, for example,
sometimes charges a one-time fixed fee to prepare a plan.
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These requirements are consistent with the current fee disclosure
requirements for the Form ADV brochure and how investment advisers
typically describe asset-based fees, and we believe that retail
investors would find this type of disclosure helpful.\171\ We are not
proposing to require that investment advisers provide the range of
fees, as ranges an investment adviser charges can vary based on a
number of factors individual to the retail investor and the services
they choose. Additionally, although we do not believe that ranges for
investment advisers' asset based fees vary as much as broker-dealers'
transaction-based fees, we recognize that requiring firms to provide a
fee range for advisory accounts and not brokerage accounts could cause
confusion among retail investors and be of limited benefit when
comparing advisory and brokerage services. However, we recognize that
providing such a range could promote comparability between different
advisers, and we request comment below on whether we should require
disclosure of the adviser's range of principal fees charged.
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\171\ As discussed above, when completing Form CRS, investment
advisers should generally consider achieving consistency with the
type(s) of fee(s) that the investment adviser reports on Item 5.E.
of Form ADV Part 1A. See supra note 126.
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An investment adviser that provides advice to retail investors
about investing in a wrap fee program would be required to include
specified language about the program fees.\172\ A ``wrap fee program''
would be defined as an advisory program that charges a specified fee
not based directly upon transactions in the account for investment
advisory services and the execution of transactions.\173\ The advisory
services may include portfolio management or advice concerning
selection of other advisers.\174\ An
[[Page 21435]]
investment adviser that provides advice to retail investors about
investing in a wrap fee program and does not also offer another type of
advisory account would be required to include the following (emphasis
required): ``We offer advisory account programs called wrap fee
programs. In a wrap fee program, the asset-based fee will include most
transaction costs and fees to a broker-dealer or bank that will hold
your assets (known as ``custody''), and as a result wrap fees are
typically higher than non-wrap advisory fees.'' \175\ An investment
adviser that provides advice about investing in a wrap fee program and
offers another type of advisory account would be required to include
similar prescribed wording, modified as applicable to reflect that the
adviser also offers other types of advisory accounts.\176\
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\172\ Proposed Items 4.C.3., 4.C.6., 4.C.9. and 4.C.10. of Form
CRS. We also refer to these types of investment advisers as
``client-facing firms.''
\173\ Proposed General Instruction 9.(g) to Form CRS. This
proposed definition is identical to the definition already used in
Form ADV.
\174\ Proposed General Instruction 9.(g) to Form CRS.
\175\ Proposed Item 4.C.3. of Form CRS. The asset-based fee in a
wrap program does not always include all transaction costs. For
example, in some cases retail investors pay mark-ups, mark-downs, or
spreads, and mutual fund fees and expenses in addition to the wrap
fee program's asset-based fee. In addition, as discussed below, an
investment adviser may select a broker-dealer outside of the wrap
fee program to execute certain trades in a retail investor's
account--a practice sometimes referred to as ``trading away''--that
results in the retail investor's account incurring separate
brokerage fees. See infra note 187 and accompanying text.
\176\ Such investment advisers would be required to include the
following (emphasis required): ``For some advisory accounts, known
as wrap fee programs, the asset-based fee will include most
transaction costs and custody services, and as a result wrap fees
are typically higher than non-wrap advisory fees.'' Proposed Item
4.C.3. of Form CRS.
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Many retail investors participate in wrap fee programs.\177\ We
believe that retail investors would benefit from receiving information
about certain characteristics of wrap fee programs, particularly with
respect to their fees. Requiring investment advisers to describe the
asset-based fee, what it includes, and that it is typically higher than
non-wrap advisory fees would help a retail investor to distinguish wrap
fee programs from other types of advisory accounts that charge or incur
separate transaction fees.
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\177\ Based on IARD data as of December 31, 2017, of the 12,667
SEC-registered investment advisers, 1,035 (8.17%) sponsor a wrap fee
program, and 1,597 (12.61%) act as a portfolio manager for one or
more wrap fee programs.
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Next, investment advisers would be required to state that some
investments impose additional fees that will reduce the value of a
retail investor's investment over time, and provide examples of such
investments that the firm offers to retail investors.\178\ Investment
advisers also would state that a retail investor could be required to
pay fees when certain investments are sold, for example, surrender
charges for selling variable annuities.\179\ These proposed
requirements are identical to the disclosure that broker-dealers would
provide.\180\
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\178\ Proposed Item 4.C.4 of Form CRS. See supra notes 151-155
and accompanying text for a discussion of this requirement
applicable to both investment advisers and broker-dealers.
\179\ Proposed Item 4.C.4. of Form CRS.
\180\ See proposed Item 4.B.2.b. of Form CRS.
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In addition, investment advisers would be required to state whether
or not the fees they charge retail investors for their advisory
accounts vary and are negotiable.\181\ They would be required to
describe the key factors that they believe would help a reasonable
retail investor understand the fee that he or she is likely to pay for
the firm's services.\182\ Such factors could include, for example, the
services the retail investor receives and the amount of assets in the
account. As discussed above with regard to broker-dealers, we believe
investors would benefit from knowing at account opening whether they
have the ability to negotiate the fees they pay.
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\181\ Proposed Item 4.C.5. of Form CRS.
\182\ Id.
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Investment advisers would next be required to state, if applicable,
that a retail investor will pay transaction-based fees when the firm
buys and sells an investment for the retail investor (e.g., commissions
paid to broker-dealers for buying or selling investments) in addition
to the firm's principal fee it charges retail investors for the firm's
advisory accounts.\183\ Investment advisers would also be required to
state, if applicable, that a retail investor will pay fees to a broker-
dealer or bank that will hold the retail investor's assets and that
this is called ``custody,'' and would be required to list other fees
the retail investor will pay.\184\ Examples could include fees for
account maintenance services. These other fees we are proposing to
require firms to disclose are ones that we believe are among the most
common or can have an impact on a retail investor's return.\185\ As
discussed above, we believe that investors would benefit from being
aware of the fees associated with an account that they will pay in
addition to the principal fee that the firm charges retail investors
for their brokerage or advisory account.
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\183\ Proposed Item 4.C.6. of Form CRS.
\184\ Id.
\185\ See, e.g., Advisers Act rule 204-3; Item 5 of Form ADV
Part 2A (requiring each adviser to describe the types of other
costs, such as brokerage, custody fees and fund expenses that
clients may pay in connection with the advisory services provided to
them by the adviser).
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An investment adviser that provides advice to retail investors
about investing in a wrap fee program also would be required to state:
``Although transaction fees are usually included in the wrap program
fee, sometimes you will pay an additional transaction fee (for
investments bought and sold outside the wrap fee program).'' \186\ The
Commission is aware that wrap fee program portfolio managers employ, to
varying degrees, ``trading away'' practices, in which they use a broker
other than the sponsoring broker to execute trades for which a
commission or other transaction-based fee is charged, in addition to
the wrap fee, to the retail investor.\187\ The Commission has
identified instances in which firms participating in wrap fee programs
had poor disclosure about the overall cost of selecting a wrap fee
program, including the effect of their trade away practices.\188\ We
believe that investors would benefit from the relationship summary
highlighting that, even in a wrap fee program, they sometimes will pay
an additional transaction fee.
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\186\ Proposed Item 4.C.7. of Form CRS.
\187\ A wrap fee program portfolio manager may trade away
because, for example, it believes that doing so will allow it to
seek best execution of clients' transactions, as investment advisers
have an obligation to seek best execution of clients' securities
transactions where they have the responsibility to select broker-
dealers to execute client trades (typically in the case of
discretionary accounts). See Advisers Act rule 206(3)-2(c)
(referring to adviser's duty of best execution of client
transactions). See also Commission Guidance Regarding Client
Commission Practices Under Section 28(e) of the Securities Exchange
Act of 1934, Exchange Act Release No. 54165 (Jul. 18, 2006) (stating
that investment advisers have ``best execution obligations'')
(``Release 54165''). See also Brochure Adopting Release at 9.
\188\ The Commission has brought enforcement actions in these
circumstances. See, e.g., In re Robert W. Baird, supra note 133; In
re Raymond James, supra note 133; In the Matter of Riverfront
Investment Group, LLC, Investment Advisers Act Release No. 4453
(Jul. 14, 2016) (settled action); In the Matter of Stifel, Nicolaus
& Company, Inc., Investment Advisers Act Release No. 4665 (Mar. 13,
2017) (settled action).
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As with broker-dealers, investment advisers that charge an ongoing
asset-based fee for advisory services would next be required to address
the incentives they have to put their own interests ahead of their
retail investors' interests based on the type of fee charged for
investment advisory services.\189\ These advisers would be required to
include the following statement: ``The more assets you have in the
advisory account, including cash, the more you will pay us. We
therefore have an incentive to increase the assets in your account in
order to increase our fees. You pay our fee [insert frequency of fee
(e.g., quarterly)] even if you do not
[[Page 21436]]
buy or sell,'' replacing the brackets with the frequency of their
fee.\190\ Investment advisers that provide advice to retail investors
about participating in a wrap fee program would, in addition, be
required to include the following: ``Paying for a wrap fee program
could cost more than separately paying for advice and for transactions
if there are infrequent trades in your account.'' \191\ We are
proposing to require prescribed wording to promote consistency and
because we believe these particular incentives and considerations
generally apply to all advisers that charge retail investors ongoing
asset-based fees or provide advice about participating in a wrap fee
program. While we are not proposing any prescribed language for other
fee types, such as fixed fees, we request comment, below, on whether
advisers that charge other types of fees for their advisory services
have incentives to act in their own interest based on the type of fee
charged, and whether we should require disclosure of such incentives.
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\189\ Proposed Item 4.C.8. of Form CRS.
\190\ Proposed Item 4.C.8. of Form CRS.
\191\ Proposed Item 4.C.9. of Form CRS.
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These disclosures would help retail investors understand how the
fee structures for advisory accounts could affect their investments and
the incentives that firms and financial professionals have to place
their interests ahead of retail investors' interests. The disclosures
for investment advisers that provide advice about investing in a wrap
fee program also would help retail investors to understand that in
certain circumstances a wrap fee would cost them more than separately
paying for advice and for transactions in a different type of advisory
account. Similarly, wrap fee sponsors that complete the Form ADV Wrap
Fee Program Brochure are required to explain that the wrap fee program
may cost the client more or less than purchasing such services
separately and describe the factors that bear upon the relative cost of
the program, such as the cost of the services if provided separately
and the trading activity in the client's account.\192\ As with some of
the proposed requirements described above, we are proposing to
prescribe wording because we believe these particular considerations
generally apply to any investment in a wrap fee program and would
promote consistency. Also, as discussed above, we believe this
disclosure would reinforce a key theme of the relationship summary,
which is choice across account types and services.
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\192\ See Item 4.B. of Form ADV Part 2A; Appendix 1 of Form ADV:
Wrap Fee Program Brochure.
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Finally, dual registrants that charge ongoing asset-based fees for
advisory accounts would be required to include the following with
respect to their investment advisory services: ``An asset-based fee may
cost more than a transaction-based fee, but you may prefer an asset-
based fee if you want continuing advice or want someone to make
investment decisions for you.'' \193\ Dual registrants that provide
advice to retail investors about investing in wrap fee programs would
also be required to include the following with respect to wrap fee
program accounts: ``You may prefer a wrap fee program if you prefer the
certainty of a [insert frequency of the wrap fee (e.g., quarterly)] fee
regardless of the number of transactions you have.'' \194\ We believe
that these features--ongoing advice, discretion, standards of conduct,
and, for wrap fee programs, certainty in pricing--distinguish advisory
accounts and wrap fee programs from brokerage accounts. We also believe
it is important to highlight how costs relate to the services
included.\195\ We are proposing to prescribe wording because we believe
these particular considerations generally apply to all advisory
accounts and wrap fee programs, and using uniform wording would promote
consistency. We believe these disclosures, in conjunction with the
corresponding disclosure regarding broker-dealer accounts that would
appear next to it for dual registrants, would help retail investors to
compare the two types of services and combinations of those services
and make an informed choice about the account type that is the right
fit for them based on their goals and preferences.
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\193\ Proposed Item 4.C.10. of Form CRS. Standalone investment
advisers and standalone broker-dealers would also be required to
include similar wording under the headings ``Compare with Typical
Brokerage Based Accounts,'' and ``Compare with Typical Advisory
Accounts,'' as applicable. Proposed Items 5.A.4 and 5.B.5. of Form
CRS.
\194\ Proposed Item 4.C.10. of Form CRS.
\195\ We also propose to require dual registrants to include the
following with respect to broker-dealer services: ``From a cost
perspective, you may prefer a transaction-based fee if you do not
trade often or if you plan to buy and hold investments for longer
periods of time.'' See proposed Items 4.B.6. See also Items 5.A.4.
and 5.B.5 of Form CRS (including similar disclosures to be made by
standalone investment advisers and broker-dealers).
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We request comment generally on the proposed fees and costs
disclosures, and in particular on the following issues:
Is the proposed disclosure discussing fees and expenses
useful to investors?
Do the proposed requirements encourage disclosure that is
simple, clear and useful to retail investors? Would the proposed
disclosure help investors to understand and compare the fees and costs
associated with a firm's advisory services and brokerage services? Are
there any revisions to the descriptions of fees that would make the
proposed disclosure more useful to investors? Is it clear that retail
investors would incur different costs for different types of accounts
and advice services? Are there common assumptions or misconceptions
regarding account fees and services that firms should be required to
discuss, clarify, or address?
Is the proposed order of the information appropriate, or
should it be modified? If so, how should it be modified?
Do the proposed requirements strike the right balance
between requiring specific wording and allowing firms to draft their
own responses? Why or why not? Should the Commission permit or require
a more open-ended narrative or require more prescribed wording? Do the
proposed Instructions cover the range of business models and fee
structures that investment advisers and broker-dealers offer fully and
accurately? Are there other fees that should be required to be
disclosed for broker-dealers or investment advisers?
Is the proposed format useful for retail investors to
understand and compare fees and costs as between broker-dealers and
investment advisers? Should we require further use of bullet points,
tables, charts, graphs or other illustrative format? Should we require,
as proposed, that dual registrants present the fee and cost information
in a tabular format, comparing advisory services and brokerage services
side-by-side, or permit other formats such as in a bulleted format?
How would the required disclosures contribute to
readability and length of the proposed relationship summary? Should
each of these disclosures be required? Should any of these disclosures
not be required but instead permitted? Should any of these disclosures
be required to appear in the relationship summary, but outside the
proposed summary of fees and costs?
Should any additional disclosures about fees and costs be
included for investment advisers? In particular, should we require any
disclosures from an investment adviser's Form ADV Part 2A narrative
brochure, such as more details about an investment adviser's fees? Some
other disclosures about fees that are included in Form ADV Part 2A, but
that we have not included in the proposed relationship summary, include
an adviser's fee schedule; whether the adviser bills clients or
[[Page 21437]]
deducts fees directly from clients' accounts; and an explanation of how
an adviser calculates and refunds prepaid fees when a client contract
terminates (for an adviser charging fees in advance). Should we require
some or all of such disclosures, or other disclosures about fees?
Should we require or permit advisers to disclose whether
they charge performance-based fees, which is a type of compensation
investment advisers may charge to ``qualified clients,'' that is based
on a share of capital gains on, or capital appreciation of, such
clients' assets? \196\ Advisers are required to disclose their receipt
of performance-based fees on Form ADV, and they provide an incentive
for the adviser to take additional investment risks with the account.
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\196\ See Advisers Act rule 205-3.
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Should we permit or require each firm to provide the range
of its fees? If so, should broker-dealers be required to include a
range for each type of transaction-based fee it charges or the
aggregate range for all of the firm's transaction-based fees? Should
investment advisers be required to include a range for each type of
principal fee they charge retail investors for advisory services, or
the aggregate range for all of its principal advisory fees? Do broker-
dealers and investment advisers currently compute or have the ability
to compute such aggregated fee information? What factors determine the
type or amount of fee that firms charge (e.g., for broker-dealers, such
factors could include the: means of placing an order, such as online,
by telephone or in person; type of account, such as full-service or
discount brokerage, and; type of product)? Do commenters have
suggestions for how best to convey one or more ranges in a space-
limited disclosure in light of the different fee structures? Are there
other ways to give retail investors a better sense of the amount of
fees they will pay without providing account-specific disclosures?
Should we require firms to state whether their fees are
``negotiable,'' as we have proposed? At firms that offer negotiable
fees, are retail investors generally able to negotiate their fees, and
if not, would they find this disclosure helpful or could it be
confusing? Will firms be able to succinctly describe the key factors
they believe would help a reasonable retail investor understand the fee
that he or she is likely to pay for a firm's services (e.g., the size
of the transaction, the type of investment purchased, and the type of
account and services he or she receives)?
Will any of the required disclosures be misleading or make
it more difficult for investors to select the right type of account for
them?
Should we make the proposed relationship summary more
personalized to individual retail investors, such as by requiring or
permitting estimates for each retail investor, reflecting the fees and
charges incurred for the retail investor's brokerage or advisory
account? Is personalization feasible for this type of relationship
summary disclosure? If so, what information should be included in the
personalized fees and cost disclosure, and how should such information
be presented? How would firms calculate those estimates? How often
should we require firms to update the personalized fees and
compensation disclosure, and how should the personalized fee disclosure
updates be delivered or made available to retail investors? What would
be the costs to firms to prepare and update personalized fee and
compensation disclosures?
Should we require firms to provide investors with
personalized fee information in a different disclosure, such as an
account statement? What would be the cost and benefits, including the
costs of books and records requirements, of personalizing information
to investors relative to the proposal? Do firms currently provide
retail investors with personalized fee disclosure estimates at or
before account opening? Do they provide personalized fee disclosures in
periodic account statements? For firms that provide personalized fee
disclosures, do they include all fees paid by the retail investor as
well as compensation received by the firm and financial professionals,
even if such compensation is not paid directly or indirectly by the
retail investor, such as commissions, mark-ups, mark-downs, other fees
embedded in the investment or fees from third parties? What other types
of fee information do firms include? Do they automate such disclosures?
How expensive and complex a process is creating and delivering such
personalized fee disclosures?
Should we require firms to state where retail investors
can find personalized information about account fees and costs, such as
on account statements and trade confirmations? What other source of
such information might be available for prospective customers and
clients? Should we require firms to include hyperlinks to fee and cost
calculators on investor.gov?
Should we require firms to provide an example showing how
sample fees and charges apply to a hypothetical advisory account and a
hypothetical brokerage account, as applicable? Should we require a more
general example that shows the impact of hypothetical fees on an
account? If so, what assumptions should we require firms to make in
preparing such an example? For example, should we specify assumptions
such as the kinds of assets that are most typical for a broker-dealer's
customers, stated commission schedules, and aggregate third-party
compensation? If the assumptions were standardized, would such examples
be useful to the retail investor, whose circumstances may be different
from the assumptions used or would they help give an investor a better
idea about what kind of fees are being charged? Would such examples
provide retail investors with a clear understanding of the application
of ongoing asset-based, transaction-based and product-level fees to an
account? Should we require one example for an advisory account and one
example for a brokerage account? How should the information be
presented (e.g., mandated graphical presentation)? Should we require
firms to present more than one hypothetical example showing a range of
fees instead (e.g., based on representative holdings or
recommendations)? Should specific assumptions be included in
calculating the hypothetical example? What disclosures would need to
accompany the example? Should the example(s) track the effect of the
fees over time, and if so, over what time period (e.g., over one, five
and 10 years)? Or should firms describe the impact of different amounts
or types of fees over a longer period of time, such as 20 years?
Should firms be permitted or required to include in the
relationship summary a detailed fee table or schedule? Should we permit
or require firms to create a fee schedule as separate disclosure, and
then include it as an attachment (or cross reference it with a website
address and hyperlink) to the relationship summary? What should be
included in such a fee table or schedule? Should it include
compensation received by the firm and financial professionals, even if
such compensation is not paid directly or indirectly by the retail
investor, such as commissions or fees from third parties?
Regarding fees related to funds and other investments that
reduce the value of the investment over time, would the required
disclosures by investment advisers and broker-dealers be clear and
understandable to retail investors?
[[Page 21438]]
Should we, as proposed, permit firms to select their own example that
they offer to retail investors? Are there other considerations related
to fees for funds and other investments that we should require firms to
highlight for retail investors? Would our proposed requirement that
firms disclose the existence of such fees, along with examples of
investments that impose such fees, adequately inform retail investors
of these costs? Should we require an example showing how investment
fees and expenses and other account fees and expenses may affect a
retail investor's investment over time? Should we require a reference
to such an example if available elsewhere (e.g., in mutual fund, ETF or
variable annuity prospectuses)?
Should firms describe the types of compensation they and
their financial professionals receive from sources other than the
retail investor in the description of their conflicts of interest, as
we have proposed (for example, with respect to revenue sharing
arrangements, such as payments for ``shelf space,'' i.e., product
distribution by broker-dealers)? Or, should we require firms to state
in the fees and costs section of the relationship summary that they and
their financial professionals receive such compensation? If so, what
types of additional compensation should we require firms to disclose in
the summary of fees and costs? Should we require firms to disclose how
the amount of fees received from retail investors relates to the amount
of fees received from others in connection with recommendations or
other services to those investors? Would such disclosure be confusing
to retail investors? Should we require firms only to disclose which
source of fees is greater or to provide a reasonable estimate of the
relative magnitude of the categories of such fees (e.g., that on
average for retail customers that the amount the firm receives from
third parties is twice as much as the firm charges investors)?
Should we require firms to state, as proposed, that a
retail investor will also pay other fees in addition to the firm's
principal fee for brokerage or advisory services, and to list such
fees? Should we also require firms to state ranges for such fees?
We are proposing disclosures that are intended to help
retail investors understand how the principal types of fees firms
charge for advisory and brokerage accounts affect the incentives of the
firm and their financial professionals. Are these disclosures clear? Do
they capture all incentives that broker-dealers or investment advisers
may have from their fee structures? Are there other considerations
related to fees and compensation that we should require firms to
highlight for retail investors that are not captured here or elsewhere
in the relationship summary? Should we require firms to include the
prescribed wording, as proposed, or should we allow more flexibility in
the words they use? Should we modify the prescribed wording? For
example, should we expressly permit or require broker-dealers to modify
the prescribed wording regarding their incentive to encourage retail
investors to engage in transactions, to the extent they also receive
compensation that might lower such incentive, such as asset-based
compensation (e.g., rule 12b-1 fees, sub-transfer agent or other
similar service fees)?
For our prescribed wording for investment advisers
regarding the adviser's incentive to increase the assets in a retail
investor's advisory account, would different wording better reflect
this incentive? Does the proposed wording capture the conflict of
interest, or does the wording suggest that advisers will increase
retail investors' assets by generating higher investment returns?
Because many advisers do not charge ongoing asset-based fees as their
principal fees for retail investor advisory accounts, and instead
charge fixed fees, hourly fees, commissions or other types of fees,
should we require these firms to state the incentives they have as a
result of receiving such other types of fees? If so, what are the
incentives that such firms have that are important for retail investors
to understand and would be relevant to the relationship summary?
These proposed disclosures about a firm's incentives can
also be considered to involve conflicts, as they address the incentives
that investment advisers and broker-dealers have as a result of
receiving certain types of fees. Should we require this disclosure in
the conflicts of interest disclosure instead of the summary of fees and
costs? Should we require firms to include in the summary of fees and
costs any other fee-related conflicts that we propose to include in the
conflicts of interest disclosure, as discussed in Section II.B.6 below?
Should we require firms to include other fee-related conflicts in these
sections that are not included elsewhere in the relationship summary?
Would our proposed disclosure for advisers and broker-
dealers, that retail investors may, in certain circumstances, prefer
one type of fee over another, be useful to retail investors? Are these
proposed disclosures clear? Do they adequately capture the typical
circumstances in which retail investors would prefer one fee type over
another? Are there other considerations related to fees and
compensation that we should require or permit firms to highlight for
retail investors that are not captured here or elsewhere in the
relationship summary? Should we require firms to include the prescribed
wording, as proposed, or should we allow more flexibility in the words
they use? Should we modify the prescribed wording? Does the proposed
prescribed wording capture the range of business models among
investment advisers and broker-dealers? Would the prescribed wording
require a firm to provide any inaccurate information given that
particular firm's circumstances?
Should we require firms to make disclosures about wrap fee
programs, as proposed? Would the proposed disclosures help investors to
understand the fees and costs associated with a wrap fee program as
compared to unbundled advisory accounts and brokerage accounts? Would
the proposed disclosures help retail investors to make informed choices
about whether a wrap fee program suits their needs, as compared with
unbundled investment advisory or brokerage services? If not, how could
we revise it? Are there any revisions to the descriptions of wrap fee
programs that would make the proposed disclosures more useful to
investors?
Are there other differences between wrap fee programs,
unbundled advisory accounts, and brokerage accounts that we should
require firms to include, such as other differences in fees and
services? Would more or less information about wrap fee programs be
helpful for retail investors? For instance, should we require firms to
disclose information about the firms that participate in the wrap fee
programs they recommend (e.g., the wrap fee program sponsors or
managers), and any particular conflicts relevant to investors in wrap
fee programs? Should we require more or less disclosure, or different
disclosure, about the amount and frequency of additional transaction
fees retail investors incur in wrap fee programs? Are there any
elements of the proposed requirements that we should exclude? If so,
why? Should any of the required disclosures be included in a different
section of or an appendix to the relationship summary?
Have we appropriately tailored the information required
for advisers that provide advice about investing in both a wrap fee and
a non-wrap fee program, and advisers that only provide advice about
investing in a wrap fee program?
[[Page 21439]]
Should we require firms that provide advice about investing in both a
wrap fee and a non-wrap fee program to prepare a separate relationship
summary for the wrap fee program? Should we instead require firms to
prepare an appendix with information about the wrap fee program, in
addition to the relationship summary, as we do for the Form ADV
brochure? If so, what types of information should we require firms to
include about wrap fee programs in a separate relationship summary or
appendix, and why should we require such disclosure?
Should we require broker-dealers that sponsor wrap fee
programs to include any additional disclosures about wrap fee programs,
other than the disclosures that would be made by dual registrants?
We understand that client-facing firms--or advisers that
provide advice to retail investors about investing in wrap fee
programs--are not necessarily the same firms that sponsor wrap fee
programs (we define a wrap fee program sponsor in Form ADV General
Instructions as a firm that sponsors, organizes, or administers the
program or selects, or provides advice to clients regarding the
selection of, other investment advisers in the program). Should we
require each client-facing firm to include the proposed wrap fee
disclosures in its relationship summary, even if the firm is not the
wrap fee program sponsor, as proposed? Please describe how this
information is currently provided to wrap fee program clients.
Should we require only sponsors of wrap fee programs (and
not all client-facing firms) to include the proposed wrap fee
disclosures in the relationship summary, similar to the Form ADV wrap
fee brochure delivery requirement, which requires only investment
advisers that sponsor wrap fee programs to deliver to their wrap fee
clients the Form ADV wrap fee brochure? If so, should we permit only
one sponsor of a wrap fee program that has multiple sponsors to include
the proposed wrap fee disclosures in the relationship summary, similar
to the delivery requirements for the Form ADV wrap fee brochure?
In addition to wrap fee programs, are there other types of
retail investor programs and services for which it would be useful to
require investment advisers and broker-dealers to disclose additional
information about the nature and scope of services, fees and conflicts
of interest? If so, which programs and services, and why should we
require such disclosure?
Are there any common misconceptions about broker-dealers'
and investment advisers' compensation that the relationship summary
should specifically seek to clarify or correct (e.g., that the firm or
financial professional will only be compensated if the retail investor
makes money on the investment)?
5. Comparisons
We are proposing to require standalone investment advisers and
standalone broker-dealers to prepare this section under the following
headings: ``Compare with Typical Brokerage Accounts'' (for standalone
investment advisers) or ``Compare with Typical Advisory Accounts'' (for
standalone broker-dealers).\197\ Specifically, standalone broker-
dealers would include the following information about a generalized
retail investment adviser: (i) The principal type of fee for investment
advisory services; (ii) services investment advisers generally provide,
(iii) advisers' standard of conduct; and (iv) certain incentives
advisers have based on the investment adviser's asset-based fee
structure.\198\ For investment advisers, this section would include
parallel categories of information regarding broker-dealers.\199\
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\197\ Proposed Items 5.A. and 5.B. of Form CRS. As discussed
above, for purposes of the relationship summary, we propose to
define a standalone investment adviser as a registered investment
adviser that offers services to retail investors and (i) is not
dually registered as a broker-dealer or (ii) is dually registered as
a broker-dealer but does not offer services to retail investors as a
broker-dealer. We propose to define a standalone broker-dealer as a
registered broker-dealer that offers services to retail investors
and (i) is not dually registered as an investment adviser or (ii) is
dually registered as an investment adviser but does not offer
services to retail investors as an investment adviser. Proposed
General Instruction 9.(f) to Form CRS. See supra note 51. A dually
registered firm that offers retail investors only advisory or
brokerage services (but not both) may in the future decide to offer
retail investors both services. We would expect a firm to update its
relationship summary within 30 days whenever any information in the
relationship summary becomes materially inaccurate. See proposed
General Instruction 6.(a). to Form CRS and infra note 350 and
accompanying text. In addition, the firm would communicate the
information in its amended relationship summary to retail investors
who are existing clients or customers of the firm within 30 days
after the updates are required to be made and without charge. See
proposed General Instruction 6.(b) to Form CRS and infra note 354
and accompanying text.
\198\ Proposed Item 5.B. of Form CRS.
\199\ Proposed Item 5.A. of Form CRS.
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We are proposing to require these disclosures to help retail
investors choose among different account types and services. Having a
clear explanation of differences in the fees, scope of services,
standard of conduct, and incentives that are generally relevant to
advisory and brokerage accounts would help retail investors that are
considering one such type of relationship to compare whether their
needs might be better met with the other type of relationship. In
addition, we are proposing to prescribe wording in this section because
it is intended to provide a general comparison of what we believe is a
typical brokerage or investment adviser account that is offered to
retail investors. Moreover, we believe prescribing language will
promote uniformity and allow retail investors to receive the same
information to use in comparing choices from different standalone
firms.
Standalone investment advisers would be required to include the
following prescribed language (emphasis required): ``You could also
open a brokerage account with a broker-dealer, where you will pay a
transaction-based fee, generally referred to as a commission, when the
broker-dealer buys or sells an investment for you.'' \200\ They would
be required to include prescribed statements in bullet point format
(except as otherwise specified) under the lead-in ``Features of a
typical brokerage account include:'' \201\ First, there would be a
general description of brokerage accounts: ``With a broker-dealer, you
may select investments or the broker-dealer may recommend investments
for your account, but the ultimate decision as to your investment
strategy and the purchase and sale of investments will be yours.''
\202\ This statement would highlight for the retail investor two
aspects of a typical broker-dealer's services that differ from that of
an investment adviser--specifically, that an investor may select
investments without advice or he or she may receive recommendations
from the broker-dealer, and that the investor will make the ultimate
investment decision.
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\200\ Id.
\201\ Id.
\202\ Proposed Item 5.A.1. of Form CRS.
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Standalone investment advisers would then include the following
information about the standard of conduct applicable to broker-dealers:
``A broker-dealer must act in your best interest and not place its
interests ahead of yours when the broker-dealer recommends an
investment or an investment strategy involving securities. When a
broker-dealer provides any service to you, the broker-dealer must treat
you fairly and comply with a number of specific obligations. Unless you
and the broker-dealer agree otherwise, the broker-dealer is not
[[Page 21440]]
required to monitor your portfolio or investments on an ongoing
basis.'' \203\ As discussed above in Section II.B.3, above, the
applicable standard of conduct for financial professionals has been a
source of confusion among retail investors. This statement would
provide information to retail investors about the obligations of
broker-dealers, including some differences from investment advisers'
obligations so that they can consider this factor when determining
whether brokerage services might better suit their needs.
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\203\ Proposed Item 5.A.2. of Form CRS.
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Standalone investment advisers would then include the following
statement discussing incentives created by a typical broker-dealer's
fee: ``If you were to pay a transaction-based fee in a brokerage
account, the more trades in your account, the more fees the broker-
dealer charges you. So it has an incentive to encourage you to trade
often.'' \204\ This disclosure is substantially similar to the
disclosure we propose a broker-dealer would be required to include in
the ``Fees and Costs'' section of its relationship summary.\205\ As
discussed above, we believe this information would help retail
investors understand how the fee structures for brokerage accounts
could affect their investments, which they could compare with the
incentives advisers have based on their fee structure.\206\
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\204\ Proposed Item 5.A.3. of Form CRS.
\205\ See supra Section II.B.4.
\206\ Id.
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Finally, a tabular chart would compare certain specified
characteristics of a transaction-based fee and an ongoing asset-based
fee side-by-side, set off by the wording ``You can receive advice in
either type of account, but you may prefer paying:'' \207\ One column
would include the following (emphasis required): ``a transaction-based
fee from a cost perspective, if you do not trade often or if you plan
to buy and hold investments for longer periods of time.'' \208\ The
other column would include the following (emphasis required): ``an
asset-based fee if you want continuing advice or want someone to make
investment decisions for you, even though it may cost more than a
transaction-based fee.'' \209\ This disclosure is substantially similar
to the disclosure we propose that each dual registrant would include in
the ``Fees and Costs'' section of its relationship summary.\210\ For
the reasons discussed above, we are proposing this requirement to
encourage choice across account types and services.\211\ We are also
proposing that advisers include this information in the specified side-
by-side manner in order to promote comparisons between the relevant
considerations for both types of relationships.
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\207\ Proposed Item 5.A.4. of Form CRS.
\208\ Id.
\209\ Id.
\210\ See supra Section II.B.4.
\211\ Id.
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Standalone broker-dealers would be required to include the
following prescribed language (emphasis required), which would
highlight for the retail investor the different fee structure of many
investment advisers: ``You could also open an advisory account with an
investment adviser, where you will pay an ongoing asset-based fee that
is based on the value of the cash and investments in your advisory
account.'' \212\ Standalone broker-dealers would list prescribed
statements describing certain differences from investment advisers in
bullet point format (except as otherwise specified) under the lead-in
``Features of a typical advisory account include:''.\213\ First, there
would be a general description of investment advisory accounts as
follows: ``Advisers provide advice on a regular basis. They discuss
your investment goals, design with you a strategy to achieve your
investment goals, and regularly monitor your account.'' \214\ The next
bullet would highlight that investment advisers offer discretionary
accounts and non-discretionary accounts by including the following
(emphasis included): ``You can choose an account that allows the
adviser to buy and sell investments in your account without asking you
in advance (a ``discretionary account'') or the adviser may give you
advice and you decide what investments to buy and sell (a ``non-
discretionary account'').'' \215\ Together, these statements would
highlight for the retail investor two aspects of a typical investment
adviser's services that differ from the typical services of a broker-
dealer--specifically, ongoing advice and monitoring and discretionary
accounts.
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\212\ Proposed Item 5.B. of Form CRS. We recognize that some
investment advisers charge other types of fees for their advisory
services, including fixed fees for one-time services such as
financial planning. However, because asset-based fees are a common
type of fee for advisory services, we think it would be useful for
firms to describe asset-based fees in this section of the
relationship summary for comparison with broker-dealers'
transaction-based fees.
\213\ Proposed Item 5.B. of Form CRS.
\214\ Proposed Item 5.B.1. of Form CRS.
\215\ Proposed Item 5.B.2. of Form CRS.
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Standalone broker-dealers would then include the following
disclosure about an investment adviser's standard of conduct:
``Advisers are held to a fiduciary standard that covers the entire
relationship. For example, advisers are required to monitor your
portfolio, investment strategy and investments on an ongoing basis.''
\216\ As discussed above, the applicable standard of conduct for
financial professionals has been a source of confusion among retail
investors. This statement would provide information to retail investors
about the obligations of investment advisers so that they can consider
this factor when determining whether investment advisory services might
better suit their needs.
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\216\ Proposed Item 5.B.3. of Form CRS.
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Standalone broker-dealers would then include the following
disclosure about a typical investment advisory asset-based fee, as
follows: ``If you were to pay an asset-based fee in an advisory
account, you would pay the fee periodically, even if you do not buy or
sell.'' \217\ They would also be required to include the following
prescribed disclosure about hourly fees and one-time flat fees, which
are common among investment advisers that offer financial planning
services and other advisory services to retail investors: ``You may
also choose to work with an investment adviser who provides investment
advice for an hourly fee, or provides a financial plan for a one-time
fee.'' \218\
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\217\ Proposed Item 5.B.4. of Form CRS.
\218\ Id.
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The next statement would note certain incentives created by an
investment adviser's ongoing asset-based fee. Broker-dealers would
include the following: ``For an adviser that charges an asset-based
fee, the more assets you have in an advisory account, including cash,
the more you will pay the adviser. So the adviser has an incentive to
increase the assets in your account in order to increase its fees.''
\219\ This statement is substantially similar to the disclosure an
investment adviser would be required to include in the ``Fees and
Costs'' section of its relationship summary.\220\ For the reasons
discussed above, we believe this information would help retail
investors understand how the principal fee structures for typical
advisory accounts could affect their investments and the incentives
financial professionals may have based on charging ongoing asset-based
fees for investment advisory services. This proposed disclosure would
encourage retail investors to compare these incentives with certain
incentives broker-dealers have based on their fee structure, which
broker-dealers
[[Page 21441]]
would describe under ``Fees and Costs.'' \221\
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\219\ Proposed Item 5.B.5. of Form CRS.
\220\ See supra Section II.B.4.
\221\ Id.
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Finally, standalone broker-dealers would be required to include the
same tabular chart that standalone investment advisers would
include.\222\ As discussed above, requiring this information side-by-
side would promote comparisons of typical advisory and brokerage
relationships.
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\222\ Proposed Item 5.B.6. of Form CRS.
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We request comment generally on the proposed comparison disclosures
to be provided by standalone investment advisers and broker-dealers,
and in particular on the following issues:
Is it useful to require firms to include disclosures about
services and fees they do not offer, so that investors know other
choices are available and are better able to compare different types of
firms?
Is it clear from the headings that the information
provided in this section describes a typical investment adviser and
broker-dealer, and does not describe the circumstances of all
investment advisers and broker-dealers? Why or why not? Should we
modify the headings or provide additional information at the beginning
of this section?
Do the proposed requirements encourage disclosure that is
simple, clear, and useful to retail investors? Would the proposed
disclosure help investors to understand and compare the fees, services
and standard of conduct associated with a firm's advisory services and
brokerage services? Are there any revisions to the descriptions of
fees, services, standard of conduct, and incentives that would make the
proposed disclosure more useful to investors?
Is the proposed order of the information appropriate, or
should it be modified? If so, how should it be modified?
Is the proposed disclosure about how often a typical
advisory firm monitors retail investors' accounts useful to retail
investors, given that different firms may view ``ongoing monitoring''
differently?
Is the proposed format useful for retail investors to
understand and compare fees, services, standard of conduct and
incentives among broker-dealers and investment advisers? Should we
permit or require further use of tables, charts, graphs or other
graphics or text features?
Should we require firms to include the prescribed wording,
as proposed, or should we allow more flexibility in the words they use?
Does the proposed prescribed wording capture the range of typical
business models and fee structures that investment advisers and broker-
dealers offer? Would the prescribed wording require a firm to provide
any inaccurate information given that particular firm's circumstances?
If so, how should it be modified? Instead of the proposed prescriptive
wording, should the Commission permit or require a more open-ended
narrative?
How would the required explanations and various
disclosures contribute to readability and length of the proposed
relationship summary? Should each of these explanations be required,
permitted, or prohibited? Should any of these explanations be required
to appear in the relationship summary, but outside the comparisons
section?
Are there other considerations related to investment
advisers and broker-dealers that we should require or permit firms to
highlight for retail investors? For example, should we require advisers
to state that broker-dealers sometimes offer both full-service and
discount brokerage accounts, and the differences between them,
including fees? Are there any disclosures that we should omit?
Is the proposed prescriptive wording describing the
standard of conduct required for investment advisers and broker-dealers
clear and useful to retail investors? Would the proposed disclosure
help investors to understand the standard of conduct associated with a
firm's advisory services and brokerage services? Should such disclosure
be modified? If so, how should it be modified?
Should we amend the proposed wording that describes the
standard of conduct for broker-dealers to incorporate or refer to any
fiduciary obligations that certain broker-dealers have under state law
or other laws or regulations?
Our proposal would require a standalone investment adviser
to include prescribed disclosure about a broker-dealer's incentives
based on a typical broker-dealer's principal fee structure, and vice
versa. Should these disclosures be substantially similar to the
disclosures we propose certain dual registrants to include, as
proposed? \223\ Or should we modify these disclosures for firms that do
not offer retail investors both brokerage and advisory services? If so,
how should these disclosures be modified?
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\223\ See supra Section II.B.4.
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Our proposal would require a standalone investment adviser
and a standalone broker-dealer to include prescribed disclosure that a
retail investor may prefer one type of fee over another in certain
circumstances. Should these disclosures be substantially similar to the
disclosures we propose certain dual registrants to include, as
proposed? Or should we modify these disclosures for firms that do not
offer retail investors both brokerage and advisory services? If so, how
should these disclosures be modified?
6. Conflicts of Interest
We are proposing to require that investment advisers and broker-
dealers summarize their conflicts of interest related to certain
financial incentives. Specifically, firms would be required to disclose
conflicts relating to: (i) Financial incentives to offer to, or
recommend that the retail investor invest in, certain investments
because (a) they are issued, sponsored or managed by the firm or its
affiliates, (b) third parties compensate the firm when it recommends or
sells the investments, or (c) both; (ii) financial incentives to offer
to, or recommend that the retail investor invest in, certain
investments because the manager or sponsor of those investments or
another third party (such as an intermediary) shares revenue it earns
on those products with the firm; and (iii) the firm buying investments
from and selling investments to a retail investor for the firm's own
account (i.e., principal trading).\224\
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\224\ Proposed Item 6 of Form CRS. Studies have shown, for
example, that for broker-dealers, the most frequently identified
disclosures concerned issues of compensation--e.g., how clients
compensate the firm, how other firms compensate it, and how
employees are compensated. See, e.g., Rand Study, supra note 5, at
xviii. We sometimes refer interchangeably to payments, compensation
and benefits that firms and financial professionals receive. These
terms are all meant to capture the various ways through which firms
and financial professionals have financial incentives to favor a
product, service, account type, investor, or provider over another.
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Investment advisers, broker-dealers, and their financial
professionals have incentives to put their interests ahead of the
interests of their retail investor clients and customers. The federal
securities laws do not preclude broker-dealers or investment advisers
from having conflicts of interest that might adversely affect the
objectivity of the advice they provide; however, firms and financial
professionals have obligations regarding their conflicts. Investment
advisers are required to eliminate, or, at a minimum, fully and fairly
disclose conflicts of interest clearly enough for a client to make an
informed decision to consent to such conflicts and practices,
[[Page 21442]]
or reject them.\225\ For broker-dealers, the federal securities laws
and rules and self-regulatory organization rules address broker-dealer
conflicts in one (or more) of the following ways: Express
prohibitions,\226\ mitigation,\227\ or disclosure.\228\ Under
Regulation Best Interest, broker-dealers would be required to
establish, maintain and enforce written policies and procedures
reasonably designed to identify and disclose and mitigate, or
eliminate, material conflicts of interest arising from financial
incentives associated with such recommendation,\229\ as well as to
disclose, in writing, all material conflicts of interest that are
associated with the recommendation.\230\
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\225\ See SEC v. Capital Gains Research Bureau, Inc., 375 U.S.
180, 194 (1963) (An adviser must deal fairly with clients and
prospective clients, seek to avoid conflicts with its clients and,
at a minimum, make full disclosure of any material conflict or
potential conflict.); see also Instruction 3 of General Instructions
to Part 2 of Form ADV. See Fiduciary Duty Interpretive Release,
supra note 123.
\226\ For example, FINRA rules establish restrictions on the use
of non-cash compensation in connection with the sale and
distribution of mutual funds, variable annuities, direct
participation program securities, public offerings of debt and
equity securities, and real estate investment trust programs. These
rules generally limit the manner in which members can pay for or
accept non-cash compensation and detail the types of non-cash
compensation that are permissible. See FINRA Rules 2310, 2320, 2341,
and 5110.
\227\ See, e.g., FINRA Rule 3110(c)(3) (firm must have
procedures to prevent the effectiveness of an internal inspection
from being compromised due to conflicts of interest); FINRA Rule
3110(b)(6)(C) (supervisory personnel generally cannot supervise
their own activities); FINRA Rule 3110(b)(6)(D) (firm must have
procedures reasonably designed to prevent the required supervisory
system from being compromised due to conflicts of interest).
\228\ For example, when engaging in transactions directly with
customers on a principal basis, a broker-dealer violates Exchange
Act rule 10b-5 when it knowingly or recklessly sells a security to a
customer at a price not reasonably related to the prevailing market
price and charges excessive mark-ups, without disclosing the fact to
the customer. See, e.g., Grandon v. Merrill Lynch & Co., 147 F.3d
184, 189-90 (2d. Cir. 1998). See also Exchange Act rule 10b-10
(requiring a broker-dealer effecting transactions in securities to
provide written notice to the customer of certain information
specific to the transaction at or before completion of the
transaction, including the capacity in which the broker-dealer is
acting (i.e., agent or principal) and any third party remuneration
it has received or will receive.
\229\ Broker-dealers would also be required to establish,
maintain, and enforce written policies and procedures reasonably
designed to identify and at a minimum disclose, or eliminate, all
material conflicts of interest that are associated with such
recommendation. See Regulation Best Interest Proposal, supra note
24, section II.D.3.
\230\ See Regulation Best Interest Proposal, supra note 24,
section II.D.1.
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Conflicts of interest with retail investors often arise when firms
and/or their financial professionals recommend or sell proprietary
products or products offered by third parties, recommend products that
have revenue sharing arrangements, and engage in principal
trading.\231\ For example, a firm could have a financial incentive to
recommend proprietary products because the firm (or its affiliate)
would receive additional revenue or an affiliate could pay a firm for
recommending affiliate products. A broker-dealer making a platform
available for self-directed transactions may select investments
available for purchase on the platform based on financial incentives
the broker-dealer receives. Similarly, a financial professional could
be paid for recommending affiliated products or could get a bonus or
greater promotion potential for recommending certain investments.\232\
These conflicts create an incentive for firms and their financial
professionals to make available for sale or base investment
recommendations on the compensation or profit that firms will receive,
rather than on the client's best interests.\233\ The Commission's
enforcement actions underscore how these types of compensation
arrangements and activities may produce conflicts of interest that can
lead firms and their financial professionals to act in their own
interests, rather than the interests of their retail investors.\234\
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\231\ See, e.g., Rand Study, supra note 5, at 13 (``Examples of
such conflicts include various practices in which an adviser may
have pecuniary interest (through, e.g., fees or profits generated in
another commercial relationship, finder's fees, outside commissions
or bonuses) in recommending a transaction to a client.'') and 15
(noting that the formation of the Committee on Compensation
Practices was, in part, motivated by concerns that commission-based
compensation may encourage registered representatives to churn
accounts or make unsuitable recommendations).
\232\ Jason Zweig & Anne Tergesen, Advisers at Leading Discount
Brokers Win Bonuses to Push Higher-Priced Products, Wall Street
Journal (Jan. 10, 2018), available at https://www.wsj.com/articles/advisers-at-leading-discount-brokers-win-bonuses-to-push-higher-priced-products-1515604130.
\233\ See, e.g., Brochure Adopting Release, supra note 157, at
n.62 and accompanying text and n.132; Report of the Committee on
Compensation Practices (Apr. 10, 1995), at 3, available at https://www.sec.gov/news/studies/bkrcomp.txt (``The prevailing commission-
based compensation system inevitably leads to conflicts of interest
among the parties involved.''). See also FINRA Report on Conflicts
of Interest (Oct. 2013), available at https://www.finra.org/sites/default/files/Industry/p359971.pdf (discussing conflicts of interest
in the broker-dealer industry and highlighting effective conflicts
management practices); SEC v. Capital Gains Research Bureau Inc.,
375 U.S. at 191, 196-97 (``The Investment Advisers Act of 1940 thus
reflects a congressional recognition of the delicate fiduciary
nature of an investment advisory relationship. . . . An investor
seeking the advice of a registered investment adviser must, if the
legislative purpose is to be served, be permitted to evaluate such
overlapping motivations, through appropriate disclosure, in deciding
whether the adviser is serving two masters or only one, especially
if one happens to be economic self-interest.''); In the Matter of
Feeley & Willcox Asset Management Corp., Investment Advisers Act
Release No. 2143 (Jul. 10, 2003) (Commission opinion) (``It is the
client, not the adviser, who is entitled to make the determination
whether to waive the adviser's conflict. Of course, if the adviser
does not disclose the conflict, the client has no opportunity to
evaluate, much less waive, the conflict.'').
\234\ See infra notes 243, 255, 256, 260 and 267, citing
examples of where we have brought enforcement actions regarding
conflicts of interest arising from one or more of the following
categories of compensation practices and activities: the
compensation of the firm's financial professionals; payments from
others; incentives for selling the firm's own products, and
principal trading.
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We are not proposing to require or permit the relationship summary
disclosure to include specific information about all of the conflicts
of interests that are or could be present in a firm's relationship with
retail investors. For example, conflicts that can be applicable to
investment advisers include using certain affiliated service
providers,\235\ charging performance-based fees to some accounts but
not others,\236\ personal trading by an adviser's personnel,\237\
receipt of soft dollar products and services provided by brokers in
connection with client transactions,\238\ and voting client
securities.\239\ Likewise, a broker-dealer
[[Page 21443]]
may have several conflicts of interest with its retail investors that
we are not proposing to include in the relationship summary. These
include, for example, a broker-dealer's incentive to favor its
institutional customers over its retail customers when making available
proprietary research or certain investment opportunities, such as
widely anticipated initial public offerings, acting as a market maker
for a recommended security, using certain service providers, or voting
client securities.\240\ In addition, broker-dealers are subject to
Exchange Act rules that require them to disclose in writing to the
customer if they have any control, affiliation, or interest in a
security they are offering or the issuer of such security.\241\
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\235\ Item 10.C. of Form ADV Part 2A. Item 10 requires an
investment adviser to describe in its brochure material
relationships or arrangements the adviser (or any of its management
persons) has with related financial industry participants, any
material conflicts of interest that these relationships or
arrangements create, and how the adviser addresses the conflicts.
The disclosure that Item 10 requires highlights for clients their
adviser's other financial industry activities and affiliations that
can create conflicts of interest and may impair the objectivity of
the adviser's investment advice. See Brochure Adopting Release,
supra note 157, at 29.
\236\ Item 6 of Form ADV Part 2A. An adviser faces a variety of
conflicts of interest that it is required to address in its Form ADV
brochure, including that the adviser can potentially receive greater
fees from its accounts having a performance-based compensation
structure than from those accounts it charges a fee unrelated to
performance (e.g., an asset-based fee). See Brochure Adopting
Release, supra note 157, at n.64 and accompanying text; 2008
Brochure Proposing Release, supra note 157, at n.51 and accompanying
text.
\237\ Items 11.C. and 11.D. of Form ADV Part 2A. For example,
because of the information they have, advisers and broker-dealers
and their personnel are in a position to abuse clients' positions
by, for example, placing their own trades before or after client
trades are executed in order to benefit from any price movements due
to the clients' trades. An investment adviser is required to address
this conflict in its Form ADV brochure. See Brochure Adopting
Release, supra note 157, at n.83 and accompanying text.
\238\ Item 12 of Form ADV Part 2A. Use of client commissions to
pay for research and brokerage services presents money managers with
significant conflicts of interest, and may give incentives for
managers to disregard their best execution obligations when
directing orders to obtain client commission services as well as to
trade client securities inappropriately in order to earn credits for
client commission services. See Brochure Adopting Release, supra
note 157, at n.128 (citing Release 54165, supra note 187).
\239\ Item 17 of Form ADV Part 2A. Each adviser must describe
how the adviser addresses conflicts of interest when it votes
securities pursuant to its proxy voting authority, as applicable.
See Brochure Adopting Release, supra note 157, at n.172 and
accompanying text.
\240\ See 913 Study, supra note 3, at nn.251 and 254 and
accompanying text (discussing that courts have found that broker-
dealers should have disclosed these conflicts).
\241\ See Exchange Act rules 15c1-1, 15c1-5, and 15c1-6.
Similarly, rule 15c1-6 requires written disclosure of the broker-
dealer's interest in a security it is offering at or before the
completion of the transaction. Self-regulatory organizations require
similar disclosures. See, e.g., FINRA Rules 2262 and 2269; and MSRB
Rule G-22.
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It is important for firms to disclose information about each of
these conflicts to retail investors; however, we believe that requiring
an exhaustive discussion of all conflicts in the relationship summary
would make the relationship summary too long for its intended purpose--
that is, focusing on key aspects of a firm and its services, as well as
helping retail investors to make an informed choice between receiving
the services of a broker-dealer or an investment adviser or among
different broker-dealers or investment advisers. Since investment
advisers already report conflicts of interest in Form ADV Part 2, a
more exhaustive discussion of conflicts by investment advisers would be
duplicative of certain disclosures provided in Form ADV Part 2, which
is provided to clients of investment advisers, including retail
investors.\242\ While we are not proposing to require such detailed
disclosures for broker-dealers in the relationship summary, Regulation
Best Interest would require broker-dealers to disclose, in writing, all
material conflicts of interest that are associated with a
recommendation to a retail customer.\243\
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\242\ For investment advisers, the Form ADV Part 2 brochure and
the brochure supplement address many of the conflicts an adviser may
have. Items in Part 2 of Form ADV may not address all conflicts an
adviser may have, and may not identify all material disclosure that
an adviser may be required to provide clients. As a result,
delivering a brochure prepared under Form ADV's requirements may not
fully satisfy an adviser's disclosure obligations under the Advisers
Act. See Brochure Adopting Release, supra note 157, at n.7. Broker-
dealers also must make a variety of disclosures, but the extent,
form and timing of the disclosures are different. See 913 Study,
supra note 3, at 55--58. In accordance with the Instructions to Form
CRS, if a relationship summary is posted on a firm's website or
otherwise provided electronically, the firm must use hyperlinks for
any document that is cross-referenced in the relationship summary if
the document is available online. See proposed General Instruction
1.(g) to Form CRS.
\243\ See supra notes 229- 230 and accompanying text. When
recommending a security, broker-dealers generally are liable under
the antifraud provisions if they do not give ``honest and complete
information'' or disclose any material adverse facts or material
conflicts of interest, including any economic self-interest. See,
e.g., De Kwiatkowski v. Bear, Stearns & Co., 306 F.3d 1293, 1302 (2d
Cir. 2002); Chasins v. Smith, Barney & Co., 438 F.2d 1167, 1172 (2d
Cir. 1970); In the Matter of Richmark Capital Corp., Exchange Act
Release No. 48758 (Nov. 7, 2003) (Commission opinion) (``Release
48758'') (``When a securities dealer recommends stock to a customer,
it is not only obligated to avoid affirmative misstatements, but
also must disclose material adverse facts of which it is aware. That
includes disclosure of ``adverse interests'' such as ``economic self
interest'' that could have influenced its recommendation.'')
(citations omitted).
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We are proposing to require specific information about conflicts of
interest related to financial incentives for recommending or selling
proprietary products or products offered by third parties, and from
revenue sharing arrangements. Such incentives could include, for
example, the firm earning more money or the financial professional
receiving compensation or other benefits, including an increase in
compensation such as a bonus, when a retail investor invests in the
product. Disclosure of these conflicts would highlight for retail
investors that firms and financial professionals have financial
incentives to place their own interests first when making investment
recommendations. Including these disclosures prominently, in one place,
at or before the start of a retail investor's relationship with a firm
or financial professional would facilitate retail investors'
understanding of the incentives that may be present throughout the
course of the relationship. Retail investors also have indicated they
find information about the sources and amount of compensation from
third parties useful and relevant to making informed financial
decisions before engaging a firm.\244\ In addition, a number of
commenters responding to Chairman Clayton's Request for Comment
suggested disclosure that would focus on incentives associated with the
products and services offered and how associated persons are
compensated.\245\
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\244\ See 917 Financial Literacy Study, supra note 20, at xxi.
(``The most useful and relevant information that the online survey
respondents indicated that they favored to make informed financial
decisions before engaging a financial intermediary includes
information about . . . [s]ources and amount of compensation that a
financial intermediary may receive from third parties in connection
with and [sic] investment transaction . . .'').
\245\ See, e.g., SIFMA 2017 Letter; UBS 2017 Letter; ICI 2017
Letter; State Farm 2017 Letter; IAA 2017 Letter; Bernardi Securities
2017 Letter; Fidelity 2017 Letter.
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We are also proposing to require disclosures about conflicts
relating to principal transactions. Commenters recognized the
importance of principal trading, with appropriate safeguards, including
disclosure.\246\ As we explain further below, we believe that investors
should be aware of and understand this conflict at or before the start
of the relationship.
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\246\ See, e.g., SIFMA 2017 Letter (recommending that a best
interest standard of conduct for broker-dealers would not prohibit
principal trading, provided that such transactions be accompanied by
written disclosure and corresponding client consent); Wells Fargo
2017 Letter. See also ICI 2017 Letter (recommending that a broker-
dealer would be able to engage in principal trading, subject to
appropriate limitations, disclosure, and customer consent); Bernardi
Securities 2017 Letter (recommending that any revised standard of
conduct for broker-dealers permit principal transactions, and
suggesting that firms could implement disclosures and policies and
procedures to protect investors from the related potential
conflicts).
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Specifically, we are proposing that firms use the heading
``Conflicts of Interest'' under which a broker-dealer, investment
adviser or dual registrant would describe three categories of
conflicts, as applicable to the firm.\247\ To emphasize the importance
of conflicts, broker-dealers would be required to state the following
language after the heading: ``We benefit from our recommendations to
you.'' \248\ Similarly, investment advisers would be required to state:
``We benefit from the advisory services we provide you.'' \249\ Dual
registrants would be required to state: ``We benefit from the services
we provide you.'' \250\ If all or a portion of a conflict is not
applicable to the firm's business, the firm should omit that conflict
or portion thereof.\251\ If a conflict only applies to a dual
registrant's brokerage accounts or investment advisory accounts, the
firm would include that conflict in the applicable column.\252\
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\247\ Proposed Items 6.A. and 6.B. of Form CRS.
\248\ Proposed Item 6.A. of Form CRS..
\249\ Id.
\250\ Id.
\251\ Proposed Item 6.B. of Form CRS.
\252\ Id.
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First, we propose that a firm be required to state, as applicable,
that it has a financial incentive to offer or
[[Page 21444]]
recommend to the retail investor certain investments because: (a) They
are issued, sponsored or managed by the firm or the firm's affiliates,
(b) third parties compensate the firm when it recommends or sells the
investments, or (c) both.\253\ The firm also would provide examples of
such types of investments, and state if its financial professionals
receive additional compensation if the retail investor buys these
investments.\254\
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\253\ Proposed Item 6.B.1. of Form CRS. We are not prescribing
the specific language that firms must use to discuss each of these
conflicts, which would give firms some flexibility to structure
their disclosure, particularly if they offer proprietary products
and receive compensation from third parties.
\254\ Proposed Items 6.B.1. of Form CRS.
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This conflict disclosure would highlight that a variety of
financial incentives affects the incentives of the firm or its
financial professional to offer or recommend certain investments to the
retail investor.\255\ These financial incentives can range from cash
and non-cash compensation that a firm or financial professional
receives for selling those investments as well as less direct financial
incentives. In particular, investors might not be aware that the firm
or its affiliate offers proprietary products that provide a financial
incentive to the firm to recommend those products, that a third party
provides incentives for a firm to recommend investments, or that the
firm's financial professional will receive additional compensation if
the retail investor buys certain investments. We believe that requiring
this disclosure is consistent with indications that retail investors
find information about sources and amount of compensation that firms
receive from third parties useful to make informed financial
decisions.\256\ Additionally, we believe that it is important for firms
to separately and explicitly disclose if the financial professionals
benefit from these payments because these individuals are making the
recommendations to the retail investors and their compensation is an
incentive that could affect their advice.
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\255\ The Commission has brought enforcement actions against
firms that the Commission alleged to have failed to disclose fees,
such as referral fees, that financial professionals receive as a
result of recommending certain investments to retail investors. See,
e.g., In the Matter of Financial Design Associates, Inc. and Albert
Coles Jr., Investment Advisers Act Release No. 2654 (Sept. 25, 2007)
(settled action) (respondents failed to disclose to investment
advisory clients payments received from a company in which clients
were advised to invest); In the Matter of Energy Equities, Inc. and
David G. Snow, Investment Advisers Act Release No. 1811 (Aug. 2,
1999) (settled action) (respondents received finder's fees or other
compensation from issuers, the securities of which were recommended
to clients or prospective clients); Vernazza v. SEC, 327 F.3d 851
(9th Cir. 2003).
\256\ See 917 Financial Literacy Study, supra note 20, at xxi.
The Commission's enforcement actions also have underscored how these
types of compensation and benefits from third parties for
recommending certain investments may produce conflicts of interest
that lead firms and their financial professionals to favor those
investments over others. See, e.g., In the Matter of the Robare
Group, LTD., Investment Advisers Act Release No. 3907 (Sep. 2, 2014)
(Commission opinion) (investment adviser failed to disclose
compensation it received through agreements with a registered
broker-dealer and conflicts arising from that compensation).
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We are also proposing to require examples of the types of
investments associated with each of these conflicts (e.g., mutual funds
and variable annuities) because we believe it would be helpful for
investors to be aware of the types of products for which firms and
financial professionals have these incentives.\257\ We considered
whether to require a complete list of investments; however, we believe
that a long list of the names of each of the affected products would
not necessarily benefit investors or be helpful to them in their review
of the firm's conflicts and could detract from the other information in
the relationship summary.
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\257\ See proposed Items 6.B.1. of Form CRS.
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Next, we propose that firms disclose revenue sharing arrangements
by stating that the firm has an incentive to offer or recommend the
retail investor to invest in certain investments because the manager or
sponsor of those investments or another third party (such as an
intermediary) shares with the firm revenue it earns on those
investments.\258\ The firm also would provide examples of such types of
investments.\259\ This disclosure would highlight another type of
compensation firms receive that affects their incentives to offer or
recommend certain investments to the retail investor, and like the
disclosures regarding proprietary products and third party payments,
would provide retail investors with information about sources of
compensation the firm receives from third parties.\260\ This
requirement is intended to capture arrangements pursuant to which a
firm receives payments or other benefits from third parties for
recommending certain investments, including, for example, conflicts
related to payment for distribution support or ongoing services from
distributors or advisers of mutual funds, annuity products or other
products. We are proposing that firms would be required to describe
these and other conflicts of interest even if the compensation the firm
receives is not shared with the firm's financial professionals, as the
compensation can create incentives for the firm to promote certain
investments over others. These types of distribution-related
arrangements may give broker-dealers heightened incentives to market
the shares of particular mutual funds, or particular classes of fund
shares. Those incentives may be reflected in a broker-dealer's use of
``preferred lists'' that explicitly favor the distribution of certain
funds, or they may be reflected in other ways, including incentives or
instructions that the broker-dealer provides to its managers or its
salespersons.\261\
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\258\ Proposed Item 6.B.2. of Form CRS.
\259\ Id.
\260\ The Commission has pursued enforcement actions against
firms that the Commission alleged to have failed to disclose revenue
sharing arrangements. See, e.g., In re Edward D. Jones & Co,
Securities Act Release No. 8520 (Dec. 22, 2004) (broker-dealer
violated antifraud provisions of Securities Act and Exchange Act by
failing to disclose conflicts of interest arising from receipt of
revenue sharing, directed brokerage payments and other payments from
``preferred'' fund families that were exclusively promoted by
broker-dealer); In re Morgan Stanley DW Inc., Securities Act Release
No. 8339 (Nov. 17, 2003) (``Release 8339'') (broker-dealer violated
antifraud provisions of Securities Act by failing to disclose
special promotion of funds from fund families that paid revenue
sharing and portfolio brokerage); In the Matter of KMS Financial
Services, Inc., Investment Advisers Act Release No. 4730 (Jul. 19,
2017) (dually-registered investment adviser and broker-dealer that
failed, in its capacity as an investment adviser, to disclose to its
advisory clients compensation it received from a third party broker-
dealer for certain investments it selected for its advisory
clients); In the Matter of Voya Financial Advisors, Inc., Investment
Advisers Act Release No. 4661 (Mar. 8, 2017) (registered investment
adviser failed to disclose to its clients compensation it received
through an arrangement with a third party broker-dealer and
conflicts arising from that compensation).
\261\ See, e.g., Release 8339, supra note 260.
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Finally, we propose that firms address principal trading by stating
that the firm can buy investments from a retail investor, and sell
investments to a retail investor, from its account (called ``acting as
principal'').\262\ Firms must state that they can earn a profit on
those trades, and disclose that the firm has an incentive to encourage
the retail investor to trade with it.\263\ If this activity is part of
the firm's investment advisory business, it must state that the retail
investor's specific approval is required on each transaction.\264\
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\262\ Proposed Item 6.B.3. of Form CRS.
\263\ Id.
\264\ Section 206(3) of the Advisers Act. Proposed Item 6.B.3.
of Form CRS.
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While access to securities that are traded on a principal basis,
such as certain types of municipal bonds, is important to many
investors, principal trades by broker-dealers and investment advisers
raise potential conflicts of
[[Page 21445]]
interest.\265\ Principal trading raises concerns because of the risks
of price manipulation or the placing of unwanted securities into client
accounts (i.e., ``dumping'').\266\ Under the Advisers Act, an adviser
may not engage in a principal trade with an advisory client unless it
discloses to the client in writing, before completion of the
transaction, the capacity in which the adviser is acting, and obtains
the consent of the client to the transaction.\267\ Broker-dealers also
are subject to a number of requirements when they engage in principal
transactions with customers, including disclosure of such capacity on
the trade confirmation.\268\ There is no specific requirement for
broker-dealers, however, to provide written disclosure prior to the
trade or obtain consent for each principal transaction.\269\ Our
proposal to require firms to disclose, if applicable, that they engage
in principal transactions, and to summarize the conflict of interest
raised by principal transactions, would not replace the disclosure and
consent requirements under the Advisers Act or any other requirement,
such as under the Exchange Act. Rather, our disclosure requirement
would supplement such disclosures by alerting retail investors to this
practice and the related conflicts of interest at the start of the
relationship.
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\265\ See 913 Study, supra note 3, at 120.
\266\ See id., at 118.
\267\ Section 206(3) of the Advisers Act. See also Opinion of
Director of Trading and Exchange Division interpreting the reference
to ``the transaction'' to require separate disclosure and consent
for each transaction. Investment Advisers Act Release No. 40 (Feb.
5, 1945) (``[T]he requirements of written disclosure and of consent
contained in this clause must be satisfied before the completion of
each separate transaction. A blanket disclosure and consent in a
general agreement between investment adviser and client would not
suffice.''); 913 Study, supra note 3, at n.534 and accompanying
text. An investment adviser must provide written disclosure to a
client and obtain the client's consent at or prior to the completion
of each transaction. 913 Study, supra note 3, at n.535 and
accompanying text. See also, e.g., Release 3929, supra note 133; In
the Matter of JSK Associates, et al., Investment Advisers Act
Release No. 3175 (Mar. 14, 2011) (settled action).
\268\ As an example of one such requirement, broker-dealers must
disclose their capacity in the transactions (typically on the
confirmation statement). See Exchange Act rule 10b-10.
\269\ See 913 Study, supra note 3, at n.540 and accompanying
text.
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We request comment generally on the conflicts of interest
disclosures proposed to be included in the relationship summary, and in
particular on the following issues:
Do the proposed conflicts of interest disclosures
encourage firms to provide information that is simple, clear, and
useful to retail investors? Would the proposed disclosures help retail
investors to compare the conflicts of interest associated with advisory
services and brokerage services and the conflicts among firms? Does the
relationship summary help retail investors understand that compensation
to firms and financial professionals creates incentives that could
impact the advice or recommendations that they provide? If not, should
it do so and if so, what modifications should be made to the summary to
address this concern?
Should we require brief statements about particular
conflicts of interest, as proposed, or should we require a more open-
ended narrative or more prescribed wording? Would an open-ended
narrative permit firms to tailor the disclosure and describe all of the
conflicts they believe retail investors should know? Or would firms
seek to provide so much information about their conflicts that the
proposed page limit (or equivalent limit in electronic format) would
not provide enough space for all of the disclosures? How would the
required explanations of various items contribute to the readability
and length of the relationship summary?
Our intent in using layered disclosure for conflicts
(i.e., short summaries of certain types of conflicts of interest with
information later in the relationship summary on where retail investors
can find more information) is to highlight these conflicts and
encourage retail investors to ask questions and seek more information
about the firm's and its financial professionals' conflicts of
interest. Do our proposed requirements achieve this goal? In light of
our objective of keeping the relationship summary short, should we
instead prescribe general language concerning the importance of
understanding conflicts, while simply requiring cross-references to the
relevant sections of Form ADV Part 2 brochure or brochure supplement
(for investment advisers) and relevant disclosures typically included
in account opening documents or websites (for broker-dealers)? Should
we provide wording to encourage retail investors to ask questions about
conflicts, including advising customers to go through all of the firm's
and financial professional's conflicts with the financial professional?
Are there other modifications or alternatives we should consider?
Should we instead require firms to make the conflicts of
interest disclosure more detailed, even if it results in a lengthier
relationship summary?
Are the proposed conflicts of interest disclosures too
limited? Are there other types of conflicts we should include, such as
additional disclosure currently required in the Form ADV Part 2
brochure or brochure supplement (for investment advisers), or
disclosure typically included in account opening documents or websites
(for broker-dealers)? Should we, for example, require firms to describe
all of their conflicts and how they address them, such as specific
information about incentives to favor certain clients over others,
agency cross-trades, relationships with certain clients, personal
trading by personnel, soft dollar practices, directed brokerage, proxy
voting practices, or acting as a market maker for a recommended
security? Or should we require firms to list all of their conflicts and
provide cross references to where additional information about each
conflict can be found (i.e., cross referencing the relevant sections of
Form ADV Part 2 and analogous broker-dealer disclosures)? Would this
detract from the brevity of the disclosure? Is there another way to
provide additional information about conflicts to retail investors in a
way that would be meaningful to them and would facilitate their ability
to obtain additional information?
Are there certain types of investments that should be
disclosed by firms as ones that the firm ``issues, sponsors, or
manages?'' For example, should we require firms to disclose that any
investment with a firm's name in the title is generally an investment
that the firm issues, sponsors, or manages? If a firm uses a name other
than its own name to market proprietary investments, should we require
firms disclose such other names?
Should we require firms to disclose whether they provide
ancillary services to retail investors themselves or through their
affiliates so that retail investors better understand that the firm has
incentives to select its affiliates over third parties?
With respect to the required disclosure regarding
financial incentives a firm has to offer or recommend investment in
certain investments because they are offered by the firm's affiliates,
or third parties compensate the firm for selling their investments, or
both, would firms understand what types of financial incentives would
be covered by this item--and what would not be covered? Should the
Commission provide additional guidance or instructions to clarify?
Should we require firms to disclose that they use third-
party service providers that offer the firms or their financial
professionals additional compensation? For example, some investment
advisers select broker-
[[Page 21446]]
dealers to execute their clients' transactions that provide the adviser
or financial professionals with compensation or other benefits,
including in the form of client referrals. Should we highlight that
compensation can be in the form of advisory client referrals?
Firms would be required to provide examples of investments
that firms have a financial incentive to offer. Are these requirements
clear? Should we provide additional guidance? Should firms also be
required to identify specific account types for which financial
professionals receive incentives? Or should firms list all of their
services or products that create the stated conflicts (or cross-
reference to such disclosure elsewhere)? Should additional information
be provided in this section of the relationship summary or should it be
provided in an attachment?
Should firms explicitly state that other firms offer
similar products that could be less expensive for the retail investor?
Should we require firms to disclose if the firm engages in principal
trading, as proposed, including that the firm can earn a profit on
these trades and may have an incentive to encourage the retail investor
to trade with the firm? Should we require investment advisers to state
the retail investor's specific approval on each principal transaction
is required? Are there additional disclosures that we should require
for broker-dealers?
Should we require firms to disclose any additional
conflicts of interest related to the compensation of financial
professionals? For example, should firms be required to include any
specific conflicts related to financial professionals' outside business
activities? Should we require firms to include additional disclosure on
compensation that a financial professional receives from third parties,
such as compensation that an investment adviser representative receives
in his or her capacity as a registered representative of an unrelated
broker-dealer?
Should we allow firms to choose the order they present the
conflicts? For example, should firms be permitted to base the order on
the conflicts they believe are most relevant in their business, or is a
standardized order preferable to increase the comparability of the
disclosures among different firms? If a firm does not engage in any
practices that would be required to be disclosed, should we permit or
require a firm to state that it does not have that conflict, or should
we require firms to say nothing, as proposed? Would it be confusing to
investors if, as proposed, the order was prescribed but some firms omit
certain conflicts because they do not have the particular conflict?
Would such presentation lessen the ability to compare conflicts across
firms?
Is the proposed format useful for retail investors in
understanding and comparing conflicts of interest among firms? Would
the use of tables, charts, graphs or other graphics or text features be
helpful in explaining all or any particular conflict? If so, how could
firms structure that disclosure?
Should any of the conflicts be required to appear in the
relationship summary, but outside of the conflicts of interest section?
7. Additional Information
We are proposing to require that firms include information on where
retail investors can find more information about the firm's
disciplinary events, services, fees, and conflicts, which facilitates
the layered disclosure that the relationship summary provides.\270\
This section would be titled ``Additional Information'' and firms would
include the following after the title: ``We encourage you to seek out
additional information.'' First, firms would be required to state
whether or not they or their financial professionals currently disclose
or are currently required to disclose certain legal or disciplinary
events to the Commission, self-regulatory organizations, state
securities regulators or other jurisdictions, as applicable. We are
including information about a firm's and its financial professionals'
disciplinary information because this information may assist retail
investors in evaluating the integrity of a firm and its financial
professionals.\271\ For example, a prior disciplinary event could
reflect upon the firm's integrity, affect the degree of trust and
confidence a client would place in the firm, or impose limitations on
the firm's activities.\272\ Knowledge of a firm's and financial
professional's disciplinary history is among the most important items
for retail investors when deciding whether to receive financial
services from a particular firm, according to one study.\273\
Approximately 67.5% of the online survey respondents considered
information about an adviser's disciplinary history to be absolutely
essential, and about 20.0% deemed it important, but not essential.\274\
But despite its importance, many investors do not review this
information prior to engaging a firm.\275\ A study also found that many
retail investors would check the Investment Adviser Public Disclosure
site (``IAPD'') for comparative information on investment advisers,
including disciplinary history, if they were made aware of its
existence.\276\ We believe that requiring firms to state the existence
of
[[Page 21447]]
disciplinary events, provide specific questions for retail investors to
ask, and provide information on where retail investors can find more
information, would cause more retail investors to seek out this
information and would make them better informed when they choose a firm
and a financial professional.\277\
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\270\ See supra notes 37, 48-50 and 139-141 and accompanying
text (regarding the use of layered disclosure and alternative
approaches to presentation).
\271\ See Brochure Adopting Release, supra note 157, at n.81 and
accompanying text. See also Electronic Filing by Investment
Advisers; Proposed Amendments to Form ADV, Investment Advisers Act
Release No. 1862 (Apr. 5, 2000) [65 FR 20524 (Apr. 17, 2000)], at
nn.148-149 and accompanying text (``2000 Brochure Proposing
Release'') (``When assessing whether an adviser will fulfill its
obligations to clients, an investor would likely give great weight
to whether the adviser has met its fiduciary and other legal
obligations in the past.''); Self-Regulatory Organizations;
Financial Industry Regulatory Authority, Inc.; Order Approving a
Proposed Rule Change to Amend FINRA Rule 8312 (FINRA BrokerCheck
Disclosure) to Expand the Categories of Civil Judicial Disclosures
Permanently Included in BrokerCheck, Release No. 34-71196 (Dec. 27,
2013) [79 FR 417 (Jan. 3, 2014)] (``By making certain of this
information publicly available, BrokerCheck, among other things,
helps investors make informed choices about the individuals and
firms with which they conduct business.'').
\272\ See Brochure Adopting Release, supra note 157, at n.85.
\273\ See 917 Financial Literacy Study, supra note 20, at nn.308
and 498 and accompanying text (``When asked how important certain
factors would be to them if they were to search for comparative
information on investment advisers, the majority of online survey
respondents identified the fees charged and the adviser's
disciplinary history as the most important factors.'').
\274\ Id.
\275\ 917 Financial Literacy Study, supra note 20, at n.770
(citing Applied Research Consulting LLC for FINRA Investor Education
Foundation, Financial Capability in the United States: Initial
Report of Research Findings from the 2009 National Survey (Dec. 1,
2009), available at http://www.usfinancialcapability.org/downloads/NFCS_2009_Natl_Full_Report.pdf (``2009 National Survey Initial
Report''), which revealed that only 15% of respondents claimed that
they had checked a financial professional's background or
credentials with a state or federal regulator, although the
Commission notes that the study encompasses a wide group of
advisors, such as debt counselors and tax professionals.). In
addition, the FINRA 2015 Investor Survey found that only 24% of
investors were aware of Investor.gov; only 16% were aware of
BrokerCheck; only 14% were aware of the IAPD website, and only 7%
had used BrokerCheck. FINRA, Investors in the United States 2016
(Dec. 2016), available at http://www.usfinancialcapability.org/downloads/NFCS_2015_Inv_Survey_Full_Report.pdf).
\276\ See 917 Financial Literacy Study, supra note 20, at
nn.317-319 and accompanying text ([A]bout 76.5% of the online survey
respondents reported that, in selecting their current adviser, they
did not use an SEC-sponsored website to find information about the
adviser. 73% of respondents stated that they would check IAPD if
they were made aware of its existence. Of that subset--those who
reported not using an SEC-sponsored website--approximately 85.2%
indicated that they did not know that such a website was available
for that purpose. Of that majority (i.e., a further subset)--those
who were unaware of such a website--approximately 73.5% reported
that they would review information about their adviser on an SEC-
sponsored website if they knew it were available).
\277\ In addition, this would address an issue that was
highlighted by the Commission's Investor Advisory Committee, which,
among other things, encouraged the Commission to develop an enhanced
approach to the disclosure of disciplinary events. Broker-Dealer
Fiduciary Duty Recommendations, supra note 10 (recommending a
summary disclosure document that includes, among other disclosures,
basic information about a firm's disciplinary record).
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Specifically, in the relationship summary, firms would state ``We
have legal and disciplinary events'' if they are required to disclose
(i) disciplinary information per Item 11 of Part 1A or Item 9 of Part
2A of Form ADV,\278\ or (ii) legal or disciplinary events per Items
11A-K of Form BD (``Uniform Application for Broker-Dealer
Registration'') \279\ except to the extent such information is not
released through BrokerCheck pursuant to FINRA Rule 8312 or in
IAPD.\280\ Regarding their financial professionals, firms would
determine whether they need to include the statement based on legal and
disciplinary information on Form U4,\281\ Form U5 \282\ and Form
U6.\283\ In particular, firms would be required to state, ``We have
legal and disciplinary events'' if they have financial professionals
for whom disciplinary events are reported per Items 14 A-M on Form U4,
Items 7(a) and 7(c)-(f) on Form U5,\284\ and Form U6 except to the
extent such information is not released through BrokerCheck pursuant to
FINRA Rule 8312 or in IAPD.\285\
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\278\ Proposed Item 7.B. of Form CRS. Generally, investment
advisers are required to disclose on Form ADV Part 2A any legal or
disciplinary event, including pending or resolved criminal, civil
and regulatory actions, if it occurred in the previous 10 years,
that is material to a client's (or prospective client's) evaluation
of the integrity of the adviser or its management personnel, and
include events of the firm and its personnel. See Brochure Adopting
Release, supra note 157, at 22-27. Items 9.A., 9.B., and 9.C.
provide a list of disciplinary events that are presumptively
material if they occurred in the previous 10 years. However, Item 9
requires that disciplinary events more than 10 years old be
disclosed if the event is so serious that it remains material to a
client's or prospective client's evaluation of the adviser and the
integrity of its management.
\279\ Item 11 of Form BD requires disclosure on the relevant
Disclosure Reporting Page (``DRP'') with respect to: (A) felony
convictions, guilty pleas, ``no contest'' pleas or charges in the
past ten years; (B) investment-related misdemeanor convictions,
guilty pleas, ``no contest'' pleas or charges in the past ten years;
(C) certain SEC or the Commodity Futures Trading Commission (CFTC)
findings, orders or other regulatory actions (D) other federal
regulatory agency, state regulatory agency, or foreign financial
regulatory authority findings, orders or other regulatory actions;
(E) self-regulatory organization or commodity exchange findings or
disciplinary actions; (F) revocation or suspension of certain
authorizations; (G) current regulatory proceedings that could result
in ``yes'' answers to items (C), (D) and (E) above; (H) domestic or
foreign court investment-related injunctions, findings, settlements
or related civil proceedings; (I) bankruptcy petitions or SIPC
trustee appointment; (J) denial, pay out or revocation of a bond;
and (K) unsatisfied judgments or liens. Some of these disclosures
are only required if the relevant action occurred within the past
ten years, while others must be disclosed if they occurred at any
time.
\280\ FINRA Rule 8312 governs the information FINRA releases to
the public via BrokerCheck. FINRA established BrokerCheck in 1988
(then known as the Public Disclosure Program) to provide the public
with information on the professional background, business practices,
and conduct of FINRA member firms and their associated natural
persons. The information that FINRA releases to the public through
BrokerCheck is derived from the CRD system, the securities industry
online registration and licensing database. Firms, their associated
natural persons and regulators report information to the CRD system
via the uniform registration forms (Form U4 (Uniform Application for
Securities Industry Registration or Transfer), Form U5 (Uniform
Termination Notice for Securities Industry Registration), Form U6
(Uniform Disciplinary Action Reporting Form), Form BD (Uniform
Application for Broker-Dealer Registration), Form BDW (Uniform
Request for Broker-Dealer Withdrawal), and Form BR (``Uniform Branch
Office Registration Form'')). Under FINRA Rule 8312, FINRA limits
the information that is released to BrokerCheck in certain respects.
For example, pursuant to FINRA Rule 8312(d)(2), FINRA shall not
release ``information reported on Registration Forms relating to
regulatory investigations or proceedings if the reported regulatory
investigation or proceeding was vacated or withdrawn by the
instituting authority.'' We believe it is appropriate to limit
disclosure in the relationship summary to disciplinary information
or history that would be released to BrokerCheck.
\281\ Form U4 (Uniform Application for Securities Industry
Registration or Transfer) requires disclosure of registered
representatives' criminal, regulatory, and civil actions similar to
those reported on Form BD as well as certain customer-initiated
complaints, arbitration, and civil litigation cases. See generally
Form U4.
\282\ Form U5 (Uniform Termination Notice for Securities
Industry Registration) requires information about representatives'
termination from their employers. See Form U5.
\283\ Form U6 (Uniform Disciplinary Action Reporting Form) is
used by SROs, regulators, and jurisdictions to report disciplinary
actions against broker-dealers and associated persons. This form is
also used by FINRA to report final arbitration awards against
broker-dealers and associated persons. See Form U6.
\284\ The disclosure would be triggered by reportable
information on Items 7(a) and 7(c) through (f). Item 7(b) (Internal
Review Disclosure) is not released to BrokerCheck by FINRA, pursuant
to FINRA Rule 8312(d)(3). As noted above (see supra note 280), we
believe it is appropriate to limit disclosure in the relationship
summary to disciplinary information or history that would be
released to BrokerCheck.
\285\ Proposed Item 7.B.3. of Form CRS.
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We considered requiring firms to provide additional details about
the reported legal and disciplinary events of the firms and their
financial professionals. For example, we could have proposed to require
firms to include details about the type and number of the reported
events. Broker-dealers and investment advisers do not report all of the
same types of disciplinary events. We also considered whether to
require firms to only discuss the types of disciplinary events that
both broker-dealers and investment advisers report, require investment
advisers to disclose complaints and other disciplinary events that only
broker-dealers report, or create separate requirements to require firms
to disclose certain types of events in the relationship summary without
reference to information in other disclosures.
We are not proposing to take any of these approaches because this
is summary disclosure rather than a comprehensive discussion of a
firm's legal and disciplinary history. We believe that for many firms,
requiring additional information would include too much detail for
short summary disclosure, and updating these details in the
relationship summary on an ongoing basis would add significant costs
without compensating benefit. The information already is required to be
disclosed elsewhere, and the relationship summary as proposed would
direct retail investors to those resources. We believe that requiring
an affirmative statement that the firm and its financial professionals
have reportable legal or disciplinary events, if applicable, will flag
this important issue for retail investors and help them to determine
whether they want additional information in other disclosures. By
proposing to base the new disclosure on information that is already
reported elsewhere and also to include details about where to find more
information, we would give retail investors the tools to learn
more.\286\ Furthermore, as discussed below, the statement encouraging
retail investors to visit Investor.gov for more information would help
retail investors to more easily learn additional details from the firms
themselves and from their existing disclosures.\287\
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\286\ Proposed Item 7.D. of Form CRS.
\287\ Id.
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Next, all firms would be required to include the following wording
to highlight where retail investors can find more information about the
disciplinary history of the firm and its financial professionals,
whether or not the firm is required to state the existence of legal or
disciplinary events in the relationship summary: ``Visit Investor.gov
for a free and simple search tool to research our
[[Page 21448]]
firm and our financial professionals.'' \288\
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\288\ Proposed Item 7.C. of Form CRS.
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Retail investors would further benefit from understanding how to
report problems and complaints to the firm and regulators. Accordingly,
we propose to require that firms include the following wording next in
this section:
``To report a problem to the SEC, visit Investor.gov or call the
SEC's toll-free investor assistance line at (800) 732-0330. [To report
a problem to FINRA, [ ].] If you have a problem with your investments,
account or financial professional, contact us in writing at [insert
your primary business address].\289\
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\289\ Proposed Item 7.D. of Form CRS.
Broker-dealers and dual registrants also would include the bracketed
language regarding how to report a problem to FINRA. Firms would be
required to review and update (if needed) the current telephone numbers
for the SEC and FINRA at least annually.\290\
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\290\ Id.
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Firms would be required to state where the retail investor can find
additional information about their brokerage and investment advisory
services, as applicable. Broker-dealers would be required to direct
retail investors to additional information about their brokers and
services on BrokerCheck (https://brokercheck.finra.org), their firm
websites (including a link to the portion of the website that provides
up-to-date information for retail investors), and the retail investor's
account agreement.\291\ Broker-dealers that do not have public websites
would be required to state where retail investors can find up-to-date
information.\292\
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\291\ Proposed Item 7.E.1. of Form CRS.
\292\ Id.
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Investment advisers likewise would be required to direct retail
investors to additional information in the firm's Form ADV Part 2
brochure and any brochure supplement provided by a financial
professional to the retail investor.\293\ If an adviser has a public
website and maintains a current version of its firm brochure on the
website, the firm would be required to provide the website
address.\294\ If an adviser does not have a public website or does not
maintain its current brochure on its public website, then the adviser
would provide the IAPD website address (https://
adviserinfo.sec.gov).\295\
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\293\ Proposed Item 7.E.2. of Form CRS.
\294\ Id.
\295\ Id. SEC- and state-registered investment advisers are
required to file their brochures and brochure amendments through the
IARD system. See rules 203-1 and 204-1 of the Advisers Act and
similar state rules. Members of the public can view an adviser's
most recent Form ADV online at the IAPD website:
www.adviserinfo.sec.gov.
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Unlike investment advisers, which deliver brochures and brochure
supplements to clients, broker-dealers are not currently required to
deliver to their retail investors written disclosures covering their
services, fees, conflicts, and disciplinary history in one place.\296\
However, under Regulation Best Interest, broker-dealers would be
required to disclose, in writing, the material facts relating to the
scope and terms of the relationship with the retail customer including
all material conflicts of interest that are associated with the
recommendation.\297\ We understand that, under current practice,
broker-dealers typically provide information about some or all of the
categories of disclosure included in this relationship summary on their
firm websites and in their account opening agreements. We recognize
that the different disclosure requirements for investment advisers and
broker-dealers may result in retail investors having access to more
information about investment advisers on a particular topic as compared
to information about broker-dealers and vice versa. We request comment
on whether we should take additional steps to ensure that retail
investors have access to a similar amount of additional information
about each of the topics covered by the relationship summary, such as
by requiring firms to include appendices or hyperlinks with specific
information.
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\296\ Broker-dealers are required under certain circumstances,
such as when effecting certain types of transactions, to disclose
certain conflicts of interest to their customers in writing, in some
cases at or before the time of the completion of the transaction.
See, e.g., supra notes 228 and 241 and accompanying text. See also
913 Study, supra note 3, at nn.256-259 and accompanying text; supra
notes 230 and 243-243 and accompanying text (describing broker-
dealer obligations under proposed Regulation Best Interest).
\297\ See Regulation Best Interest Proposal, supra note 24, at
section II.D.1.
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We request comment generally on the disclosure about where to find
additional information, and in particular on the following issues:
Do commenters agree that it is important for retail
investors to know of a firm and its financial professionals' legal and
disciplinary events before entering into an agreement with a firm? Why
or why not?
Is including the disciplinary history disclosure in the
additional information section sufficient to draw a retail investors'
attention or encourage retail investors to ask follow-up questions on
this topic?
Would the proposed format with prescribed wording
effectively communicate information about disciplinary events to retail
investors? Or should we use a table with yes/no check boxes or another
graphical format to describe this information, or should we permit a
firm to state in its own words whether it has reported any events? What
approach would permit easier comparison by retail investors across
firms, including dual registrants?
Would more detail about these events be more beneficial
and easily understandable for retail investors? For example, should
firms be required to provide background about the types of events that
would trigger the disclosure (such as criminal, civil, and regulatory
actions and, for broker-dealers and financial professionals, customer
complaints, arbitrations and bankruptcies)? Should we require separate
disclosures for firms and their financial professionals? Should we
consider requiring a more specific list of the types of disciplinary
events that firms and financial professionals report and require firms
to state whether there are reported disclosures for each type? For
example, should firms be required to state they have reported
disclosures for criminal actions, civil actions and administrative
proceedings, and for broker-dealers specifically, arbitrations and
complaints? Should we instead require firms to disclose the total
number of the legal and disciplinary events that are reported on Form
BD, Form ADV, and/or Forms U4, U5, and U6, as applicable? Or should we
require firms to report the total number of all reported criminal
actions, civil actions, administrative proceedings, arbitrations, and
complaints for them and their financial professionals, as applicable?
Would this information be confusing for retail investors without more
information about each reported event? If we do require this
information, should we require firms to disclose the percentage of a
firm's total financial professionals that have reported disciplinary
events? As part of this approach, should we require a firm to disclose
its total number of financial professionals to provide additional
context for the percentage?
Should we require firms to include specific wording
directing retail investors to ask them questions about these events and
to review more detailed disclosures by searching Investor.gov?
Should firms be required or permitted to state that they
do not currently have reportable legal and/or disciplinary events, if
that is the case? Should we require firms to distinguish whether they
or their financial professionals have reportable
[[Page 21449]]
disciplinary events, for example by stating ``Our firm has legal and
disciplinary events'' or ``We have financial professionals who have
legal and disciplinary events''?
Do commenters agree with requiring disclosure if firms or
financial professionals have reported legal and/or disciplinary events
on Form BD, Forms U4, U5 or U6, and Form ADV, as applicable? Do
commenters agree with the specific items on those forms that we have
identified as triggering reportable events? Should we only require
disclosure of the types of legal events that both broker-dealers and
investment advisers report? For example, should we require all firms to
disclose financial information, which broker-dealers are required to
report pursuant to Items 11 (I, J, and K) on Form BD but investment
advisers do not report? Or, in the alternative, should we exclude
financial disclosures from a broker-dealer's reportable legal or
disciplinary events? Do commenters agree that the legal or disciplinary
events triggering disclosure on the relationship summary should be the
same for financial professionals working for broker-dealers as for
investment advisers? If not, why not?
Do commenters agree that, for broker-dealers and financial
professionals of broker-dealers and investment advisers, we should
exclude information that is not released to BrokerCheck or IAPD
pursuant to FINRA Rule 8312? BrokerCheck and IAPD include additional
information, including summary information about certain arbitration
awards against a financial professional, or against a firm in
BrokerCheck, involving a securities or commodities dispute with a
public customer. Although broker-dealers are not required to report
arbitrations on Form BD, should we include arbitrations as reportable
events in light of the BrokerCheck disclosures? If so, how would
commenters suggest articulating the required disclosure?
Pursuant to FINRA Rule 4530, broker-dealers are required
to disclose certain information to FINRA that is not reported on Form
BD (e.g., customer complaints and arbitrations). Should we include
disclosures made to FINRA pursuant to FINRA Rule 4530 as reportable
events? If so, should we require disclosure of similar events by
investment advisers? Why or why not?
Do commenters believe that stating whether a firm has
legal and disciplinary events and then providing hyperlinks on where to
find additional information is the correct approach? Should we
explicitly require deep links? Why or why not? Do commenters believe
that retail investors will check Investor.gov? Should we require firms
to cross reference other sources of disciplinary information, including
providing direct links to the IAPD or BrokerCheck? Why or why not?
Rather than asking firms to identify whether they have
legal and disciplinary events, should the relationship summary note
that retail investors may want to consider this information and then
encourage retail investors to ask their financial professional for more
details and include cross references to where further information can
be found? Why or why not? With respect to robo-advisers or broker-
dealers providing online services, will a financial professional be
available to answer these types of questions? \298\
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\298\ Robo-advisers should also keep in mind the considerations
set forth in the robo-adviser guidance update specifically as it
relates to the substance and presentation of disclosures. See Robo-
Advisers, IM Guidance Update No. 2017-02 (Feb. 23, 2017), available
at https://www.sec.gov/investment/im-guidance-2017-02.pdf.
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Should we adopt a definition of ``financial professional''
for purposes of this disclosure? If so, how would commenters suggest
formulating the definition?
Our intent in using layered disclosure, with short
summaries of selected disclosures and information on where retail
investors can find more information, is to encourage retail investors
to ask questions and seek more information about the firm's and their
financial professionals' services, fees, conflicts of interest and
disciplinary events. Does the proposed relationship summary, in
general, and this additional information section, in particular,
achieve this goal? Are there modifications or alternatives we should
consider to achieve this goal?
In addition or as an alternative to the proposed cross
references to an investment adviser's Form ADV brochure and brochure
supplement(s) and account agreement, and to a broker-dealer's public
website, account agreement and BrokerCheck, should the relationship
summary direct retail investors to other sources of information? Should
we require firms to include public website addresses and hyperlinks to
the sources of additional information, if available? Do firms' websites
typically include additional information about topics included in the
relationship summary? Given that not all firms have a public website or
maintain current information on a public website (e.g., its current
brochure or other current information), are there other places to which
firms should direct retail investors to look for up-to-date
information? Should we require firms that do not already maintain a
public website to establish one for purposes of making the relationship
summary publicly available?
8. Key Questions
We are proposing to require that firms include questions for retail
investors to ask their financial professionals in the relationship
summary. By requiring these questions, we intend to encourage retail
investors to have conversations with their financial professionals
about how the firm's services, fees, conflicts and disciplinary events
affect them. We encourage financial professionals to engage in balanced
and meaningful conversations with their retail investors to facilitate
investors making informed decisions, using these key questions as a
guide. Firms should use formatting to make the questions more
noticeable and prominent (for example, by using a larger font, a text
box, different font, or lines to offset the questions from the other
sections).\299\ Firms would be required to include ten questions, as
applicable to their particular business, under the heading ``Key
Questions to Ask'' after stating the following: ``Ask our financial
professionals these key questions about our investment services and
accounts.'' The required questions would be:
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\299\ Proposed Item 8 of Form CRS.
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1. Given my financial situation, why should I choose an advisory
account? Why should I choose a brokerage account?
2. 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?
3. What additional costs should I expect in connection with my
account?
4. 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?
5. 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.
6. How will you choose investments to recommend for my account?
7. How often will you monitor my account's performance and offer
investment advice?
8. Do you or your firm have a disciplinary history? For what type
of conduct?
[[Page 21450]]
9. 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.
10. 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? \300\
---------------------------------------------------------------------------
\300\ Proposed Item 8 of Form CRS.
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We are proposing to allow firms to modify or omit portions of these
questions, as applicable to their business.\301\ We are also proposing
to require a standalone broker-dealer and a standalone investment
adviser, to modify the questions to reflect the type of account they
offer to retail investors (e.g., advisory or brokerage account).\302\
In addition, we are proposing that firms could include any other
frequently asked questions they receive following these questions.
Firms would not, however, be permitted to exceed fourteen questions in
total in order to limit the length of the relationship summary.\303\
---------------------------------------------------------------------------
\301\ Id.
\302\ Id.
\303\ Id.
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We recognize that advisers providing computer-generated, automated
advice, often referred to as ``robo-advisers,'' and online-only broker-
dealers may employ business models that offer varying levels of
interaction or no interaction with a financial professional. We are
proposing to require advisers providing automated advice or broker-
dealers providing online-only services without a particular individual
with whom a retail investor can discuss these questions to include a
section or page on their website that answers each of the above
questions, and provide a hyperlink in the relationship summary to that
section or page.\304\ If the firm provides automated advice, but makes
a financial professional available to discuss the existing account with
a retail investor, that firm generally should also make the financial
professional available to discuss these questions with the retail
investor.
---------------------------------------------------------------------------
\304\ Id.
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We believe that many of these questions would help retail investors
to elicit more detail concerning the items discussed in the
relationship summary. For example, the questions asking why an investor
should choose an advisory or brokerage account and how much the
investor can expect to pay are intended to help the retail investor
receive information about services and fees that are tailored to that
particular investor's circumstances. We believe that the financial
professional generally would have access to the information needed to
provide this information to a particular retail investor during the
account opening process.\305\ Questions about how the financial
professional and the firm make money and about conflicts of interest
would assist investors in understanding the extent to which
compensation creates incentives for a financial professional to take
his or her own interests into account in providing services. Similarly,
the last question in the list of questions, which asks about a retail
investor's primary contact at the firm and that financial
professional's legal obligations, is intended to elicit a conversation
about the different legal obligations of firms and financial
professionals acting in an investment advisory capacity and in a
brokerage capacity. Other items allow the investor to learn more
specific information about the firms and financial professional, such
as additional conflicts the firms or its financial professionals might
have or disciplinary history.
---------------------------------------------------------------------------
\305\ See supra Section II.B.4, ``Summary of Fees and Costs.''
---------------------------------------------------------------------------
The proposed questions cover all of the sections in the
relationship summary. They also include one additional topic about the
financial professional's relevant experience, including licenses and
other qualifications. In our experience, the relevant experience,
including licenses, education, and other qualifications for a
particular financial professional are important to retail
investors.\306\ However, if we required firms to disclose the
educational and professional certifications of each financial
professional, firms would have to attach a separate disclosure for each
particular financial professional (similar to the Form ADV brochure
supplement or the information about financial professionals provided on
BrokerCheck and IAPD) or would have to include lengthy disclosure with
information about all of their financial professionals. We believe this
would be more burdensome than prompting retail investors to ask their
financial professionals these questions to encourage a conversation
about these topics, if such a conversation is important to that
investor. We understand that including ``Key Questions to Ask'' would
result in some firms creating policies and procedures, including
supervision and compliance reviews, relating to how their financial
professionals respond to the questions.
---------------------------------------------------------------------------
\306\ See 917 Financial Literacy Study, supra note 20, at 24
(``Some examples of information that commenters indicated should be
included in a summary disclosure document for an investment product
or service include descriptions of. . . any eligibility
requirements.''); Brochure Adopting Release, supra note 157, at
nn.213-216 and accompanying text (discussing commenters that
supported the brochure supplement, which contains information about
the educational background, business experience, and disciplinary
history (if any) of the supervised persons who provide advisory
services to the client).
---------------------------------------------------------------------------
We request comment generally on the questions proposed to be
included in the relationship summary, and in particular on the
following issues:
Would our proposed questions encourage discussions between
retail investors and their financial professionals? Would they help
retail investors become informed about how a firm's services, fees,
conflicts, and disciplinary events affect them? Would they help
investors to compare investment advisers and broker-dealers?
Would financial professionals be able to answer these
``Key Questions to Ask''? Do they have access to personalized
information about the retail investor and the retail investor's account
to be able to, for example, put together personalized fee information
and estimates during the account opening process? To the extent
responses would require information about the particular retail
investor, would firms need to change the account opening process in
order to obtain that information and provide responses?
Should we require or permit firms to include these
questions throughout the relationship summary rather than, or in
addition to, including the questions in the ``Key Questions to Ask''?
In our proposal, for example, the fees and costs section of the
relationship summary directs retail investors to ask their financial
professionals for personalized fee information. Are there other
disclosures in the relationship summary for which we should require or
permit firms to also include a question to ask as part of the
disclosure? If so, which disclosures? Could firms use technology such
as pop-ups or hovers, or internal links, to connect the relevant
question(s) in the key questions to ask to the disclosure in the
relationship summary?
Would firms create policies and procedures, including
supervision and compliance reviews, relating to how their financial
professionals respond to these questions? Would implementing and
maintaining such processes be burdensome or costly for firms? Why or
why not? Do investment advisers and broker-dealers currently have
systems in place to answer these questions, particularly the request to
``do the math for me'' and provide not only fee
[[Page 21451]]
information related to the relationship and certain externalized fees,
but also information about fees that are implicit to a given product?
Do firms anticipate that they would implement
recordkeeping policies and procedures to address communications between
financial professionals and retail investors about the ``Key Questions
to Ask''? What kind of recordkeeping policies and procedures would
firms anticipate implementing in order to address such communications?
Should we require financial professionals to highlight these key
questions when they deliver a relationship summary to a retail
investor? How could the questions be highlighted when the relationship
summary is delivered electronically?
Should we require financial professionals to initiate a
conversation about these key questions if the retail investor does not
raise these questions?
Should we, as proposed, permit firms to omit any of the
proposed questions that are not applicable to their business, and
permit firms to add additional questions for retail investors to ask
about the disclosures in their relationship summaries? For example,
should robo-advisers and online broker-dealers be allowed to omit the
questions concerning the financial professional's relevant experience
and whether the investor's primary contact is an investment adviser or
broker-dealer? Should we add questions specific to investment advisers
offering automated advice, such as how the robo-adviser's models are
designed, including the underlying assumptions?
Should we include any additional questions in our proposed
list of questions, or remove any proposed questions? If so, what
additional questions should we add, and which questions should we
remove, and why? For example, instead of including a question about a
financial professional's licenses and other qualifications in this
section, should we instead require firms to discuss information about
licensing and other qualifications in the relationship summary,
including educational background, designations held, and examinations
passed? Should we add a question comparing services offered with
financial planning and wrap fee programs?
Do commenters agree that including a question about a
financial professional's licenses and other qualifications would
provide useful information to retail investors, given the expansive
list of professional designations? Should we instead permit or require
financial professionals to include a list of certain licenses or other
qualifications in a separate disclosure and, if so, which designations
should be included?
We are proposing to permit firms to include up to fourteen
questions. Do commenters agree with this approach? Should we allow
firms to include more or fewer questions?
We are proposing to require that robo-advisers and online-
only brokers include a section or page on their websites that answers
each of these proposed questions, and include a hyperlink in the
relationship summary to where the answers are posted. How will these
advisers and broker-dealers be able to answer the fact specific
questions in a generalized format on the website? Are there alternative
ways in which such advisers or broker-dealers should be required to
provide answers to these proposed questions? For example, should robo-
advisers use a chat or other message function, or answer questions by
email? Would this work for robo-advisers that offer recommendations to
retail investors without providing them any way to reach a financial
professional at the firm? Should we require all advisers to include the
responses to these questions on their websites, including robo-advisers
that make available financial professionals to answer retail investors'
questions?
Should we require the order of the questions to be fixed?
Does the proposed order advance our goal? What changes, if any, should
be made to the proposed order? Should there be sub-categories of
questions?
C. Delivery, Updating, and Filing Requirements
Our proposal would require registered investment advisers,
registered broker-dealers that serve retail customers and dual
registrants to deliver a relationship summary.\307\ Delivery of the
relationship summary would not necessarily relieve the firm of any
other disclosure obligations it has to its retail investors or
prospective retail investors under any federal or state laws or
regulations.
---------------------------------------------------------------------------
\307\ See Advisers Act proposed rule 204-5 and Exchange Act
proposed rule 17a-14.
---------------------------------------------------------------------------
The relationship summary requirement would be in addition to, and
not in lieu of, current disclosure and reporting requirements or other
obligations for broker-dealers and investment advisers.\308\ Broker-
dealers are liable under the antifraud provisions of the federal
securities laws for failure to disclose material information to their
customers when they have a duty to make such disclosure.\309\ When
recommending a security, broker-dealers may be liable under the
antifraud provisions if they do not give ``honest and complete
information'' or disclose any material adverse facts or material
conflicts of interest, including any economic self-interest.\310\ Among
other specific disclosure obligations, broker-dealers are required to
disclose certain potential conflicts to their customers under certain
circumstances, such as disclosing at or before the time of the
completion of the transaction whether the broker-dealer is acting as
agent or principal, and its compensation and any third-party
remuneration it has received or will receive.\311\ Broker-dealers
typically provide information about their services, fees, and conflicts
on their websites and in their account opening agreements. Disciplinary
history on broker-dealers, details on the background, qualifications,
and disciplinary history of financial professionals associated with
broker-dealers, and customer complaints and arbitrations against them,
are available on FINRA's BrokerCheck website.\312\
---------------------------------------------------------------------------
\308\ For example, the relationship summary would not
necessarily satisfy the disclosure requirements under proposed
Regulation Best Interest. Regulation Best Interest would require
broker-dealers to disclose in writing, before or at the time of a
recommendation, the material facts related to the scope and terms of
the relationship with the retail customer, including all material
conflicts of interest that are associated with the recommendation.
Regulation Best Interest Proposal, supra note 24, at section II.D.1
(noting that the relationship summary would reflect initial layers
of disclosure, and the disclosure obligation of proposed Regulation
Best Interest would reflect more specific and additional, detailed
layers of disclosure).
\309\ See Basic v. Levinson, 485 U.S. 224, 239 n.17 (1988)
(``Silence, absent a duty to disclose, is not misleading under Rule
10b-5.''); Chiarella v. U.S., 445 U.S. 222, 228 (1980) (explaining
that a failure to disclose material information is only fraudulent
if there is a duty to make such disclosure arising out of ``a
fiduciary or other similar relation of trust and confidence''); SEC
v. Monarch Funding Corp., 192 F.3d 295, 308 (2d Cir. 1999)
(explaining that defendant is liable under section 10(b) and rule
10b-5 for material omissions ``as to which he had a duty to
speak'').
\310\ See, e.g., De Kwiatkowski v. Bear, Stearns & Co., 306 F.3d
at 1302; Chasins v. Smith, Barney & Co., 438 F.2d at 1172.
\311\ 17 CFR 240.10b-10(a)(2).
\312\ See https://brokercheck.finra.org.
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Investment advisers deliver to clients a ``brochure'' (and/or a
``wrap fee program brochure,'' as applicable) and ``brochure
supplement'' required by Form ADV Part 2.\313\ The brochure is a plain
language, narrative document that addresses, among other things, an
investment adviser's advisory business,
[[Page 21452]]
conflicts of interest with its clients, fees, and disciplinary
history.\314\ The brochure supplement contains information about the
advisory personnel providing clients with investment advice.\315\ The
wrap fee program brochure provides prospective wrap fee program clients
with important information regarding the cost of the programs and the
services provided. The current Form ADV Parts 1 and 2A are filed by
investment advisers, and details about the background qualifications,
registrations and disciplinary history of financial professionals
supervised by the investment adviser, are available on IAPD.\316\
---------------------------------------------------------------------------
\313\ See Advisers Act rule 204-3; Instructions 1 and 2 of
Instructions for Part 2A of Form ADV; Instructions 2 and 3 of
Instructions for Part 2B of Form ADV. An investment adviser that
sponsors a wrap fee program is generally required to complete a wrap
fee program brochure. See Appendix 1 to Form ADV Part 2A.
\314\ Much of the disclosure in Part 2A addresses an investment
adviser's conflicts of interest with its clients, and is disclosure
that the adviser, as a fiduciary, must make to clients in some
manner regardless of the form requirements. See Brochure Adopting
Release, supra note 157, at 9.
\315\ Form ADV Part 2B includes information about certain
advisory personnel on whom clients may rely for investment advice,
including their educational background, disciplinary history, and
the adviser's supervision of the advisory activities of its
personnel. Investment advisers are not required to file with the
Commission the brochure supplements required by Form ADV Part 2B.
Advisers Act rules 203-1(a), 204-1(b).
\316\ IAPD is available at https://www.adviserinfo.sec.gov.
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The current disclosure requirements and obligations result in
varying degrees and kinds of information to investors, but we believe
that all retail investors would benefit from a short summary that
focuses on certain key aspects of the firm and its services. By
requiring both investment advisers and broker-dealers to deliver a
relationship summary that discusses both types of services and their
differences, the relationship summary would help all retail investors,
whether they are considering an investment adviser or a broker-dealer.
A relationship summary would help retail investors to understand key
aspects of a particular firm, to compare different types of accounts,
and to compare that firm with other firms. While the information
required by the relationship summary is generally already provided in
greater detail for investment advisers by Form ADV Part 2, the
relationship summary would provide in one place, for the first time,
summary information about the services, fees, conflicts, and
disciplinary history for broker-dealers.
1. Filing Requirements
As proposed, firms would be required to file their relationship
summary with the Commission, and the relationship summary will be
available on the Commission's public disclosure website. The essential
purpose of the relationship summary is to provide information to retail
investors to help them decide whether to engage a particular firm or
financial professional and open an investment advisory or brokerage
account. If a firm does not have retail investor clients or customers
and is not required to deliver a relationship summary to any clients or
customers, the firm would not be required to prepare or file a
relationship summary.\317\ Broker-dealers would file their relationship
summaries electronically in a text-searchable format with the
Commission on EDGAR. Investment advisers would file their relationship
summaries electronically in a text-searchable format through IARD in
the same manner as they currently file Form ADV Parts 1A and 2A. Dual
registrants would file on both EDGAR and IARD. All previously filed
versions of relationship summaries filed via EDGAR will remain
available to the public. Although previously filed versions of an
adviser's relationship summary would remain stored as Commission
records in IARD, only the most recent version of an adviser's
relationship summary will be available through the Commission's public
disclosure website.
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\317\ See proposed amended Advisers Act rule 203-1 note to
paragraph (a)(1); proposed Exchange Act rule 17a-14(a), (b). See
infra Section II.C.2 for a discussion of the delivery requirements.
---------------------------------------------------------------------------
We considered proposing other electronic filing platforms, either
maintained by the Commission or by a third-party contractor. We are
proposing IARD and EDGAR because they are familiar filing systems for
investment advisers and broker-dealers. Investment advisers registered
with the Commission file Form ADV on IARD.\318\ Many broker-dealers
submit documents to the Commission on EDGAR and all broker-dealers have
an EDGAR CIK number.\319\ As mentioned above, a dual registrant would
be required to file the relationship summary on EDGAR and IARD. The
information for dual registrants would be accessible through IARD or
EDGAR, which are both available through the Commission's website
www.Investor.gov. Exact processes for firms to follow in filing under
each system is specified on the IARD system website and in the EDGAR
filer manual, respectively.
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\318\ Investment advisers may instead file a paper copy of the
Form ADV with the Commission if they apply for a hardship exemption
by filing Form ADV-H.
\319\ During fiscal year 2017, approximately 1,100 broker-
dealers submitted documents to the Commission using EDGAR. Broker-
dealers can file their annual reports on EDGAR and broker-dealers
that also conduct another business activity (e.g., broker-dealers
that are also municipal advisers or large traders) use EDGAR for
other required filings.
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There are several reasons we propose having the relationship
summaries filed with the Commission. First, every relationship summary
would be easily accessible through the Commission's website. The public
would benefit by being able to use a central location to find any
firm's relationship summary. Easy access to various relationship
summaries through one source may facilitate simpler comparison across
firms. Second, some firms may not maintain a website, and therefore
their relationship summaries would not otherwise be accessible to the
public. Although we are proposing that firms without a website include
a toll-free telephone number in their relationship summaries that
retail investors can call to obtain up-to-date information,\320\
requiring filing with the Commission will allow the public to access
any firm's relationship summary. Lastly, by having firms file the
relationship summaries with the Commission, the Commission can more
easily monitor the filings for compliance with Form CRS.
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\320\ Proposed General Instruction 8.(a) to Form CRS.
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2. Delivery Requirements
We propose to require that a firm deliver the relationship summary
to each retail investor, in the case of an investment adviser, before
or at the time the firm enters into an investment advisory agreement
or, in the case of a broker-dealer, before or at the time the retail
investor first engages the firm's services.\321\ A dual registrant
should deliver the relationship summary at the earlier of entering into
an investment advisory agreement with the retail investor or the retail
investor engaging the firm's services.\322\ We encourage delivery of
the relationship summary far enough in advance of a final decision to
engage the firm to allow for meaningful discussion between the
financial professional and retail investor, including by using the Key
Questions, and for the retail investor to understand the information
and weigh the available options. The delivery requirement
[[Page 21453]]
applies to investment advisers even if the investment advisory
agreement is oral, and to broker-dealers even if a transaction is
executed outside of an account or without an account opening agreement,
as further discussed below. In the case of paper delivery, if firms do
not deliver the relationship summary as the sole document, firms should
ensure that it is the first among any documents that are delivered at
that time.\323\ A firm would be permitted to deliver the relationship
summary (including updates) electronically, consistent with the
Commission's guidance regarding electronic delivery.\324\ We are also
proposing a requirement for firms that maintain a public website to
post their relationship summaries on their websites in a way that is
easy for retail investors to find.\325\ Firms that do not maintain a
website would be required to include in their relationship summaries a
toll-free number for investors to call to obtain documents.\326\
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\321\ Advisers Act proposed rule 204-5(b)(1) and Exchange Act
proposed rule 17a-14(c)(1); proposed General Instruction 5.(b) to
Form CRS.
\322\ Advisers Act proposed rule 204-5(b)(1) (investment
advisers or their supervised persons must deliver to each retail
investor a current Form CRS before or at the time the investment
adviser enters into an investment advisory contract with the retail
investors) and Exchange Act proposed rule 17a-14(c)(1) (broker-
dealers must deliver to each retail investor a current Form CRS
before or at the time the retail investor first engages the broker-
dealer's services). See also proposed General Instruction 5.(b) to
Form CRS.
\323\ Proposed General Instruction 8.(c) to Form CRS.
\324\ See 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. 37182 (May 9, 1996) [61 FR 24644 (May 15, 1996)]
(``96 Guidance''). See also Use of Electronic Media, Exchange Act
Release No. 42728 (Apr. 28, 2000) [65 FR 25843 (May 4, 2000)]
(``2000 Guidance''); and Use of Electronic Media for Delivery
Purposes, Exchange Act Release No. 36345 (Oct. 6, 1995) [60 FR 53458
(Oct. 13, 1995)] (``95 Guidance'').
\325\ Advisers Act proposed rule 204-5(b)(3) and Exchange Act
proposed rule 17a-14(c)(3); proposed General Instruction 8.(a) to
Form CRS.
\326\ Proposed General Instruction 8.(a) to Form CRS.
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The timing of the initial delivery of the relationship summary for
investment advisers generally tracks that of Form ADV Part 2A.\327\ The
requirement for broker-dealers is intended to capture the earliest
point in time at which a retail investor engages the services of a
broker-dealer, including instances when a customer opens an account
with the broker-dealer, or effects a transaction through the broker-
dealer in the absence of an account, for example, by purchasing a
mutual fund through the broker-dealer via ``check and application.''
\328\ We believe that providing the retail investor the relationship
summary at this first juncture would better assist the retail investor
in making a determination whether to open an account with a broker-
dealer. The rule does not require delivery to a retail investor to whom
a broker-dealer makes a recommendation, if that retail investor does
not open or have an account with the broker-dealer, or that
recommendation does not lead to a transaction with that broker-dealer.
If the recommendation leads to a transaction with the broker-dealer who
made the recommendation, we would consider the retail investor to be
``engaging the services'' of that broker-dealer at the time the
customer places the order or an account is opened, whichever occurs
first.
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\327\ See Instruction 1 of General Instructions for Part 2A of
Form ADV.
\328\ The obligation for a broker-dealer to deliver a
relationship summary is broader than the proposed application of
Regulation Best Interest, which would apply when a broker-dealer
provides a recommendation. See supra note 29. Broker-dealers and
investment advisers that offer online services would be required to
provide the relationship summary to retail investors even if the
only services provided to the customer or client is to offer a
choice of investment options from an online menu of products, i.e.,
even if the broker-dealer does not provide a recommendation,
provided that the retail investor engages its services. See also
infra note 337 and accompanying text.
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In addition, a firm would be required to provide a relationship
summary to an existing client or customer who is a retail investor
before or at the time a new account is opened or changes are made to
the retail investor's account(s) that would materially change the
nature and scope of the firm's relationship with the retail
investor.\329\ Such changes would include a recommendation that the
retail investor transfer from an investment advisory account to a
brokerage account or from a brokerage account to an investment advisory
account, or move assets from one type of account to another in a
transaction that is not in the normal, customary, or already agreed
course of dealing.\330\ A move of assets from one type of account to
another in a transaction not in the normal, customary, or already
agreed course of dealing could include, for example, asset transfers
due to an IRA rollover; deposits or the investment of monies based on
infrequent events or unusual size, such as an inheritance or receipt
from a property sale; or a significant migration of funds from savings
to an investment account. If a firm does not have any retail investors
to whom it must deliver a relationship summary, it would not be
required to prepare one.\331\ A firm would be required to deliver the
relationship summary to a retail investor within 30 days upon
request.\332\
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\329\ Advisers Act proposed rule 204-5(b)(2) and Exchange Act
proposed rule 17a-14(c)(2); proposed General Instruction 7.(a) to
Form CRS.
\330\ Advisers Act proposed rule 204-5(b)(2) and Exchange Act
proposed rule 17a-14(c)(2); proposed General Instruction 7.(a) to
Form CRS.
\331\ Proposed General Instruction 5.(a) to Form CRS.
\332\ Advisers Act proposed rule 204-5(b)(5) and Exchange Act
proposed rule 17a-14(c)(5); proposed General Instruction 7.(b) to
Form CRS.
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We are proposing different triggers for initial delivery of the
relationship summary by investment advisers (before or at the time the
firm enters into an investment advisory agreement with the retail
investor) and by broker-dealers (before or at the time the retail
investor first engages the firm's services). These proposed
requirements are intended to make the relationship summary readily
accessible to retail investors at the time when they are choosing
investment services and are generally consistent with the approach many
commenters recommended.\333\ In addition, the trigger for investment
advisers is consistent with current requirements for investment
advisers to deliver the Form ADV Part 2 brochure.\334\ A few commenters
suggested that disclosures be delivered before a broker-dealer first
executes a transaction based on a recommendation to a retail
investor.\335\ Along these lines, we believe that retail investors
should receive the relationship summary as part of the process of
engaging the services of a financial professional or firm so the retail
investor has the relevant information to make that decision.\336\ In
particular, because broker-dealers are not required to enter into a
formal agreement with a customer in order to provide services, there
may be instances in which retail investors engage the services of a
broker-dealer without (or before) formally opening a brokerage account
(e.g., by entering an agreement
[[Page 21454]]
with the broker-dealer). For example, some broker-dealers assist their
customers in purchasing mutual funds or variable insurance products to
be held with the mutual fund or variable insurance product issuer, by
sending checks and applications directly to the fund or issuer (this is
sometimes referred to as ``check and application,'' ``application-
way,'' ``subscription-way'' or ``direct application'' business; we use
the term ``check and application'' for simplicity).\337\ In light of
these types of circumstances, we are proposing to require broker-
dealers to deliver the relationship summary before or at the time the
retail investor first engages the firm's services. As noted above, we
would not interpret the term ``engage the firm's services'' to capture
a recommendation by a broker-dealer to a retail investor who does not
already have an account with that broker-dealer, if that recommendation
does not lead to a transaction with that broker-dealer.
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\333\ Many commenters suggested that the document be provided at
the beginning of the relationship with a firm; such as before or at
the time the retail investor enters into the agreement. See, e.g.,
Stifel 2017 Letter; Equity Dealers of America 2017 Letter; Fidelity
2017 Letter; AARP 2017 Letter; State Farm 2017 Letter; AFL-CIO 2017
Letter; CFA 2017 Letter; Wells Fargo 2017 Letter.
\334\ An investment adviser is required to give a firm brochure
to each client before or at the time the adviser enter into an
advisory agreement with that client. See Advisers Act rule 204-3(b).
\335\ See, e.g., SIFMA 2017 Letter.
\336\ See, e.g., 917 Financial Literacy Study, supra note 20, at
iv (``Generally, retail investors prefer to receive disclosures
before making a decision on whether to engage a financial
intermediary or purchase an investment product or service.'');
Equity Dealers of America 2017 Letter, at 2 (``[W]e believe that [a
relationship summary] should be a pillar to any new standard when
establishing a new brokerage or advisory account relationship . . .
Whether a client wants incidental advice, the ability to provide
their own investment ideas or to direct their own transactions as
associated with a brokerage account or whether a client wants
ongoing advice, monitoring, and a level fee as associated with an
advisory account will determine the type of account they choose.'');
State Farm 2017 Letter; AARP 2017 Letter; AFL-CIO 2017 Letter, at 3
(``If [a proposed enhanced standard of conduct] were supplemented by
pre-engagement disclosures that briefly and clearly describe the
sales nature of the broker's services, . . . investors would be
modestly better off than they are today.''); Fidelity 2017 Letter;
Kiley 2017 Letter; CFA 2017 Letter.
\337\ The broker-dealer is typically listed as the broker-dealer
of record on the retail investor's account application, and
generally receives fees or commissions resulting from the retail
investor's transactions in the account. See, e.g., Transfers of
Mutual Funds and Variable Annuities, FINRA Notice to Members 04-72
(Oct. 2004), available at http://www.finra.org/sites/default/files/NoticeDocument/p011634.pdf. See also supra note 328 and accompanying
text.
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We also believe that retail investors who are existing clients and
customers should be reminded of the information highlighted in the
relationship summary before or at the time (i) a new account is opened
that is different from the retail investor's existing account(s); or
(ii) changes are made to the retail investor's existing accounts that
would materially change the nature and scope of the firm's relationship
with the retail investor.\338\ For example, firms would be required to
provide a current version of the relationship summary before or at the
time a recommendation is made that the retail investor transfers from
an investment advisory account to a brokerage account, transfers from a
brokerage account to an investment advisory account, or moves assets
from one type of account to another in a transaction not in the normal,
customary or already agreed course of dealing.\339\ In these instances,
retail investors are again making decisions about whether to invest
through an advisory account or a brokerage account and would benefit
from information about the different services and fees that the firm
offers to make an informed choice. Therefore, we are proposing that
firms be required to deliver the relationship summary to existing
retail investors before or at the time these changes occur. Whether a
change would require delivery of the relationship summary would depend
on the specific facts and circumstances.\340\ For example, transfers
among accounts that occur in the ordinary course of business, such as a
periodic rebalancing of assets among two accounts or quarterly
investments in a retirement account, would not require the delivery of
a relationship summary.\341\
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\338\ Advisers Act proposed rule 204-5(b)(2) and Exchange Act
proposed rule 17a-14(c)(2); proposed General Instruction 7.(a) to
Form CRS.
\339\ Id.
\340\ Id.
\341\ Id.
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As with other disclosures firms must deliver, firms would be able
to deliver the relationship summary (including updates) electronically,
within the framework of the Commission's guidance regarding electronic
delivery of documents.\342\ The Commission's previously issued guidance
applicable to electronic delivery of certain documents by investment
advisers and broker-dealers consists of the following elements: (i)
Notice to the investor that information is available electronically;
(ii) access to information comparable to that which would have been
provided in paper form and that is not so burdensome that the intended
recipients cannot effectively access it; and (iii) evidence to show
delivery, i.e., reason to believe that electronically delivered
information will result in the satisfaction of the delivery
requirements under the federal securities laws.\343\
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\342\ Proposed General Instruction 8.(b) to Form CRS. See 96
Guidance, supra note 324.
\343\ 96 Guidance, supra note 324.
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We believe that retail investors who are prospective clients or
customers of a firm would benefit from receiving the relationship
summary as early as possible when engaging the services of a financial
professional or firm, so the retail investor has the relevant
information to make that decision. Further to that goal, and in an
effort to provide flexibility and recognize the proliferation of means
of electronic communications that firms and retail investors may
utilize, a firm would be able to deliver the relationship summary to
new or prospective clients or customers in a manner that is consistent
with how the retail investor requested information about the firm or
financial professional.\344\ This method of initial delivery for the
relationship summary would be consistent with the Commission
guidance.\345\ With respect to existing clients or customers, firms
should deliver the relationship summary in a manner consistent with the
firm's existing arrangement with that client or customer and with the
Commission guidance.
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\344\ For example, a retail investor without access to a
computer or email would likely request information in person or by
telephone, and the financial professional would deliver a hard copy
of the relationship summary in person or by mail.
\345\ Firms could meet the elements of the Commission's
electronic delivery guidance in other ways as well when delivering
the relationship summary to new or prospective clients or customers.
See 2000 Guidance, supra note 324, at 65 FR 25845-46; 96 Guidance,
supra note 324, at 61 FR at 24647; 95 Guidance, supra note 324, at
60 FR at 53461.
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In connection with account openings conducted online, the
Commission previously stated in its 2000 Guidance that broker-dealers
could obtain consent from a new customer to electronic delivery of
documents through an account-opening agreement that contains a separate
section with a separate e-delivery authorization, or through a separate
document altogether.\346\ The Commission noted that a global consent to
e-delivery would not be an informed consent if the opening of a
brokerage account were conditioned upon providing the consent; in such
cases other evidence of delivery would be required.\347\ However, the
2000 Guidance made an exception for brokerage firms that require
accounts to be opened online and all account transactions to be
initiated and conducted online, stating, ``In these instances only, the
opening of a brokerage account may be conditioned upon providing global
consent to electronic delivery.'' \348\ We understand that for some
robo-advisers, the account opening process and subsequent investment
decisions and transactions may involve similarly limited interaction
with a financial professional. Therefore, it would be consistent with
the Commission's prior guidance if firms that offer only online account
openings and account transactions, including robo-advisers and online
broker-dealers, made global consent to electronic delivery a condition
of account opening, for purposes of delivering the relationship
summary.
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\346\ 2000 Guidance, supra note 324, at 65 FR 25846.
\347\ Id. Evidence of delivery could include, for example:
Obtaining evidence that an investor actually received the
information such as by electronic mail return receipt or
confirmation of access, downloading, or printing; an investor's
accessing a document with hyperlinking to a required document; or
using other forms or material available only by accessing the
information. See 1995 Guidance, supra note 324, at section II.C.
\348\ Id. at n.27.
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We request comment on whether the Commission should provide
additional guidance with respect to electronic delivery of the
relationship summary to
[[Page 21455]]
new and prospective or existing clients and customers.
3. Updating Requirements
The relationship summary is designed to provide information to
assist retail investors in making a decision about whether to engage a
firm and open a particular type of account, but it is also important
for retail investors to know when there have been changes to this
information to inform their continuing choice to keep their account
with the firm. For example, as noted above, the staff's 917 Financial
Literacy Study indicates that retail investors find the nature and
scope of a firm's services, its fees and conflicts of interest, and the
disciplinary history of financial professionals to be important in
choosing financial intermediaries.\349\ To the extent that this
information changes in a material way, existing clients and customers
should be made aware so that they can decide whether the choice of that
particular firm or financial professional remains appropriate and
consistent with their decision-making criteria. Therefore, we are
proposing to require a firm to update its relationship summary within
30 days whenever the relationship summary becomes materially
inaccurate.\350\ Firms also would be required to post the latest
version on their websites (if they have one), and electronically file
the relationship summary with the Commission.\351\ We believe this
approach is consistent with the current requirements for investment
advisers to update the Form ADV Part 2 brochure,\352\ and with broker-
dealers' current obligations, including to update Form BD if its
information is or becomes inaccurate for any reason, which information
generally would be made available through EDGAR.\353\ We believe
allowing 30 days for firms to make updates provides sufficient time for
firms to make the necessary changes and gives the benefit of certainty
of when the updates must be made.
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\349\ See 917 Financial Literacy Study, supra notes 20-21 and
accompanying text.
\350\ Advisers Act proposed rule 204-1(a)(2) and Exchange Act
proposed rule 17a-14(b)(3); proposed General Instruction 6.(a) to
Form CRS.
\351\ Advisers Act proposed rules 203-1(a)(1), 204-5(b)(3) and
Exchange Act proposed rule 17a-14(b)(2), 17a-14(c)(3); proposed
General Instructions 5.(a), 6.(c) and 8 to Form CRS.
\352\ See, e.g., Advisers Act proposed rule 204-5(b)(4) and
Exchange Act proposed rule 17a-14(a)(3); proposed General
Instruction 6 to Form CRS. Generally, an investment adviser
registered with the SEC or a state securities authority is required
to amend its Form ADV promptly if information it provided in its
brochure becomes materially inaccurate. See Advisers Act rule 204-
1(a)(2); Instruction 4 of General Instructions to Form ADV.
\353\ See, e.g., Exchange Act rule 15b3-1.
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Our proposal would also require firms to communicate without charge
the information in an amended relationship summary to retail investors
who are existing clients or customers of the firm within 30 days after
the updates are required to be made.\354\ Firms could communicate this
information by delivering the amended relationship summary or by
communicating the information another way to the retail investor.\355\
For example, if an investment adviser communicated a material change to
information contained in its relationship summary to a retail investor
by delivering an amended Form ADV brochure or Form ADV summary of
material changes containing the updated information, this would support
a reasonable belief that the information had been communicated to the
retail investor, and the investment adviser would not be required to
deliver an updated relationship summary to that retail investor. This
requirement provides firms the ability to disclose changes without
requiring them to duplicate disclosures and incur additional costs. A
retail investor also would be able to find the latest version of the
relationship summary on the firm's website, if it has one, and firms
would be required to deliver it upon the retail investor's
request.\356\
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\354\ Advisers Act proposed rule 204-5(b)(4) and Exchange Act
proposed rule 17a-14(c)(4); proposed General Instruction 6.(b) to
Form CRS.
\355\ Id.
\356\ Advisers Act proposed rules 204-5(b)(3) and 204-5(b)(5)
and Exchange Act proposed rules 17a-14(c)(3) and 17a-14(c)(5);
proposed General Instructions 7 and 8 to Form CRS.
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For purposes of this requirement, it is important that broker-
dealers identify their existing customers who are retail investors and
recognize that a customer relationship may take many forms. For
example, under this requirement, a broker-dealer would be required to
provide the relationship summary to customers who have so-called
``check and application'' arrangements with the broker-dealer, under
which a broker-dealer directs the customer to send the application and
check directly to the issuer. We believe this approach would facilitate
broker-dealers building upon their current compliance infrastructure in
identifying existing customers \357\ and would enhance investor
protections to retail investors engaging the financial services of
broker-dealers.
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\357\ For example, broker-dealers may already have compliance
infrastructure to identify customers pursuant to FINRA's suitability
rule, which applies to dealings with a person (other than a broker
or dealer) who opens a brokerage account at a broker-dealer or who
purchases a security for which the broker-dealer receives or will
receive, directly or indirectly, compensation even though the
security is held at an issuer, the issuer's affiliate or custodial
agent, or using another similar arrangement. See Guidance on FINRA's
Suitability Rule, FINRA Regulatory Notice 12-55 (Dec. 2012), at
Q6(a), available at http://finra.complinet.com/net_file_store/new_rulebooks/f/i/FINRANotice12_55.pdf.
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Finally, our proposal would require a firm to file its relationship
summary with the Commission and to maintain the relationship summary
and all updates as part of its books and records and make it available
to Commission staff upon request, as discussed in Section IV
below.\358\
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\358\ See Advisers Act proposed rule 204-2(a)(14)(i) and
Exchange Act proposed rule 17a-3(a)(24).
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We request comment on filing, delivery, and updating requirements
generally, and on the following areas specifically:
Does this approach to filing, delivery, and updating
create unique challenges for firms that are providing the relationship
summary electronically? Does this approach provide retail investors
with ready access to the information that they need and want in
connection with the decision to engage a broker-dealer or investment
adviser?
Should a relationship summary be required for all
investment advisers, broker-dealers and dual registrants that provide
services to retail investors, or should there be any exceptions? For
example, should execution-only broker-dealers be excluded from the
requirement to provide the relationship summary because they do not
provide investment advice to their customers? Should clearing broker-
dealers be excluded from the requirement to prepare and deliver the
relationship summary to the extent their customers are introduced by an
introducing broker-dealer pursuant to a clearing agreement? If so, why?
Should the Commission consider any other exclusions for clearing
broker-dealers or other entities? If so, why?
Should a clearing broker-dealer and introducing broker-
dealer be allowed to agree to allocate the responsibility to deliver
the relationship summary pursuant to applicable self-regulatory rules?
\359\ Should investment advisers with sub-advisory relationships be
allowed to receive the relationship summary, and any updated
information in relationship summaries, from the
[[Page 21456]]
sub-advisers, on behalf of the primary investment adviser's clients?
Should such clients receive the relationship summary of the sub-
adviser?
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\359\ See, e.g., FINRA Rule 4311(c) (Carrying Agreements)
(requiring each carrying agreement in which accounts are to be
carried on a fully disclosed basis to specify the responsibilities
of each party to the agreement), available at http://finra.complinet.com/en/display/display.html?rbid=2403&element_id=10028.
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Should the relationship summary be required in addition to
firms' existing disclosure requirements, as proposed? Is the
relationship summary duplicative of or does it conflict with any
existing disclosure requirements in any way? What, if any, changes
would we need to make to the relationship summary if we were to permit
its delivery in lieu of other disclosures and why would those changes
be appropriate? Should the Commission instead make any changes to
existing rules to permit the relationship summary to serve as the venue
for disclosures required by those rules?
Should investment advisers that deliver a relationship
summary have different delivery requirements for the Form ADV brochure
and brochure supplement?
Is IARD the optimal system for investment advisers to file
Form CRS with the Commission? Is EDGAR the optimal system for broker-
dealers to file Form CRS with the Commission? Should dual registrants
be required to file on both EDGAR and IARD? \360\ Should broker-dealers
instead be required to file Form CRS solely through IARD? What would be
the costs or benefits associated with broker-dealers becoming familiar
with and filing through IARD system rather than through EDGAR? Is there
another method of electronic filing the Commission should consider for
Form CRS and why? If broker-dealers should file using a system other
than EDGAR, what would be the costs and benefits associated with
creation of, and/or becoming familiar with and filing through, that
system? Should investment advisers and broker-dealers be required to
file on the same system?
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\360\ See proposed General Instruction 5.(a) to Form CRS.
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How important to investors and other interested parties is
the fact that IAPD serves as the single public disclosure website to
access an adviser's current filings with the Commission, and compare
certain filings of other advisers? What would be the impact of retail
investors having to access a separate website for the relationship
summary?
How should the relationship summary be filed? Should it be
filed as a text-searchable PDF, similar to how Form ADV is currently
filed? Would a structured PDF, a web-fillable form, HTML, XML, XBRL,
Inline XBRL or another format be more appropriate, and why? Should the
Commission require a single, specified format for all firms, require
one format for EDGAR filings and another format for IARD filings, or
permit filers to select from two or more possible formats? Would retail
investors use the relationship summary to obtain information about one
particular firm, or to compare information among firms? What type of
format would make it easier for retail investors to use the
relationship summary in these ways? For example, would retail investors
seek to compare the information about fees across a number of firms,
and if so, would a structured format, such as XML or Inline XBRL or an
unstructured format, such as PDF or HTML, better facilitate such a
comparison? Which filing formats would illustrate the formatting of
relationship summaries that are provided electronically, for example,
relationship summaries sent in the body of an email, posted on the
firm's website, or formatted for a mobile device? Which formats might
be most beneficial to retail investors?
What time or expense is associated with particular
formats? What time or expense would be required of the public to view
disclosures in a particular format? Would open source, freely available
formats be preferred by users and filers, or would commercial
proprietary formats be preferred? Would a particular format require any
filers or users to license commercial software they otherwise would
not, and, if so, at what expense? Would a particular format or formats
provide more or fewer features with respect to comparability,
reusability, validation, or analysis? What other considerations are
related to specific formats? Would a particular format make it possible
to confirm that a firm complied with the Form CRS requirements and
validate the information provided before filing? If so, which format
would filers or users find the most useful?
We propose to require that an investment adviser deliver
the relationship summary before or at the time the firm enters into an
investment advisory agreement with a retail investor or, in the case of
a broker-dealer, before or at the time the retail investor first
engages the firm's services. Would this requirement give a retail
investor ample time to process the information and ask questions before
entering into an agreement? Or should we require that the relationship
summary be delivered a certain amount of time before the firm enters
into an agreement with a retail investor (e.g., 48 hours or a 15 minute
waiting period)? For broker-dealers, should we require delivery of the
relationship summary at the earlier of a recommendation or engagement,
as opposed to just engagement? We also propose that a broker-dealer
would not need to deliver the relationship summary to a retail investor
to whom a broker-dealer makes a recommendation, if that retail investor
does not open or have an account with the broker-dealer, or that
recommendation does not lead to a transaction with that broker-dealer.
Should we instead require that broker-dealers deliver the relationship
summary to prospective customers regardless of whether that leads to a
transaction or account opening?
Would the delivery requirements applicable to firms that
offer only online account openings, investment advice, and transactions
provide sufficient notice to retail investors of the relationship
summary's availability and content? Should the Commission require such
firms to ensure that the relationship summary is delivered separately
from other disclosures, with additional prominence and emphasis? For
example, should firms consider employing the technology to require a
retail investor to scroll through the entirety of the relationship
summary before entering the next stage in the account opening process,
accessing a different part of the website in order to obtain more
information, or permitting the retail investor to check a box in order
to accept the client agreement? Are there other requirements that
should be considered for such firms in the delivery of the relationship
summary when entering into the brokerage or advisory relationship, when
the nature of that relationship changes, or when updates to the
relationship summary are made?
We also propose to require that a firm deliver a
relationship summary before or at the time the firm implements changes
that would materially change the nature and scope of the existing
relationship with a retail investor, for example by the opening of an
additional account or accounts and/or the migration of assets from one
account type to another. Should the Commission provide more guidance
for what might constitute a material change to the nature and scope of
the relationship or the moving of a significant amount of assets from
one type of account to another? If so, do commenters have suggestions
on how the Commission should interpret ``material change to the nature
and scope of the relationship'' and ``significant amount of assets''?
Should the delivery of the relationship summary under these
circumstances be accompanied by additional oral
[[Page 21457]]
disclosures or other types of supplemental information? Would this
requirement give retail investors sufficient opportunity to process the
information and ask questions before the changes are made? Should we
specify how far in advance a firm should deliver the relationship
summary before making such changes?
Should we require that firms deliver an updated
relationship summary to retail investors periodically (e.g., quarterly,
semi-annually or annually) or whenever there is a material change, as
proposed, such as a change in fees or commission structure?
We propose to require that a firm deliver the relationship
summary to a retail investor upon request. Would that requirement be
helpful for retail investors? Would that requirement be burdensome for
firms? Should we require firms to deliver the relationship summary upon
request by any investor, not just retail investors and any trust or
other similar entity that represents natural persons?
We propose to require broker-dealers to initially deliver
the relationship summary ``before or at the time the retail investor
first engages the firm's services.'' Would the proposed formulation
capture instances where a retail investor engages the services of a
broker-dealer to carry out a transaction outside of an account, for
example, by purchasing a mutual fund or variable annuity product
through the broker-dealer via ``check and application''? We do not
intend to capture instances in which a broker-dealer makes a
recommendation to a retail investor who does not already have an
account with that broker-dealer, if that recommendation does not lead
to a transaction with that broker-dealer. Would such recommendations be
captured by the proposed language? Would a different formulation be
clearer (e.g., ``before or at the time the retail investor first enters
a relationship,'' or ``before or at the time the retail investor
engages in a transaction or opens an account, whichever occurs first,''
or ``before or at the time the retail investor indicates an intent to
open an account or engage in a transaction, whichever occurs first'')?
Why or why not? Should the delivery requirements for investment
advisers and broker-dealers be identical? Why or why not?
For investment advisers, our proposal generally tracks the
initial delivery requirements for Form ADV Part 2.\361\ Should we
instead follow a different disclosure delivery requirement? Should we
adopt a different delivery requirement, recognizing that the purpose of
the relationship summary is to provide information to retail investors
to help them decide whether to engage a particular firm and open an
investment advisory or brokerage account?
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\361\ See Advisers Act rule 204-3.
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We propose to permit firms to deliver the relationship
summary electronically consistent with prior Commission guidance on
electronic delivery, as discussed above. Is the guidance clear on how
firms may meet their obligations with respect to delivering the
relationship summary, or should we provide more guidance? Should any
additional guidance be more or less prescriptive? Would our proposed
approach adequately protect investors who have no internet access or
limited internet access or who prefer not to receive information about
firms electronically? Is the guidance workable for a disclosure
delivered at or before the retail investor enters into an agreement
with an investment adviser or first engages the services of a broker-
dealer?
Should we permit firms to meet their relationship summary
obligations by filing their relationship summary with the Commission or
by posting it online without giving or sending it to specific retail
investors?
Should firms also be required to notify retail investors
that an updated relationship summary is available online? Should we
require firms to highlight the information that has changed since the
prior version in an updated relationship summary? If firms communicate
the changes in the relationship summary by means other than delivery of
the updated relationship summary, should they be required to inform
existing retail investors that the existing version is outdated? Are
there additional requirements that we should consider for amendments to
relationship summaries, particularly for firms without a website?
How can we encourage the prominence of the relationship
summary for retail investors? We are proposing that, if the
relationship summary is delivered on paper and not as a standalone
document, firms should ensure that it is the first among any other
materials or documents that are delivered at that time. Should we
require that the relationship summary be given greater prominence than
other materials that accompany it in some other way or that the
relationship summary not be bound together with any of those materials?
Should we impose additional requirements to encourage the prominence
and separateness of the relationship summary? Should we include
additional or different requirements for relationship summaries that
are delivered electronically? Should we require that the entire text of
the relationship summary be provided in the text of an email or other
form of electronic messaging, instead of an attachment or a link to the
summary disclosure on the firm's website? Are there more dynamic ways
to present the relationship summary information online, such as with
the use of tool tips, explanatory videos, or chat bots to provide
answers to questions? Are there other ways of increasing the prominence
of the relationship summary, whether delivered in paper format or
electronically?
Should we require a financial professional to make certain
oral disclosures at time of delivery? For example, should we require
that a financial professional ask the retail investor if he or she has
any questions about the relationship summary? How would this be
satisfied in the context of a primarily or exclusively online or
electronic delivery?
Should a firm be required to communicate any material
changes made to the relationship summary within 30 days, as proposed,
or sooner, for example in the case of transactions not in the normal,
customary, or already agreed course of dealing? Should a firm have the
option of choosing to communicate the new information by either filing
an amended Form CRS or by communicating the new information to retail
investors in another way? Should we provide more guidance on the types
of ways in which the information may be communicated? Should we instead
require a firm to deliver an amended relationship summary to its
existing retail investors?
Are there other changes in conditions that should trigger
a delivery requirement?
We are proposing that firms that do not maintain a website
include in their relationship summaries a toll-free phone number for
investors to call to obtain documents. Are there additional
requirements or different approaches that we should consider for firms
that do not maintain websites, to make it easier for the public to
access their relationship summaries?
D. Transition Provisions
To provide adequate notice and opportunity to comply with the
proposed relationship summary filing requirements, newly registered
broker-dealers and new applicants for registration with the Commission
as
[[Page 21458]]
investment advisers would not be required to file or deliver their
relationship summaries until the date six months after the effective
date of the proposed new rules and rule amendments.\362\ After that
date, newly registered broker-dealers would be required to file their
Form CRS with the Commission by the date on which their registration
with the Commission becomes effective, and the Commission would not
accept any initial application for registration as an investment
adviser that does not include a relationship summary that satisfies the
requirements of Form ADV, Part 3: Form CRS.\363\
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\362\ See Advisers Act proposed rule 203-1(a)(2) and Exchange
Act proposed rule 17a-14(f)(1).
\363\ See Advisers Act proposed rule 203-1(a)(2) and Exchange
Act proposed rule 17a-14(f)(3).
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Similarly, we believe it would be helpful to provide sufficient
time for advisers and broker-dealers already registered with us to
prepare the new Form CRS and file it electronically with the
Commission. Accordingly, we propose to require a broker-dealer that is
registered with us as of the effective date of the proposed new rules
and rule amendments to comply with the new Form CRS filing requirements
by the date that is six months after the effective date of the proposed
new rules and rule amendments.\364\ We also propose requiring an
investment adviser or a dual registrant that is registered with us as
of the effective date to comply with the new filing requirements as
part of the firm's next annual updating amendment to Form ADV that is
required after six months after the rule's effective date.\365\ Such an
adviser or dual registrant would be required to include Form CRS as
part of its next such annual updating amendment filing with the
Commission.\366\
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\364\ See Exchange Act proposed rule 17a-14(f)(1); proposed
General Instruction 5.(c)(i) to Form CRS.
\365\ See Advisers Act proposed rule 204-1(b)(3); proposed
General Instruction 5.(c)(i) to Form CRS.
\366\ See id.
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We are proposing to require that a firm deliver its relationship
summary to all of its existing clients and customers who are retail
investors on an initial one-time basis within 30 days after the date
the firm is first required to file its relationship summary with the
Commission.\367\ This proposed requirement would allow existing retail
investor clients and customers to receive the important disclosures in
the relationship summary that will be provided to new and prospective
retail investor customers and clients. A firm would be required to give
its relationship summary to its new and prospective clients and
customers who are retail investors beginning on the date the firm is
first required to electronically file its relationship summary with the
Commission, and would be required to give the relationship summary to
its existing clients and customers who are retail investors within 30
days, pursuant to the rule's requirements for initial delivery and
updating.\368\
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\367\ See Advisers Act proposed rule 204-5(e)(1) and Exchange
Act proposed rule 17a-14(f)(2); proposed General Instruction
5.(c)(iii) to Form CRS.
\368\ See Advisers Act proposed rule 204-5(e) and Exchange Act
proposed rule 17a-14(f)(1), (2); proposed General Instruction
5.(c)(ii), (iii) to Form CRS.
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We request comment on our proposed implementation requirements.
Would a six-month period from the effective date of Form
CRS provide enough time for newly registered broker-dealers and
investment advisers that are filing their initial applications for
registration with the Commission to complete Form CRS? If not, please
explain why and how much time these advisers and broker-dealers would
need to complete Form CRS.
Should implementation of Form CRS filing requirements for
broker-dealers be on a separate timetable from implementation of Form
CRS filing requirements for investment advisers, as we have proposed,
because registered investment advisers are not all required to file
their Form ADV annual updating amendments on the same timetable? If
not, please explain why and whether, in order to have one uniform
initial filing date for broker-dealers and investment advisers, we
should require investment advisers to potentially file their initial
Form CRS more than once.
Should a firm be required to comply with the rule's
requirements for initial delivery to new and prospective clients and
customers and for updating beginning on the date the firm is first
required to electronically file its relationship summary with the
Commission, as proposed? Should a firm deliver the relationship summary
to all existing clients and customers who are retail investors within
30 days after first filing the relationship summary with the
Commission, as proposed? These requirements would result in a different
delivery timetable for broker-dealers and investment advisers because
investment advisers would file Form CRS with their Form ADV annual
updating amendments. Should we instead require all firms to deliver the
relationship summary to retail investors beginning on the same date
(e.g., within six months from the effective date of Form CRS), even if
investment advisers file Form CRS after that date? Or should we require
firms to deliver to existing retail investor customers and clients
initial relationship summaries at a later date? For example, firms
could be required to deliver the relationship summary only before or at
the time a new account is opened or changes are made to the retail
investor's account(s) that would materially change the nature and scope
of the firm's relationship with the retail investor (including before
or at the time the firm recommends that the retail investor transfers
from an investment advisory account to a brokerage account or from a
brokerage account to an investment advisory account, or moves assets
from one type of account to another in a transaction not in the normal,
customary or already agreed course of dealing).
E. Recordkeeping Amendments
We are also proposing conforming amendments to Advisers Act rule
204-2 and Exchange Act rules 17a-3 and 17a-4, which set forth
requirements for maintaining, making and preserving specified books and
records, to require SEC-registered investment advisers and broker-
dealers to retain copies of each relationship summary.\369\ Firms would
also be required to maintain each amendment to the relationship summary
as well as to make and preserve a record of dates that each
relationship summary and each amendment was delivered to any client or
to any prospective client who subsequently becomes a client, as well as
to any retail investor before such retail investor opens an
account.\370\ Requiring maintenance of these disclosures as part of the
firm's books and records would facilitate the Commission's ability to
inspect for and enforce compliance with firms' obligations with respect
to Form CRS.
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\369\ Advisers Act proposed rule 204-2(a)(14)(i); Exchange Act
proposed rules 17a-3(a)(24) and 17a-4(e)(10).
\370\ Id.
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These proposed changes are designed to update the books and records
rules in light of our proposed addition of Form ADV Part 3 for
registered investment advisers and Form CRS for broker-dealers, and
they mirror the current recordkeeping requirements for the Form ADV
brochure and brochure supplement. The records for investment advisers
would be required to be maintained in the same manner, and for the same
period of time, as other books and records required to be maintained
under rule 204-2(a), and the records for broker-dealers would be
required to
[[Page 21459]]
maintained for a period of six years.\371\ The proposed required
documentation, like other records, would be required to be provided to
the staff ``promptly'' upon request.\372\
---------------------------------------------------------------------------
\371\ See Advisers Act rule 204-2(e)(1); Exchange Act rule 17a-
4(e)(10). Pursuant to Advisers Act rule 204-2(e)(1), investment
advisers will be required to maintain the relationship summary for a
period of five years, while Exchange Act proposed rule 17a-4(e)(10)
would require broker-dealers to maintain the relationship summary
for a period of six years.
\372\ See Advisers Act rule 204-2(g)(2); Exchange Act rule 17a-
4(j).
---------------------------------------------------------------------------
We request comment on these proposed amendments.
Are there other records related to the relationship
summary or its delivery that we should require firms to keep? Should we
require them to maintain copies of the relationship summary for a
longer or shorter period than we have proposed? Should broker-dealers
and investment advisers be required to keep relationship summary-
related records for the same amount of time? Should firms be required
to document their responses to the ``key questions'' from investors?
III. Restrictions on the Use of Certain Names and Titles and Required
Disclosures
As discussed above, both broker-dealers and investment advisers
provide investment advice to retail investors, but the regulatory
regimes and business models under which they give that advice are
different. For example, the principal services, compensation
structures, conflicts, disclosure obligations, and legal standards of
conduct can differ.\373\ We therefore believe that it is vital that
retail investors understand whether the firm is a registered investment
adviser or registered broker-dealer, and whether the individual
providing services is associated with one or the other (or both), so
that retail investors can make an informed selection of their financial
professional, and then appropriately monitor their financial
professional's conduct.
---------------------------------------------------------------------------
\373\ See, e.g., 913 Study, supra note 3.
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While investors should understand who their financial professional
is, and why that matters, studies indicate that retail investors do not
understand these differences and are confused about whether their firm
or financial professional is a broker-dealer or an investment adviser,
or both.\374\ Proposed Form CRS, as set out in Section II above, should
help to ameliorate this confusion by helping retail investors
understand the services that a particular firm offers, and how those
services differ based on whether the firm is a registered broker-
dealer, registered investment adviser, or both. We preliminarily
believe, however, that Form CRS is not a complete remedy for investor
confusion. The education and information that Form CRS provides to
retail investors could potentially be overwhelmed by the way in which
financial professionals present themselves to potential or current
retail investors, including through advertising and other
communications. This could particularly be the case where the
presentation could be misleading in nature, or where advertising and
communications precede the delivery of Form CRS and may have a
disproportionate impact on shaping or influencing retail investor
perceptions.
---------------------------------------------------------------------------
\374\ See, e.g., Siegel & Gale Study, supra note 5; RAND Study,
supra note 5; 913 Study, supra note 3. Additionally, the RAND Study
noted that participants ``commented that the interchangeable titles
and `we do it all' advertisements [by broker-dealers] made it
difficult to discern broker-dealers from investment advisers.''
Those participants also stated that these lines were further blurred
by the marketing efforts which depicted an ``ongoing relationship
between the broker and the investor. . . .'' See RAND Study, supra
note 5, at xix, 19.
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Specifically, we believe that certain names or titles used by
broker-dealers, including ``financial advisor,'' contribute to retail
investor confusion about the distinction among different firms and
investment professionals, and thus could mislead retail investors into
believing that they are engaging with an investment adviser--and are
receiving services commonly provided by an investment adviser and
subject to an adviser's fiduciary duty, which applies to the retail
investors' entire relationship--when they are not.\375\ Additionally,
broker-dealers and investment advisers, and the financial professionals
that are associated with them, currently engage in communications with
prospective or existing retail investors without making clear whether
they are a broker-dealer or an investment adviser, which can further
confuse retail investors if this distinction is not clear from context
(whether intentionally or not).
---------------------------------------------------------------------------
\375\ See supra notes 122 and 216 and accompanying texts.
---------------------------------------------------------------------------
As discussed below, our proposed restriction seeks to mitigate the
risk that the names or titles used by a firm or financial professional
result in retail investors being misled, including believing that the
financial professional is a fiduciary, leading to uninformed decisions
regarding which firm or financial professional to engage, which may in
turn result in investors being harmed. Additionally, we believe that
requiring firms and their associated natural persons or supervised
persons to disclose whether the firms are broker-dealers or investment
advisers and whether such financial professionals are associated with
or supervised by, respectively, such firms would also help to address
investor confusion and mitigate potential harm to investors resulting
from that confusion. We preliminarily believe that restricting certain
persons from using the term ``adviser'' or ``advisor'' coupled with the
requirement that firms disclose their regulatory status in retail
investor communications would deter potentially misleading sales
practices. Investors who understand whether their financial
professional or firm is a broker-dealer or investment adviser will be
better consumers of the information presented in Form CRS, and less
likely to mistakenly obtain the services of a broker-dealer when they
intend to engage an investment adviser, or vice versa.\376\
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\376\ Section 15(l)(2) of the Exchange Act and section 211(h)(2)
of the Advisers Act.
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A. Investor Confusion
Over the past decade, various studies have documented that retail
investors are confused regarding the services offered by, and the
standards of conduct applicable to, broker-dealers and investment
advisers, including their use of certain titles.\377\
---------------------------------------------------------------------------
\377\ See, e.g., Siegel & Gale Study, supra note 5; RAND Study,
supra note 5; 913 Study, supra note 3.
---------------------------------------------------------------------------
In 2005, the Siegel & Gale Study found that with respect to titles
specifically, ``[r]espondents in all focus groups were generally
unclear about the distinctions among the titles brokers, financial
advisors/financial consultants, investment advisers, and financial
planners . . .'' \378\ The following year, the Commission retained RAND
to conduct a study of broker-dealers and investment advisers for the
purpose of examining, among other things, whether investors understood
the duties and obligations owed by investment advisers and broker-
dealers.\379\ The RAND Study
[[Page 21460]]
noted that ``thousands of firms'' are structured in a variety of ways
and provide various different combinations of services and
products.\380\ The RAND Study concluded that ``partly because of this
diversity of business models and services, investors typically fail to
distinguish broker-dealers and investment advisers along the lines
defined by federal regulations.'' \381\
---------------------------------------------------------------------------
\378\ See Siegel & Gale Study, supra note 5, at 2. The study
used focus groups in both Baltimore, MD and Memphis, TN to ``explore
investor opinions regarding the services, compensation and legal
obligations of several types of financial services professionals.''
Id., at 5.
\379\ See RAND Study, supra note 5, at xiv. In conducting the
study, RAND used several methods to study current practices in the
financial industry and analyze whether investors understand
differences between types of financial service professionals. Among
these methods, RAND sent out national household surveys through the
internet which studied ``household investment behavior and
preferences, experience with financial service providers, and
understanding of the different types of financial service
providers.'' Additionally, RAND conducted six focus groups with
investors in Alexandria, Virginia, and Fort Wayne, Indiana to gain
additional evidence on investor beliefs about and experience with
financial service providers. RAND also conducted two sets of [in
person] interviews: one set of interviews with interested parties
and one set with financial service firms. See RAND Study, supra note
5, at 3[dash]4.
\380\ See RAND Study, supra note 5, at 118.
\381\ Id.
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The RAND Study concluded that, based on interviews with industry
representatives, investor surveys, and focus groups, there was
generally investor confusion about the distinction between broker-
dealers and investment advisers. In particular, ``[interview]
participants [in the RAND Study] mentioned that the line between
investment adviser and broker-dealers has become further blurred, as
much of the recent marketing by broker-dealers focuses on the ongoing
relationship between the broker and the investor and as brokers have
adopted such titles as `financial advisor' and `financial manager.' ''
\382\ Additionally, participants in RAND's survey believed that
financial professionals using the title ``financial advisor'' were
``more similar to investment advisers than to brokers . . .'' \383\
---------------------------------------------------------------------------
\382\ See id., at 19.
\383\ See id., at xix.
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Moreover, focus group participants shed further light on this
confusion when they ``commented that the interchangeable titles and `we
do it all' advertisements by broker-dealers made it difficult to
discern broker-dealers from investment advisers.'' \384\ More
specifically, focus group participants observed that ``common job
titles for investment advisers and broker-dealers are so similar that
people can easily get confused over the type of professional with which
they are working.'' \385\ The focus group results also showed that when
``[c]omparing beliefs on services provided by investment advisers to
services provided by brokers, participants were more likely to say that
investment advisers provide advice about securities, recommend specific
investments, and provide planning services.'' \386\ According to the
RAND Study, focus-group participants were more likely to say that
brokers rather than investment advisers execute stock transactions and
earn commissions and believed ``that investment advisers and brokers
are required to act in the client's best interest'' and ``were more
likely to say that brokers rather than investment advisers are required
to disclose any conflicts of interest.'' \387\ In highlighting part of
the confusion, the RAND Study noted that the responses from survey
participants indicated the opposite conclusion from those of the focus-
group participants, namely, that investment advisers are more likely to
disclose conflicts of interest.\388\
---------------------------------------------------------------------------
\384\ See id., at xix. Interview participants also stated that
these lines were further blurred by the marketing efforts which
depicted an ``ongoing relationship between the broker and the
investor. . . .''. See id., at 19.
\385\ See id., at 111.
\386\ See id., at 109.
\387\ Id.
\388\ Id.
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As discussed above, in light of significant intervening market
developments and advances in technology, Chairman Clayton in 2017
invited input on, among other things, investor concerns about the
current regulatory framework. Commenters highlighted the risk of harm
to investors who obtain services from broker-dealers under the
misimpression that they are receiving services protected by the
fiduciary duty that applies to investment advisers.\389\ For example,
one commenter examined the websites of nine different brokerage firms
and ``found that the firms' advertising presents the image that the
firms are acting in a fiduciary capacity'' with many firm
advertisements continuing to present the firm ``as providing all-
encompassing advice, with no differentiation between the firms'
investment adviser services and brokerage services.'' \390\ This
commenter also noted that ``[w]ithout uniform standards, persons
seeking financial advice are left to fend for themselves in deciding
whether their financial advisor is serving two masters or only one, and
whether one of those masters is the advisor's financial self-
interest.'' \391\ In addition, a different commenter argued that the
use of certain titles, such as ``advisor,'' should be standardized by
the Commission because they are currently ``catch all'' terms for firms
with ``wildly different practices, standards, and responsibilities to
their clients.'' \392\ Some of the commenters to Chairman Clayton's
Request for Comment also noted that this confusion is the result of the
misleading nature of these titles. Specifically, one commenter stated
that ``[t]he problem is that investors are being misled into relying on
biased sales recommendations as if they were objective, best interest
advice and are suffering significant financial harm as a result.''
\393\ The commenter noted that ``these titles and marketing materials
are misleading'' [if] . . . broker-dealers truly are the ``mere
salespeople they've claimed to be in their legal challenge to the DOL
fiduciary rule.'' \394\ A different commenter stated that ``a financial
professional should not be able to use a title that conveys a standard
of conduct to which the professional is not in fact held under the law.
. . .'' \395\ Additionally, another commenter noted that customer
confusion is ``also driven by misleading marketing and misleading
titles.'' \396\ Finally, one commenter stated that ``having SEC
registered entities and their agent, claim such title gives false
credence and implies a responsibility which the agent never claims to
provide (numerous brokers go by the title `Financial Advisor', implying
Fiduciary standard that is not being upheld).'' \397\
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\389\ See, e.g., CFA 2017 Letter; PIABA 2017 Letter; IAA 2017
Letter; Pefin 2017 Letter; First Ascent 2018 Letter.
\390\ See PIABA 2017 Letter, at 7. See also IAA 2017 Letter, at
11 (``investor confusion persists where certain financial
professionals are permitted to use terms such as ``financial
adviser'' or ``financial advisor'' that imply a relationship of
trust and confidence but, in effect, disclaim fiduciary
responsibility for such a relationship''); Pefin 2017 Letter, at 3
(noting that `` `Investment Advisor' or `Financial Advisor' are not
defined terms, and are currently a ``catch all'' for firms with
wildly different practices, standards, and responsibilities to their
clients. Many of these firms attempt to imply in external
communication that they are a Fiduciary, while disclaiming their
responsibilities in the fine print.''); CFA 2017 Letter.
\391\ See PIABA 2017 Letter, at 17.
\392\ See Pefin 2017 Letter, at 3. See also First Ascent 2017
Letter.
\393\ See CFA 2017 Letter, at 2.
\394\ See id., at 11.
\395\ See Comment letter of the U.S. Chamber of Commerce (Dec.
13, 2017), at 10.
\396\ See Comment letter of the Steering Group for the Committee
for the Fiduciary Standard (Nov. 8, 2017) (``Committee for the
Fiduciary Standard 2017 Letter''), at 3.
\397\ See Pefin 2017 Letter, at 9.
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For many years, the Commission has considered approaches for
remedying investor confusion about the differing services and
obligations of broker-dealers and investment advisers. In particular,
in 2005 we considered addressing how investors perceive the differences
between broker-dealers and investment advisers by proposing to
proscribe the use of certain broker-dealer titles.\398\ In adopting our
final rule, which was subsequently vacated on other grounds by the
Court of
[[Page 21461]]
Appeals for the D.C. Circuit,\399\ we declined to follow this approach,
believing that the better approach was to require broker-dealers to
clearly inform their customers receiving investment advice that they
are entering into a brokerage, and not an advisory, relationship.\400\
However, in light of comments in response to Chairman Clayton's Request
for Comment and our experience, we believe that it is appropriate to
revisit that approach.
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\398\ Certain Broker-Dealers Deemed Not To Be Investment
Advisers, Exchange Act Release No. 50980 (Jan. 6, 2005), [70 FR 2716
(Jan. 14, 2005)] (``Broker Dealer Reproposing Release'').
\399\ Financial Planning Association v. Securities and Exchange
Commission, 482 F.3d 481 (D.C. Cir. 2007).
\400\ As further discussed in the 2005 final rule release, we
considered but did not adopt a rule which would have placed
limitations on how a broker-dealer may hold itself out or titles it
may employ without registering as an investment adviser and
complying with the Advisers Act. In deciding to not prohibit the use
of specific titles such as ``financial advisor,'' ``financial
consultant'' or other similar names, we noted that ``the statutory
broker-dealer exception is a recognition by Congress that a broker-
dealer's regular activities include offering advice that could bring
the broker-dealer within the definition of investment adviser, but
which should nonetheless not be covered by the Act.'' As a result,
we noted that the ``terms `financial advisor' and `financial
consultant,' for example, were descriptive of such services provided
by broker-dealers.'' We also stated our view that these titles were
generic terms that describe what various persons in the financial
services industry do, including banks, trust companies, insurance
companies, and commodity professionals. See 2005 Broker Dealer
Release, supra note 7; see also Broker Dealer Reproposing Release,
supra note 398.
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A broker-dealer can, and does, provide investment advice to retail
investors without being regulated as an investment adviser, provided
that such advice is ``solely incidental to'' its brokerage business and
the broker-dealer receives no ``special compensation'' for the
advice.\401\ While we believe such advice is important for providing
retail investors access to a variety of services, products, and payment
options, for example, thereby increasing investor choice, we are
concerned that use of the terms ``adviser'' and ``advisor'' in a name
or title would continue to result in some retail investors being misled
that their firm or financial professional is an investment adviser
(i.e., a fiduciary), resulting in investor harm. We believe that these
terms can obscure the fact that investment advisers and broker-dealers
typically have distinct business models with varying services, fee
structures, standards of conduct, and conflicts of interest.\402\
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\401\ The Advisers Act regulates the activities of certain
``investment advisers,'' which are defined in section 202(a)(11) as
persons who receive compensation for providing advice about
securities as part of a regular business. Broker-dealers are
excluded from the definition of investment adviser by section
202(a)(11)(C) provided that they meet two prongs: (i) The broker-
dealer's advisory services must be ``solely incidental to'' its
brokerage business; and (ii) the broker-dealer must receive no
``special compensation'' for the advice.
\402\ See RAND Study, supra note 5, at 18 (``There were also
concerns as to what investors understand regarding similarities and
differences of brokerage and advisory accounts, the legal
obligations of each type of account, and the effect of titles and
marketing used by investment professionals on the expectations of
investors.'').
---------------------------------------------------------------------------
It is important for retail investors to better understand the
distinction between investment advisers and broker-dealers and to have
access to the information necessary to make an informed choice and
avoid potential harm. Investor choices of firm type and financial
professionals can, for example, affect the extent or type of services
received, the amount and type of fees investors pay for such services,
and the conflicts of interest associated with any such services. For
example, if a retail investor prefers an advisory relationship with an
active trading strategy, and he or she mistakenly retains a broker-
dealer ``financial adviser,'' this investor potentially could incur
more costs if he or she is placed in a brokerage account than he or she
would have paid in an advisory account with an asset-based fee.
Likewise, an investor could also be misled into believing that the
broker-dealer is subject to a fiduciary standard that may not
apply,\403\ and provides services it may not offer, such as regular
monitoring of the account, offering advice on a regular basis, and
communicating with the investor on a regular basis.
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\403\ See supra note 375. Cf. Comment letter of Russel Walker
(Jun. 17, 207); Comment letter of Jeanne Davis (Jul. 20, 2017);
Comment letter of Nancy Lowell (Jul. 20, 2017); Comment letter of
John Dalton (Jul. 21, 2017); Comment letter of Nancy Tew (Jul. 21,
2017); Comment letter of Bonitta Knapp (Jul. 21, 2017); Comment
letter of Alan Gazetski (Jul. 21, 2017); Comment letter of A. Arias
(Jul. 21, 2017); Comment letter of Al Cohen (Jul. 21, 2017); Comment
letter of James Melloh (Jul. 21, 2017); Comment letter of Mary
Pellecchia (Jul. 21, 2017); Comment letter of William Muller (Jul.
21, 2017); Comment letter of Susan Lee (Jul. 22, 2017); Comment
letter of Steve Daniels (Jul. 22, 2017); AARP 2017 Letter; AFL-CIO
2017 Letter; Pefin 2017 Letter; PIABA 2017 Letter; IAA 2017 Letter;
CFA 2017 Letter. These commenters argued that as a result of the use
of certain titles and communications, retail investors are confused
and are erroneously led to believe that their financial
professionals are required to act ``in their best interest.''
---------------------------------------------------------------------------
While we are proposing to require broker-dealers and investment
advisers to provide retail investors with a relationship summary that
would highlight certain features of an investment advisory or brokerage
relationship, that information might be provided after the retail
investor has initially decided to meet with the firm or its financial
professional. The retail investor may make a selection based on such
person's name or title. If firms and financial professionals that are
not investment advisers are restricted from using ``adviser'' or
``advisor'' in their names or titles, retail investors would be less
likely to be confused or potentially misled about the type of financial
professional being engaged or nature of the services being received.
Conversely, an associated natural person of a broker-dealer using the
term ``adviser'' or ``advisor'' may result in an investor believing
that such financial professional is an adviser with a fiduciary duty,
as discussed in the relationship summary the investor would
receive.\404\ Similarly, requiring firms and their associated natural
persons or supervised persons, as applicable, to disclose whether the
firms are broker-dealers or investment advisers would help to address
investor confusion and complement the information provided in the
proposed relationship summary.
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\404\ See proposed Item 5.B.3. of Form CRS.
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B. Restrictions on Certain Uses of ``Adviser'' and ``Advisor''
We are proposing to restrict any broker or dealer, and any natural
person who is an associated person of such broker or dealer, when
communicating with a retail investor, from using as part of its name or
title the words ``adviser'' or ``advisor'' unless such broker or
dealer, is registered as an investment adviser under the Advisers Act
or with a state, or any natural person who is an associated person of
such broker or dealer is a supervised person of an investment adviser
registered under section 203 of the Advisers Act or with a state and
such person provides investment advice on behalf of such investment
adviser.\405\
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\405\ See Exchange Act proposed rule 151-2.
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1. Firms Solely Registered as Broker-Dealers and Associated Natural
Persons
In relevant part, the proposed rule would restrict a broker-
dealer's or its associated natural persons' use of the term ``adviser''
or ``advisor'' as part of a name or title when communicating with a
retail investor in particular circumstances.\406\ This would include
names or titles which include, in whole or in part, the term
``adviser'' or ``advisor'' such as financial advisor (or adviser),
wealth advisor (or adviser), trusted advisor (or adviser), and advisory
(e.g., ``Sample Firm Advisory'') when communicating with any retail
investor. In addition, we believe that the proposed rule should apply
to communications with retail investors (i.e., natural persons), rather
than
[[Page 21462]]
institutions, for reasons similar to those detailed above for the
relationship summary.\407\ Additionally, our proposed rule
appropriately applies to retail investors and not to institutions, as
institutions generally would be less likely to be misled by such names
or titles. The proposed rule, however, would not restrict a broker-
dealer's or its associated natural persons' use of the terms
``adviser'' or ``advisor'' when acting on behalf of a bank or insurance
company, or when acting on behalf of a municipal advisor or a commodity
trading advisor.
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\406\ See id.
\407\ See supra note 29 and accompanying text. See also Exchange
Act proposed rule 151-2(b).
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We acknowledge that there may be titles other than ``adviser'' or
``advisor'' used by financial professionals that might confuse and thus
potentially mislead investors. We considered whether we should restrict
broker-dealers from using additional terms, such as, for example,
``financial consultant.'' Given this concern, we focused our proposal
on the terms ``adviser'' or ``advisor'' because they are more closely
related to the statutory term ``investment adviser.'' Thus, as compared
to additional terms such as ``financial consultant,'' ``adviser'' and
``advisor'' are more likely to be associated with an investment adviser
and its advisory activities rather than with a broker-dealer and its
brokerage activities. Moreover, the term ``investment adviser,'' as
compared to terms like ``financial consultant,'' is a defined term
under the Advisers Act as any person who, for compensation, engages in
the business of advising others, either directly or through
publications or writings, as to the value of securities.\408\ As
discussed above, we believe that use of the terms ``adviser'' and
``advisor'' by broker-dealers and their associated natural persons has
particularly contributed to investor confusion about the typical
services, fee structures, conflicts of interest, and legal standards of
conduct to which broker-dealers and investment advisers are
subject.\409\ Conversely, we preliminarily believe that other terms,
even if investors might find them confusing, unclear, or misleading (as
some commenters have suggested), do not necessarily imply that a firm
or its financial professional is an ``investment adviser'' who would
have the principal services, compensation structures, conflicts of
interest, disclosure obligations, and legal standards of conduct that
are typically associated with being an investment adviser.\410\
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\408\ See section 202(a)(11)(A) of the Advisers Act, defining an
``investment adviser'' as ``any person who, for compensation,
engages in the business of advising others, either directly or
through publications or writings, as to the value of securities or
as to the advisability of investing in, purchasing, or selling
securities, or who, for compensation and as part of a regular
business, issues or promulgates analyses or reports concerning
securities.''
\409\ See supra note 402 and accompanying text. We are not
proposing restrictions on names or titles for investment advisers.
Our staff is not aware of an investment adviser using a name or
title that could cause retail investors to mistakenly believe that
such adviser provides brokerage services. Studies and commenters
also have not identified retail investor confusion as relating to an
investment adviser's use of names or titles. We request comment on
our understanding below.
\410\ Firms and financial professionals should keep in mind the
applicability of the antifraud provisions of the federal securities
laws, including section 17(a) of the Securities Act, and section
10(b) of the Exchange Act and rule 10b-5 thereunder, to the use of
names or titles. See also generally FINRA Rule 2210 (stating in part
``[a]ll retail communications and correspondence must: (A)
Prominently disclose the name of the member, or the name under which
the member's broker-dealer business primarily is conducted as
disclosed on the member's Form BD, and may also include a fictional
name by which the member is commonly recognized or which is required
by any state or jurisdiction; (B) reflect any relationship between
the member and any non-member or individual who is also named; and
(C) if it includes other names, reflect which products or services
are being offered by the member.'')
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Accordingly, we preliminarily do not believe these terms would
cause retail investors to believe that their financial professional is
an investment adviser when he or she is, in fact, a broker-dealer. We
therefore preliminarily believe that restricting use of terms that are
similar to ``investment adviser'' appropriately tailors the rule to
terms that are likely to result in confusion or mislead retail
investors about whether such broker-dealer is an investment adviser and
thus a fiduciary.
As we discuss in more detail above, the proposed relationship
summary is designed to provide clarity to retail investors regarding
information about broker-dealers and investment advisers under a
prescribed set of topics (e.g., services, fees, standards of conduct,
conflicts). While the proposed relationship summary is designed to help
retail investors to distinguish between investment advisers and broker-
dealers, we are concerned that the effectiveness of the relationship
summary could be undermined if we do not restrict a broker-dealer from
using in a name or title the terms ``adviser'' and ``advisor.''
For instance, we preliminarily believe that restricting a broker-
dealer or its associated natural persons from using ``adviser'' or
``advisor'' in a name or title would mitigate the risk that a retail
investor would be misled into believing and expecting that his or her
``financial advisor,''--who may solely provide brokerage services at a
broker-dealer--is an investment adviser because of the name or title.
For example, if a retail investor were to engage a financial
professional with the title ``wealth advisor'' who solely provides
brokerage services but who is associated with a dually registered
firm,\411\ such investor would likely receive the dually registered
firm's relationship summary. The relationship summary would include a
description of both business models; however, the retail investor could
incorrectly match the services he or she would receive from such
``wealth advisor'' to the description in the relationship summary of
investment advisory services. As a result, the retail investor may be
misled to believe that the brokerage services provided by the ``wealth
advisor'' are in fact the investment advisory services as described in
the relationship summary.
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\411\ For the purposes of Section III, we are defining a
``dually registered firm'' in the same manner as it is defined in
the baseline of the Economic Analysis. See infra Section IV, note
453.
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Similarly, a retail investor who engages a financial professional
with the title ``wealth advisor'' who is associated solely with a
broker-dealer entity would likely receive the broker-dealer's
relationship summary, which focuses on the characteristics of the
broker-dealer business model. As a result, there would be an
inconsistency between the description of the broker-dealer business
model and the investors' likely perceptions that their professional is
an investment adviser. Therefore, the proposed restriction on the use
of names or titles would increase the effectiveness of the relationship
summary by reducing the risk of a mismatch between investor preferences
and type of services received.
We acknowledge that studies have demonstrated that many retail
investors select financial professionals and firms based on personal
referrals by family, friends, or colleagues.\412\ Even if the name or
title of the firm or professional may not impact choices made by such
investors, we preliminarily believe that the protections offered to
other investors by the proposed restriction and disclosure requirements
justify the rules.
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\412\ See infra note 546 and accompanying text. See also Section
IV.A.3.g.
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2. Dually Registered Firms and Dual Hatted Financial Professionals
The proposed rule would permit firms that are registered both as
investment advisers (including state-registered investment advisers)
and broker-dealers to use the term ``adviser'' or ``advisor'' in their
name or title.\413\ The proposed
[[Page 21463]]
rule would, however, only permit an associated natural person of a
dually registered firm to use these terms where such person is a
supervised person of a registered investment adviser and such person
provides investment advice on behalf of such investment adviser.\414\
This would limit the ability of natural persons associated with a
broker-dealer who do not provide investment advice as an investment
adviser from continuing to use the term ``adviser'' or ``advisor''
simply by virtue of the fact that they are associated with a dually
registered firm.\415\ We discuss these aspects of the rule in further
detail below.
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\413\ See Exchange Act proposed rule 151-2(a)(1).
\414\ See Exchange Act proposed rule 151-2(a)(2).
\415\ See section 202(a)(25) of the Advisers Act [15 U.S.C. 80b-
2(a)(25)] defining ``supervised person'' as ``any partner, officer,
director (or other person occupying a similar status or performing
similar functions), or employee of an investment adviser, or other
person who provides investment advice on behalf of the investment
adviser and is subject to the supervision and control of the
investment adviser''.
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a. Dually Registered Firms
We are not proposing to apply the restriction to dually registered
firms. We believe that it is inappropriate to restrict a dually
registered firm from using a name or title that accurately describes
its registration status. We recognize that under our proposed rule
there might be occasions where a dually registered firm provides a
particular retail investor only brokerage services, which could lead to
some investor confusion.
At the firm level, we do not believe that the determination of when
the restriction applies should be based on what capacity a dually
registered firm is acting in a particular circumstance, i.e., whether a
dually registered firm is acting solely as a broker-dealer and not
offering investment advisory services. If we were to apply the
restriction in this manner, it could result in firms using multiple
names and titles, which may lead to further confusion and create
operational and compliance complexities. Accordingly, this could lead
to dually registered firms avoiding the use of the title ``adviser'' or
``advisor'' unless they believe they would always offer investment
advisory services, which we believe is not necessary to avoid the
potential investor harm. Additionally, we also seek to avoid the
potential misimpression that may result should a firm use a name or
title to reflect only its brokerage services and not its investment
advisory services. In such a circumstance, a retail investor may not
know that such firm offers both business models and could be led to
believe that only brokerage services are available.
b. Dual Hatted Financial Professionals
Dual hatted financial professionals of dually registered firms
(including state-registered investment advisers) can provide brokerage
services, advisory services, or both. We believe it is appropriate for
financial professionals that provide services as an investment adviser
to retail investors to be permitted to use names or titles which
include ``adviser'' and ``advisor,'' even if, as a part of their
business, they also provide brokerage services. As such, our proposed
rule would not restrict, for example, a financial professional that is
both a supervised person of an investment adviser and an associated
person of a broker-dealer from using the term ``adviser'' or
``advisor'' in his or her name or title if such person provides
investment advice to retail investors on behalf of the investment
adviser.\416\ We believe that the relationship summary can sufficiently
reduce the risk of investors being misled and avoid investor harm
because it contains parallel information with respect to each of the
services the dual hatted financial professional offers.
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\416\ See Exchange Act proposed rule 151-2(a)(2).
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By contrast, we recognize that some financial professionals of
dually registered firms only provide brokerage services. We are
concerned that if these financial professionals use ``adviser'' or
``advisor'' in their names or titles, retail investors may be misled
about the nature of services they are receiving, and may incorrectly
believe that such person would provide them investment advisory
services rather than brokerage services. Therefore, we believe that a
financial professional who does not provide investment advice to retail
investors on behalf of the investment adviser, i.e., a financial
professional that only offers brokerage services to retail investors,
should be restricted from using the title ``adviser'' or ``advisor''
despite such person's association with a dually registered firm.
We recognize that, as with dually registered firms, some dual
hatted financial professionals may under some circumstances only offer
brokerage services to a particular retail investor, which has the
potential to cause confusion. For the same reasons discussed above
regarding dually registered firms, however, we do not believe that the
determination of when the restriction applies should be based on what
capacity a dual hatted financial professional is acting in a particular
circumstance, i.e., whether a dual hatted professional is offering only
brokerage services to that particular investor and not offering
investment advisory services.\417\ Moreover, we are proposing in
Regulation Best Interest to require a broker-dealer to make certain
disclosures, including the capacity of the financial professional and
firm.\418\ We request comment below on whether and if so how the
proposed rule should address this particular circumstance.
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\417\ See supra note 410. Firms and financial professionals
should keep in mind the applicability of the antifraud provisions of
the federal securities laws, including section 17(a) of the
Securities Act, and section 10(b) of the Exchange Act and rule 10b-5
thereunder, to the use of names or titles.
\418\ See Regulation Best Interest Proposal, supra note 24.
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C. Alternative Approaches
Over the past decade, we and commenters have expressed concern
about broker-dealer marketing efforts, including through the use of
titles, and whether these efforts are consistent with a broker-dealer's
reliance on the exclusion from the definition of investment adviser
under section 202(a)(11)(C) of the Advisers Act.\419\ Under section
202(a)(11)(C), a broker-dealer is excluded from the definition of
investment adviser if its ``performance of [advisory] services is
solely incidental to the conduct of his business as a broker or dealer
and who receives no special compensation therefor.'' \420\ In this
regard, and as an alternative to our proposed rule today, we considered
proposing a rule which would have stated that a broker-dealer that uses
the term ``adviser'' or ``advisor'' as part of a name or title cannot
be considered to provide investment advice solely incidental to the
conduct of its business as a broker-dealer and therefore is not
excluded from the definition of investment adviser under section
202(a)(11)(C). We also considered proposing a rule that would preclude
a broker-dealer from relying on the exclusion when such a broker-dealer
held itself out as an investment adviser. We are not proposing these
alternatives for the reasons discussed below. However, we request
comment on these alternatives below.
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\419\ See, e.g., Comment letter of Investment Counsel
Association of America (Feb. 7, 2005) (``ICAA 2005 Letter); Comment
letter of T. Rowe Price (Feb. 22, 2005) (``T. Rowe Price 2005
Letter'') on Broker Dealer Reproposing Release, supra note 398. See
also Certain Broker-Dealers Deemed Not to Be Investment Advisers,
Exchange Act Release No. 42099 (Nov. 4, 1999) (``Release 42099'').
\420\ Section 202(a)(11)(C) of the Advisers Act.
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Our concerns regarding broker-dealer marketing efforts are not new.
For example, we have previously requested comment on whether we should
preclude broker-dealers from relying on the solely incidental prong of
the exclusion if they market their services
[[Page 21464]]
in a manner that suggests that they are offering advisory accounts,
including through the use of names or titles.\421\ While we have never
viewed the broker-dealer exclusion as precluding a broker-dealer from
marketing itself as providing some amount of advisory services, we have
noted that these marketing efforts raised ``troubling questions as to
whether the advisory services are not (or would be perceived by
investors not to be) incidental to the brokerage services.'' \422\
Certain commenters have voiced similar concerns, arguing that the use
of certain titles, such as ``financial advisor,'' is inconsistent with
the broker-dealer exclusion, with some noting that the marketing of
advisory services by a broker-dealer is inconsistent with those
services being solely incidental to the brokerage business.\423\
Others, however, contended that the titles are consistent with the
services provided by broker-dealers, whether in fee-based or
commission-based accounts.\424\
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\421\ See, e.g., Release 42099, supra note 419.
\422\ See id.
\423\ See, e.g., ICAA 2005 Letter; T. Rowe Price 2005 Letter.
See also e.g. AFL-CIO 2017 Letter; CFA 2017 Letter; Comment letter
of CFA Institute (Jan. 10, 2018); Comment letter of The Committee
for the Fiduciary Standard (Jan. 12, 2018).
\424\ See Broker Dealer Reproposing Release.
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Taking into account our concerns and the views of commenters, we
considered proposing a rule which would have stated that a broker-
dealer that uses the term ``adviser'' or ``advisor'' as part of a name
or title would not be considered to provide investment advice solely
incidental to the conduct of its brokerage business and therefore would
not be excluded from the definition of investment adviser under section
202(a)(11)(C) of the Advisers Act.\425\ In considering this
alternative, we questioned whether a broker-dealer that uses these
terms to market or promote its services to retail investors is doing so
because its advice is significant or even instrumental to its brokerage
business. Consequently, we questioned whether that broker-dealer's
provision of advice is therefore no longer solely incidental to its
brokerage business. Similarly, we believe that if a broker-dealer
invests its capital into marketing, branding, and creating intellectual
property in using the terms ``adviser'' or ``advisor'' in its name or
its financial professionals' titles, the broker-dealer is indicating
that advice is an important part of its retail investor broker-dealer
business. As compared to the more principles-based ``holding out''
approach below, this alternative may offer more certainty and clarity
to broker-dealers. It also specifically addresses our concerns about
the use of ``adviser'' and ``advisor,'' as discussed in this release.
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\425\ As with the proposal, our alternative approach would
likewise preclude an associated natural person of a dually
registered firm from using the term ``adviser'' or ``advisor'' in a
name or title unless he or she is a supervised person of an
investment adviser and provides investment advice on behalf of such
investment adviser.
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We also considered a broader approach that would have precluded a
broker-dealer from relying on the solely incidental exclusion of
section 202(a)(11)(C) if a broker-dealer ``held itself out'' as an
investment adviser to retail investors.\426\ For example, ``holding
out'' could encompass a broker-dealer that represented or implied
through any communication or other sales practice (including through
the use of names or titles) that it was offering investment advice to
retail investors subject to a fiduciary relationship with an investment
adviser. As with our alternative approach above, we questioned whether
these activities could suggest, or could reasonably be understood as
suggesting, that such broker-dealer or its associated natural persons
were performing investment advisory services in a manner that was not
solely incidental to their business as a broker-dealer. In particular,
this approach could reduce the risk that if we restricted certain
titles (or limited the use of certain titles used to market services)
other potentially misleading titles could proliferate. Certain
commenters to Chairman Clayton's Request for Comment also supported
this approach, so that retail investors receiving advice from firms
``holding out'' as investment advisers would receive appropriate
protections, either under the Advisers Act or through a heightened
standard of conduct for broker-dealers.\427\ However, we preliminarily
believe that a ``holding out'' approach would create uncertainty
regarding which activities (and the extent of such activities) would be
permissible. Such an approach could also reduce investor choice, as
broker-dealers may decide to provide fewer services out of an abundance
of caution.
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\426\ See AFL-CIO 2017 Letter, at 3 (stating that ``[o]ne way
for the SEC to proceed is to clarify that those firms that offer
advisory services, or hold themselves out as offering such services,
cannot take advantage of the existing broker-dealer `solely
incidental to' exemption from the Investment Advisers Act.''); IAA
2017 Letter; AICPA 2017 Letter.
\427\ See IAA 2017 Letter, at 11 (``We urge the Commission to
address this source of investor confusion by prohibiting firms or
individuals from holding themselves out as trusted advisers without
being subject to either the Advisers Act fiduciary principles or a
new equally stringent best interest standard under the Exchange Act,
discussed above.''). See also, e.g. AFL-CIO 2017 Letter, at 3
(``clarify that those firms that offer advisory services, or hold
themselves out as offering such services, cannot take advantage of
the existing broker-dealer ``solely incidental to'' exemption from
the Investment Advisers Act. Permitting brokers to rely on this
exemption when engaged in advisory activities has had the effect of
exempting them from the fiduciary duty appropriate to that advisory
role. Adopting this approach would require the SEC to determine what
constitutes ``holding out'' as an adviser, addressing marketing
practices, as well as job titles, that create the reasonable
expectation among investors that they will receive advice and not
just sales recommendations.'').
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We are not proposing any of these approaches however, because we
preliminarily believe that a restriction on the use of ``adviser'' and
``advisor'' in names and titles in combination with the requirement to
deliver a relationship summary would be a simpler, more administrable
approach to address the confusion about the difference between
investment advisers and broker-dealers, and to prevent investors from
being potentially misled, compared to the alternatives presented above.
While we acknowledge that there are other titles or marketing
communications that may contribute to investor confusion or mislead
investors, our proposal is tailored toward creating greater clarity
with respect to the names and titles that are most closely related to
the statutory term investment adviser. In particular, our proposed
rule, in combination with the relationship summary, would help
distinguish between who is and who is not an investment adviser and
allow retail investors to select the business model that best suits
their financial goals. The restriction of the use of the terms
``adviser'' and ``advisor'' that we are proposing is intended to
augment protections provided to investors by applicable provisions of
the federal securities laws. Broker-dealers and their natural
associated persons can face liability for intentionally, recklessly, or
negligently misleading investors about the nature of the services they
are providing through, among other things, materially misleading
advertisements or other communications that include statements or
omissions, or deceptive practices or courses of business.\428\
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\428\ See, e.g., rule 10b-5 under the Securities Exchange Act
and section 17(a) of the Securities Act.
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We request comment generally on our proposed restriction on the use
of certain titles and in particular on the following issues:
Given the required relationship summary, is it necessary
to impose any restrictions on the use of names or titles?
Do you agree with our proposed restriction on the use of
``adviser'' and ``advisor''? Why or why not? To what extent does the
disclosure provided in Form CRS complement our proposed
[[Page 21465]]
restriction? To what extent could it be a substitute?
Is our approach too broad or too narrow? Are there
additional terms that we should explicitly include in the rule? For
example, do any of the following names or titles have the potential to
confuse investors about the differences between investment advisers and
broker-dealers: Wealth manager; financial consultant; financial
manager; money manager; investment manager; and investment consultant?
Why or why not? What are the names or titles most commonly used that
have the potential for investor confusion? Should we consider
restricting the use of names, titles, or terms that are synonymous with
``adviser'' or ``advisor'' and if so, what would those names, titles,
or terms be?
Do commenters believe that names or titles are a main
factor contributing to investor confusion and the potential for
investors to be misled, or are there other more significant factors?
For example, do particular services offered by broker-dealers
contribute to, or primarily cause, investor confusion and the potential
for the broker-dealer's customers to be misled into believing that the
broker-dealer is an investment adviser? If so, which services
specifically? For example, do commenters believe that retirement and
financial planning is more often associated with investment advisers
rather than broker-dealers or vice versa? Additionally, do commenters
believe that monitoring is more often associated with investment
advisers than broker-dealers or vice versa?
Our proposed rule does not apply to financial
professionals of a broker-dealer when acting in the capacity, for
example, as an insurance broker on behalf of an insurance company or a
banker on behalf of a bank. Do you believe our proposed rule is clear
that such persons are excluded from the restriction? If not, how should
we provide such clarification?
As discussed above, our proposed rule would not prohibit
dually registered firms from using the term ``adviser'' or ``advisor''
in their name or title. However, it would restrict the use of such
names or titles by some associated natural persons and supervised
persons of those firms, depending on whether they provide investment
advice to retail investors on behalf of the investment adviser. Do you
agree with our proposed approach? Is there investor confusion
concerning what capacity a dually registered firm, a dual hatted
financial professional, or an associated or supervised person of a
dually registered firm is acting in when communicating with a retail
investor? If such confusion exists, how should we address it, in
addition to the proposed relationship summary? For example, are retail
investors confused about which type of account their financial
professional is referring to when he or she makes a particular
recommendation? If this is a source of confusion, how should we address
it (e.g., should we address it through affirmative disclosures of
account types in account statements or another form of disclosure)?
Given the prevalence of dually registered firms and their
associated dual hatted financial professionals, do retail investors
typically believe they are engaging a financial professional who is
solely a broker-dealer or investment adviser, or do investors
understand that such person is a dual hatted professional and therefore
may be able to engage with them as a broker-dealer and an investment
adviser? Or do retail investors currently not understand enough to
distinguish among these options in any meaningful manner?
Do commenters believe that retail investors will
understand that there is, and will continue to be under proposed
Regulation Best Interest, differences in the standards of conduct,
compensation structures, and services offered (among other items)
depending on the capacity in which such professional engages a retail
investor?
We are proposing to permit or restrict financial
professionals associated with dually registered firms from using the
term ``adviser'' or ``advisor'' in their name or title based on whether
they provide investment advice on behalf of such investment advisers.
Are there alternatives we should consider in implementing this portion
of the rule? For example, should we only allow a supervised person to
use such names or titles where ``a substantial part of his or her
business consists of rendering investment supervisory services'' to
retail investors, based upon a facts and circumstances determination?
\429\
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\429\ See section 208(c) of the Advisers Act: ``[i]t shall be
unlawful for any person registered under section 203 of this title
to represent that he is an investment counsel or to use the name
`investment counsel' as descriptive of his business unless (1) his
or its principal business consists of acting as investment adviser,
and (2) a substantial part of his or its business consists of
rendering investment supervisory services.''
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Our proposed rule would not prohibit dually registered
firms or dually hatted financial professionals from using ``adviser''
or ``advisor'' in their names or titles, even in circumstances where
the firm or financial professional provides only brokerage services to
a particular retail investor. Do you agree with our approach? Why or
why not? For example, should the proposed rule's application depend on
the capacity in which a financial professional engages a particular
retail investor? If so, should financial professionals use multiple
titles that would vary based on the capacity in which they are acting,
and what titles would they use? Are there compliance challenges
associated with this approach? Conversely, would this discourage dually
registered firms or dually hatted financial professionals from using
any title with ``adviser'' or ``advisor,'' even when they are providing
advisory services? Would this discourage dually hatted financial
professionals from providing brokerage services? Would a firm use
different names or titles for different subsets of their financial
professionals?
Do you agree that the use of the terms ``adviser'' or
``advisor'' by broker-dealers are the main sources of investor
confusion? If so, what do these terms confuse investors about (e.g.,
the differences as to the standard of conduct their financial
professional owes, the duration of the relationship, fees charged,
compensation)? Are investors harmed by this confusion? If so, how? Do
you agree that ``adviser'' and ``advisor'' are often associated with
the statutory term ``investment adviser''? Do you believe that retail
investors understand what the terms ``adviser'' and ``broker-dealer''
mean and can correctly identify what type of financial professional
they have engaged?
We understand that the terms ``adviser'' or ``advisor''
are included in some professional designations earned by financial
professionals.\430\ We also understand that particular professional
designations have been an area of concern for FINRA and NASAA.\431\
Should we include an exception to permit the use of professional
designations that use the terms ``adviser'' or ``advisor''? What
factors should the Commission consider if it were to include such an
exception? For example, should such an exception be conditioned on
prominent disclosure
[[Page 21466]]
that the individual is not an investment adviser or supervised by one?
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\430\ See FINRA, Professional Designations, available at https://www.finra.org/investors/professional-designations.
\431\ See Senior Designations, FINRA Notice 11-52 (Nov. 2011),
available at http://www.finra.org/sites/default/files/NoticeDocument/p125092.pdf; NASAA, NASAA Model Rule on the Use of
Senior-Specific Certifications and Professional Designations (Mar.
20, 2008), available at http://www.nasaa.org/wp-content/uploads/2011/07/3-Senior_Model_Rule_Adopted.pdf.
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Do you agree with the proposed approach in Exchange Act
proposed rules 15l-2 and 15l-3 and Advisers Act proposed rule 211h-1 of
limiting our proposed rules to ``retail investors'' where such persons
are defined to include all natural persons as discussed above? \432\
Should we instead exclude certain categories of natural persons based
on their net worth or income level, such as accredited investors,\433\
qualified clients \434\ or qualified purchasers? \435\ If we did
exclude certain categories of natural persons based on their net worth,
what threshold should we use for measuring net worth? Should we exclude
certain categories of natural persons for other reasons?
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\432\ See supra notes 28-32 and accompanying text.
\433\ See supra note 66.
\434\ See supra note 67.
\435\ See supra note 68.
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Should we conform the definition of retail investor to the
definition of retail customer as proposed in Regulation Best Interest,
which would include non-natural persons, provided the recommendation is
primarily for personal, family, or household purposes? What kind of
compliance burdens would it create to base Form CRS delivery off of a
definition of retail investor that only included recommendations
primarily for personal, family, or household purposes? Should the
definition of retail investor include trusts or similar entities that
represent natural persons, as proposed? Are there other persons or
entities that should be covered? Should we expand the definition to
cover plan participants in workplace retirement plans who receive
services from a broker-dealer or investment adviser for their
individual accounts within a plan?
What costs would broker-dealers impacted by our proposed
rule incur as a result of having to rebrand themselves and their
financial professionals along with revising their communications? Are
there means to mitigate such costs? Would the costs differ if we made
the broker-dealer exclusion in the Advisers Act unavailable to broker-
dealers that use the terms ``adviser'' or ``advisor''?
How would broker-dealers and associated natural persons of
broker-dealers who would be impacted by our proposed rule change the
way they market themselves or communicate with retail investors as a
result of our proposed rule? Would this cause any other changes to
their business? For example, would more broker-dealer firms also
register with the Commission or the states as investment advisers as a
result of our proposed rule? Will firms exit the brokerage business as
a result of our proposed rule? Would more associated natural persons of
broker-dealers become dual hatted?
Would our proposed rule impact the marketing and
communications of dually registered firms and their professionals in
any manner? If so, how?
Do investment advisers and their supervised persons also
use names, titles, or professional designations that can lead or
contribute to retail investor confusion? If so, please provide examples
of these names or titles and how they can lead or contribute to
confusion. Should we restrict investment advisers and their supervised
persons from using these names or titles?
What costs would our proposed restriction on certain names
and titles impose? Are there greater or lower costs associated with our
proposed rules as compared to alternative approaches that consider
whether certain titles or marketing practices are consistent with
advice being ``solely incidental'' to the firm's brokerage activities
and thus permissible for a firm relying on the broker-dealer exclusion
from the Advisers Act? If so, what are the specific cost estimates of
each approach and the components of those estimates? Are there ways to
mitigate their impact and if so, what methods could be taken? Are there
operational and compliance challenges associated with our proposed
approach as compared to the alternatives approaches, and if so, what
are they?
We request comment on the alternative approach in which a
broker-dealer would not be considered to provide investment advice
solely incidental to the conduct of its brokerage business if it uses
the term ``adviser'' or ``advisor'' to market or promote its services
and would instead treat such practices as indicating that the broker-
dealer's advisory services are not ``solely incidental'' to its conduct
of business as a broker-dealer. What would be the advantages or
disadvantages of using this approach instead of the approach we have
proposed? Would the alternative approach address and mitigate investor
confusion about the differences between broker-dealers and investment
advisers? Would the alternative approach reduce the likelihood that
investors may be misled as to the type of firm they are engaging with
and therefore make an uninformed decision? Would the alternative
approach have other effects on the analysis of when advisory activities
are or are not solely incidental to brokerage activities? How would
this alternative approach impact dually registered firms and dual
hatted financial professionals? Are there operational and compliance
challenges associated with this approach, and if so, what are they? How
would broker-dealers and associated natural persons of broker-dealers
impacted by the alternative approach change the way they market
themselves or communicate with retail investors as a result of our
proposed rule? Would this cause any other changes to their business?
Would the alternative approach discussed above that would
preclude a broker-dealer or an associated natural person of a broker-
dealer from relying on the broker-dealer exclusion of section
202(a)(11)(C) of the Advisers Act if it ``held itself out'' as an
investment adviser address investor confusion? What would be the
advantages or disadvantages of using this approach instead of the
approach we have proposed? Which communications or level of advice do
you think imply that a broker-dealer or its associated natural person
is ``holding out'' as an investment adviser? How would an approach that
focuses on ``holding out'' as an investment adviser impact access to
advice from different kinds of firms, and how retail investors pay for
this advice? How would this approach affect competition? Would this
``holding out'' approach address any confusion that may arise from
broker-dealer marketing efforts focusing on the ongoing relationship
between the broker and the investor? Are there operational and
compliance challenges associated with this approach, and if so, what
are they?
Instead of a prohibition or restriction on the use of
certain terms, should we permit such terms but require broker-dealers
and their associated natural persons other than dual registrants and
dual hatted financial professionals to include a disclaimer in their
communications that they are not an investment adviser or investment
adviser representative, respectively, each time they use or refer to
the term ``adviser'' or ``advisor''? Would this approach address
investor confusion or mitigate the likelihood that investors may be
misled when broker-dealers and their associated natural persons use the
term ``adviser'' or ``advisor''? Should this approach be coupled with
an affirmative obligation that a dually registered broker-dealer or its
dual hatted associated natural persons disclose that it is an
investment adviser or an investment adviser representative,
respectively, when using terms other than ``adviser'' or ``advisor''?
Would this requirement discourage broker-dealers from using
[[Page 21467]]
these terms even if they were not prohibited? How would this approach
impact our proposed rule requiring disclosure of the firm's regulatory
status and the financial professional's association with the firm? How
would this approach impact dually registered firms and dually hatted
financial professionals? Are there operational and compliance
challenges associated with this approach, and if so, what are they?
We recognize that the term ``adviser'' is used differently
in connection with the regulation of investment advisory services
provided to workplace retirement plans and IRAs under ERISA and the
prohibited transaction provisions of the Internal Revenue Code. For
example, a statutory exemption for the provision of investment advice
to participants of ERISA-covered workplace retirement plans and IRAs,
and related DOL regulations, define the term ``fiduciary adviser''
broadly to include a variety of persons acting in a fiduciary capacity
in providing investment advice, including investment advisers
registered under the Advisers Act or under state laws, registered
broker-dealers, banks or similar financial institutions providing
advice through a trust department, and insurance companies, and their
affiliates, employees and other agents.\436\ Given that there are
definitions of ``adviser'' under other federal regulations that capture
entities and individuals who are not regulated under the Advisers Act,
would a restriction on the use of the term ``adviser'' that applies
only to registered broker-dealers and their registered representatives
contribute to investor confusion or result in conflicting regulations,
and possibly increased compliance burdens, or affect competition?
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\436\ See ERISA Sec. 408 (g)(11)(A); Code Sec.
4975(f)(8)(J)(i) and 29 CFR 2550.408g-1. In addition, under the
DOL's BIC Exemption, the term ``Adviser'' would mean an individual
who is an employee or other agent (including a registered
representative) of a state or federally registered investment
adviser, registered broker-dealer, bank or similar financial
institution, or an insurance company. See Corrected BIC Exemption,
infra note 504, section VIII(a).
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What would be the effect on competition by prohibiting
broker-dealers from using these terms? What would be the effect on
competition by the alternative approaches described?
D. Disclosures About a Firm's Regulatory Status and a Financial
Professional's Association
We are also proposing rules under the Exchange Act and the Advisers
Act to require a broker-dealer and an investment adviser registered
under section 203 to prominently disclose that it is registered as a
broker-dealer or investment adviser, as applicable, with the Commission
in print or electronic retail investor communications.\437\ We are also
proposing as part of our proposed Exchange Act rule to require an
associated natural person of a broker or dealer to prominently disclose
that he or she is an associated person of a broker-dealer registered
with the Commission in print or electronic retail investor
communications.\438\ In addition, we are proposing as part of our
Advisers Act rule to require a supervised person of an investment
adviser registered under section 203 to prominently disclose that he or
she is a supervised person of an investment adviser registered with the
Commission in print or electronic retail investor communications.\439\
For example, an investment adviser registered with the Commission would
prominently disclose the following on its print or electronic
communications: ``[Name of Firm], an investment adviser registered with
the Securities and Exchange Commission'' or ``[Name of Firm], an SEC-
registered investment adviser.'' Dually registered firms would
similarly be required to prominently disclose both registration
statuses in their print or electronic communications, for example:
``[Name of Firm], an SEC-registered broker-dealer and SEC-registered
investment adviser.'' Similarly, an associated natural person of a
broker-dealer would prominently disclose the following, for example, on
his or her business card or signature block: ``[Name of professional],
a [title] of [Name of Firm], an associated person of an SEC-registered
broker-dealer.'' Alternatively, a supervised person of an investment
adviser would prominently disclose the following on, for example, his
or her business card or signature block: ``[Name of professional], a
[title] of [Name of Firm], a supervised person of an SEC-registered
investment adviser.'' Finally, a financial professional who is both an
associated person of a broker-dealer and a supervised person of an
investment adviser would prominently disclose the following, for
example: ``[Name of professional], a [title] of [Name of Firm], an
associated person of an SEC-registered broker-dealer and a supervised
person of an SEC- registered investment adviser.''
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\437\ See Exchange Act proposed rule 15l-3(a) and Advisers Act
proposed rule 211h-1(a). We note that in Form ADV investment
advisers are required to state that registration with the Commission
does not imply a certain level of skill or training. See Item 1.C.
of Form ADV Part 2A. We are requesting comment on whether we should
require broker-dealers and investment advisers to include this
statement in addition to disclosing their applicable regulatory
status.
\438\ See Exchange Act proposed rule 15l-3(b).
\439\ See Advisers Act proposed rule 211h-1(b).
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Our proposed registration disclosure rules, like the proposed
restriction on names and titles, or our proposed alternative
approaches, complement our proposed requirement that broker-dealers and
investment advisers deliver a relationship summary to retail investors.
Even if a firm uses various titles, such as ``wealth consultant'' or
``wealth manager,'' the legal term for these firms is ``investment
adviser'' and/or ``broker-dealer.'' These statutory terms have meaning
because they relate to a particular regulatory framework that is
designed to address the nature and scope of the firm's activities,
which the firm would describe for a retail investor in the relationship
summary.\440\ Accordingly, we preliminarily believe that requiring a
firm to disclose whether it is a broker-dealer or an investment adviser
in print or electronic communications to retail investors would assist
retail investors to determine which type of firm is more appropriate
for their specific investment needs.
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\440\ For similar reasons, we are requiring the use of the terms
``supervised person'' and ``associated person'' as they are defined
legal terms generally describing the financial professional's
association with the investment adviser or broker-dealer,
respectively.
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For similar reasons, we preliminarily believe that because retail
investors interact with a firm primarily through financial
professionals, it is important that financial professionals disclose
the firm type with which they are associated. We acknowledge that in
the studies and the comments received, retail investors generally
believe broker-dealers and investment advisers are similar, and that
they did not understand differences between them.\441\ As discussed
above, while we acknowledge that broker-dealers and investment advisers
are similar in that they provide investment advice, they commonly are
dissimilar in a variety of key areas such as disclosure of conflicts of
interest, types of fees charged, and standard of conduct. In
particular, the
[[Page 21468]]
proposed relationship summary would inform retail investors about many
of these differences, and in so doing, would be addressing investor
confusion. As a result, even if investors are currently confused, over
time they should better understand that investment advisers and broker-
dealers may be different, and how they are different.
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\441\ See supra Section III.A. See also, e.g., RAND Study, supra
note 5, at 19, 20 (``Many [industry interview] participants reported
that they thought that offering such [fee-based account] products
and services meant that broker-dealers and investment advisers
became less distinguishable from one another. They claimed that
bundling of advice and sales by broker-dealers also added to
investor confusion . . . . [Industry Representative] interviews
suggest that individual investors do not distinguish between
investment advisers and broker-dealers. Marketplace changes that
have resulted in investment advisers and broker-dealers offering
similar services have added to investor confusion.'').
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Similarly, our proposed rules to require a firm to disclose whether
it is a broker-dealer or an investment adviser in print or electronic
communications to retail investors would help to facilitate investor
understanding, even if investors currently may not understand the
differences between investment advisers and broker-dealers.
We believe that disclosures that are as important as whether a firm
is a broker-dealer or an investment adviser or whether a financial
professional is associated with a broker-dealer or is a supervised
person of an investment adviser, should not be inconspicuous or placed
in fine print. Accordingly, we are proposing to require a firm and its
financial professionals to disclose their registration statuses in
print communications in a type size at least as large as and of a font
style different from, but at least as prominent as, that used in the
majority of the communication.\442\ To be ``prominent,'' for example,
we believe the disclosures should be included, at a minimum, on the
front of a business card or in another communication, in a manner
clearly intended to draw attention to it. In addition, we are proposing
to require the disclosure to be presented in the body of the
communication and not in a footnote.\443\ If a communication is
delivered through an electronic communication or in any publication by
radio or television, the disclosure must be presented in a manner
reasonably calculated to draw retail investors' attention to it.\444\
For example, in a televised or video presentation, a voice overlay and
on-screen text could clearly convey the required information. Finally,
we propose to stage the compliance date to ensure that firms and
financial professionals can phase out certain older communications from
circulation through the regular business lifecycle rather than having
to retroactively change them.\445\
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\442\ See Exchange Act proposed rule 15l-3(c)(1) and Advisers
Act proposed rule 211h-1(c)(1).
\443\ See supra note 442.
\444\ See Exchange Act proposed rule 15l-3(c)(2) and Advisers
Act proposed rule 211h-1(c)(2). See also Proposed Amendments to
Investment Company Advertising Rules, Investment Company Act Release
No. 25575 (May 17, 2002); Amendments to Investment Company
Advertising Rules, Investment Company Act Release No. 26195 (Sept.
29, 2003) (stating that ``radio and television advertisements [must]
give the required narrative disclosures emphasis equal to that used
in the major portion of the advertisement''). See also 17 CFR
230.420.
\445\ Similarly, we are not requiring firms to send new
communications to replace all older print communications as this
would be overly burdensome and costly for firms.
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We request comment generally on our proposed requirement to
disclose a firm's regulatory status and, for financial professionals,
their association with such firm, and in particular on the following
issues:
Does our proposed rule requiring disclosure of a firm's
registration status, either alone or in combination with the proposed
relationship summary, sufficiently address the concerns addressed by
our proposed restriction on certain names or titles? If not, why not?
Would the proposed rules requiring disclosure of
registration status and the financial professional's association with
the firm give retail investors greater clarity about various aspects of
their relationship with a financial professional (e.g., his or her
services, compensation structures, conflicts of interest, and legal
obligations)?
To what extent do firms already clearly and conspicuously
disclose their federal and/or state registration as investment advisers
or broker-dealers? To what extent do financial professionals already
disclose their association with the broker-dealer or investment
adviser? If such status is disclosed, is it typically in fine print or
presented in a manner that it is not easily recognizable to investors?
Do retail investors understand what it means for a firm to
be ``registered'' with the Commission or a state? Additionally, do
retail investors understand what it means for a financial professional
to be an ``associated person'' of a broker-dealer or a ``supervised
person'' of an investment adviser?
Would our proposed rules improve clarity and consistency
for investors in identifying a firm's regulatory status and a financial
professional's association with a firm or will it lead to unnecessary,
wordy, and possibly redundant disclosure? If the latter, how can we
address this?
Are we correct that investors would find it helpful to
know whether a firm is registered as an investment adviser or a broker-
dealer or a financial professional is associated with a broker-dealer
or supervised by an investment adviser so that they can refer to the
relationship summary to better understand the practical implications of
the firm's registration and such financial professional's association
with that firm?
Should dually registered firms be required to disclose
both registration statuses? Would this requirement cause more confusion
or help to address it? If so, how? By requiring a financial
professional to disclose whether he or she is an associated person of a
broker-dealer or a supervised person of an investment adviser, would we
be assisting retail investors in understanding the capacity in which
their financial professional services them? For example, would retail
investors serviced by dual hatted financial professionals understand
that their financial professional may act in dual capacities (i.e.,
brokerage and advisory)?
Are our proposed requirements prescribing the presentation
of the disclosure appropriate? Should we consider removing any of these
requirements? Alternatively, are there requirements we should add? If
so, which requirements and why? Are there requirements that we should
modify? For example, could the Commission's objective of ensuring
prominence of disclosure be served through a more principles-based
approach, or through different requirements (e.g., that the disclosure
be not 20% smaller than the principal text)?
Should the account statement or other disclosure clarify
whether a retail investor has an advisory or a brokerage account? If
so, how?
Should our proposed rules define ``communication''? For
example, should we include in the rule a definition that tracks FINRA's
definition of ``communication'' in Rule 2210? In particular, FINRA Rule
2210 defines a ``communication'' as correspondence, retail
communications and institutional communications. ``Correspondence''
means any written (including electronic) communication that is
distributed or made available to 25 or fewer retail investors within
any 30 calendar day period and ``Retail communication'' means any
written (including electronic) communication that is distributed or
made available to more than 25 retail investors within any 30 calendar
day period. Finally, ``Institutional communication'' means any written
(including electronic) communication that is distributed or made
available only to institutional investors, but does not include a
member's internal communications. Are there other definitions of
``communication'' we should consider? As an alternative to the word
[[Page 21469]]
``communication'' in our proposed rules, should we use
``advertisements'' as defined in rule 206(4)-1 under the Advisers Act,
or a different term? \446\
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\446\ See FINRA Rule 2210(a); rule 206(4)-1 under the Advisers
Act.
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Should the proposed rules apply to all communications to
retail investors, including oral communications? On the other hand, are
there certain types of written communications that could be exempted,
e.g. communications that do not make any financial or investment
recommendation or otherwise promote a product or service of the member?
\447\
---------------------------------------------------------------------------
\447\ See FINRA Rule 2210(b)(1)(D)(iii) (exempting certain
communications from principal pre-approval).
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Should we permit the use of hyperlinks to the registration
status disclosure statement for electronic communications rather than
requiring the disclosure statement on the communication itself? Would
permitting hyperlinks limit or promote the effectiveness of this
disclosure requirement, and if so, how?
Should we require broker-dealers, investment advisers and
financial professionals to state that registration with the Commission
does not imply a certain level of skill or training? Are there
potential benefits or drawbacks to requiring this type of statement?
IV. Economic Analysis
We are sensitive to the economic effects, including the costs and
benefits that stem from the proposed rules. Whenever the Commission
engages in rulemaking and is required to consider or determine whether
an action is necessary or appropriate in the public interest, section
3(f) of the Exchange Act requires the Commission to consider whether
the action would promote efficiency, competition, and capital
formation, in addition to the protection of investors.\448\ Further,
when making rules under the Exchange Act, section 23(a)(2) of the
Exchange Act requires the Commission to consider the impact such rules
would have on competition.\449\ Section 23(a)(2) of the Exchange Act
also prohibits the Commission from adopting any rule that would impose
a burden on competition not necessary or appropriate in furtherance of
the purposes of the Exchange Act.\450\
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\448\ See 15 U.S.C. 77b(b) and 15 U.S.C. 78c(f).
\449\ See 15 U.S.C. 78w(a)(2).
\450\ Id.
---------------------------------------------------------------------------
Section 202(c) of the Advisers Act requires the Commission, when
engaging in rulemaking and required to consider or determine whether an
action is necessary or appropriate in the public interest, also to
consider whether the action will promote efficiency, competition, and
capital formation, in addition to the protection of investors.\451\ The
Commission provides both a qualitative assessment of the potential
effects and, where feasible, quantitative estimates of the potential
aggregate initial and aggregate ongoing costs. In some cases, however,
quantification is particularly challenging due to the difficulty of
predicting how market participants would act under the conditions of
the proposed rules. For example, although we expect that the proposal
would increase retail investors' understanding of the services provided
to them, investors could respond differently to the increased
understanding--by transferring to a different financial firm or
professional, hiring a financial professional for the first time, or
entirely abandoning the financial services market while moving their
assets to other products or markets (e.g., bank deposits or insurance
products). The Commission encourages commenters to provide any data and
information that could help us quantify these long-term effects.
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\451\ 15 U.S.C. 80b-2(c).
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In the economic analysis that follows, we first examine the current
regulatory and economic landscape to form a baseline for our analysis.
We then analyze the likely economic effects--including benefits and
costs and impact on efficiency, competition, and capital formation--
arising from the proposed rules relative to the baseline discussed
below.
A. Baseline
This section discusses, as it relates to this proposal, the current
state of the broker-dealer and investment adviser markets, the current
regulatory environment, and the current state of retail investor
perceptions in the market.
1. Providers of Financial Services
a. Broker-Dealers
As noted above, one market that would be affected by these proposed
rules \452\ is the market for broker-dealer services, including firms
that are dually registered as broker-dealers and investment
advisers.\453\ The market for broker-dealer services encompasses a
small set of large broker-dealers and thousands of small broker-dealers
competing for niche or regional segments of the market.\454\
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\452\ ``Proposed rules'' used in this economic analysis is
inclusive of Form CRS and related proposed forms as well as the
proposed rules themselves.
\453\ Not all firms that are dually registered as an investment
adviser and a broker-dealer offer both brokerage and advisory
accounts to retail investors--for example, some dual registrants
offer advisory accounts to retail investors but offer only brokerage
services, such as underwriting services, to institutional clients.
For purposes of the discussion of the baseline in this economic
analysis, a dual registrant is any firm that is dually registered
with the Commission as an investment adviser and a broker-dealer.
For the purposes of the relationship summary, however, we propose to
define dual registrant as a firm that is dually registered as a
broker-dealer and an investment adviser and offers services to
retail investors as both a broker-dealer and investment adviser. See
supra note 25.
\454\ See Risk Management Controls for Brokers or Dealers with
Market Access, Securities Exchange Act Release No. 63241 (Nov. 3,
2010) [75 FR 69791, 69822 (Nov. 15, 2010)].
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As of December 2017, there were approximately 3,841 registered
broker-dealers with over 130 million customer accounts. In total, these
broker-dealers have close to $4 trillion in total assets.\455\ More
than two-thirds of all brokerage assets and close to one-third of all
customer accounts are held by the 16 largest broker-dealers, as shown
in Table 1, Panel A.\456\ Of the broker-dealers registered with the
Commission as of December 2017, 366 broker-dealers were dually
registered as investment advisers; \457\ however, these firms hold
nearly 90 million (68%) customer accounts.\458\ Approximately 546
broker-
[[Page 21470]]
dealers (14%) reported at least one type of non-securities business,
including insurance, retirement planning, mergers & acquisitions, and
real estate, among others.\459\ Approximately 74% of registered broker-
dealers report retail customer activity.\460\
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\455\ Assets are estimated by Total Assets (allowable and non-
allowable) from Part II of the FOCUS filings (Form X-17A-5 Part II,
available at https://www.sec.gov/files/formx-17a-5_2.pdf) and
correspond to balance sheet total assets for the broker-dealer. The
Commission does not have an estimate of the total amount of customer
assets for broker-dealers. We estimate broker-dealer size from the
total balance sheet assets as described above.
\456\ Approximately $3.91 trillion of total assets of broker-
dealers (98%) are at firms with total assets in excess of $1
billion. Of the 30 dual registrants in the group of broker-dealers
with total assets in excess of $1 billion, total assets for these
dual registrants are $2.46 trillion (62%) of aggregate broker-dealer
assets. Of the remaining 88 firms, 81 have affiliated investment
advisers.
\457\ Because this number does not include the number of broker-
dealers who are also registered as state investment advisers, the
number undercounts the full number of broker-dealers that operate in
both capacities. Further, not all firms that are dually registered
as an investment adviser and a broker-dealer offer both brokerage
and advisory accounts to retail investors--for example, some dual
registrants offer advisory accounts to retail investors but offer
only brokerage services, such as underwriting services, to
institutional customers. For purposes of the discussion of the
baseline in this economic analysis, a dual registrant is any firm
that is dually registered with the Commission as an investment
adviser and a broker-dealer.
\458\ Some broker-dealers may be affiliated with investment
advisers without being dually registered. From Question 10 on Form
BD, 2,145 broker-dealers report that directly or indirectly, they
either control, are controlled by, or under common control with an
entity that is engaged in the securities or investment advisory
business. Comparatively, 2,478 (19.57%) SEC-registered investment
advisers report an affiliate that is a broker-dealer in Section 7A
of Schedule D of Form ADV, including 1,916 SEC-registered investment
advisers that report an affiliate that is a registered broker-
dealer. Approximately 75% of total assets under management of
investment advisers are managed by these 2,478 investment advisers.
\459\ We examined Form BD filings to identify broker-dealers
reporting non-securities business. For the 546 broker-dealers
reporting such business, staff analyzed the narrative descriptions
of these businesses on Form BD, and identified the most common types
of businesses: Insurance (208), management/financial/other
consulting (101), advisory/retirement planning (80), mergers &
acquisitions (71), foreign exchange/swaps/other derivatives (31),
real estate/property management (31), tax services (15), and other
(141). Note that a broker-dealer may have more than one line of non-
securities business.
\460\ The value of customer accounts is not available from FOCUS
data for broker-dealers. Therefore, to obtain estimates of firm size
for broker-dealers, we rely on the value of broker-dealers total
assets as obtained from FOCUS reports. Retail sales activity is
identified from Form BR, which categorizes retail activity broadly
(by marking the ``sales'' box) or narrowly (by marking the
``retail'' or ``institutional'' boxes as types of sales activity).
We use the broad definition of sales as we preliminarily believe
that many firms will just mark ``sales'' if they have both retail
and institutional activity. However, we note that this may capture
some broker-dealers that do not have retail activity, although we
are unable to estimate that frequency. We request comment on whether
firms that intermediate both retail and institutional customer
activity generally market only ``sales'' on Form BR.
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Panel B of Table 1 limits the broker-dealers to those that report
some retail investor activity. As of December 2017, there were
approximately 2,857 broker-dealers that served retail investors, with
over $3.6 trillion in assets (90% of total broker-dealer assets) and
128 million (96%) customer accounts.\461\ Of those broker-dealers
serving retail investors, 360 are dually registered as investment
advisers.\462\
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\461\ Total assets and customer accounts for broker-dealers that
serve retail customers also include institutional accounts. Data
available from Form BD and FOCUS data is not sufficiently granular
to identify the percentage of retail and institutional accounts at
firms.
\462\ Of the 36 dual registrants in the group of retail broker-
dealers with total assets in excess of $500 million, total assets
for these dual registrants are $2.19 trillion (60%) of aggregate
retail broker-dealer assets. Of the remaining 72 retail broker-
dealers, 67 have affiliated investment advisers.
\463\ The data is obtained from FOCUS filings as of December
2017. Note that there may be a double-counting of customer accounts
among in particular the larger broker-dealers as they may report
introducing broker-dealer accounts as well in their role as clearing
broker-dealers.
\464\ In addition to the approximately 130 million individual
accounts at broker-dealers, there are approximately 293,000 omnibus
accounts (0.2% of total accounts at broker-dealers), across all
3,841 broker-dealers, of which approximately 99% are held at broker-
dealers with greater than $1 billion in total assets. See also supra
note 455. Omnibus accounts reported in FOCUS data are the accounts
of non-carrying broker-dealers with carrying broker-dealers. These
accounts may have securities of multiple customers (of the non-
carrying firm), or securities that are proprietary assets of the
non-carrying broker-dealer. We are unaware from the data available
to determine how many customer accounts non-carrying broker-dealers
may have. The data does not allow the Commission to parse the total
assets in those accounts to determine to whom such assets belong.
Therefore, our estimate may be underinclusive of all customer
accounts held at broker-dealers.
\465\ Customer Accounts includes both broker-dealer and
investment adviser accounts for dual registrants.
Table 1--Panel A: Registered Broker-Dealers as of December 2017 \463\
[Cumulative Broker-Dealer Total Assets and Customer Accounts \464\]
----------------------------------------------------------------------------------------------------------------
Cumulative
Total number Number of Cumulative number of
Size of broker-dealer (total assets) of BDs dual- total assets customer
registered BDs Accounts \465\
----------------------------------------------------------------------------------------------------------------
>$50 billion.................................... 16 10 $2,717 bil. 40,969,187
$1 billion to $50 billion....................... 102 20 1,196 bil. 81,611,933
$500 million to $1 billion...................... 38 7 26 bil. 4,599,330
$100 million to $500 million.................... 118 26 26 bil. 1,957,981
$10 million to $100 million..................... 482 94 17 bil. 2,970,133
$1 million to $10 million....................... 1,035 141 4 bil. 233,946
<$1 million..................................... 2,055 68 1 bil. 5,588
---------------------------------------------------------------
Total....................................... 3,841 366 3,987 bil. 132,348,098
----------------------------------------------------------------------------------------------------------------
Table 1--Panel B: Registered Retail Broker-Dealers as of December 2017
[Cumulative Broker-Dealer Total Assets and Customer Accounts]
----------------------------------------------------------------------------------------------------------------
Cumulative
Total number Number of Cumulative number of
Size of broker-dealer (total assets) of BDs dual- total assets customer
registered BDs accounts
----------------------------------------------------------------------------------------------------------------
>$50 billion.................................... 15 10 $2,647 bil. 40,964,945
$1 billion to $50 billion....................... 70 19 923 bil. 77,667,615
$500 million to $1 billion...................... 23 7 16 bil. 4,547,574
$100 million to $500 million.................... 93 25 20 bil. 1,957,981
$10 million to $100 million..................... 372 94 14 bil. 2,566,203
$1 million to $10 million....................... 815 139 3 bil. 216,158
<$1 million..................................... 1,469 66 $.4 bil. 5,588
---------------------------------------------------------------
Total....................................... 2,857 360 $3,624 bil. 127,926,064
----------------------------------------------------------------------------------------------------------------
[[Page 21471]]
Table 2 reports information on brokerage commissions,\466\ fees,
and selling concessions from the fourth quarter of 2017 for all broker-
dealers, including dual registrants.\467\ On average, broker-dealers,
including those that are dually registered as investment advisers, earn
about $2.1 million per quarter in revenue from commissions and more
than double that amount in fees,\468\ although the Commission notes
that fees encompass a variety of fees, not just those related to
advisory services.\469\ The level of revenues earned from broker-
dealers for commissions and fees increases with broker-dealer size, but
also tends to be more heavily weighted towards commissions for broker-
dealers with less than $10 million in assets and is weighted more
heavily towards fees for broker-dealers with assets in excess of $10
million. For example, for the 102 broker-dealers with assets between $1
billion and $50 billion, average revenues from commissions are $25
million, while average revenues from fees are approximately $91
million.\470\
---------------------------------------------------------------------------
\466\ FOCUS data does not provide mark-ups or mark-downs as a
separate revenue category and they are not included as part of the
brokerage commission revenue.
\467\ Source: FOCUS data.
\468\ Fees, as detailed in the FOCUS data, include fees for
account supervision, investment advisory and administrative
services. Beyond the broad classifications of fee types included in
fee revenue, we are unable to determine whether fees such as 12b-1
fees, sub-accounting, or other such service fees are included. The
data covers both broker-dealers and dually-registered firms. FINRA's
Supplemental Statement of Income, Line 13975 (Account Supervision
and Investment Advisory Services) denotes that fees earned for
account supervision are those fees charged by the firm for providing
investment advisory services where there is no fee charged for trade
execution. Investment Advisory Services generally encompass
investment advisory work and execution of client transactions, such
as wrap arrangements. These fees also include fees charged by
broker-dealers that are also registered with the Commodity Futures
Trading Commission (``CFTC''), but do not include fees earned from
affiliated entities (Item A of question 9 under Revenue in the
Supplemental Statement of Income).
\469\ With respect to the FOCUS data, additional granularity of
what services comprise ``advisory services'' is not available.
\470\ A rough estimate of total fees in this size category would
be 102 broker-dealers with assets between $1 billion and $50 billion
multiplied by the average fee revenue of $91 million, or $9.381
billion in total fees. Divided by the number of customer accounts in
this size category (81,611,933), the average account would be
charged approximately $115 in fees per quarter, or $460 per year.
---------------------------------------------------------------------------
In addition to revenue generated from commissions and fees, broker-
dealers may also receive revenues from other sources, including margin
interest, underwriting, research services, and third-party selling
concessions, such as from sales of investment company (``IC'') shares.
As shown in Table 2, Panel A, these selling concessions are generally a
smaller fraction of broker-dealer revenues than either commissions or
fees, except for broker-dealers with total assets between $10 million
and $100 million. For these broker-dealers, revenue from third-party
selling concessions is the largest category of revenues and constitutes
approximately 44% of total revenues earned by these firms.
Table 2, Panel B, below provides aggregate revenues by revenue type
(commissions, fees, or selling concessions) for broker-dealers
delineated by whether the broker-dealer is also a dual registrant.
Broker-dealers dually registered as investment advisers have a
significantly larger fraction of their revenues from fees compared to
commissions or selling concessions, whereas broker-dealers that are not
dually registered generated approximately 43% of their advice-related
revenues as commissions and only 32% of their advice-related revenues
from fees, although we lack granularity to determine whether advisory
services, in addition to supervision and administrative services,
contribute to fees at standalone broker-dealers.
Table 2--Panel A: Average Broker-Dealer Revenues From Revenue Generating Activities \471\
----------------------------------------------------------------------------------------------------------------
Sales of IC
Size of broker-dealer in total assets N Commissions Fees \472\ shares
----------------------------------------------------------------------------------------------------------------
>$50 billion.................................... 16 $176,193,599 $365,014,954 $20,493,769
$1 billion-$50 billion.......................... 102 25,109,619 91,966,559 18,808,687
$500 million-$1 billion......................... 38 6,322,803 11,312,112 6,724,401
$100 million-$500 million....................... 118 7,698,889 11,338,175 4,536,407
$10 million-$100 million........................ 483 1,801,079 2,811,290 3,653,475
$1 million-$10 million.......................... 1,035 633,720 372,757 217,444
<$1 million..................................... 2,049 66,503 38,618 26,270
---------------------------------------------------------------
Average of All Broker-Dealers............... 3,841 2,132,544 4,897,521 1,322,759
----------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------
\471\ The data obtained from December 2017 FOCUS reports and
averaged across size groups.
\472\ Fees, as detailed in the FOCUS data, include fees for
account supervision, investment advisory and administrative
services. The data covers both broker-dealers and dually-registered
firms.
---------------------------------------------------------------------------
---------------------------------------------------------------------------
\473\ See id.
Table 2--Panel B: Aggregate Total Revenues From Revenue Generating Activities for Broker-Dealers Based on Dual
Registrant Status
----------------------------------------------------------------------------------------------------------------
Sales of IC
Broker-dealer type N Commissions Fees \473\ shares
----------------------------------------------------------------------------------------------------------------
Dual Registered as IAs.......................... 366 $4.27 bil. $15.88 bil. $2.8 bil.
Standalone Registered BDs....................... 3,475 3.92 bil. 2.93 bil. 2.28 bil.
---------------------------------------------------------------
All......................................... 3,841 8.19 bil. 18.81 bil. 5.08 bil.
----------------------------------------------------------------------------------------------------------------
[[Page 21472]]
i. Disclosures for Broker-Dealers
Broker-dealers register with and report information to the
Commission, the SROs, and other jurisdictions through Form BD. Form BD
requires information about the background of the applicant, its
principals, controlling persons, and employees, as well as information
about the type of business the broker-dealer proposes to engage in and
all control affiliates engaged in the securities or investment advisory
business.\474\ Broker-dealers report whether a broker-dealer or any of
its control affiliates have been subject to criminal prosecutions,
regulatory actions, or civil actions in connection with any investment-
related activity, as well as certain financial matters.\475\ Once a
broker-dealer is registered, it must keep its Form BD current by
amending it promptly when the information is or becomes inaccurate for
any reason.\476\ In addition, firms report similar information and
additional information to FINRA pursuant to FINRA Rule 4530.\477\ The
current Paperwork Reduction Act estimate for the total industry-wide
annual filing burden to comply with rule 15b1-1 and file Form BD is
approximately 4,999 hours, with an estimated internal cost of
compliance associated with those burden hours for all broker-dealers of
$1,394,721.
---------------------------------------------------------------------------
\474\ See generally Form BD.
\475\ See Item 11 and Disclosure Reporting Pages, Form BD.
\476\ See Exchange Act rule 15b3-1(a).
\477\ See supra Section II.B.7.
---------------------------------------------------------------------------
A significant amount of information concerning broker-dealers and
their associated natural persons, including information from Form BD,
Form BDW, and Forms U4, U5, and U6, is publicly available through
FINRA's BrokerCheck system. This information includes violations of and
claims of violations of the securities and other financial laws by
broker-dealers and their financial professionals; criminal or civil
litigation, regulatory actions, arbitration, or customer complaints
against broker-dealers and their financial professionals; and the
employment history and licensing information of financial professionals
associated with broker-dealers, among other things.\478\
---------------------------------------------------------------------------
\478\ FINRA Rule 8312 governs the information FINRA releases to
the public via BrokerCheck. See supra note 280 and accompanying
text.
---------------------------------------------------------------------------
Broker-dealers are subject to other disclosure requirements under
the federal securities laws and SRO rules. For instance, under existing
antifraud provisions of the Exchange Act, a broker-dealer has a duty to
disclose material information to its customers conditional on the scope
of the relationship with the customer.\479\ Disclosure has also been a
feature of other regulatory efforts related to financial services,
including those of DOL and certain FINRA rules.\480\
---------------------------------------------------------------------------
\479\ A broker-dealer also may be liable if it does not disclose
``material adverse facts of which it is aware''. See, e.g., Chasins
v. Smith, Barney & Co., 438 F.2d at 1172; SEC v. Hasho, 784 F. Supp.
at 1110; Release 48758, supra note 243 (``When a securities dealer
recommends stock to a customer, it is not only obligated to avoid
affirmative misstatements, but also must disclose material adverse
facts of which it is aware. That includes disclosure of ``adverse
interests'' such as ``economic self-interest'' that could have
influenced its recommendation.'') (citations omitted).
\480\ See, infra Section IV.A.1.c; FINRA Notice 10-54, supra
note 12. Generally, all registered broker-dealers that deal with the
public must become members of FINRA, a registered national
securities association, and may choose to become exchange members.
See Exchange Act section 15(b)(8) and Exchange Act rule 15b9-1.
FINRA is the sole national securities association registered with
the SEC under section 15A of the Exchange Act. Accordingly, for
purposes of discussing a broker-dealer's regulatory requirements
when providing advice, we focus on FINRA's regulation, examination
and enforcement with respect to member broker-dealers. FINRA
disclosure rules include but are not limited FINRA rules 2210(d)(2)
(communications with the public), 2260 (disclosures), 2230 (customer
account statements and confirmations), and 2270 (day-trading risk
disclosure statement).
---------------------------------------------------------------------------
b. Investment Advisers
Other parties that would be affected by the proposed rules and
proposed Form CRS are SEC-registered investment advisers.\481\ This
section first discusses SEC-registered investment advisers, followed by
a discussion of state-registered investment advisers.
---------------------------------------------------------------------------
\481\ In addition to SEC-registered investment advisers, which
are the focus of this section, the proposed rules and proposed Form
CRS could also affect banks, trusts, insurance companies, and other
providers of financial advice.
---------------------------------------------------------------------------
As of December 2017, there are approximately 12,700 investment
advisers registered with the Commission. The majority of SEC-registered
investment advisers report that they provide portfolio management
services for individuals and small businesses.\482\
---------------------------------------------------------------------------
\482\ Of the approximately 12,700 SEC-registered investment
advisers, 7,979 (64%) report in Item 5.G.(2) of Form ADV that they
provide portfolio management services for individuals and/or small
businesses. In addition, there are approximately 17,800 state-
registered investment advisers, of which 145 are also registered
with the Commission. Approximately 13,800 state-registered
investment advisers are retail facing (see Item 5.D of Form ADV).
---------------------------------------------------------------------------
Of all SEC-registered investment advisers, 366 identified
themselves as dually registered broker-dealers.\483\ Further, 2,478
investment advisers (20%) reported an affiliate that is a broker-
dealer, including 1,916 investment advisers (15%) that reported an SEC-
registered broker-dealer affiliate.\484\ As shown in Panel A of Table 3
below, in aggregate, investment advisers have over $72 trillion in
assets under management (``AUM''). A substantial percentage of AUM at
investment advisers is held by institutional clients, such as
investment companies, pooled investment vehicles, and pension or profit
sharing plans; therefore, although the dollar value of AUM for
investment advisers and of customer assets in broker-dealer accounts is
comparable, the total number of accounts for investment advisers is
only 27% of the number of customer accounts for broker-dealers.
---------------------------------------------------------------------------
\483\ See supra note 457.
\484\ Item 7.A.1 of Form ADV.
---------------------------------------------------------------------------
Based on staff analysis of Form ADV data, approximately 60% of
investment advisers (7,600) have some portion of their business
dedicated to retail investors, including both high net worth and non-
high net worth individual clients, as shown in Panel B of Table 3.\485\
In total, these firms have approximately $32 trillion of assets under
management.\486\ Approximately 6,600 registered investment advisers
(52%) serve 29 million non-high net worth individual clients and have
approximately $5.33 trillion in assets under management, while nearly
7,400 registered investment advisers (58%) serve approximately 4.8
million high net worth individual clients with $6.56 trillion in assets
under management.\487\
---------------------------------------------------------------------------
\485\ We use the responses to Items 5.D.(a)(1), 5.D.(a)(3),
5.D.(b)(1), and 5.D.(b)(3) of Part 1A. If at least one of these
responses was filled out as greater than 0, the firm is considered
as providing business to retail investors. Form ADV Part 1A.
\486\ The aggregate AUM reported for these investment advisers
that have retail investors includes both retail AUM as well as any
institutional AUM also held at these advisers.
\487\ Estimates are based on IARD system data as of December 31,
2017. The AUM reported here is specifically that of those non-high
net worth clients. Of the 7,600 investment advisers serving retail
investors, 360 may also be dually registered as broker-dealers.
[[Page 21473]]
Table 3--Panel A: Registered Investment Advisers (RIAs) as of December 2017
[Cumulative RIA assets under management (AUM) and accounts]
----------------------------------------------------------------------------------------------------------------
Number of dual- Cumulative
Size of investment adviser (AUM) Number of RIAs registered Cumulative AUM number of
RIAs accounts
----------------------------------------------------------------------------------------------------------------
>$50 billion.................................... 246 15 $48,221 bil. 17,392,968
$1 billion to $50 billion....................... 3,238 115 21,766 bil. 11,560,805
$500 million to $1 billion...................... 1,554 53 1,090 bil. 2,678,084
$100 million to $500 million.................... 5,568 129 1,303 bil. 3,942,639
$10 million to $100 million..................... 1,103 24 59 bil. 198,659
$1 million to $10 million....................... 172 2 1 bil. 5,852
<$1 million..................................... 778 28 .02 bil. 31,291
---------------------------------------------------------------
Total....................................... 12,659 366 72,439 bil. 35,810,298
----------------------------------------------------------------------------------------------------------------
Table 3--Panel B: Retail Registered Investment Advisers (RIAs) as of December 2017
[Cumulative RIA assets under management (AUM) and accounts]
----------------------------------------------------------------------------------------------------------------
Number of
dual- Cumulative
Size of investment adviser (AUM) Number of RIAs registered Cumulative AUM number of
RIAs accounts
----------------------------------------------------------------------------------------------------------------
>$50 billion.................................... 106 15 $22,788 bil. 16,638,548
$1 billion to $50 billion....................... 1,427 114 8,472 bil. 10,822,275
$500 million to $1 billion...................... 934 52 652 bil. 2,602,220
$100 million to $500 million.................... 4,114 126 917 bil. 3,814,900
$10 million to $100 million..................... 711 24 40 bil. 231,663
$1 million to $10 million....................... 98 1 .4 bil. 5,804
<$1 million..................................... 198 29 .02 bil. 31,271
---------------------------------------------------------------
Total....................................... 7,588 361 32,870 bil. 34,146,681
----------------------------------------------------------------------------------------------------------------
As an alternative to registering with the Commission, smaller
investment advisers could register with state regulators.\488\ As of
December 2017, there are 17,635 state registered investment
advisers,\489\ of which 145 are also registered with the Commission. Of
the state-registered investment advisers, 236 are dually registered as
broker-dealers, while 5% (920) report a broker-dealer affiliate. In
aggregate, state-registered investment advisers have approximately $341
billion in AUM. Eighty-two percent of state-registered investment
advisers report that they provide portfolio management services for
individuals and small businesses, compared to just 64% for SEC-
registered investment advisers.
---------------------------------------------------------------------------
\488\ Pursuant to the Dodd-Frank Act, Item 2.A. of Part 1A of
Form ADV requires an investment adviser to register with the SEC if
it (i) is a large adviser that has $100 million or more of
regulatory assets under management (or $90 million or more if an
adviser is filing its most recent annual updating amendment and is
already registered with the SEC); (ii) is a mid-sized adviser that
does not meet the criteria for state registration or is not subject
to examination; (iii) meets the requirements for one or more of the
revised exemptive rules under section 203A discussed below; (iv) is
an adviser (or subadviser) to a registered investment company; (v)
is an adviser to a business development company and has at least $25
million of regulatory assets under management; or (vi) received an
order permitting the adviser to register with the Commission.
Although the statutory threshold is $100 million, the SEC raised the
threshold to $110 million for those investment advisers that do not
already file with the SEC.
\489\ There are 79 investment advisers with latest reported
Regulatory Assets Under Management in excess of $110 million but are
not listed as registered with the SEC. For the purposes of this
rulemaking, these are considered erroneous submissions.
---------------------------------------------------------------------------
Approximately 77% of state-registered investment advisers (13,470)
have some portion of their business dedicated to retail investors,\490\
and in aggregate, these firms have approximately $308 billion in
AUM.\491\ Approximately 12,700 (72%) state-registered advisers serve
616,000 non-high net worth retail clients and have approximately $125
billion in AUM, while over 11,000 (63%) state-registered advisers serve
approximately 194,000 high net worth retail clients with $138 billion
in AUM.\492\
---------------------------------------------------------------------------
\490\ We use the responses to Items 5.D.(a)(1), 5.D.(a)(3),
5.D.(b)(1), and 5.D.(b)(3) of Part 1A. If at least one of these
responses was filled out as greater than 0, the firm is considered
as providing business to retail investors. Form ADV Part 1A.
\491\ The aggregate AUM reported for these investment advisers
that have retail investors includes both retail AUM as well as any
institutional AUM also held at these advisers.
\492\ Estimates are based on IARD system data as of December 31,
2017. The AUM reported here is specifically that of those non-high
net worth investors. Of the 13,471 investment advisers serving
retail investors, 144 may also be dually registered as broker-
dealers.
---------------------------------------------------------------------------
Table 4 details the compensation structures employed by
approximately 12,700 investment advisers. Approximately 95% are
compensated through a fee-based arrangement, where a percentage of
assets under management are remitted to the investment adviser from the
investor for advisory services. As shown in the table below, most
investment advisers rely on a combination of different compensation
types, beyond fee-based compensation, including fixed fees, hourly
charges, and performance based fees. Less than 4% of investment
advisers charge commissions \493\ to their investors.
---------------------------------------------------------------------------
\493\ Some investment advisers report on Item 5.E. of Form ADV
that they receive ``commissions.'' As a form of deferred sales load,
all payments of ongoing sales charges to intermediaries would
constitute transaction-related compensation. Intermediaries
receiving those payments should consider whether they need to
register as broker-dealers under section 15 of the Exchange Act.
[[Page 21474]]
Table 4--Registered Investment Advisers Compensation by Type
------------------------------------------------------------------------
Compensation type Yes No
------------------------------------------------------------------------
A percentage of assets under management. 12,041 617
Hourly charges.......................... 3,670 8,988
Subscription fees (for a newsletter or 119 12,539
periodical)............................
Fixed fees (other than subscription 5,406 7,252
fees)..................................
Commissions............................. 490 12,168
Performance-based fees.................. 4,780 7,878
Other................................... 1,846 10,812
------------------------------------------------------------------------
As discussed above, many investment advisers participate in wrap
fee programs. As of December 31, 2017, more than 5% of the SEC-
registered investment advisers sponsor a wrap fee program and more than
9% act as a portfolio manager for one or more wrap fee programs.\494\
From the data available, we are unable to determine how many advisers
provide advice about investing in wrap fee programs, because advisers
providing such advice may be neither sponsors nor portfolio managers.
---------------------------------------------------------------------------
\494\ A wrap fee program sponsor is as a firm that sponsors,
organizes, or administers the program or selects, or provides advice
to clients regarding the selection of, other investment advisers in
the program. See General Instructions to Form ADV.
---------------------------------------------------------------------------
ii. Disclosures for Investment Advisers
As fiduciaries, investment advisers have a duty to provide full and
fair disclosure of material facts and are subject to express disclosure
requirements in Form ADV.\495\ Consistent with this duty and those
requirements, investment advisers file Form ADV to register with the
Commission or state securities authorities, as applicable, and provide
an annual update to the form.\496\ Part 1 of Form ADV provides
information to regulators, and made available to clients, prospective
clients, and the public, about the registrants' ownership, investors,
and business practices. Advisers also prepare a Form ADV Part 2A
narrative brochure that contains information about the investment
adviser's business practices, fees, conflicts of interest, and
disciplinary information,\497\ in addition to a Part 2B brochure
supplement that includes information about the specific individuals,
acting on behalf of the investment adviser, who actually provide
investment advice and interact with the client.\498\ Currently, the
Part 2A brochure is the primary client-facing disclosure document,\499\
however, Parts 1 and 2A are both made publicly available by the
Commission through IAPD,\500\ and advisers are generally required to
deliver Part 2A and Part 2B to their clients. The current Paperwork
Reduction Act estimate of the average annual cost and hour burden for
investment advisers to complete, amend, and file all parts of Form ADV
are $6,051 and 23.77 hours.\501\
---------------------------------------------------------------------------
\495\ See SEC v. Capital Gains Research Bureau, Inc., 375 U.S.
at 194; see also Brochure Adopting Release, supra note 157. See also
913 Study, supra note 3, at n.92. For example, if an adviser selects
or recommends other advisers to investors, it must disclose any
compensation arrangements or other business relationships between
the advisory firms, along with the conflicts created, and explain
how it addresses these conflicts. See Item 10 of Form ADV Part 2A.
See also 913 Study, supra note 3, at n.93. Other potential conflicts
of interest include acting as a principal in transactions with
investors and compensation received thereof; incentives provided by
third parties to sell their services and products; and agency cross-
trades, where the advisers is also a broker-dealer and executes a
client's order by crossing the orders with those of non-advisory
clients. See Interpretation of Section 206(3) of the Investment
Advisers Act of 1940, Investment Advisers Act Release No. 1732 (Jul.
20, 1998), at n.3.
\496\ See Advisers Act rules 203-1 and 204-1. Part 1A (1B) of
Form ADV is the registration application for the Commission (and
state securities authorities). Part 2 of Form ADV consists of a
narrative ``brochure'' about the adviser and ``brochure
supplements'' about certain advisory personnel on whom clients may
rely for investment advice. See Brochure Adopting Release, supra
note 157.
\497\ Part 2A of Form ADV contains 18 mandatory disclosure items
about the advisory firm, including information about an adviser's:
(1) Range of fees; (2) methods of analysis; (3) investment
strategies and risk of loss; (4) brokerage, including trade
aggregation polices and directed brokerage practices, as well as the
use of soft dollars; (5) review of accounts; (6) client referrals
and other compensation; (7) disciplinary history; and (8) financial
information, among other things. Much of the disclosure in Part 2A
addresses an investment adviser's conflicts of interest with its
investors, and is disclosure that the adviser, as a fiduciary, must
make to investors in some manner regardless of the form
requirements. See Brochure Adopting Release, supra note 157.
\498\ Part 2B, or the ``brochure supplement,'' includes
information about certain advisory personnel that provide retail
client investment advice, and contains educational background,
disciplinary history, and the adviser's supervision of the advisory
activities of its personnel. See Instruction 5 of General
Instructions for Form ADV. Registrants are not required to file Part
2B (brochure supplement) electronically, but must preserve a copy of
the supplement(s) and make them available upon request.
\499\ See Brochure Adopting Release, supra note 157.
\500\ See Investment Adviser Public Disclosure, available at
https://adviserinfo.sec.gov/.
\501\ See infra Section V.A.2.
---------------------------------------------------------------------------
c. Disclosure Obligations for Broker-Dealers and Investment Advisers
Under DOL Rules and Exemptions
As noted, firms and financial professionals providing services to
customers in retirement accounts, including workplace retirement plans
and IRAs, are subject to certain disclosure obligations under rules and
exemptions issued by the DOL under ERISA and the prohibited transaction
provisions of the Code.\502\ For example, DOL regulations under a
statutory exemption for investment advice services provided to plan
participants and IRAs requires firms and financial professionals to
disclose information about the services that they will provide and
their fees and other compensation, and to acknowledge that the adviser
is acting as a fiduciary.\503\
---------------------------------------------------------------------------
\502\ See supra note 11.
\503\ See 29 CFR 2550.408g-1(b)(7). In general, firms and
financial professionals who receive commissions or other
transaction-related compensation in connection with providing
certain fiduciary investment recommendations relating to the assets
of ERISA-covered workplace retirement plans and IRAs could violate
provisions under the Code prohibiting fiduciaries from engaging in
self-dealing and receiving compensation from third parties in
connection with investments by these plans and IRA (and, with
respect to such plans, substantially similar prohibited transaction
rules that apply under ERISA to transactions involving ERISA plans
but not IRAs). To receive such compensation, firms have historically
complied with one or more prohibited transaction exemptions
(``PTEs'') issued by the DOL over time, which generally required
(among other conditions) disclosures about, e.g., direct and
indirect compensation received in connection with a recommended
transactions. See Definition of the Term ``Fiduciary;'' Conflict of
Interest Rule--Retirement Investment Advice, 81 FR 20945, 20991-92
(Apr. 8, 2016) (to be codified at 20 C.F.R. pts. 2509, 2510 and
2550) (``DOL Fiduciary Rule Adopting Release'') (describing action
to adopt new and amended PTEs and revoke certain PTEs applicable to
investment advice services).
---------------------------------------------------------------------------
More recently, the DOL's BIC Exemption would require that firms
seeking to rely on the exemption to receive commissions and other fees
in connection with making investment recommendations to IRAs and
participants of ERISA-covered plans (including advice relating to
rollovers from plans or between account types) \504\
[[Page 21475]]
generally must (among other conditions) provide disclosure about the
services to be performed (including monitoring of recommendations,
offering proprietary products and limiting recommendations) and how the
investor will pay for services, material conflicts of interest
(including third party compensation to the firm, affiliates and
financial professionals), and must also make certain ongoing
disclosures on a public website.\505\ The DOL adopted the BIC Exemption
in connection with the amendment of its regulation defining
``investment advice,'' which had the effect of expanding the
circumstances under which broker-dealers and investment advisers may be
fiduciaries for purposes of the prohibited transaction provisions under
ERISA and the Code (the ``DOL Fiduciary Rule'').\506\ Although a
decision of the Court of Appeals for the Fifth Circuit recently vacated
the DOL Fiduciary Rule,\507\ we understand that many firms already have
taken steps to implement conditions under the BIC Exemption.\508\
---------------------------------------------------------------------------
\504\ See Best Interest Contract Exemption, 81 FR 21002, 21006-7
(Apr. 8, 2016) (``BIC Exemption Release'') Best Interest Contract
Exemption; Correction (Prohibited Transaction Exemption 2016-01), 81
FR 44773 (July 11, 2016) (``Corrected BIC Exemption''), as amended
18-Month Extension of Transition Period and Delay of Applicability
Dates; Best Interest Contract Exemption (PTE 2016-01); Class
Exemption for Principal Transactions in Certain Assets Between
Investment Advice Fiduciaries and Employee Benefit Plans and IRAs
(PTE 2016-02); Prohibited Transaction Exemption 84-24 for Certain
Transactions Involving Insurance Agents and Brokers, Pension
Consultants, Insurance Companies, and Investment Company Principal
Underwriters (PTE 84-24), 82 FR 56545 (Nov. 29, 2017). Depending on
how they are compensated, investment advisers receiving a level fee
may not be subject to the full set of contract, disclosure and other
conditions of the BIC Exemption.
\505\ See Corrected BIC Exemption, supra note, 504, at sections
II and III. Ongoing website disclosure would include information
about certain material conflicts of interest and third party
payments, a schedule of typical fees and service charges, a
description of the compensation and incentive arrangements for
individual financial professionals, and a written description of the
financial institution's policies and procedures. Id., at section
III. In the case of recommendations provided to an IRA, the firm
also would be required to enter into a written contract with the IRA
owner that includes an acknowledgement of fiduciary status and an
enforceable promise to adhere to certain ``impartial conduct
standards'' (including a best interest standard of conduct). Id., at
section II(a).
\506\ See DOL Fiduciary Rule Adopting Release, supra note 503.
\507\ See Chamber of Commerce of the U.S.A., e. al. v. U.S.
Dep't of Labor, et. al., No. 17-10238 (5th Cir. Mar 15, 2018).
\508\ See SIFMA and Deloitte, The DOL Fiduciary Rule: A study on
how financial institutions have responded and the resulting impacts
on retirement investors (Aug. 9, 2017), available at https://www.sifma.org/wp-content/uploads/2017/08/;Deloitte-White-Paper-on-
the-DOL-Fiduciary-Rule-August-2017.pdf.
---------------------------------------------------------------------------
The Commission does not currently have data on the number of firms
that are subject to disclosure obligations under applicable DOL rules
and exemptions.\509\ However, because we understand that most broker-
dealers expected that they would be required to comply with the BIC
Exemption to continue to provide services to retail investors in IRAs
and participant-directed workplace retirement plans,\510\ the
Commission can broadly estimate the maximum number of broker-dealers
that could be subject to disclosure obligations under DOL rules and
exemption including the BIC Exemption from the number of broker-dealers
that have retail investor accounts. Approximately 74.4% (2,857) of
registered broker-dealers report sales to retail customers.\511\
Similarly, approximately 60% (7,600) of investment advisers serve high
net worth and non-high net worth individual clients. The Commission
believes that this number likely overestimates those broker-dealers and
investment advisers that provide retirement account services.
Therefore, these 2,850 broker-dealers and 7,600 investment advisers
that provide retail services represent an upper bound of the number of
broker-dealers and investment advisers that would likely be subject to
compliance with disclosure obligations under DOL rules and exemptions
and may have taken steps to comply with the contract, disclosure and
other conditions under the DOL's BIC Exemption.\512\
---------------------------------------------------------------------------
\509\ In order to obtain this information, the Commission would
need to know which financial firms have retirement-based accounts as
part of their business model. Under the current reporting regime for
both broker-dealers and investment advisers, they are not required
to disclose whether (or what fraction) of their accounts are held by
retail investors in retirement-based accounts.
\510\ See BIC Exemption Release, supra note 504, at 21006-07
(DOL states that it ``anticipates that the [DOL Fiduciary Rule] will
cover many investment professionals who did not previously consider
themselves to be fiduciaries under ERISA or the Code.'').
\511\ As of December 2017, 3,841 broker-dealers filed Form BD.
Retail sales by broker-dealers were obtained from Form BD.
\512\ The DOL's Regulatory Impact Analysis estimated that the
numbers of broker-dealers and investment advisers (including state-
registered investment advisers) that could be affected by their rule
are approximately 2,500 and 17,500, respectively. See Regulatory
Impact Analysis for Final Rule and Exemptions, Definition Of The
Term ``Fiduciary'' Conflicts Of Interest--Retirement Investment
Advice (Apr. 2016), at 215-229, available at https://www.dol.gov/sites/default/files/ebsa/laws-and-regulations/rules-and-regulations/completed-rulemaking/1210-AB32-2/conflict-of-interest-ria.pdf.
---------------------------------------------------------------------------
d. Trends in the Relative Numbers of Providers of Financial Services
Over time, the relative number of broker-dealers and investment
advisers has changed. Figure 1 presented below shows the time series
trend of growth in broker-dealers and investment advisers between 2005
and 2017. Over the last 13 years, the number of broker-dealers has
declined from over 6,000 in 2005 to less than 4,000 in 2017, while the
number of investment advisers has increased from approximately 9,000 in
2005 to over 12,000 in 2017. This change in the relative numbers of
broker-dealers and investment advisers over time likely affects the
competition for advice, and potentially alters the choices available to
investors on how to receive or pay for such advice, the nature of the
advice, and the attendant conflicts of interest.
BILLING CODE 8011-01-P
[[Page 21476]]
[GRAPHIC] [TIFF OMITTED] TP09MY18.002
Increases in the number of investment advisers and decreases in the
number of broker-dealers could have occurred for a number of reasons,
including anticipation of possible regulatory changes to the industry,
other regulatory restrictions, technological innovation (i.e., robo-
advisers and online trading platforms), product proliferation (e.g.,
index mutual funds and exchange-traded products), and industry
consolidation driven by economic and market conditions, particularly
among broker-dealers.\513\ Commission staff has observed the transition
by broker-dealers from traditional brokerage services to also providing
investment advisory services (often under an investment adviser
registration, whether federal or state), and many firms have been more
focused on offering fee-based accounts than accounts that charge
commissions. \514\ Broker-dealers have indicated that the following
factors have contributed to this migration: Provision of stability or
increase in profitability,\515\ perceived lower regulatory burden, and
provisions of more services to retail customers.
---------------------------------------------------------------------------
\513\ See, Hester Peirce, Dwindling numbers in the financial
industry, Brookings Center on Markets and Regulation (May 15, 2017),
available at https://www.brookings.edu/research/dwindling-numbers-in-the-financial-industry/ (``Brookings Report'') which notes that
``SEC restrictions have increased by almost thirty percent [since
2000],'' and that regulations post-2010 were driven in large part by
the Dodd-Frank Act, page 5. Further, the Brookings Report
observation of increased regulatory restrictions on broker-dealers
only reflects CFTC or SEC regulatory actions, but does not include
regulation by FINRA, SROs, NFA, or the MSRB.
\514\ The Brookings Report, supra note 513, also discusses the
shift from broker-dealer to investment advisory business models for
retail investors, in part due to the DOL Fiduciary Rule (page 7).
See also the RAND Study, supra note 5, which documents a shift from
transaction-based to fee-based accounts prior to recent regulatory
changes. Declining transaction-based revenue due to declining
commission rates and competition from discount brokerage firms has
made fee-based products and services more attractive. Although
discount brokerage firms generally provide execution-only services
and do not compete directly in the advice market with full service
broker-dealers and investment advisers, entry by discount brokers
has contributed to lower commission rates throughout the broker-
dealer industry. Further, fee-based activity generates a steady
stream of revenue regardless of the customer trading activity,
unlike commission-based accounts.
\515\ Commission staff examined a sample of recent Form 10-K or
Form 10-Q filings of large broker-dealers, many of which are dually
registered as investment advisers, that have a large fraction of
retail customer accounts to identify relevant broker-dealers. See,
e.g., Edward Jones 9/30/2017 Form 10-Q available at https://www.sec.gov/Archives/edgar/data/815917/000156459017023050/ck0000815917-10q_20170929.htm; Raymond James 9/30/2017 Form 10-K
available at https://www.sec.gov/Archives/edgar/data/720005/000072000517000089/rjf-20170930x10k.htm; Stifle 12/31/2016 Form 10-K
available at https://www.sec.gov/Archives/edgar/data/720672/000156459017022758/sf-10q_20170930.htm; Wells Fargo 9/30/2017 10-Q
available at https://www.sec.gov/Archives/edgar/data/72971/000007297117000466/wfc-09302017x10q.htm; and Ameriprise 12/31/2016
Form 10-K available at https://www.sec.gov/Archives/edgar/data/820027/;000082002717000007/ameriprisefinancial12312016.htm. We note
that discussions in Form 10-K and 10-Q filings of this sample of
broker-dealers here may not be representative of other large broker-
dealers or of small to mid-size broker-dealers. Some firms have
reported record profits as a result of moving clients into fee-based
accounts, and cite that it provides ``stability and high returns.''
See ``Morgan Stanley Wealth Management fees climb to all-time
high,'' Bloomberg, Jan. 18, 2018, available at https://www.bloomberg.com/news/articles/2018-01-18/morgan-stanley-wealth-management-fees-hit-record-on-stock-rally. Morgan Stanley increased
the percentage of client assets in fee-based accounts from 37% in
2013 to 44% in 2017, while decreasing the dependence on transaction-
based revenues from 30% to 19% over the same time period (Morgan
Stanley Strategic Update, (Jan. 18, 2018), available at https://www.morganstanley.com/about-us-ir/shareholder/4q2017-strategic-update.pdf). See also Beilfuss, Lisa & Brian Hershberg, WSJ Wealth
Adviser Briefing: The Reinvention of Morgan and Merrill, Adviser
Profile, The Wall Street Journal (Jan. 25, 2018), available at
https://blogs.wsj.com/moneybeat/2018/01/25/wsj-wealth-adviser-briefing-the-reinvention-of-morgan-and-merrill-adviser-profile/.
---------------------------------------------------------------------------
Further, there has been a substantial increase in the number of
retail clients at investment advisers, both high net worth clients and
non-high net worth clients as shown in Figure 2. Although the number of
non-high net worth retail customers of investment advisers dipped
between 2010 and 2012, since 2012, more than 12 million new non-
[[Page 21477]]
high net worth retail clients have been added. With respect to assets
under management, we observe a similar, albeit more pronounced pattern
for non-high net worth retail clients as shown in Figure 3. For high
net worth retail clients, there has been a pronounced increase in AUM
since 2012, although AUM has leveled off since 2015.
[GRAPHIC] [TIFF OMITTED] TP09MY18.003
BILLING CODE 8011-01-C
e. Registered Representatives of Broker-Dealers, Investment Advisers
and Dually Registered Firms
We estimate the number of associated natural persons of broker-
dealers through data obtained from Form U4, which generally is filed
for individuals who are engaged in the securities or investment banking
business of a broker-dealer that is a member of a self-regulatory
organization (``registered
[[Page 21478]]
representatives'' or ``RR''s). \516\ Similarly, we approximate the
number of supervised persons of registered investment advisers through
the number of registered investment adviser representatives (or
``registered IAR''s), who are supervised persons of investment advisers
who meet the definition of investment adviser representatives in
Advisers Act rule 203A-3 and are registered with one or more state
securities authorities to solicit or communicate with clients.\517\
---------------------------------------------------------------------------
\516\ The number of associated natural persons of broker-dealers
may be different from the number of registered representatives of
broker-dealers, because clerical/ministerial employees of broker-
dealers are associated persons, but are not required to register
with the firm. Therefore, using the registered representative number
does not include such persons. However, we do not have data on the
number of associated natural persons and therefore are not able to
provide an estimate of the number of associated natural persons. We
believe that the number of registered representatives is an
appropriate approximation because they are the individuals at
broker-dealers that provide advice and services to customers.
\517\ See Advisers Act rule 203A-3. However, we note that the
data on numbers of registered IARs may undercount the number of
supervised persons of investment advisers who provide investment
advice to retail investors because not all supervised persons who
provide investment advice to retail investors are required to
register as IARs. For example, Commission rules exempt from IAR
registration supervised persons who provide advice only to non-
individual clients or to individuals that meet the definition of
``qualified client.'' As discussed above, the definition of retail
investor for purposes of this proposed rulemaking would include
qualified clients who are natural persons and trusts that represent
natural persons. Proposed General Instruction 9.(e) to Form CRS. In
addition, state securities authorities may impose different criteria
for requiring registration as an investment adviser representative.
---------------------------------------------------------------------------
We estimate the number of registered representatives and registered
IARs (together ``registered financial professionals'') at broker-
dealers, investment advisers, and dual registrants by considering only
the employees of those firms that have Series 6 or Series 7 licenses or
are registered with a state as a broker-dealer agent or investment
adviser representative.\518\ We only consider employees at firms who
have retail-facing business, as defined previously.\519\ We observe in
Table 5, that approximately 61% of registered financial professionals
are employed by dually registered entities. The percentage varies by
the size of the firm. For example, for firms with total assets between
$1 billion and $50 billion, 72% of all registered financial
professionals in that size category are employed by dually registered
firms. Focusing on dually registered firms only, approximately 59.7% of
total licensed representatives at these firms are dual-hatted,
approximately 39.9% are only registered representatives; and less than
one percent are only registered investment adviser representatives.
---------------------------------------------------------------------------
\518\ We calculate these numbers based on Form U4 filings.
Representatives of broker-dealers, investment advisers, and issuers
of securities must file this form when applying to become registered
in appropriate jurisdictions and with self-regulatory organizations.
Firms and representatives have an obligation to amend and update
information as changes occur. Using the examination information
contained in the form, we consider an employee a financial
professional if he has an approved, pending, or temporary
registration status for either Series 6 or 7 (RR) or is registered
as an investment adviser representative in any state or U.S.
territory (IAR). We limit the firms to only those that do business
with retail investors, and only to licenses specifically required to
be licensed as an RR or IAR.
\519\ See supra notes 460 and 485.
\520\ The classification of firms as dually registered,
standalone broker-dealers, and standalone investment advisers comes
from Forms BD, FOCUS, and ADV as described earlier. The number of
representatives at each firm is obtained from Form U4 filings. Note
that all percentages in the table have been rounded to the nearest
whole percentage point.
Table 5--Total Licensed Representatives at Broker-Dealers, Investment Advisers, and Dually Registered Firms With
Retail Investors \520\
----------------------------------------------------------------------------------------------------------------
% of
Size of firm (total assets for standalone representatives % of %
BDs and dually registered firms; AUM for Total number of in dually representatives representatives
standalone IAs) representatives registered in standalone in standalone
firms BD IA
----------------------------------------------------------------------------------------------------------------
>$50 billion................................ 82,668 75 8 18
$1 billion to $50 billion................... 150,662 72 10 18
$500 million to $1 billion.................. 31,673 67 16 16
$100 million to $500 million................ 62,539 58 24 18
$10 million to $100 million................. 116,047 52 47 1
$1 million to $10 million................... 37,247 34 63 2
<$1 million................................. 13,563 7 87 6
-------------------------------------------------------------------
Total Licensed Representatives.......... 494,399 61 27 12
----------------------------------------------------------------------------------------------------------------
In Table 6 below, we estimate the number of employees who are
registered representatives, registered investment adviser
representatives, or both (``dual-hatted representatives'').\521\
Similar to Table 5, we calculate these numbers using Form U4 filings.
Here, we also limit the sample to employees at firms that have retail-
facing businesses as discussed previously.\522\
---------------------------------------------------------------------------
\521\ We calculate these numbers based on Form U4 filings.
\522\ See supra notes 460 and 485.
---------------------------------------------------------------------------
---------------------------------------------------------------------------
\523\ Firm size is defined as total assets from the balance
sheet (source: FOCUS reports) for broker-dealers and dual
registrants and is assets under management for investment advisers
(source: Form ADV).
---------------------------------------------------------------------------
In Table 6, approximately 24% of registered employees at registered
broker-dealers or investment advisers are dual-hatted representatives.
However, this proportion varies significantly across size categories.
For example, for firms with total assets between $1 billion and $50
billion,\523\ approximately 36% of all registered employees are both
registered representatives and investment adviser representatives. In
contrast, for firms with total assets below $1 million, 15% of all
employees are dual-hatted representatives.
[[Page 21479]]
Table 6--Number of Employees at Retail Facing Firms Who Are Registered Representatives, Investment Adviser
Representatives, or Both \524\
----------------------------------------------------------------------------------------------------------------
Size of firm (total assets for standalone Percentage of
BDs and dually registered firms; AUM for Total number dual-hatted Percentage of Percentages of
standalone IAs) of employees representatives RRs only IARs only
----------------------------------------------------------------------------------------------------------------
>$50 billion................................ 216,655 18 17 1
$1 billion to $50 billion................... 292,663 36 11 3
$500 million to $1 billion.................. 50,531 15 40 6
$100 million to $500 million................ 112,119 23 24 8
$10 million to $100 million................. 189,318 19 41 1
$1 million to $10 million................... 61,310 19 39 1
<$1 million................................. 19,619 15 46 3
-------------------------------------------------------------------
Total Employees at Retail Facing Firms.. 942,215 24 24 3
----------------------------------------------------------------------------------------------------------------
Approximately 88% of investment adviser representatives are dual-
hatted as registered representatives. This percentage is relatively
unchanged from 2010. According to information provided in a FINRA
comment letter in connection with the 913 Study, 87.6% of registered
investment adviser representatives were dually registered as registered
representatives as of mid-October 2010.\525\ In contrast, approximately
50% of registered representatives were dually registered as investment
adviser representatives at the end of 2017.\526\
---------------------------------------------------------------------------
\524\ See supra notes 520-521. Note that all percentages in the
table have been rounded to the nearest whole percentage point.
\525\ Comment letter of FINRA to File Number 4-606; Obligations
of Brokers, Dealers and Investment Advisers (Nov. 3, 2010), at 1,
available at https://www.sec.gov/comments/4-606/4606-2836.pdf.
\526\ In order to obtain the percentage of IARs that are dually
registered as registered representatives of broker-dealers, we sum
the representatives at dually-registered entities and those at
investment advisers, across size categories to obtain the aggregate
number of representatives in each of the two categories. We then
divide the aggregate dually-registered representatives by the sum of
the dually-registered representatives and the IARs at investment
adviser-only firms. We perform a similar calculation to obtain the
percentage of registered representatives of broker-dealers that are
dually registered as IARs.
---------------------------------------------------------------------------
With respect to disclosure made about licensed individuals, broker-
dealers and investment advisers must report certain criminal,
regulatory, and civil actions and complaint information and information
about certain financial matters in Forms U4 \527\ and U5 \528\ for
their representatives. Self-regulatory organizations, regulators and
jurisdictions report disclosure events on Form U6.\529\ FINRA's
BrokerCheck system discloses to the public certain information on
registered representatives and investment adviser representatives such
as principal place of business, business activities, owners, and
criminal prosecutions, regulatory actions, and civil actions in
connection with any investment-related activity.
---------------------------------------------------------------------------
\527\ Form U4 requires disclosure of registered representatives'
and investment adviser representatives' criminal, regulatory, and
civil actions similar to those reported on Form BD or Form ADV as
well as certain customer-initiated complaints, arbitration, and
civil litigation cases. See generally Form U4.
\528\ Form U5 requires information about representatives'
termination from their employers.
\529\ See FINRA, Current Uniform Registration Forms for
Electronic Filing in Web CRD, available at http://www.finra.org/industry/web-crd/current-uniform-registration-forms-electronic-filing-web-crd.
---------------------------------------------------------------------------
f. Current Use of Names and Titles
Although many financial services firms are registered as broker-
dealers, investment advisers, or are dually registered, both firms and
financial professionals use a variety of terms to label both the firm
and the professional. Approximately 103 broker-dealers that are not
dually registered as investment advisers use the term ``adviser,''
``advisor,'' or ``advisory'' as part of their current company
name.\530\ Of these broker-dealers, 16 reported at least one type of
non-securities business. Approximately 39 percent of the 103 broker-
dealers described above used a proper name coupled with the term
``advisor'' alone,\531\ and an additional 31 percent used a proper name
coupled with the term ``capital advisor.'' In addition to those terms,
less than 10% of these broker-dealers use the terms ``financial
advisor,'' ``investment advisor,'' or ``wealth advisor'' in their
corporate name. The remainder of the broker-dealers (approximately 25
firms) use unique combinations of other words along with ``adviser,''
``advisor'' or ``advisory.''
---------------------------------------------------------------------------
\530\ Source: Form BD.
\531\ E.g. ``ABC Advisor.''
---------------------------------------------------------------------------
In addition to company names or professional titles, firms are
likely to use labels or terms other than their formal company names to
describe themselves in corporate descriptions, marketing material, or
other communications with the public. To gauge the extent that
registered broker-dealers and investment advisers use terms other than
their registration status as descriptors, Commission staff conducted an
analysis to evaluate the different terms that broker-dealer, investment
adviser, and dually-registered firms use to describe themselves.\532\
Commission staff reviewed firm websites to collect the terms that were
used on the website to describe the firm.\533\ Many firms provided
multiple descriptions of their businesses.\534\
---------------------------------------------------------------------------
\532\ From the full sample of broker-dealers with retail
investors (2,857) and investment advisers with retail investors
(7,600), the Commission staff used a random number generator to
select 20 firms in each of the size categories listed in Table 7,
from which to construct a sample of firms for which staff hand-
collected data on firm descriptions from firm website homepages and
``About'' pages, as available. When a size category contained less
than 20 firms we sampled all firms in that category. Relative to the
overall proportion of firms, we oversampled firms from the larger
size categories because they employ a majority of all licensed
representatives and are therefore the firms the average retail
investor is most likely to come in contact with. Overall, 83
randomly selected standalone broker-dealers, 100 randomly selected
investment advisers, and 91 randomly selected dual registrants based
on the previously identified size categories (either total assets
for broker-dealers and dual registrants or assets under management
for investment advisers) provided the sample reviewed in the staff
study. Further, the 917 Financial Literacy Study (see supra note 20)
showed that a substantial percentage of retail investors use
information obtained from firm websites in making the selection of
their financial professional.
\533\ See Table 7, Panel A for firm level identifiers for
broker-dealers, Panel B for identifiers for investment advisers, and
Panel C for dual registrants. Not all firms provided a description
of their firm on their website, which we coded as ``N/A'' for not
available.
\534\ For purposes of our classification analysis, if ``ABC &
Co.'' were to be a SEC-registered standalone broker-dealer and, on
ABC's webpage in describing its business and operations, ABC refers
to itself as a brokerage firm and a wealth manager, we would
classify, ABC & Co. as using both ``brokerage'' and ``wealth
manager'' as descriptors in our analysis.
---------------------------------------------------------------------------
As shown below in Panel A of Table 7, over 50% of broker-dealers
sampled use the term ``broker,'' ``dealer,'' ``broker-dealer,'' or
``brokerage'' to
[[Page 21480]]
describe their business, while less than 10% use ``financial advisor,''
``wealth advisor,'' or ``investment advisor.'' Registered investment
advisers (Panel B) are more likely to use the term ``investment
advisor,'' ``wealth advisor,'' or ``financial advisor'' as a
description of their business compared to broker-dealers (approximately
40%). Nearly 50% of the sampled standalone investment advisers use the
term ``investment manager'' or ``wealth manager'' to describe their
business model compared to less than 10% of broker-dealers that use
these terms. Dually registered firms (Panel C) are much more diverse in
their use of firm descriptions; approximately 40% use the term
``brokerage,'' ``broker-dealer,'' ``broker,'' or ``dealer,'' while
nearly 30% use a firm description that contains the term ``adviser'' or
``advisor.''
---------------------------------------------------------------------------
\535\ Broker-dealers are randomly drawn from Form BD data (as of
Dec. 2017). The data on firm descriptions is hand collected from
individual broker-dealer websites.
\536\ Investment advisers are randomly drawn from Form ADV data
(as of Dec. 2017). The data on firm descriptions is hand collected
from individual investment adviser websites.
\537\ Dual registrants are randomly drawn from Form BD data (as
of Dec. 2017). The data on firm descriptions is hand collected from
individual dually-registered firms' websites.
Table 7--Panel A: Description of Standalone Broker-Dealer Firms on Firm Websites \535\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Wealth/
Broker- dealer Investment investment Advisory Other N/A
bank management
--------------------------------------------------------------------------------------------------------------------------------------------------------
>$50 billion............................................ 2 2 0 2 0 0
$1 billion to $50 billion............................... 15 6 0 0 0 1
$500 million to $1 billion.............................. 14 2 0 0 1 0
$100 million to $500 million............................ 12 7 4 2 4 0
$10 million to $100 million............................. 11 2 5 3 4 0
-----------------------------------------------------------------------------------------------
Total............................................... 54 19 9 7 9 1
--------------------------------------------------------------------------------------------------------------------------------------------------------
Table 7--Panel B: Description of Standalone Investment Adviser Firms on Firm Website \536\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Wealth/
Broker- dealer Investment investment Advisory Other N/A
bank management
--------------------------------------------------------------------------------------------------------------------------------------------------------
>$50 billion............................................ 0 1 16 3 4 0
$1 billion to $50 billion............................... 0 0 13 5 8 0
$500 million to $1 billion.............................. 0 0 10 13 9 0
$100 million to $500 million............................ 0 0 6 7 9 3
$10 million to $100 million............................. 2 0 2 10 7 1
-----------------------------------------------------------------------------------------------
Total............................................... 2 1 47 38 37 4
--------------------------------------------------------------------------------------------------------------------------------------------------------
Table 7--Panel C: Description of Dually-Registered Firms on Firm Website \537\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Wealth/
Broker- dealer Investment investment Advisory Other N/A
bank management
--------------------------------------------------------------------------------------------------------------------------------------------------------
>$50 billion............................................ 5 8 2 4 1 0
$1 billion to $50 billion............................... 7 8 5 6 9 0
$500 million to $1 billion.............................. 3 1 2 1 2 0
$100 million to $500 million............................ 13 3 1 7 6 0
$10 million to $100 million............................. 10 1 3 10 7 0
-----------------------------------------------------------------------------------------------
Total............................................... 38 21 13 28 25 0
--------------------------------------------------------------------------------------------------------------------------------------------------------
Regarding the use of titles by individual financial professionals,
a 2008 RAND Study,\538\ found that households responding to the survey
\539\ reported a wide variety of titles were used by financial
professionals with whom they worked. The RAND Study Table 6.3
(replicated below in Table 8) provides an overview of the most commonly
used titles by services provided. As shown in the table, financial
professionals providing brokerage services use a large variety of
titles to describe their business and the services that they offer,
including ``financial advisor,'' ``financial consultant,'' ``banker,''
and ``broker.'' Around 31% of professionals providing only brokerage
services used titles containing the terms ``adviser'' or ``advisor.''
Professionals providing advisory services or both brokerage and
advisory services similarly also use a wide variety of titles, but the
proportion of professionals who use titles containing the terms
``adviser'' or ``advisor'' are somewhat larger at 35%. Note that the
RAND Study did not distinguish financial professionals' use of tiles
based on whether they were RRs or IARs, but rather by type of services
provided.
---------------------------------------------------------------------------
\538\ RAND Study, supra note 5.
\539\ Internet survey administered to members of the American
Life Panel; 654 (out of 1000) households completed the survey.
[[Page 21481]]
Table 8--Replication of Table 6.3 of the RAND Study--Professional Titles Most Commonly Reported by Respondents
--------------------------------------------------------------------------------------------------------------------------------------------------------
Provide Provide Provide both
Title All individual advisory brokerage types of
professionals services only services only services
----------------------------------------------------------------------------------------------------------------------------
Advisor..................................................... 11 1 1 9
Banker...................................................... 21 2 8 11
Broker, stockbroker, or registered representative........... 38 0 8 30
CFP (Certified Financial Planner)........................... 21 3 3 15
Financial adviser or financial advisor...................... 78 7 11 60
Financial consultant........................................ 25 2 0 23
Financial planner........................................... 44 6 1 37
Investment adviser or investment advisor.................... 22 3 3 16
President or vice president................................. 20 0 2 18
--------------------------------------------------------------------------------------------------------------------------------------------------------
2. Investor Account Statistics
Investors seek financial advice and services to achieve a number of
different goals, such as saving for retirement or children's college
education. As shown above in Figures 2 and 3, the number of retail
investors and their assets under management associated with investment
advisers has increased significantly, particularly since 2012. As of
December 2016, nearly $24.2 trillion is invested in retirement
accounts, of which $7.5 trillion is in IRAs.\540\ In 2016, a total of
43.3 million U.S. households have either an IRA or a brokerage account,
of which an estimated 20.2 million U.S. households have a brokerage
account and 37.7 million households have an IRA (including 72% of
households that also hold a brokerage account).\541\ Table 9 below
provides an overview of account ownership segmented by account type
(e.g., IRA, brokerage, or both) and investor income category based on
the Survey of Consumer Finances (SCF).\542\
---------------------------------------------------------------------------
\540\ See ICI Research Perspective, The Role of IRAs in U.S.
Households' Saving for Retirement, 2016 (Jan. 2017), available at
https://www.ici.org/pdf/per23-01.pdf.
\541\ The data is obtained from the Federal Reserve System's
2016 Survey of Consumer Finances (``SCF''), a triennial survey of
approximately 6,200 U.S. households and imputes weights to
extrapolate the results to the entire U.S. population. As noted,
some survey respondent households have both a brokerage and an IRA.
Federal Reserve, Survey of Consumer Finances (2016), available at
https://www.federalreserve.gov/econres/scfindex.htm. The SCF data
does not directly examine the incidence of households that could use
advisory accounts instead of brokerage accounts; however, some
fraction of IRA accounts reported in the survey could be those held
at investment advisers.
\542\ Id. To the extent that investors have IRA accounts at
banks that are not also registered as broker-dealers, our data may
overestimate the numbers of IRA accounts held by retail investors
that could be subject to this proposed rulemaking.
Table 9--Ownership by Account Type in the U.S. by Income Group
[As reported by the 2016 SCF]
----------------------------------------------------------------------------------------------------------------
% Both
Income category % Brokerage % IRA only brokerage and
only IRA
----------------------------------------------------------------------------------------------------------------
Bottom 25%...................................................... 1.2 7.6 2.4
25%-50%......................................................... 3.2 14.5 5.4
50%-75%......................................................... 4.1 21.4 11.4
75%-90%......................................................... 7.5 33.4 16.5
Top 10%......................................................... 12.0 24.7 43.9
Average......................................................... 4.4 18.3 11.6
----------------------------------------------------------------------------------------------------------------
One question in the SCF asks what sources of information
households' financial decision-makers use when making decisions about
savings and investments. Respondents can list up to fifteen possible
sources from a preset list that includes ``Broker'' or ``Financial
Planner'' as well as ``Banker,'' ``Lawyer,'' ``Accountant,'' and a list
of non-professional sources.\543\ Panel A of Table 10 below presents
the breakdown of where households who have brokerage accounts seek
advice about savings and investments. The table shows that of those
respondents with brokerage accounts, 23% (4.7 million households) used
advice services of broker-dealers for savings and investment decisions,
while 49% (7.8 million households) took advice from a ``financial
planner.'' Approximately 36% (7.2 million households) sought advice
from other sources such as bankers, accountants, and lawyers. Almost
25% (5.0 million households) did not use advice from the above sources.
---------------------------------------------------------------------------
\543\ The SCF specifically asks participants ``Do you get advice
from a friend, relative, lawyer, accountant, banker, broker, or
financial planner? Or do you do something else?'' (see Federal
Reserve, Codebook for 2016 Survey of Consumer Finances (2016),
available at https://www.federalreserve.gov/econres/files/codebk2016.txt). Other response choices presented by the survey
included ``Calling Around,'' ``Magazines,'' ``Self,'' ``Past
Experience,'' ``Telemarketer,'' and ``Insurance Agent,'' as well as
other choices. Respondents could also choose ``Do Not Save/Invest.''
The SCF allows for multiple responses, so these categories are not
mutually exclusive. However, we would note that the list of terms in
the question did not specifically include ``investment adviser.''
---------------------------------------------------------------------------
Panel B of Table 10 below presents the breakdown of advice received
for households who have an IRA. 15% (5.7 million households) relied on
advice services of their broker-dealers, 48% (18.3 million households)
obtained advice from financial planners. Approximately 41% (15.5
million households) sought advice from bankers, accountants, or
lawyers, while the 25% (9.5 million households) used no advice or
sought advice from other sources.
[[Page 21482]]
Table 10--Panel A: Sources of Advice for Households Who Have a Brokerage Account in the U.S. by Income Group
\544\
----------------------------------------------------------------------------------------------------------------
% Taking
% Taking % Taking advice from % Taking no
Income category advice from advice from lawyers, advice or
brokers financial bankers, or from other
planners accountants sources
----------------------------------------------------------------------------------------------------------------
Bottom 25%...................................... 20.55 53.89 35.64 24.30
25%-50%......................................... 22.98 38.03 43.92 32.36
50%-75%......................................... 20.75 52.00 31.42 23.61
75%-90%......................................... 22.56 48.94 32.25 28.10
Top 10%......................................... 25.29 50.53 38.47 21.06
---------------------------------------------------------------
Average..................................... 23.02 49.02 35.99 24.94
----------------------------------------------------------------------------------------------------------------
Table 10--Panel B: Sources of Advice for Households Who Have an IRA in the U.S. by Income Group \545\
----------------------------------------------------------------------------------------------------------------
% Taking
% Taking % Taking advice from % Taking no
Income category advice from advice from bankers, advice or
brokers financial accountants, from other
planners or lawyers sources
----------------------------------------------------------------------------------------------------------------
Bottom 25%...................................... 12.14 38.30 43.69 31.85
25%-50%......................................... 9.79 43.82 40.67 32.74
50%-75%......................................... 14.93 45.20 41.23 25.23
75%-90%......................................... 14.68 52.14 41.65 24.26
Top 10%......................................... 21.40 55.40 40.03 18.56
---------------------------------------------------------------
Average..................................... 15.25 48.45 41.17 25.28
----------------------------------------------------------------------------------------------------------------
3. Investor Perceptions About Broker-Dealers and Investment Advisers
---------------------------------------------------------------------------
\544\ Id.
\545\ Id.
---------------------------------------------------------------------------
Although many retail investors rely on broker-dealers and
investment advisers to help them achieve financial goals, evidence
indicates that many retail investors do not understand, or are confused
by, among other items, the different standards of conduct applicable to
broker-dealers and investment advisers, and are also confused and
potentially misled by the titles used by firms and financial
professionals. In the subsections below, we review in greater detail
five aspects of investor perceptions with respect to: (1) How investors
search for financial professionals and firms and; (2) the nature of the
relationship with their financial professional (investment adviser or
broker-dealer) and the meaning of company names and professional
titles; (3) the structure and level of fees in the industry; (4) the
existing conflicts of interest; (5) and the disciplinary history of the
financial professional or firm.
g. How Investors Select Financial Firms or Professionals
A number of surveys show that retail investors predominantly find
their current financial firm or financial professional from personal
referrals by family, friends, or colleagues.\546\ For instance, the
RAND Study reported that 46% of survey respondents indicated that they
located a financial professional from personal referral, although this
percentage varied depending on the type of service provided (e.g., only
35% of survey participants used personal referrals for brokerage
services). After personal referrals, RAND survey participants ranked
professional referrals (31%), print advertisements (4%), direct
mailings (3%), online advertisements (2%), and television
advertisements (1%), as their source of locating individual
professionals. The RAND Study separately inquired about locating a
financial firm, which yielded substantially different results from the
selection of the financial professional.\547\ Respondents reported
selecting financial firm (of any type) based on: Referral from family
or friends (29%), professional referral (18%), print advertisement
(11%), online advertisements (8%), television advertisements (6%),
direct mailings (2%), with a general ``other'' category (36%).
---------------------------------------------------------------------------
\546\ See RAND Study, supra at 5; 917 Financial Literacy Study,
supra note 20.
\547\ The Commission notes that only one-third of the survey
respondents that responded to ``method to locate individual
professionals'' also provided information regarding locating the
financial firm.
---------------------------------------------------------------------------
The 917 Financial Literacy Study provides similar responses,
although it allowed survey respondents to identify multiple sources
from which they obtained information that facilitated the selection of
the current financial firm or financial professional.\548\ In the 917
Financial Literacy Study,\549\ 51% of survey participants received a
referral from family, friends, or colleagues. Other sources of
information or referrals came from: referral from another financial
professional (23%), online search (14%), attendance at a financial
professional-hosted investment seminar (13%), advertisement (e.g.,
television or newspaper) (11.5%), other (8%), while approximately 4%
did not know or could not remember how they selected their financial
firm or financial professional. Twenty-five percent of survey
respondents indicated that the ``name or reputation of the financial
firm or financial professional'' affected the selection decision.
---------------------------------------------------------------------------
\548\ See 917 Financial Literacy Study, supra note 20.
\549\ The data used in the 917 Financial Literacy Study comes
from the Siegel & Gale Investor Research Report (Jul. 26, 2012),
available at https://www.sec.gov/news/studies/2012/917-financial-literacy-study-part3.pdf, at 249-250.
---------------------------------------------------------------------------
h. Nature of the Relationship
Comment letters as well as several studies provide us with
information about retail investor confusion about the distinctions
among different types firms and financial professionals. Several
[[Page 21483]]
commenters in response to Chairman Clayton's recent Request for Comment
highlighted investor confusion about whether financial services
providers are subject to the fiduciary duty.\550\ Particularly, some
commenters tied investor confusion about the standard of care
applicable to financial service providers to the names or titles of
such firms and financial professionals.\551\ Similarly, during the
public comment process as part of the 913 Study, commenters indicated
that retail investors did not understand or found confusing the
distinctions between broker-dealers and investment advisers, for
example, in terms of services provided and applicable standards of
care.\552\ Investor advocate groups submitted comments that reiterated
the view that many market participants also believe that financial
professionals should act in investors' best interests.\553\ 913 Study
commenters also expressed beliefs that certain titles used by firms and
financial professionals are confusing to investors.\554\
---------------------------------------------------------------------------
\550\ See, e.g., CFA 2017 Letter; PIABA 2017 Letter; IAA 2017
Letter; Pefin 2017 Letter.
\551\ See Chamber 2017 Letter, at 10; Committee for the
Fiduciary Standard 2017 Letter, at 3; Pefin 2017 Letter, at 9.
\552\ See 913 Study, supra note 3, at section III.A.
\553\ Id. See also AFL-CIO 2017 Letter; AARP 2017 Letter.
\554\ See, e.g., Comment letters on 913 Study, available at
https://www.sec.gov/comments/4-606/4-606.shtml. Comment letter of
Bert Oshiro (Aug. 29, 2010) (``Years ago, I was pretty sure who I
was dealing with based on their titles. . . Today it's a totally
different story. All kinds of products such as securities,
insurance, fee based products, bank accounts, loans, health
insurance, auto/homeowners insurance, etc. are sold by people
calling themselves: Financial advisors; financial consultants;
investment advisors; investment consultants; financial planners;
asset managers; financial services advisors; [and] registered
representatives. . . It has come to the point that I really don't
know who I'm dealing with.''); Comment letter of Larry J. Massung
(Aug. 29, 2010) (``I believe there is considerable confusion within
the general public with the fiduciary duty, responsibilities, and
titles of brokers, dealers and investment advisors''); and Comment
letter of Cecylia Escarcega (Aug. 30, 2010) (``Personally, I find
the titles confusing because the broker, dealer or investment
advisor typically does not tell me what their role is and the scope
of their fiduciary duty to me as an investor'').
---------------------------------------------------------------------------
Further findings of investor confusion about the roles and titles
of financial professionals comes from studies conducted by Siegel &
Gale \555\ in 2004, RAND \556\ in 2008 and CFA in 2010.\557\ The Siegel
& Gale Study found that focus group participants did not understand
that the roles and legal obligations of broker-dealers differed from
investment advisers, and were further confused by different labels or
titles used by advice providers (e.g., financial planner, financial
advisor, financial consultant, broker-dealer, or investment adviser).
More specifically, participants in the Siegel & Gale Study focus groups
believed that brokers executed trades and were focused on ``near-term''
advice, while financial advisors and consultants provided many of the
same services as brokers, but also provided a greater scope of long-
term planning advice (e.g., portfolio allocation). ``Investment
adviser,'' on the other hand, was a term unfamiliar to many
participants, but financial professionals using this label were
perceived to provide similar services to financial advisors and
financial consultants. Financial planners were viewed to provide
services related to insurance and estate planning in addition to
investment advice, and encompassed long-term financial planning
including college, retirement, and other long-term savings and
investment goals. The Siegel & Gale Study focus group participants
assumed that financial advisors/consultants, investment advisers, and
financial planners provided planning services, while brokers, financial
advisors/consultants, and investment advisers provided trade execution
services.\558\ Further, the focus group participants generally did not
understand certain legal terms, such as ``fiduciary.''
---------------------------------------------------------------------------
\555\ The Commission retained Siegel and Gale in 2004 to conduct
the focus group testing in order to determine how investors
distinguish the roles, legal obligations, and compensation
structures between broker-dealers and investment advisers. See
Siegel & Gale Study, supra note 549.
\556\ The RAND Study contained two components: (1) An analysis
of business practices at broker-dealers and investment advisers
based on regulatory filings and interviews with stakeholders
(including members of the broker-dealer and investment adviser
industries); and (2) a survey of 654 households or focus group
testing on household investment behavior and preferences, experience
with financial service providers, and understanding of the different
types of providers. See RAND Study, supra note 5.
\557\ See CFA Survey, supra note 5.
\558\ The Commission notes that the results of the Siegel & Gale
Study relied on a small sample of focus group testing conducted over
a decade ago. While relevant to our understanding of investor
perception about broker-dealers and investment advisers, the results
of the study may not reliably reflect the current views of the
general population of U.S. retail investors.
---------------------------------------------------------------------------
Similarly, the RAND Study generally concluded that investors did
not understand the differences between broker-dealers and investment
advisers and that common job titles contributed to investor
confusion.\559\ Further, participants responded similarly that
investment advisers and brokers are required to act in the client's
best interest. Similar to the Siegel and Gale Study, focus group
participants did not understand the term fiduciary, or how the
fiduciary standard differed from suitability. In addition, the RAND
Study noted that the confusion about titles, services, legal
obligations, and compensation persisted even after a fact sheet on
broker-dealers and investment advisers was provided to
participants.\560\
---------------------------------------------------------------------------
\559\ RAND study participants ``commented that the
interchangeable titles and `we do it all' advertisements [by broker-
dealers] made it difficult to discern broker-dealers from investment
advisers.'' Although the RAND Study indicates that investors are
confused the services provided and the titles used by financial
professionals, more than 70% of participants also answered that they
were ``very satisfied with the service received from the firm,''
that ``they trust the firm acts in their best interest,'' and that
``the firm provides a valuable service.'' These numbers increased to
80% when the length of time spent at a firm was at least 10 years.
The Commission notes that the results of the RAND Study relied on
testing conducted nearly 10 years ago; therefore, the results of the
study may not reliably reflect the current views of the general
population of U.S. retail investors
\560\ See RAND Study, supra note 5, at 111. The fact sheet
provided to RAND Study participants included information on the
definition of broker and investment adviser, including a description
of common job titles, legal duties and typical compensation.
Participants in the RAND Study focus groups indicated that they were
confused over common job titles of broker-dealers and investment
advisers, thought that because brokers are required to be licensed,
investment advisers were not as qualified as brokers, deemed the
term ``suitable'' too vague, and concluded that it would be
difficult to prove whether or not an investment adviser was not
acting in the client's best interest.
---------------------------------------------------------------------------
Similar to the Siegel and Gale Study and the RAND Study, the CFA
Survey concluded that investors do not understand differences between
broker-dealers and investment advisers, or the standards of conduct
that apply to advice or recommendations made by these firms. For
example, approximately 34% of investors surveyed believed that
``offering advice'' was a primary service of broker-dealers.\561\ With
respect to conduct-related questions, 91% of those surveyed believed
that broker-dealers and investment advisers should follow the same
investor protection rules if providing the same sort of advisory
services, while 85% believed that the person providing advice should
put the retail customer's interest ahead of theirs and should disclose
fees and commissions earned or any conflicts of interest that could
affect the advice provided. More than two-thirds believed that a
fiduciary duty is owed to customers by broker-dealers, suggesting a
degree of investor confusion.\562\
---------------------------------------------------------------------------
\561\ See CFA Study, supra note 5.
\562\ In some circumstances, broker-dealers may owe a fiduciary
duty to their customers. For example, there is a body of case law
holding that broker-dealers that exercise discretion or control over
customer assets, or have a relationship of trust and confidence with
their customers, owe customers a fiduciary duty, or the scope of
obligations that attach by virtue of that duty. See, e.g., U.S. v.
Skelly, 442 F.3d 94, 98 (2d Cir. 2006) (fiduciary duty found ``most
commonly'' where ``a broker has discretionary authority over the
customer's account''); United States v. Szur, 289 F.3d 200, 211 (2d
Cir. 2002) (``Although it is true that there `is no general
fiduciary duty inherent in an ordinary broker/customer
relationship,' a relationship of trust and confidence does exist
between a broker and a customer with respect to those matters that
have been entrusted to the broker.'') (citations omitted); Leib v.
Merrill Lynch, Pierce, Fenner & Smith, Inc., 461 F. Supp. 951, 953-
954 (E.D. Mich. 1978), aff'd, 647 F.2d 165 (6th Cir. 1981)
(recognizing that a broker who has de facto control over non-
discretionary account generally owes customer duties of a fiduciary
nature; looking to customer's sophistication, and the degree of
trust and confidence in the relationship, among other things, to
determine duties owed); Arleen W. Hughes, Exchange Act Release No.
4048 (Feb. 18, 1948) (Commission Opinion), aff'd sub nom. Hughes v.
SEC, 174 F.2d 969 (D.C. Cir. 1949) (noting that fiduciary
requirements generally are not imposed upon broker-dealers who
render investment advice as an incident to their brokerage unless
they have placed themselves in a position of trust and confidence,
and finding that Hughes was in a relationship of trust and
confidence with her clients).
---------------------------------------------------------------------------
[[Page 21484]]
i. Fees
The 917 Financial Literacy Study showed that, prior to engaging an
investment adviser,\563\ approximately 76.4% of survey participants
indicated that disclosure of the fees and compensation of investment
advisers was an absolutely essential element to any disclosure.\564\
With respect to how investors prefer information about fees and
compensation to advisers, 23% of respondents preferred a table format
with examples, 21% preferred a bulleted format with examples, 20%
preferred a bulleted format, and 12% preferred a table format.\565\
---------------------------------------------------------------------------
\563\ The 917 Financial Literacy Study, supra note 20, uses the
term financial intermediary when discussing the importance of
certain disclosures of firms or financial professionals.
\564\ See 917 Financial Literacy Study, supra note 20, at 67.
\565\ 23% of respondents also preferred the ``status quo''--
``the way it was presented'' in the example.
---------------------------------------------------------------------------
In 2015, FINRA conducted an ``Investor Survey'' which included
questions about investors' understanding of fees charged for investment
services.\566\ Approximately 70% of survey participants reported that
they thought investment firm (generically referred to as ``adviser'' in
the study) compensation and account fees to be very clear, with less
than 4% stating that they thought compensation to be unclear. Between
54.7% and 57.6% of respondents indicated that they considered account
fees to be ``reasonable,'' while between 0% and 2.3% of respondents
indicated that account fees were not reasonable. Of investors that have
commission-based accounts, approximately 28% believed that commissions
did not affect advice given. Those percentages decline to 15% or less
when asked to consider whether selling incentives and third party
compensation had not affected the advice provided by investment firms.
---------------------------------------------------------------------------
\566\ See FINRA Report on Conflicts of Interest, (Oct. 2013), at
6, available at http://www.finra.org/sites/default/files/Industry/p359971.pdf (``Investor Survey'').
Table 11--Investor Perception of Compensation to Financial Professionals
[As obtained from the 2015 FINRA Investor Survey]
----------------------------------------------------------------------------------------------------------------
Advised:
Unadvised (%) Advised: asset commission-
fee (%) based fee (%)
----------------------------------------------------------------------------------------------------------------
Advisor Compensation Clear?
Very........................................................ NA 70.9 68.5
Somewhat.................................................... NA 27.6 28.0
Not......................................................... NA 1.5 3.5
Account Fees Clear?
Very........................................................ 68.0 70.3 74.7
Somewhat.................................................... 29.0 29.7 23.5
Not......................................................... 2.9 0 1.8
Account Fees Reasonable?
Agree....................................................... 55.6 54.7 57.6
Somewhat Agree.............................................. 42.1 45.3 40.2
Disagree.................................................... 2.3 0 2.2
Commissions Affect Advice?
Great Deal.................................................. 58.3 21.8 29.7
Somewhat.................................................... 32.8 57.8 42.5
Not At All.................................................. 8.9 20.4 27.7
Selling Incentives Affect Advice?
Great Deal.................................................. 66.1 41.9 44.3
Somewhat.................................................... 28.4 43.7 40.6
Not At All.................................................. 5.5 14.4 15.1
Third Party Compensation Affects Advice?
Great Deal.................................................. 68.6 32.8 41.4
Somewhat.................................................... 26.3 56.4 45.3
Not At All.................................................. 5.1 10.8 13.4
----------------------------------------------------------------------------------------------------------------
[[Page 21485]]
Academic evidence also indicates that retail investors exhibit
limited understanding of the fees and commissions of financial
products. Several academic studies show that even when disclosures are
provided to investors, investors experience difficulty in accounting
for and understanding how fees affect their financial choices.\567\
---------------------------------------------------------------------------
\567\ Experimental evidence from the U.S. mutual fund market is
provided by, James J. Choi, David Laibson, & Brigitte C. Madrian,
Why Does the Law of One Price Fail? An Experiment on Index Mutual
Funds Review of Financial Studies 23(4): 1405-1432 (Nov. 14, 2009)
(``Choi Laibson Article'') (finding that experimental subjects fail
to minimize fees among four different actual S&P 500 index funds and
80-90% of the subjects in the study presented with simplified fee
disclosures still failed to select the lowest-priced options among
products with similar characteristics). Field-based evidence from
the payday loans market is provided by, Marianne Bertrand & Adair
Morse, Information Disclosure, Cognitive Biases, and Payday
Borrowing, The Journal of Finance 46(6): 1865-1893 (Nov. 14, 2011).
For a comprehensive survey of the literature see George Loewenstein,
Cass R. Sunstein, & Russell Golman, Disclosure: Psychology Changes
Everything, Annual Review of Economics 6: 391-419 (Aug. 2014)
(``Loewenstein Sunstein Article'').
---------------------------------------------------------------------------
j. Conflicts of Interest
Studies have found that investors consider conflicts of interest to
be an important factor in the market for financial advice. For example,
in the 917 Financial Literacy Study,\568\ approximately 52.1% of survey
participants indicated that an essential component of any disclosure
would be their financial intermediary's conflicts of interest, while
30.7% considered information about conflicts of interest to be
important, but not essential. Investors also were asked to rate their
level of concern about potential conflicts of interest that their
adviser might have. Approximately 36% of the investors expressed
concerns that their adviser might recommend investments in products for
which its affiliate receives a fee or other compensation, while 57%
were concerned that their adviser would recommend investments in
products for which it gets paid by other sources. In addition to
conflicts directly related to compensation practices of financial
professionals, some investors were concerned about conflicts related to
the trading activity of these firms. For example, more than 26% of
participants were concerned that an adviser might buy and sell from its
account at the same time it is recommending securities to investors;
and more than 55% of investors were also concerned about their
adviser's engaging in principal trading.
---------------------------------------------------------------------------
\568\ Section 917 of the Dodd-Frank Act further required the
Commission to conduct a study to identify the level of financial
literacy among retail investors as well as methods and efforts to
increase the financial literacy of investors. See 917 Financial
Literacy Study, supra note 20.
---------------------------------------------------------------------------
Approximately 70% of the participants in the 917 Financial Literacy
Study indicated that they would read disclosures on conflicts of
interest if made available, with 48% requesting additional information
from their adviser, 41% increasing the monitoring of their adviser, and
33% proposing to limit their exposure of specific conflicts. The
majority of investors (70%) also wanted to see specific examples of
conflicts and how those related to the investment advice provided.
Academic research also suggests that information about conflicts of
interest could improve individual decisions.\569\
---------------------------------------------------------------------------
\569\ See S. Sah & G. Loewenstein, Nothing to declare: Mandatory
and voluntary disclosure leads advisors to avoid conflicts of
interest, Psychological Science 25, 575-584 (2014).
---------------------------------------------------------------------------
k. Disciplinary History
Survey evidence indicates that knowledge of a firm's and financial
professional's disciplinary history is among the most important items
for retail investors deciding whether to receive financial services
from a particular firm, according to one study.\570\ Despite this, most
investors do not actively seek disciplinary information for their
advisers and broker-dealers.\571\ A recent FINRA survey, however, found
that only 15% of survey respondents checked their financial
professional's background, although the Commission notes that the study
encompasses a wide group of advisers, such as debt counselors and tax
professionals.\572\ Another FINRA survey found that only 7% of survey
respondents use FINRA's BrokerCheck and approximately 14% of survey
respondents are aware of the Investment Adviser Public Disclosure
(IAPD) website.\573\
---------------------------------------------------------------------------
\570\ See 917 Financial Literacy Study, supra note 20, at nn.
311 and 498 and accompanying text (Approximately 67.5% of the online
survey respondents considered information about an adviser's
disciplinary history to be absolutely essential, and about 20.0%
deemed it important, but not essential, and ``When asked how
important certain factors would be to them if they were to search
for comparative information on investment advisers, the majority of
online survey respondents identified the fees charged and the
adviser's disciplinary history as the most important factors.'').
\571\ For example, the FINRA 2015 Investor Survey finds that
only 24% of investors are aware of Investor.gov; only 16% are aware
of BrokerCheck; only 14% are aware of the IAPD website, and only 7%
have used BrokerCheck. Investor Survey, supra note 566.
\572\ 2009 National Survey Initial Report, supra note 275.
\573\ See Investor Survey, supra note 566.
---------------------------------------------------------------------------
B. Form CRS Relationship Summary
1. Broad Economic Considerations
We are proposing to require broker-dealers, investment advisers,
and firms that are dually registered to deliver a relationship summary
to retail investors.\574\ The economic tradeoffs involved in
disclosures made by financial firms and financial professionals are
complex and affected by a wide range of factors, which we consider in
more detail below. In this section, we discuss the characteristics of
disclosures that may effectively convey information that is useful to
retail investors when they are searching for a financial firm and to
facilitate matching between retail investors' expectations and the
choice of financial firm or financial professional.
---------------------------------------------------------------------------
\574\ See supra Section II.
---------------------------------------------------------------------------
Disclosure requirements provide benefits to participants in
financial markets because disclosing parties may lack private
incentives to voluntarily disclose or standardize relevant
information.\575\ Disclosure can benefit not only investors but also
the disclosing parties,\576\ as well as provide indirect benefits to
financial markets.\577\
---------------------------------------------------------------------------
\575\ See, e.g., Confirmation Requirements and Point of Sale
Disclosure Requirements for Transactions in Certain Mutual Funds and
Other Securities, and Other Confirmation Requirement Amendments, and
Amendments to the Registration Form for Mutual Funds, Exchange Act
Release No. 8358 (Jan. 29, 2004) [69 FR 6437 (Feb. 10, 2004)] (``The
Commission believes that permitting investors to more readily obtain
information about distribution-related costs that have the potential
to reduce their investment returns and to give investors a better
understanding of some of the distribution-related arrangements that
create conflicts of interest for brokers, dealers, municipal
securities dealers, and their associated natural persons. The
disclosure of information about these costs and arrangements can
help investors make better informed investment decisions.''). See
also P. Healy & K. Palepu, Information asymmetry, corporate
disclosure, and the capital markets: A review of the empirical
corporate disclosure literature, Journal of Accounting and Economics
31, 405-440 (2001).
\576\ See, Michael Jensen & William Meckling, Theory of the
firm: Managerial behavior, agency costs, and ownership structure,
Journal of Financial Economics 3, 305-360 (1976); Patel, S. and G.
Dallas, Transparency and disclosure: Overview of methodology and
study results, United States, Standard & Poor's, New York (2002); A.
Ferrell, Mandatory disclosure and stock returns: Evidence from the
over-the-counter market, The Journal of Legal Studies 36, 213-253
(2007). Regarding the effect of corporate disclosures on improved
corporate governance, see, e.g. B. Hermalin & M. Weisbach,
Transparency and corporate governance, NBER Working paper No. W12875
(2007); R. Lambert, C. Leuz, & R. Verrecchia, Accounting
information, disclosure, and the cost of capital, Journal of
Accounting Research 45, 385-420 (2007).
\577\ See L. Holder-Webb, J. Cohen, L. Nath, & D. Wood, A survey
of governance disclosures among U.S. firms, Journal of Business
Ethics 83, 543-563 (2008); Z. Rezaee, Causes, consequences, and
deterrence of financial statement fraud, Critical Perspectives on
Accounting 16, 277-298 (2005).
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[[Page 21486]]
Although the majority of the information proposed for Form CRS may
be publicly available in a number of existing regulatory forms and
platforms, including, for example, Form ADV (and IAPD) or BrokerCheck,
or may be included in disclosures developed to meet disclosure
requirements under DOL regulations or exemptions, such as the BIC
Exemption, the Commission preliminary believes that all retail
investors would benefit from short summary disclosure that focuses on
certain aspects of a firm and its services to retail investors which
could be supplemented by additional disclosure. Like other public-
facing disclosures, the objective of Form CRS would be to provide
relevant and reliable information to investors. The relationship
summary would apply to a broad array of relationships, spanning
different firms as well as both retirement and non-retirement
accounts.\578\ By requiring both investment advisers and broker-dealers
to deliver to existing and prospective retail investors and file a
publicly available concise relationship summary that discusses, in one
place, both types of services and their differences, the proposed rules
for Form CRS would also help retail investors to compare certain
different types of accounts and firms.
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\578\ For comparison, the disclosure conditions under applicable
DOL regulations and exemptions apply only to financial firms and
financial professionals servicing IRAs and ERISA-covered retirement
plans and participants in such plans.
---------------------------------------------------------------------------
Given that most of the information provided by Form CRS would
already have been made available by investment advisers through other
regulatory disclosures, and by some broker-dealers through contracts or
other voluntary disclosures, the focus of this economic analysis is on
the effects of the format and structure of the proposed Form CRS
disclosures. Studies have found that the format and structure of
disclosure may improve (or decrease) investor understanding of the
disclosures being made.\579\
---------------------------------------------------------------------------
\579\ See, Justine S. Hastings & Lydia Tejeda-Ashton, Financial
Literacy, Information, and Demand Elasticity: Survey and
Experimental Evidence from Mexico, NBER Working Paper 14538 (Dec.
2008) (finding that providing fee disclosures to Mexican investors
in peso rather than percentage terms caused financially
inexperienced investors to focus on fees); See, Richard G. Newell &
Juha Siikamaki, Nudging Energy Efficiency Behavior, Resources for
the Future Discussion Paper 13-17 (Jul. 10, 2013) (finds that
providing dollar operating costs in simplified energy efficiency
labeling significantly encouraged consumers to choose higher energy
efficiency appliances, while another related study presents similar
evidence from payday loans).
---------------------------------------------------------------------------
Before elaborating on the characteristics of an effective
disclosure regime, we note that some studies undertaken outside the
market for financial services find that sometimes certain disclosures
may result in unintended consequences. In general, the structure of the
disclosure may affect the choices that investors make. Every disclosed
item not only presents a piece of new information to retail investors
but also provides a frame within which all other items are
evaluated.\580\ This framing effect could lead investors to draw
different conclusions depending on how information is presented. For
example, if the disciplinary history information is presented first, it
could affect the way investors perceive all subsequent disclosures in
the relationship summary and, possibly, discount more heavily the
information provided by firms with disciplinary events than by firms
with clean record. The effect of the disciplinary history information
would be moderated if this information is provided at the end of the
relationship summary.
---------------------------------------------------------------------------
\580\ See Tversky, A., Kahneman, D., 1981. The framing of
decisions and the psychology of choice. Science 211, 453-458
(``Tversky Kahneman Article'').
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Existing research has also found that conflict of interest
disclosures can increase the likelihood that the disclosing party would
act on the conflict of interest.\581\ This bias can be caused by
``moral licensing,'' a belief that the disclosing party has already
fulfilled its moral obligations in the relationship and therefore can
act in any way, or it can be caused by ``strategic biasing,'' aimed at
compensating the disclosing party for the anticipated loss of profit
due to the disclosure.\582\ Experimental evidence also suggests that
disclosure could turn some clients or customers into ``reluctant
altruists.'' \583\ For example, if financial professionals disclose
that they earn a referral fee if a customer enrolls in a program, the
customer may implicitly feel that they are being asked to help their
financial professional receive the fee. One study also found evidence
that disclosure of a professional's financial interests (particularly
in face-to-face interactions) can induce a panhandler effect, whereby
customers may face an implicit social pressure to meet the
professional's financial interests.\584\ The above literature indicates
that conflicts of interest disclosures could undermine the intended
benefits of the disclosures for investors if investors become reluctant
altruists or feel an obligation to succumb to the panhandler effect.
However, these studies also suggest certain factors that may mitigate
the unintended consequences. For example, in the case of the
``panhandler effect,'' researchers have found that distancing the
client or customer from the financial professional either in the
decision or disclosure phase can dampen this effect.\585\
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\581\ See, Daylian Cain, George Loewenstein & Don Moore, The
Dirt on Coming Clean: Perverse Effects of Disclosing Conflicts of
Interest, Journal of Legal Studies 34: 1-25 (Jan. 2005) (``Cain 2005
Article''); Daylian Cain, George Loewenstein & Don Moore, When
Sunlight Fails to Disinfect: Understanding the Perverse Effects of
Disclosing Conflicts of Interest, Journal of Consumer Research 37:
1-45 (Aug. 27, 2010); Bryan Church & Xi Kuang, Conflicts of
Disclosure and (Costly) Sanctions: Experimental Evidence, Journal of
Legal Studies 38 2: 505-532 (Jun. 2009); Christopher Tarver
Robertson, Biased Advice, Emory Law Journal 60: 653-703 (Feb. 17,
2011). These papers study conflicts of interest in general,
experimental settings, not specialized to the provision of financial
advice.
\582\ Although disclosures in general may cause negative
unintended consequences, existing rules and regulations for broker-
dealers and investment advisers, as well as proposed Regulation Best
Interest, are likely to moderate the effects of moral licensing or
strategic bias for financial professionals.
\583\ See J. Dana, D. Cain & R. Dawes, What you don't know won't
hurt me: Costly (but quiet) exit in dictator games, Organizational
Behavior and Human Decision Processes 100:193-201 (2006).
\584\ Daylian Cain, George Loewenstein & Don Moore, The burden
of disclosure: Increased compliance with distrusted advice, Journal
of Personality and Social Psychology, 104(2): 289-304 (2013)
(``Burden of Disclosure Article'').
\585\ See id.
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Academic research has identified a set of characteristics,
including targeted and simple disclosures, salience, and
standardization, that may increase the effectiveness of a disclosure
regime. Adhering to these characteristics is expected to increase the
benefits of a disclosure document to consumers. These characteristics,
discussed below, frame our analysis of the economic impacts of the
proposed rule.\586\
---------------------------------------------------------------------------
\586\ See Loewenstein Sunstein Article, supra note 567. The
paper provides a comprehensive survey of the literature relevant to
disclosure regulation.
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First, existing research demonstrates that individuals exhibit
limited ability to absorb and process information.\587\ These cognitive
limitations suggest that more targeted and simpler disclosures may be
more effective in communicating information to investors than more
complex disclosures. As discussed more thoroughly below, costs, such as
increased investor confusion or reduced understanding of the key
elements of the disclosure, are likely to
[[Page 21487]]
increase as disclosure documents become longer, more convoluted, or
more reliant on narratives.\588\ Moreover, empirical evidence suggests
that simplification benefits consumers of disclosed information.\589\
These results appear to support requirements of simple disclosures,
which provide benefits to consumers of that information.
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\587\ See Nisbett RE & Ross L. Human Inference: Strategies and
Shortcomings of Social Judgment (1980). Englewood Cliffs, NJ:
Prentice Hall. David Hirshleifer & Siew Hong Teoh, Limited
attention, information disclosure, and financial reporting, Journal
of Accounting and Economics 36, 337-386 (Dec. 2003).
\588\ See, e.g., S.B. Bonsall IV & B.P. Miller, The Impact of
Narrative Disclosure Readability on Bond Ratings and the Cost of
Capital, The Review of Accounting Studies 2 (2017) and A. Lawrence,
Individual Investors and Financial Disclosure, Journal of Accounting
& Economics 56, 130-47 (2013).
\589\ See supra notes 35, 46--48 and accompanying text. See also
S. Agarwal, S. Chomsisengphet, N. Mahoney & J. Stroebel, Regulating
consumer financial products: evidence from credit cards, NBER
Working Paper 19484 (Jun. 2014) (finding that a series of
requirements in the Credit Card Accountability Responsibility and
Disclosure Act (CARD Act), including several provisions designed to
promote simplified disclosure, has produced substantial decreases in
both over-limit fees and late fees, thus saving U.S. credit card
users $12.6 billion annually).
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A second characteristic of an effective disclosure is salience, or
the tendency to `stand out' or contrast with other information on a
page. Salience detection is a key feature of the human cognition
allowing individuals to focus their limited mental resources on a
subset of the available information and causing them to over-weight
this information in their decision making processes.\590\ Within the
context of disclosures, more salient information, such as information
presented in bold text, would be more effective in attracting attention
than less salient information, such as information presented in a
footnote. There is also empirical evidence that visualization improves
individual perception of information.\591\ For example, one
experimental study shows that tabular reports lead to better decision
making and graphical reports lead to faster decision making (when
people are subject to time constraints).\592\
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\590\ Daniel Kahneman, Thinking, Fast and Slow, New York:
Farrar, Strauss, Giroux (2013). Susan Fiske & Shelley E. Taylor,
Social cognition: From Brains to Culture, SAGE Publications Ltd; 3rd
ed. (2017).
\591\ J. Hattie, Visible learning. A synthesis of over 800 meta-
analyses relating to achievement, Oxon: Routledge (2008)
(``Hattie'').
\592\ I. Benbasat & A.S. Dexter, An Investigation of the
Effectiveness of Color and Graphical Presentation under Varying Time
Constraints, MIS Quarterly 10, 59-83 (Mar. 1986) (``Benbasat &
Dexter'').
---------------------------------------------------------------------------
A third characteristic of effective disclosure is standardization.
People are generally able to make more coherent and rational decisions
when they have comparative information that allows them to assess
relevant trade-offs.\593\ Standardization could be particularly
important for the disclosure of certain quantitative aspects of
financial services, such as the level and structure of fees.
---------------------------------------------------------------------------
\593\ See, e.g., JR Kling, S. Mullainathan, E. Shafir, LC
Vermeulen & MV Wrobel, Comparison friction: experimental evidence
from Medicare drug plans, Quarterly Journal of Economics 127, 199-
235 (2012) (finding that in a randomized field experiment, in which
some senior citizens choosing between Medicare drug plans that were
randomly selected to receive a letter with personalized,
standardized, comparative cost information (``the intervention
group'') while another group (``the comparison group'') received a
general letter referring them to the Medicare website, plan
switching was 28% in the intervention group, but only 17% in the
comparison group, and the intervention caused an average decline in
predicted consumer cost of about $100 a year among letter
recipients); CK Hsee, GF Loewenstein, S. Blount & MH Bazerman,
Preference reversals between joint and separate evaluations of
options: a review and theoretical analysis, Psychological Bulletin
125, 576-590 (Oct. 2006).
---------------------------------------------------------------------------
Finally, personalization may further enhance the effectiveness of
disclosure.\594\ This approach might involve, for example, adjusting
the presentation to take account of the receiver's interests,
expectations, or format preferences or to tailor the information based
on what the receiver already knows in order not to repeat existing
knowledge. Personalization is usually achieved at the expense of
standardization, however, and can be costly to create.
---------------------------------------------------------------------------
\594\ See Loewenstein Sunstein Article, supra note 567.
---------------------------------------------------------------------------
Current reporting and disclosure requirements for broker-dealers
and registered investment advisers including Form BD and Form ADV may
provide detailed information to investors. However, because these
existing reports and disclosures (which serve the purposes for which
they were created) are made in multiple, sometimes lengthy forms, and
made available at different websites or delivery methods, it can be
difficult for investors to grasp the most important features of the
financial services and products they receive. In addition, the
information available to retail investors about broker-dealers on
BrokerCheck does not include the same information that investment
advisers provide in the Form ADV brochure and brochure supplement. The
relatively low financial literacy of many investors also makes it less
likely that they would be able to effectively compile this information
on their own and use it in their decision making. Furthermore, most
financial firms and professionals could lack the incentives and
resources to disclose the main aspects of their business practices to
their customers in the absence of the proposed requirements.
In evaluating the broad economic issues related to disclosure, the
Commission preliminarily believes that all retail investors would
benefit from a short summary that focuses on certain aspects of the
firm and its financial professionals and its services. By requiring
both investment advisers and broker-dealers to provide a concise
relationship summary that discusses both types of services and their
differences, the relationship summary would help all retail investors
to understand these aspects of a particular firm, to compare different
types of accounts, and to compare one firm with other firms. The
relationship summary would also highlight, in one place, the services,
some categories of fees, specified conflicts of interest, and whether
the firm or its financial professionals currently have reportable
disciplinary events.
2. Economic Effects of the Relationship Summary
This section analyzes the anticipated economic effects from the
proposed relationship summary to the directly affected parties: retail
investors, and broker-dealers and investment advisers that offer
brokerage or advisory services to retail investors.\595\
---------------------------------------------------------------------------
\595\ Economic effects of the proposal on the market for
financial services, including on indirectly-affected parties such as
banks or insurers that are not regulated by the SEC, are considered
in the following section.
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a. Retail Investors
As noted above, substantial evidence suggests that retail investors
lack financial literacy and do not understand many basic financial
concepts, such as the implications of investment costs for investment
performance.\596\ This, in turn, supports the notion that a well-
functioning market for financial services may provide benefits to
investors by helping them obtain information and guidance from firms
and financial professionals and thereby make better investment
decisions. At the same time, however, evidence also suggests that
investors do not fully comprehend the nature of the business
relationships and responsibilities in the market which makes them
vulnerable to confusion and being misled by firms and financial
professionals; \597\ it also implies that any improvement of retail
investor understanding of their relationship with
[[Page 21488]]
financial professionals could improve investor's investment decisions.
---------------------------------------------------------------------------
\596\ See 917 Financial Literacy Study, supra note 20.
\597\ See 913 Study, supra note 3, at section III.A.; Siegel &
Gale Study, supra note 550; RAND Study, supra note 5.
---------------------------------------------------------------------------
The content of the proposed relationship summary is intended to
alert retail investors to information that would help them to choose a
firm or a financial professional and prompt retail investors to ask
informed questions. It is also intended to facilitate comparisons
across firms that offer the same or substantially similar services.
Specifically, the relationship summary would provide information on the
relationships and services offered by investment advisers and broker-
dealers, the standards of conduct applicable to those services, certain
categories of fees and costs of the services offered, comparisons of
brokerage and investment advisory services (for standalone broker-
dealers and investment advisers),\598\ conflicts of interest, and some
additional information, including the existence of currently reportable
legal or disciplinary events. The Commission believes that the
information in the relationship summary could help alleviate investor
confusion and would promote effective communication between the firm
and its retail investors and assist investors in making an informed
choice when choosing an investment firm and professional and type of
account to help to ensure they receive services that meet their
preferences and expectations. Although the relationship summary applies
only to broker-dealers and registered investment advisers, its impact
could extend beyond the current and prospective clients of these
institutions and impact a larger set of investors through various
channels such as public filings and website posting. Both the content
and the form of the relationship summary are designed to increase the
likelihood that the disclosed information is consumed easily and
effectively by retail investors. We discuss the potential benefits and
costs of the relationship summary and its components in detail below.
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\598\ For purposes of the relationship summary, we propose to
define a standalone investment adviser as a registered investment
adviser that offers services to retail investors and (i) is not
dually registered as a broker-dealer or (ii) is dually registered as
a broker-dealer but does not offer services to retail investors as a
broker-dealer. We propose to define a standalone broker-dealer as a
registered broker-dealer that offers services to retail investors
and (i) is not dually registered as an investment adviser or (ii) is
dually registered as an investment adviser but does not offer
services to retail investors as an investment adviser. Proposed
General Instruction 9.(f) to Form CRS.
---------------------------------------------------------------------------
i. Structure of the Relationship Summary
The structure of the relationship summary is designed to facilitate
retail investors' absorption of the provided information. The proposed
design intentionally restricts the length of the relationship summary,
whether in electronic or paper format, to four pages on 8\1/2\ x 11
inch paper if converted to PDF format, with a specified font size and
margin requirements. Existing research suggests that shorter
disclosures help investors absorb and process information.\599\ Shorter
disclosure would also facilitate a layered approach to disclosure. The
Commission acknowledges that a limit on overall document length (or
equivalent length for electronic disclosure) may entail limiting the
information provided through the relationship summary. However, based
on the studies described above, we preliminarily believe that limiting
the length of the relationship summary appropriately trades off the
benefits of additional detail against the costs of increased complexity
associated with longer disclosures. Similarly, while the required
standardization across the relationship summary limits the ability of
firms to provide customized information to potential retail investors,
we preliminarily believe these constraints are appropriate to
facilitate comparability.
---------------------------------------------------------------------------
\599\ See supra Section IV.B.1.
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In addition, firms would be required to use short sentences, active
voice, and plain language throughout the relationship summary. Firms
would not be permitted to use legal jargon, highly technical business
terms, or multiple negatives. Existing research also shows that
visualization helps individuals absorb information more
efficiently.\600\ Consistent with this research, firms would be
permitted to use graphical presentations, and dual registrants would be
required in certain aspects, to use tables to simplify and highlight
the information. For example, dual registrants will be required to
provide a side-by-side tabular presentation of all relevant information
provided in the relationship summary.
---------------------------------------------------------------------------
\600\ See commenters' feedback in the Financial Literacy Study,
supra note 20, at iv, xx, 21-22.
---------------------------------------------------------------------------
Moreover, the disclosure would involve a certain degree of
standardization across firms. In particular, firms would be required to
use the same headings, prescribed wording, and present the information
under the headings in the same order. \601\ Additionally, firms would
be prohibited from adding any items to those prescribed by the
Commission and any information other than what the Instructions require
or permit. As discussed above, standardization facilitates comparisons
of content across disclosures.\602\ We believe that allowing only the
required and permitted information would promote standardization of the
information presented to retail investors, and would allow retail
investors to focus on information that we believe is particularly
helpful in deciding among firms. At the same time, we acknowledge that
standardization of disclosures not only limits personalization that may
be valuable to retail investors but also could result in disclosures
that are less precise. Further, all information in the relationship
summary must be true and not misleading. In particular, the
Instructions permit firms to omit or modify any prescribed statement
that is inapplicable to their business or would be misleading to a
reasonable retail investor. In addition, for certain items, firms will
have some flexibility in how they include the required information.
---------------------------------------------------------------------------
\601\ See supra note 593.
\602\ See supra Section IV.B.1.
---------------------------------------------------------------------------
ii. Introduction
The proposed Introduction of the relationship summary would
highlight to retail investors the type of accounts and services the
firm offers to retail investors, and the firm's SEC registration
status. In addition, the introduction would require prescribed wording
stating there are different ways for investors to get help with their
investments, and that they should carefully consider what type of
account and services would be right for them and that there are
suggested questions at the end of the disclosure. An introduction
designed in this manner may benefit retail investors by clarifying that
there are choices available in terms of accounts and services and that
the some services, firms, or financial professionals may be a better
fit than others for the investor. This in turn may trigger a closer
read of the relationship summary and perhaps also additional
information gathering by the investor that could lead to a more
informed choice of financial professional and better fit between the
investor's need and the type of accounts and services they use.
iii. Relationships and Services
In the second section of the relationship summary, firms would
discuss specific information about the nature, scope, and duration of
its relationships and services, including the types of accounts and
services the firm offers, how often it offers investment advice, and
whether the firm monitors
[[Page 21489]]
the account. As noted above, the relationships and services of firms
can differ in nature, scope, and duration. The Commission believes that
a better understanding of the relationships and services could lower
search costs and the risk of mismatch for retail investors, by
facilitating cross-firm comparisons, and make it easier for them to
find a firm and a financial professional that most closely meet their
expectations, depending on how important different types of fee
structures, services, standards of conduct or other information points
are to them.
iv. Obligations to the Retail Investor--Standard of Conduct
The third section of the relationship summary briefly describes in
plain language the firm's legal standard of conduct. As noted above,
studies show that many retail investors are confused about the standard
of conduct that applies to firms and financial professionals,\603\ and
the Commission believes that providing retail investors with a brief
description of legal obligations of firms and professionals could help
alleviate this confusion. Furthermore, to the extent this section makes
the issue of standard of conduct more salient to the investors, it may
encourage additional information gathering by the investors about the
standard of conduct, which could further increase investors'
understanding.
---------------------------------------------------------------------------
\603\ See, e.g., Siegel & Gale Study, supra note 5 and RAND
Study, supra note 5. See also CFA Survey, supra note 5.
---------------------------------------------------------------------------
Investor understanding of the obligations of their firms and
financial professionals with respect to each type of account could help
investors align their expectations with the expected conduct of their
firm or financial professional. For example, depending on their
preferences, some investors might find an advisory account more
appropriate. Other investors could prefer the services and standards of
conduct associated with a brokerage account. Thus, to the extent the
proposed disclosure of obligations in the relationship summary increase
investors understanding in this area, it may improve the match between
investors' preferences and expectations and the type of accounts and
services they select while preserving investor choice.
v. Summary of Fees and Costs
The Commission is also proposing that firms include an overview of
specified types of fees and expenses that retail investors will pay in
connection with their brokerage and investment advisory accounts.\604\
This section would include a description of the principal type of fees
that the firm will charge retail investors as compensation for the
firm's advisory or brokerage services, including whether the firm's
fees vary and are negotiable, and factors that would help a reasonable
retail investor understand the fees that he or she is likely to pay. As
such, the improved disclosure of the categories of fees, including wrap
fees, could help improve retail investor's decision to engage a firm
and a financial professional.
---------------------------------------------------------------------------
\604\ See supra Section II.B.4.
---------------------------------------------------------------------------
vi. Comparisons
The Commission is also proposing to require standalone investment
advisers and standalone broker-dealers to provide comparisons to the
other type of firm. Standalone broker-dealers would include information
about the following: (i) The primary types of fees that investment
advisers charge; (ii) services generally provided by investment
advisers, (iii) advisers' standard of conduct; and (iv) certain
incentives advisers have based on the investment adviser's asset-based
fee structure. For investment advisers, this section would include
parallel categories of information regarding broker-dealers.
The choice between a brokerage account and an advisory account in
part may determine the types of fees and costs and standard of conduct
associated with the account. Retail investors who are provided with
more information would be more likely to match their choice of the type
of account with their expectations; if retail investors do not
understand the differences between of broker-dealers and investment
advisers, they are less likely to be able to match their expectations
for financial services providers with their choices. Thus, the
Commission preliminary believes that having a clear explanation of
differences in the fees, scope of services, standard of conduct, and
incentives that are generally relevant to advisory and brokerage
accounts may help retail investors who are considering one such type of
relationship to compare how their preferences and expectations might be
better met with the other type of relationship.
vii. Conflicts of Interest
The Commission is also proposing that firms summarize their
conflicts of interest related to certain financial incentives.
Specifically, firms would be required to disclose conflicts relating
to: (i) Financial incentives to offer to, or recommend that the retail
investor invest in, certain investments because (a) such products are
issued, sponsored, or managed by the firm or its affiliates, (b) third
parties compensate the firm when it recommends or sells the
investments, or (c) both; (ii) financial incentives to offer to, or to
recommend that the retail investor invest in, certain investments
because the manager or sponsor of those investments or another third
party (such as an intermediary) shares revenue it earns on those
products with the firm; and (iii) the firm buying investments from and
selling investments to a retail investor from the firm's account (i.e.,
principal trading). Including these disclosures prominently, in one
place, at or before the start of a retail investor's relationship with
a firm or financial professional could facilitate retail investors'
understanding of the incentives that may be present throughout the
course of the relationship. Such disclosure of financial incentives
could assist investors in matching their expectations when choosing a
firm or professional and type of account to help to ensure they receive
services that meet their expectations. In addition, to the extent that
the specified conflicts of interest disclosures could draw retail
investors' attention to conflicts, monitoring of firms and financial
professionals by retail investors could be improved.
The first category of conflicts noted above makes the promotion of
own and third party products more salient for retail investors. The
possibility that an investor may request an explanation of a
transaction regarding a recommended investment or strategy, and
associated costs thereof, could serve as an additional disciplinary
device for firms and financial professionals and align better their
interests with the interests of retail investors. Similarly, the
disclosures in the relationship summary about revenue sharing
arrangements may induce retail investors to more carefully pay
attention to investments with such arrangements and request further
information. Principal trading could also make retail investors
vulnerable to transactions that transfer value from their accounts to
the accounts of the firm, and so the disclosure of principal trading
information could draw retail investors' attention to possible
conflicts that could emerge from principal transactions and generate
increased scrutiny of such transactions by investors.
While the Commission preliminarily believes that disclosures of
conflicts of
[[Page 21490]]
interest in the relationship summary could match retail investor
expectations with the choices of firms and financial professionals,
some studies have found that disclosures of conflicts of interest, in
some cases, could undermine the motivations of people to behave
ethically or to take moral license in their actions.\605\ In the
context of providing investment advice, the perception that an investor
has been warned (via the disclosure) of a firm's and financial
professional's potential bias may make them believe that they are less
obligated to provide unbiased advice.\606\ Further, other studies have
suggested that disclosures of conflicts of interest could also make
firms and financial professionals appear more trustworthy and as a
result reduce the incentives for retail investors to examine additional
information more carefully.\607\ The Commission preliminarily believes,
however, that the securities laws and existing rules and regulations
thereunder, such as investment advisers' fiduciary duty,\608\ broker-
dealers' requirements under proposed Regulation Best Interest \609\
standard, as well as under existing self-regulatory organizations'
rules and the Exchange Act,\610\ reduce the risk that broker-dealers
and investment advisers might use the proposed relationship summary to
exploit potential conflicts of interest between themselves and their
retail investors because these regulations may raise the cost of
misconduct.\611\
---------------------------------------------------------------------------
\605\ See Genevi[egrave]ve Helleringer, Trust Me, I Have a
Conflict of Interest! Testing the Efficacy of Disclosure in Retail
Investment Advice, Oxford Legal Studies Research Paper No. 14/2016
(Mar. 2016), available at https://ssrn.com/abstract=2755734; and
Cain 2005 Article, supra note 581. As discussed above, existing and
proposed rules and regulations for broker-dealers and investment
advisers could mitigate the negative unintended consequences of
disclosures of conflicts of interest.
\606\ See supra Section IV.B.1.
\607\ See Burden of Disclosure Article, supra note 584. Further,
this ``panhandler effect'' suggests that in some cases disclosure of
financial professionals' conflicts of interests (particularly in
face-to-face interactions) may create social pressure on retail
investors to meet the financial professionals' interests.
\608\ Under the Advisers Act, an adviser is a fiduciary whose
duty is to serve the best interest of its clients, including an
obligation not to subrogate clients' interest to its own. SEC v.
Capital Gains Research Bureau, Inc., 375 U.S. at 194 (the United
States Supreme Court held that, under section 206 of the Investment
Advisers Act of 1940, advisers have an affirmative obligation of
utmost good faith and full and fair disclosure of all material facts
to their clients, as well as a duty to avoid misleading them).
Section 206 applies to all firms and persons meeting the Advisers
Act's definition of investment adviser, whether registered with the
Commission, a state securities authority, or not at all. See also
Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 17
(1979) (``[T]he Act's legislative history leaves no doubt that
Congress intended to impose enforceable fiduciary obligations.'').
\609\ See Regulation Best Interest Proposal, supra note 24.
Proposed Regulation Best Interest would establish a standard of
conduct for broker-dealers and associated persons of broker-dealers
to act in the best interest of the retail customer at the time at
recommendation is made without placing the financial or other
interest of the broker-dealer or associated person of a broker-
dealer ahead of the interest of the retail customer. The standard of
conduct obligation shall be satisfied if the broker-dealer or
associated person of the broker-dealer discloses at the time of the
recommendation material facts relating to the scope and terms of the
relationship, which may be satisfied in part by the relationship
summary, and all material conflicts associated with the
recommendation. In addition, broker-dealers would be required to
satisfy the Care and Conflicts of Interest Obligations, as discussed
more fully in the Regulation Best Interest Proposal.
\610\ For example, a broker-dealer may recommend a security even
when a conflict of interest is present, but that recommendation must
be suitable. See FINRA Rule 2111. The antifraud provisions of the
federal securities laws and the implied obligation of fair dealing
prohibit a broker-dealer from, among other things, making unsuitable
recommendations and require broker-dealers to investigate an issuer
before recommending the issuer's securities to a customer. See,
e.g., Hanly v. SEC, 415 F.2d 589, 596 (2d Cir. 1969). See also
Municipal Securities Disclosure, Exchange Act Release No. 26100
(Sept. 22, 1988), at n.75. The fair dealing obligation also requires
a broker-dealer to reasonably believe that its securities
recommendations are suitable for its customer in light of the
customer's financial needs, objectives and circumstances (customer-
specific suitability). See Release 8662, supra note 118, at 18
(involving excessive trading and recommendations of speculative
securities without a reasonable basis).
\611\ Consistent with this belief, one study also finds that
regulations and legal sanctions on conflicted advice can mitigate
the effects of moral licensing discussed above. See Bryan Church &
Xi Kuang, Conflicts of Disclosure and (Costly) Sanctions:
Experimental Evidence, Journal of Legal Studies 38 2: 505-532 (Jun.
2009).
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viii. Additional Information
To facilitate the layered disclosure that the relationship summary
provides, we are proposing to require that firms include a separate
section (``Additional Information'') in the relationship summary
outlining where retail investors can find more information about the
firm's legal and disciplinary events, services, fees, and conflicts.
Retail investors may benefit from information on where to find
disclosures of the disciplinary events of firms and financial
professionals. For some retail investors, the disciplinary history of
the firm or the financial professional may affect their choices related
to obtaining investment advice. By providing information on whether the
firm or financial professionals have disciplinary history and where to
obtain more detailed information through layered disclosure may
facilitate retail investors' ability to match their expectations with
their choice of financial service provider. The required disclosure
would succinctly state whether or not the firm or its financial
professionals have legal and disciplinary events, based on whether or
not they or their financial professionals currently disclose or are
currently required to disclose certain legal or disciplinary events to
the Commission, self-regulatory organizations, state securities
regulators or other jurisdictions, as applicable. The Additional
Information section would also highlight where retail investors can
find more information about the disciplinary history of the firm and
its financial professionals on ``Investor.gov.'' While the disclosure
of the existence of disciplinary events does not provide new
information to the market,\612\ this simple disclosure in the
relationship summary, if applicable, could help retail investors more
easily identify firms that have reported disciplinary events for
themselves or their financial professionals and where to find more
information about the events. By including this disclosure, in
combination with the requirement to include a specific question for
retail investors to ask about disciplinary history in the ``Key
Questions to Ask'' section (discussed further below), the relationship
summary would potentially make retail investors more likely to seek out
disciplinary history information to use in their evaluation of firms
and financial professionals and would make them better informed when
they choose a firm and a financial professional. Finally, retail
investors themselves have indicated that they consider disciplinary
information important.\613\
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\612\ See Parts 1 and 2 of Form ADV; Form BD; Form U4.
\613\ See 917 Financial Literacy Study, supra note 20.
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Further, by drawing attention to disciplinary histories of
financial professionals for retail investors, firms could become more
selective in their employment decisions, which could benefit retail
investors by having a potentially more trustworthy pool of financial
professionals to select from when they choose providers of investment
advice, and reduce potential harm to retail investors. As such, the
overall quality of financial advice provided to retail investors could
increase, to the extent that legal and regulatory compliance is
correlated with advice quality.\614\ As a consequence, such disclosures
of disciplinary history could promote retail investor confidence in the
market.
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\614\ See Mark Egan, Gregor Matvos & Amit Seru, The Market for
Financial Adviser Misconduct, Journal of Political Economy (Dec. 14,
2017), available at https://ssrn.com/abstract=2739170.
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One potential cost of the increased salience of the existence of
disciplinary events may be that retail investors could
[[Page 21491]]
be deterred from hiring a firm or financial professional with a
disciplinary record, even if they would be better off to do so, without
further investigating the nature of the disciplinary event.
Alternatively, an investor may also incorrectly assume that a firm that
does not report legal/disciplinary history is a ``better'' or a ``more
compliant'' firm than a firm that does report such history; i.e., the
lack of currently reportable disciplinary history could signify a stamp
of approval for some investors. Therefore, disclosures of the existence
of disciplinary events could have an unintended consequence of keeping
some investors out of the market for financial advice or by selecting
financial professionals that could lead to a mismatch with the
expectations of the retail investor.
This section would also include disclosure of how investors can
contact the firm, the SEC, or FINRA (when applicable) if they have
problems with their investments, investment accounts, or financial
professionals. Highlighting this information may encourage more
outreach by investors when they experience such problems, which may
increase the likelihood of investors seeking resolution of their or the
firm's problems. Further, to the extent investors' awareness of how to
report problems is increased, it may have some incremental disciplining
effect ex ante on financial professionals to the benefit of all retail
investors in this market. For example, if retail investors, once aware
of how to contact the Commission or FINRA are more likely to do so as a
result of the information provided by the relationship summary, firms
and financial professionals may improve standards and implement
policies and procedures aimed at reducing conduct that would warrant
potential outreach to regulators by retail investors.
Finally, this section would state where to find more information
about the firm and its financial professionals. Broker-dealers would be
required to direct retail investors to additional information about
their brokers and services on BrokerCheck, their firm websites (if they
have a website; if not, they would state where retail investors can
find up-to-date information), and the retail investor's account
agreement. Investment advisers likewise would be required to direct
retail investors to additional information in the firm's Form ADV Part
2 brochure and any brochure supplement provided by a financial
professional to the retail investor. If an adviser has a public website
and maintains a current version of its firm brochure on the website,
the firm would be required to provide the website address (if an
adviser does not have a public website or does not maintain its current
brochure on its public website, then the adviser would provide the IAPD
website address). Making these links to websites available could be
important given that low levels of financial literacy could make it
less likely that investors would effectively compile information on
their own to use in decision making.
ix. Key Questions To Ask
The proposed relationship summary is expected to benefit retail
investors either directly, by providing information about the
corresponding firm and financial professional, or indirectly, by
encouraging investors to acquire additional information. The
relationship summary would also include suggested key questions to
encourage retail investors to have conversations with their financial
professionals about how the firm's services, fees, conflicts, and
disciplinary events affect them.
Under the ``Key Questions To Ask'' heading, firms would be required
to include ten questions,\615\ as applicable to their particular
business, to help retail investors to elicit more information
concerning the items discussed in the relationship summary.\616\ Given
that standardization of disclosures limits personalization that may be
valuable to retail investors, the Commission preliminarily believes
that the proposed questions would serve an important purpose in the
relationship summary--namely, to prompt retail investors to ask their
financial professionals for more personalized information.
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\615\ We are proposing to allow firms to modify or omit portions
of any of these questions that are not applicable to their business.
We are also proposing to require a standalone broker-dealer and a
standalone investment adviser, to modify the questions to reflect
the type of account they offer to retail investors (e.g., advisory
or brokerage account). In addition, we are proposing that firms
could include any other frequently asked questions they receive
following these questions. Firms would not, however, be permitted to
exceed fourteen questions in total. See supra Section II.B.8.
\616\ See proposed Item 8 of Form CRS.
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The proposed list of questions in the relationship summary may
alter the actions not only of retail investors but also of firms and
their financial professionals. In anticipation of having to answer
these key questions, firms may find it in their self-interest to train
their staff and develop materials that could help them address the
question in greater detail. Such a voluntary response by firms would
likely benefit investors to the extent the answers given to the
questions may become more informative and more accurate. However, some
firms may develop standardized answers in anticipation of the key
questions that become less informative to the retail investor than a
back and forth conversation.
We believe the proposed set of questions cover a broad range of
issues that are likely to be important to retail investors and provide
benefits, such as a platform from which to begin a dialogue with their
financial professional. However, potential costs may arise for some
retail investors. One such potential cost of the proposed questions is
that they may anchor the attention of retail investors to the list and
reduce the likelihood that they would explore other potential questions
that could be important to them based on their unique
circumstances.\617\ In addition, framing the questions as ``Key
Questions'' could lead some retail investors to believe that any other
questions they may have due to their own particular circumstances may
be of second order importance, even if they may not be.\618\
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\617\ Anchoring is a cognitive bias, whereby receivers of
information strongly rely on the initial information received when
making decisions, and do not sufficiently adjust to new information
received. See, Anderson, Jorgen Vitting, Detecting Anchoring in
Financial Markets, Journal of Behavior Finance 11, 129-133 (2010)
available at https://www.tandfonline.com/doi/abs/10.1080/15427560.2010.483186.
\618\ See, e.g., Tversky Kahneman Article, supra note 580, on
the importance of framing.
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x. Other Benefits and Costs to Investors
As indicated in the 917 Financial Literacy Study, retail investors
consider the proposed disclosures in the relationship summary to be
important pieces of information. With respect to content, disclosure
items identified as absolutely essential for retail investors were:
Adviser's fees (76%), disciplinary history (67%), adviser's conflicts
of interest (53%), and adviser's methodology in providing advice (51%).
Approximately 54% of investors also believe that disclosures that
provided comparative adviser information would be useful. In light of
this evidence, the Commission preliminarily believes the disclosure
would provide valuable information to retail investors and potentially
encourage further information gathering by retail investors that assist
them in making an informed choice of what type of account matches their
preferences and expectations.\619\
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\619\ Although the 917 Financial Literacy Study indicated that
nearly 90% of survey participants believed that certain disclosures
would have been helpful to have in advance of their selection of
their current adviser, under the current proposal, firms may and are
highly encouraged, though not required, to deliver the relationship
summary in advance of the time a retail investor enters into an
advisory contract with an investment adviser or engages the services
of a broker-dealer. Firms would be required to file the relationship
summary with the Commission and the disclosure would be made
available on public websites of broker-dealers and investment
advisers, which indicates that prospective investors could have
access to a given firm's relationship summary in advance of initial
contact with the firm or its financial professionals. In general,
however, the Commission preliminarily anticipates that most
prospective retail investors would receive the relationship summary
at the time that they meet with a financial professional to consider
entering into an agreement or engaging services.
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[[Page 21492]]
By providing specified disclosures in an abbreviated and simplified
format, the proposed relationship summary could also improve the
effectiveness of the communication between investors and investment
advisers or broker-dealers. A more effective communication may enable
retail investors to more quickly reach an understanding of what type of
firm and financial professional or type of account offered by the
broker-dealer or the investment adviser best matches their preferences.
As a result, search costs may be reduced as retail investors may need
to contact fewer broker-dealers or investment advisers and financial
professionals given that they have access to information about those
firms or financial professionals.\620\ The inclusion of key questions
as part of the relationship summary also could serve to reduce search
costs as well as the potential for mismatched expectations borne by
retail investors if such questions foster greater discussion about the
services, costs and fees, and possible conflicts associated with
broker-dealer and investment adviser business models.
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\620\ Insofar as retail customers may also search for other
providers of financial advice, such as insurance companies or banks
and trust companies, the reduction in search costs obtainable from
the relationship summary would be lower.
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The Commission preliminarily believes that the proposed
relationship summary could benefit not only the existing and
prospective customers and clients of broker-dealers and investment
advisers but also the public more broadly. First, recipients of the
relationship summary, to the extent they discuss investing in general,
may discuss the topics covered in the summary with family and friends
and in the process increase the degree of public awareness about the
issues discussed in the disclosure. Second, some prospective retail
investors could access the relationship summary independently through
the company website or the Commission's website.
The proposed relationship summary may also impose some additional
costs on retail investors. As described more fully in the section that
follows, brokers-dealers and investment advisers will bear compliance
costs associated with the production and dissemination of the
relationship summary. As a result of such increased costs, some firms
or financial professionals may transfer retail investors from
potentially lower cost transaction-based accounts to higher cost asset-
based fee advisory accounts, if the firm or the financial professional
is dually registered.
In addition to these compliance burdens which may indirectly be
borne by retail investors, the disclosures themselves may impose
certain indirect costs on retail investors. For example, since the
proposed disclosures in the relationship summary are general and
contain prescribed language in many parts, they could steer retail
investor attention away from some specific and potentially important
characteristics of the business practices of the firm or the financial
professional. This potential cost is likely to be mitigated to the
extent the required Additional Information section employs layered
disclosure and the Key Questions encourage more personalized
information gathering on part of the retail investors.
b. Broker-Dealers and Investment Advisers
The proposed disclosure requirements would impose direct costs on
broker-dealers and investment advisers, including costs associated with
delivery, filing, preparation, and firm-wide implementation of the
relationship summary, as well as training and monitoring for
compliance.\621\
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\621\ See infra Section V.A. for estimates of some of these
compliance costs for purposes of the Paperwork Reduction Act.
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With respect to initial delivery, the relationship summary would
need to be provided to retail investors \622\ in the case of an
investment adviser, before or at the time the firm enters into an
advisory agreement or, in the case of a broker-dealer, before or at the
time the retail investor first engages the firm's services. A dual
registrant should deliver the relationship summary at the earlier of
entering into an investment advisory agreement with the retail investor
or the retail investor engaging the firm's services. Firms would be
permitted to deliver the relationship summary (including updates)
electronically, consistent with prior Commission guidance.\623\ Firms
would also be required to post their relationship summaries on their
websites in a way that is easy for retail investors to find, if they
maintain a public website. Firms that do not maintain a website would
be required to include in their relationship summaries a toll-free
number for investors to call to obtain documents. In addition, firms
would be required to provide a relationship summary to an existing
client or customer who is a retail investor before or at the time a new
account is opened or changes are made to the retail investor's
account(s) that would materially change the nature and scope of the
firm's relationship with the retail investor. Firms also would be
required to implement a one-time delivery of the relationship summary
to all existing retail investors within 30 days after the date the firm
is first required to file its relationship summary with the
Commission.\624\
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\622\ In addition to the firm's delivery requirements, firms
would also file their relationship summary with the Commission, to
be publicly available. See supra Section II.C.1.
\623\ See supra Section II.C.2.
\624\ Currently, investment advisers have approximately 29
million non-high net worth individual clients and 5 million high net
worth individual clients, and the total number of individual clients
of investment advisers has increased by 10 million since 2012.
Therefore, investment advisers would need to deliver relationship
summaries to approximately 35 million existing retail clients, and
on average, would expect approximately 2.5 million new clients per
year. Item 5.D of Form ADV. Although the Commission is unable to
estimate the number of broker-dealer retail customers, we could
assume that the number of relationship summaries for broker-dealer
customers would be at least as many, if not more, than what would
have to be delivered for investment advisers.
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Regardless of the method of delivery (e.g., paper or electronic
delivery) firms would incur costs associated with delivering the
relationship summary to retail investors. Such flexibility in the
method of delivery, while being consistent with Commission guidance,
could increase efficiency by allowing a firm to communicate with retail
investors in the same medium by which it typically communicates other
information. Further, firms could reduce costs by utilizing
technologies to deliver information to retail investors at lower costs
than they may face with paper delivery.\625\ While we recognize that
some firms are likely to use electronic delivery methods, and that
these methods may be lower cost than paper delivery, some firms may
still produce paper versions of the relationship
[[Page 21493]]
summary, particularly if they have some retail investors that prefer
delivery of disclosure in this method, or do not have access to the
Internet, or if firms are delivering the relationship summary in the
same format alongside other deliverables, such as Form ADV or account
statements. Firms would also incur costs of posting the relationship
summary on their websites and filing the summary with the Commission.
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\625\ Firms would be required to create and maintain records of
deliveries of the relationship summary. See supra Section II.E. See
supra Section II.E (discussing recordkeeping requirements relating
to the relationship summary). If choosing electronic delivery, firms
would have compliance costs in providing notice to retail investors
that the relationship summary would be available electronically. See
supra Section II.C.2 (discussing elements of Commission guidance
about electronic delivery of certain documents).
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Beyond costs associated with delivery of the relationship summary
to retail investors, firms would be required to prepare the
relationship summary. The Commission preliminarily believes, however,
that these costs would be limited for several reasons. First, the
relationship summary is concise (limited to four pages in length or the
equivalent length for electronic disclosure), and would contain a
mandated set and sequence of topic areas, with much of the language to
be prescribed, thus limiting the time required to prepare the
disclosure. Second, the relationship summary will be uniform across
retail investors and would not be customized or personalized to
potential investors. Finally, the relationship summary would contain
some standardized elements across investment advisers and broker-
dealers, allowing for potential economies of scale for entities that
may have subsidiaries that would also be required to produce the
disclosure.
Further to the costs of preparing the relationship summary, we
consider the implication of the disclosure requirements attributable to
the DOL rules and exemptions, including the DOL's BIC Exemption, and
the potential effects of those disclosures relative to the relationship
summary for broker-dealers and investment advisers. The conditions of
the DOL rules and exemptions, including the BIC Exemption, discussed
above in the baseline section, are limited to retirement accounts.
Although some firms may have voluntarily adopted disclosure
requirements of the BIC Exemption for non-retirement accounts, the
proposed relationship summary would apply to a broader array of
relationships, spanning both retirement and non-retirement accounts for
broker-dealers and investment advisers. To the extent that the
information provided by the relationship summary would be duplicative
of information that would be required by the BIC Exemption (or other
DOL rules and exemptions) and provided to the same group of account
holders that would receive the DOL required disclosures, the overall
benefits of the relationship summary could be reduced. Lastly, to the
extent that some financial firms already have set up procedures and
systems to comply with the DOL disclosure requirements, these firms may
incur lower incremental compliance burdens. The Commission
preliminarily believes, however, that the scope of the disclosure
requirements under DOL rules and exemptions and the systems that firms
would have put in place to accommodate such disclosures are unlikely to
have a significant overlap with the relationship summary. Therefore,
the Commission anticipates that any potential cost savings for firms to
comply with disclosure obligations under DOL rules and exemptions and
the relationship summary are likely to be minimal.
With respect to preparing and implementing the relationship
summary, firms would also need to expend resources with respect to the
required Key Questions in the relationship summary. Firms would bear
costs of preparing responses the questions from the list and training
their employees on how to respond. Financial professionals need to
spend time to prepare their responses to the questions and to respond
to these questions when asked. As a result, some firm employees or
financial professionals could take away from the time they dedicate to
investigate investment recommendations, which could inadvertently harm
investors if financial professionals divert resources to answering key
questions but reduce their time devoted to arriving at investment
strategies. In this case, the quality of their recommendations could
decline. In both cases, the possible additional costs to firms could be
(partially) transferred to retail investors.
In addition to the costs associated with preparation, delivery,
filing, and posting on websites of the initial relationship summary,
firms would also bear costs for updating the relationship summary
within 30 days whenever any information becomes materially
inaccurate.\626\ The firm would be required to communicate updated
information to retail investors who are existing customers or clients
of the firm within 30 days whenever any information in the relationship
summary becomes materially inaccurate.\627\ Firms could communicate
this information by delivering the amended relationship summary or by
communicating the information another way to the retail investor. For
example, if an investment adviser communicated a material change to
information contained in its relationship summary to a retail investor
by delivering an amended Form ADV brochure or Form ADV summary of
material changes containing the updated information, this generally
would support a reasonable belief that the information had been
communicated to the retail investor, and the investment adviser
generally would not be required to deliver an updated relationship
summary to that retail investor. This requirement provides firms the
ability to disclose changes without requiring them to duplicate
disclosures and incur additional costs. The updated relationship
summary would also need to be posted prominently to the firm's website
if the firm has one and filed electronically with the Commission. In
addition, firms could also incur some costs to keep records of how the
updated relationship summary or the information in the updated
relationship summary was delivered to retail investors.
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\626\ Along this line, firms could also incur some costs of
modifying prescribed disclosure per the parameters of Instruction 3.
\627\ The requirement to communicate updated information to
retail investors, rather than deliver an updated relationship
summary could reduce the effectiveness of the information to the
extent that the communication does not allow retail investors to see
the context in which information was changed.
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We anticipate that the compliance costs associated with producing
updates of the relationship summary would be also relatively minor
given that the relationship summary uses largely prescribed language
and updates of the relationship summary, which are only required for
material changes, are expected to be infrequent. As a result, the costs
of such updates are expected to be small relative to the costs
associated with the initial production of the disclosure. Further,
annual costs associated with communications regarding updates to the
relationship summary are anticipated to be lower than the costs of the
initial delivery to existing retail investors to the extent the
frequency of updates is low or the firm communicates the updates
through other ways than formal delivery. The Commission anticipates
that some of the costs associated with preparation, delivery, filing,
website posting, and updates to the relationship summary for an average
broker-dealer or average dual registrant could exceed the costs for the
average investment adviser. As Table 1 and Table 3 indicate, broker-
dealers maintain a larger number of accounts than investment advisers
do; therefore, delivery costs for broker-dealers could exceed those of
investment advisers, if the number of accounts is a good indicator of
the number of retail
[[Page 21494]]
investor customers.\628\ Similarly, given that the average dual
registrant has more customer accounts than the average investment
adviser, and that the preparation of relationship summaries for dual
registrants may require more effort than for standalone broker-dealers
or investment advisers, the compliance costs could be larger for these
firms.
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\628\ The Commission is unable to obtain from Form BD or FOCUS
data information on broker-dealer numbers of customers, and instead,
is only provided with the number of customer accounts. The number of
customer accounts will exceed the number of customers as a customer
could have multiple accounts at the same broker-dealer.
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In addition, unlike investment advisers, which produce Part 2A of
Form ADV, a broker-dealer currently is not required to prepare a
narrative disclosure document for its retail investors, although under
existing antifraud provisions of the Exchange Act, a broker-dealer may
be liable if it does not disclose material information to its retail
investors. Thus, broker-dealers could expend additional time and effort
to aggregate the information required by the relationship summary
relative to investment advisers. As a result, the Commission
preliminarily believes that the investment advisers should be able to
produce the relationship summary at a relatively lower cost than
broker-dealers, given investment advisers' experience with preparing
and distributing Part 2A of Form ADV.\629\
---------------------------------------------------------------------------
\629\ For example, investment advisers may already have
specialized staff dealing with disclosure issues.
---------------------------------------------------------------------------
The Commission preliminary believes that compliance costs would
also be different across firms with relatively smaller or larger
numbers of retail investors as customers or clients. For example, to
the extent that developing the relationship summary entails a fixed
cost, firms with a relatively smaller number of retail investors as
customers or clients may be at a disadvantage relative to firms with a
larger number of such customers or clients since the former would
amortize these costs over a smaller retail investor base. Firms with a
relatively larger number of existing retail investors would face higher
costs of initial distribution of the relationship summary compared to
firms with a relatively smaller retail investor base. Further, to the
extent that certain costs associated with preparing different versions
of the proposed relationship summary scale with the number of branches
and associated financial professionals that a firm has, firms with a
relatively larger number of branches and employees may bear higher
costs than firms with a smaller number.
While the imposed four-page limit is expected to impose nominal
compliance costs on market participants, it could also generate
additional costs for some firms relative to others. For example, the
four-page limit may be more costly for firms that have more complex
business models because it will limit the information they can present
within the relationship summary.\630\ For example, a firm with a
disciplinary history that provides exceptionally good customer service
could be at a disadvantage compared to other firms with no disciplinary
history because the relationship disclosure may not summarize relevant
information about the quality of customer service or the full scope of
services offered by the firm.
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\630\ Complexity is not necessarily linked to size--for example,
there are large, simple firms and small, complex firms.
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Based on the estimates provided in Section V.A for Paperwork
Reduction Act purposes, the average cost burden for an investment
adviser to prepare the proposed Form CRS for the first time is
estimated to range between approximately $1,300 and $3,400, depending
on the extent to which external help is used.\631\ The estimated
aggregate combined internal and external costs to investment advisers
industry-wide for initially preparing and filing the relationship
summary would be approximately $22 million.\632\ Similarly, for broker-
dealers, the average cost to a firm for preparing Form CRS for the
first time is estimated to range between approximately $4,000 and
$6,100, based on the estimate provided in Section V.D.\633\ The
estimated aggregate combined internal and external costs to broker-
dealers industry-wide of initially preparing and filing the
relationship summary would be approximately $15 million.\634\ In terms
of the initial cost of delivering the relationship summary to current
retail investors, we estimate that the cost to existing and newly
registered investment advisers would be approximately $43.4 million in
aggregate, or approximately $5,350 per adviser.\635\ For broker-
dealers, the estimated initial cost of delivering the relationship
summary to current retail investors would be approximately $121.5
million in aggregate, or approximately $42,500 per broker-dealer.\636\
For both investment advisers and broker-dealers, the estimated annual
costs of the requirement to deliver the relationship summary before or
at the time a new account is opened, or changes are made to the retail
investor's account(s) that would materially change the nature and scope
of the firm's relationship with the retail investor, is approximately
10% of the respective estimated costs of the initial delivery to
existing retail investors.\637\
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\631\ The lower end estimate is based on the assessment that,
without additional external help, it will take an average investment
adviser 5 hours to prepare the relationship summary for the first
time, see infra Section V.A.2.a. We assume that performance of this
function will be equally allocated between a senior compliance
examiner and a compliance manager at a cost of $229 and $298 per
hour, (see infra note 743 for how we arrived at these costs). Thus,
the cost for one investment adviser to produce the relationship
summary for the first time is estimated at $1,317 (2.5 hours x $229
+ 2.5 hours x $298 = $1,317) if no external help is needed. In
addition, we estimate that if the investment adviser needs external
help, the average cost to an investment adviser for the most
expensive type of such help (i.e., compliance consulting services)
would be $2,109, see infra note 732, which brings the total cost to
$3,426.
\632\ See infra Sections V.A.2.a and V.A.2.b for estimates of
aggregate internal and external costs, respectively, of the initial
preparation and filing of the relationship summary.
\633\ The lower end estimate is based on the assessment that,
without additional external help, it will take an average broker-
dealer 15 hours to prepare the relationship summary for the first
time, see infra Section V.D.2.a. We assume that performance of this
function will be equally allocated between a senior compliance
examiner and compliance manager at a cost of $229 and $298 per hour,
respectively (see infra note 743 for how we arrived at these costs).
Thus, the cost for one broker-dealer to produce the relationship
summary for the first time is estimated a $3,953 (7.5 hours x $229 +
7.5 hours x $298 = $3,953) if no external help is needed. In
addition, we estimate that if the broker-dealer needs external help,
the average cost to a broker-dealer for the most expensive type of
such help (i.e., compliance consulting services) would be $2,109,
see infra note 826, which brings the total cost to $6,062.
\634\ See infra Sections V.D.2.a and V.D.2.b for estimates of
aggregate internal and external costs, respectively, of the initial
preparation and filing of the relationship summary.
\635\ See infra Section V.C.2.b.i for the estimate of costs
investment advisers would incur to deliver the relationship summary
to their existing clients. Note that the analysis includes
investment advisers that are dual registrants.
\636\ See infra Section V.D.2.d.i for the estimate of costs
investment advisers would incur to deliver the relationship summary
to their existing clients. Note that thee analysis includes broker-
dealers that are dual registrants.
\637\ See infra Section V.C.2.b.ii for the estimate of these
costs for investment advisers and infra Section V.D.2.d.ii for the
analysis of these costs for broker-dealers.
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Finally, the Commission believes that the proposed relationship
summary would bring tangible benefits to many broker-dealers and
investment advisers. Although the possibility of mismatched
expectations for retail investors and their choice of financial firm or
professional generally are most costly to the retail investors, such
mismatch also imposes costs on broker-dealers and investment advisers.
For instance, some investors who have mismatched their
[[Page 21495]]
expectations of a financial services provider with the type of provider
they have engaged may lodge complaints with the SEC or FINRA for
perceived misconduct by their financial professional without
understanding the nature of their relationship (e.g., an investor may
file a complaint of discretionary trading in an investment advisory
account because they did not understand the nature of the services for
which they contracted). These complaints are costly to firms and
financial professionals, and the Commission preliminarily believes that
the relationship summary could alleviate search costs for investors and
the likelihood of mismatch between investor expectations and their
choice of firm or financial professional.
With respect to particular elements of the relationship summary,
firms with relatively no currently reportable legal and disciplinary
disclosures could benefit directly from the reporting in the
relationship summary because the reporting would make these
characteristics more salient for retail investors by prompting
investors to research disciplinary history of firms with currently
reportable legal and disciplinary disclosures. To the extent that
including disciplinary history information in the relationship summary
increases the propensity of retail investors to consider this
information when selecting firms and financial professionals, it could
also ultimately increase the cost of misconduct for firms and financial
professionals (for example, by making it more difficult to attract
retail investors), which would make it more likely that firms take
disciplinary information into account when making employment choices,
thereby potentially raising the overall quality of their workforce. The
relationship summary could further exhibit some positive long-term
effects on the markets for broker-dealers and investment advisers and
we elaborate on these long-term effects in greater detail in the next
subsection.
3. Impact on Efficiency, Competition, and Capital Formation
In addition to the specific benefits and costs discussed in the
previous section, the Commission expects that the proposed disclosure
could cause some broader long-term effects on the market for financial
advice. Below, we elaborate on these possible effects, including a
discussion of their impact on efficiency, competition, and capital
formation.
The primary long-term effect of the disclosure on the market is
that it could enhance the competitiveness of the broker-dealer and
investment adviser markets. The increased transparency with respect to
the nature of the relationship between broker-dealers or investment
advisers and their retail investors may allow retail investors to
better evaluate their firms and financial professionals as well as the
options for financial services that are advertised by them, which may
increase the overall level of retail investor understanding in the
market. When retail investor understanding increases, the degree of
competitiveness of the financial services industry may also increase
because retail investors could better assess the types of services
available in the market. Market competitiveness could be further
enhanced by the fact that, by prompting investors to understand better
and obtain more information on the services provided as well as the
types of fees and costs associated with such services, the relationship
summary may reduce search costs for retail investors associated with
acquiring this information, thus allowing them to more readily identify
less expensive services that match their preferences and expectations
for financial services. The relationship summary also could cause
additional competition around conflicts of interest, resulting in some
firms changing their practices to decrease conflicts. Proposed
Regulation Best Interest also requires broker-dealers to disclose all
material facts relating to the scope and terms of the relationship, and
all material conflicts of interest associated with the
recommendation.\638\ The Commission preliminarily believes that the
relationship summary, which draws investor awareness to potential
conflicts of interest at the outset of the relationship with a firm or
financial professional, would address similar concerns related to the
material facts associated with the scope and terms of the relationship
as required by proposed Regulation Best Interest. Relative to the
disclosures required by proposed Regulation Best Interest, the
relationship summary conflicts of interest disclosures apply not only
to broker-dealers and dually-registered firms, but also to investment
advisers.
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\638\ Further, proposed Regulation Best Interest would establish
policies and procedures to identify and at a minimum disclose or
mitigate material conflicts of interest associated with such
recommendations, as well as policies and procedures to identify,
disclose and mitigate or eliminate material conflicts of interest
arising from financial incentives associated with such
recommendations.
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Increased competitiveness in the market for financial services
could have ancillary effects as well, including reduced pricing power
for firms and incentives for firms to innovate products and services.
Reduced pricing power, as a result of increased competitiveness, could
benefit retail investors through lower fees, effectively redistributing
value from holders of financial firm equity to their retail
investors.\639\ We note, however, that this effect could be mitigated
by the possibility that people may still be willing to pay higher
prices for other reasons, including firm reputation. Competition also
provides incentives for firms to develop and innovate. Additional
competition among financial services firms could provide incentives for
broker-dealers and investment advisers to seek alternative ways to
generate profits. In the process, firms could develop new and better
ways of providing services to retail investors, for example, by
utilizing recent developments in information technologies to deliver
information to retail investors at lower cost. In this way, innovation
could thus improve the satisfaction of retail investors and the
profitability of firms in the financial services provider market.
---------------------------------------------------------------------------
\639\ See Jean Tirole, The Theory Of Industrial Organization,
M.I.T. Press (1989).
---------------------------------------------------------------------------
Another potential positive effect of the relationship summary is
that, by reporting whether a firm or financial professional has
currently reportable legal or disciplinary events, the relationship
summary could prompt retail investors to seek out disciplinary
information on their current and prospective firms and financial
professionals and take that information into account when considering
whom to engage for financial services. In this respect, the proposed
relationship summary may also enhance competition if, for example,
firms and financial professionals with better disciplinary records
outcompete those with worse records. We note, however, that reporting
whether a firm or financial professional has currently reportable legal
or disciplinary events may also bias firms toward hiring firms or
financial professionals with fewer years of experience (i.e., fewer
opportunities for customer complaints) and against hiring experienced
financial professionals with some (minor) customer complaints. The
expected economic impact of the above effect across small and large
firms, however, is generally unclear. For investment advisers and
broker-dealers, reportable disciplinary events are less common for
smaller firms than for larger firms.\640\
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\640\ For example, while only 10% of registered investment
advisers with less than $1 million of AUM disclose at least one
disciplinary action as of January 1, 2018, 66% of registered
investment advisers with more than $50 billion of AUM disclosed at
least one disciplinary action that year. Form ADV. Similarly, while
89% of broker-dealers with less than $1 million in total assets
disclose at least one disciplinary action as of January 1, 2018,
100% of broker-dealers with more than $50 billion total assets
disclosed at least one disciplinary action that year. Form BD.
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[[Page 21496]]
However, in the market for financial services between investment
advisers and broker-dealers, disclosing the existence of currently
reportable legal and disciplinary events in the relationship summary
may confer a small competitive advantage for investment advisers
because broker-dealers are more likely to have to report that they have
a disciplinary history due to broader broker-dealer disclosure
obligations.\641\ They are also more likely to report if they have more
disciplinary issues. Reporting from Form BD with respect to broker-
dealer disclosures of disciplinary actions taken by any regulatory
agency or SRO shows that 308 (84%) out of 366 dual-registered broker-
dealers disclosed a disciplinary action. By contrast, 1,650 (47%) out
of 3,475 standalone broker-dealers have a disclosed disciplinary
action. For investment advisers, Form ADV requires disclosures of any
disciplinary actions taken in the past ten years. 289 (79%) out of 366
dual-registered investment advisers disclosed a disciplinary action. A
much lower fraction, 1,732 (14%) of 12,293, standalone investment
advisers disclosed a disciplinary action.\642\ The fact that broker-
dealers have relatively more reportable legal and disciplinary events
than investment advisers may cause retail investors to engage
investment advisers rather than broker-dealers, thus creating a
competitive advantage for some investment advisers.
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\641\ See supra notes 251, 253--255 and accompanying text.
\642\ Source: Items 11C, 11D, and 11E of Form BD and Items
11.C., 11.D. and 11.E. of Form ADV. Form BD asks if the SEC, CFTC,
other federal, state, or foreign regulatory agency, or a self-
regulatory organization have ever found the applicant broker-dealer
or control affiliate to have (1) made a false statement or omission,
(2) been involved in a violation of its regulations or statues, (3)
been a cause of an investment related business having its
authorization to do business denied, suspended, revoked, or
restricted, or (4) imposed a civil money penalty or cease and desist
order against the applicant or control affiliate. Likewise, Form ADV
asks similar questions of registered investment advisers and
advisory affiliates.
---------------------------------------------------------------------------
Although the proposed relationship summary applies to SEC-
registered broker-dealers and SEC-registered investment advisers, it
could exhibit some spillover effects for other categories of firms not
affected by the proposal such as investment advisers not registered
with the SEC, bank trust departments, and others. In particular, the
relationship summary could change the size of the broker-dealer and
investment adviser markets--relative to each other, as well as relative
to other markets. To the extent the relationship summary reduces retail
investors' confusion and makes it easier for them to choose a
relationship in line with their preferences and expectations, the
Commission expects that this could attract new retail investors to
these markets, coming from firms in other markets. Firms' current
retail investors also may consider switching to a different type of
firm if the relationship summary makes the different services provided
and the fees and costs of investment advisory and brokerage services
more prominent. The exact extent and direction of substitution between
brokerage and advisory services is hard to predict and depends on the
nature of the current mismatch between retail investor preferences and
expectations and the type of services for which they have contracted.
The proposed relationship summary may also benefit financial
markets more broadly. Recent survey evidence suggests that 60% of all
American households have sought advice from a financial
professional.\643\ Despite their prevalence and importance, however,
financial professionals are often perceived as dishonest and
consistently rank among the least trustworthy professionals.\644\ This
perception has been partly shaped by highly publicized scandals that
have affected the industry over the past decade. Systematic mistrust
may suppress household stock market participation below the optimal
threshold predicted by academic investment theory, as documented in
household survey based studies.\645\ The Commission preliminarily
believes that the increased transparency of the existing business
practices of financial professionals could raise the level of investor
trust in the market. The enhanced trust could promote retail investor
participation in capital markets which could increase the availability
of funds for businesses. Depending on the magnitude of the effect,
greater availability of funds could lower firms' cost of capital,
allowing firms to accumulate more capital over time.
---------------------------------------------------------------------------
\643\ See supra note 541. Survey of Consumer Finances, 2016. The
percentage aggregates all respondents indicating that they use at
least one of the following sources in making saving and investment
decisions--brokers, financial planners, accountants, lawyers, or
bankers. 26% of the respondents indicate that they have used brokers
or financial planners.
\644\ See Edelman Trust Barometer, 2015 Edleman Trust Barometer
Executive Summary (2015), available at https://www.edelman.com/2015-edelman-trust-barometer/; Anna Prior, Brokers are Trusted Less than
Uber Drivers, Survey Finds, Wall Street Journal (Jul. 28, 2015),
available at https://www.wsj.com/articles/brokers-are-trusted-less-than-uber-drivers-survey-finds-1438081201; Luigi Zingales, Does
Finance Benefit Society, Journal of Finance 70, 1327-1363 (Jan.
2015).
\645\ See, e.g., Luigi Guiso, Paola Sapienza & Luigi Zingales,
Trusting in the Stock Market, The Journal of Finance, Vol. 63, No.
6, 2557-2600 (2012); and J. Campbell, Household Finance, The Journal
of Finance, Vol. 61, No. 4, 1553-1604 (2006) (``Campbell Article'').
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We note a possible negative effect on the trust of some retail
investors due to the disclosure on the relationship summary that a firm
or financial professional has currently reportable legal or
disciplinary events. The decrease in the trust levels of some retail
investors, however, could also benefit these investors by bringing
their expectations and perceptions in line with their choice of a firm
or financial professional.\646\
---------------------------------------------------------------------------
\646\ See Jeremy Ko, Economics Note: Investor Confidence (Oct.
2017), available at https://www.sec.gov/files/investor_confidence_noteOct2017.pdf.
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Another possible long-term effect of the relationship summary is
that it could decrease the prevalence of third-party selling
concessions in the market by requiring broker-dealers and dual
registrants to include prescribed disclosure about indirect fees
associated with investments that compensate the broker-dealer,
including mutual fund loads. Currently, selling concessions constitute
a significant part of the compensation of broker-dealers selling mutual
fund products.\647\ For example, a mutual fund may provide a selling
concession, in the form of a sales charge, some portion of which could
be remitted to the broker-dealer that recommended the product.
---------------------------------------------------------------------------
\647\ See supra Table 2, Section IV.A.1.a.
---------------------------------------------------------------------------
Table 2, Panel A also indicates that selling concessions constitute
a larger fraction of total revenue (commissions, fees, and sales of IC
shares) for smaller broker-dealers--for example, selling concessions as
a fraction of revenues represent around 20% for broker-dealers with
total assets less than $1 million and less than 4% for broker-dealers
with total assets in excess of $50 billion. To compensate for the
potential loss of concession-based revenue, broker-dealers could try to
switch customers to advisory accounts. As noted above, however, if the
proposed disclosure also increases the competitiveness in the broker-
dealer and investment adviser markets the increased competitiveness
would create some downward price pressure in the market.
[[Page 21497]]
4. Alternatives to the Proposed Relationship Summary
This section highlights alternatives to the relationship summary
concerning an amendment of existing Forms BD and ADV for broker-dealers
and investment advisers, respectively; the form and format of the
relationship summary; extensiveness of disclosure; delivery; and
communicating information about the updated relationship summary.
a. Amendment to Existing Disclosures
As proposed, the relationship summary would be a new, standalone
disclosure produced by broker-dealers and investment advisers, in
addition to the other required information disclosed by broker-dealers
and investment advisers. As an alternative, the Commission could
consider incorporating the relationship summary information into
existing disclosures.
For example, Part 2A of Form ADV currently has 18 mandatory
reporting elements, produced as a narrative discussion, as part of the
disclosure ``brochure'' provided to prospective retail investors
initially and to existing retail investors annually. Instead of
requiring investment advisers to produce a completely new disclosure as
a separate Form CRS, the Commission could instead make an amendment to
Part 2A of Form ADV to require a brief summary at the beginning of the
brochure in addition to the existing narrative elements, or to change
certain of the disclosure requirements to reduce or eliminate
redundancy. Similarly, broker-dealers could be required to deliver
longer narrative disclosure to their retail investors with specified
elements. Such disclosure could also be required as part of Form BD or
a standalone requirement.\648\ For example, the instructions to Form BD
contain a section on the explanation of terms which could be extended
to include basic (registrant-specific) information on the business
practices of the registrant.
---------------------------------------------------------------------------
\648\ We note, however, that Form BD is a registration/
application form (rather than an existing brochure-type disclosure
form).
---------------------------------------------------------------------------
Although modifying existing disclosure and reporting in these ways
could provide the same information to retail investors as the proposed
relationship summary, the Commission believes that these approaches
would be less suited for the objective of this disclosure, which is to
provide a short, simple overview. The proposed relationship summary
would provide disclosure in a standardized, simplified manner, that
would allow retail investors not only to compare information within a
category (e.g., two investment advisers), but also across categories
(e.g., investment advisers and broker-dealers). Further, the
relationship summary would be designed to be easily comprehensible by
retail investors, relying on short, easy-to-read disclosure that would
provide an overview of information about the firm and its financial
professionals to retail investors when choosing a firm and account
type. We believe that the proposed relationship summary would benefit
retail investors by highlighting succinct information that is relevant
to a decision to select a firm, financial professional, or account type
and services, at the time such decisions are made, and relying on
layered disclosure to provide additional detail.
b. Form and Format of the Relationship Summary
The Commission is proposing to require broker-dealers and
investment advisers to create and deliver a short relationship summary
to retail investors that would highlight specified information under
prescribed headings in the same order to facilitate comparability. The
relationship summary would be limited in length and would contain a mix
of prescribed and firm-specific language. The proposal does not specify
a single format for filing the disclosure.
The Commission could require the relationship summary be filed with
the Commission in a specified format, such as an text-searchable PDF
file or in some other format, for example, an unstructured PDF or HTML,
structured PDF, a web-fillable form, XML, XBRL or Inline XBRL. Further
to this alternative, the Commission could require that the relationship
summary information be filed in a structured format to facilitate
validation, aggregation and comparison of disclosures, and the
Commission could then make the data available on IARD and EDGAR.
Structured format, such as XML, can enable the automatic generation of
unstructured formats such as PDF, HTML, and others to meet the needs of
those users who would prefer a paper-oriented layout.
As an alternative to the largely prescribed language for the
relationship summaries, the Commission could instead allow broker-
dealers and investment advisers to construct bespoke disclosure, while
providing guidance to firms on the elements of the relationship
disclosure that are required to be included. Although this disclosure
would allow firms to tailor the discussion of the nature of the
business, fees and costs, conflicts of interest, and disciplinary
history specifically to their business model, this approach would
likely be more costly to retail investors, as it would likely diminish
the usefulness of a concise, simplified disclosure that is capable of
being used by retail investors to understand firm types. Longer firm-
specific disclosures could also increase the search costs for retail
investors which could ultimately result in worse choices by lowering
investor ability and incentives to screen a large number of firms.
Higher search costs for investors could also lower the competitiveness
of the market by allowing some firms with lower-quality services to
maintain customers and sustain market share, even if better choices are
available to retail investors. As discussed above in Section III.B,
simplification of disclosures, in terms of size, presentation, and
readability, allows for ease of processing of information, while
standardization of the content would facilitate identification of
information most useful to a retail investor. Finally, lengthier
bespoke disclosure would be also costlier for firms to produce. As
another alternative, the Commission could have required the
relationship summaries to include only prescribed wording. However, the
Commission believes that a mix of prescribed and firm-drafted language
provides both information that is useful for retail investors in
comparing different firms along with some flexibility for firms to
determine how best to communicate the information about their
particular practices to retail investors.
c. Extensiveness of Disclosure
As currently proposed, the relationship summary would include high-
level information on (i) introduction; (ii) the relationships and
services provided in the firm's advisory accounts and brokerage
accounts; (iii) the standard of conduct applicable to those services;
(iv) the fees and costs that retail investors will pay, (v) comparison
to other account types; (vi) specified conflicts of interest; (vii)
where to find additional information, including whether the firm and
its financial professionals currently have reportable legal or
disciplinary events and who to contact about complaints; and (viii) key
questions for retail investors to ask the firm's financial
professional. As an alternative, the Commission could require the
inclusion of additional topics or additional disclosures on one or more
topics proposed to be covered by the relationship summary. These
disclosures could be required as part of the relationship summary or as
separate appendices.
[[Page 21498]]
With respect to the additional topics to be disclosed, the
Commission could request that firms disclose additional information on
their performance, investment style, or other business practices.
Retail investors, however, may become overwhelmed if presented with a
number of very lengthy disclosures, which therefore could bury the
information that is most useful to investors and reduce the
effectiveness of those disclosures.\649\ With respect to the specific
topics of additional information, evaluating the performance,
investment style and business practices of a firm or financial could be
subjective or speculative, and may be more suited for marketing
materials rather than prescribed language in the relationship
summary.\650\ For all these reasons, we believe that these additional
disclosure topics are not appropriate for inclusion in the relationship
summary.
---------------------------------------------------------------------------
\649\ See also supra note 50 and accompanying text (discussing
comment letters to the 917 Financial Literacy Study regarding the
length of disclosure documents).
\650\ In terms of performance, studies have shown that investors
take into account information about historic fund performance in
their investment choice; see, e.g., Choi Laibson Article, supra note
567.
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Regarding alternatives to the disclosure of fees and costs as
proposed here, the relationship summary could require additional
disclosures on one or more of these topics. For example, the
relationship summary could include the firm's fee schedule, either as
part of the body of the relationship summary or as an attachment.
Alternatively, we could require each relationship summary to include a
personalized fee schedule,\651\ to be created for each retail investor,
detailing the specific fees and costs associated with the retail
investor's account, presented both in dollars and as a percentage of
the value of the retail investor's account. These fee schedules could
also include compensation received by the firm and its financial
professionals related to the account, and the indirect fees that are
payable by the retail investor to others (e.g., mutual fund and
exchange-traded fund fees and expenses). However, ex ante identifying
possible fee schedules for investors at the outset of a relationship as
opposed to at the time of the transaction could impose costs to both
investors and firms. For example, firms might need to outline a long
list of possible transactions and the associated fee schedules, which
in turn could be confusing to investors.
---------------------------------------------------------------------------
\651\ One requirement of proposed Regulation Best Interest would
be to provide to investors at the time of or prior to a
recommendation the expected fees and costs, and possibly a fee
schedule, associated with the individual transaction.
---------------------------------------------------------------------------
We could also require more comprehensive disclosures regarding
conflicts of interest and disciplinary history, including requiring
firms to summarize more or all of their conflicts of interest.\652\ For
example, firms could disclose potential conflicts of interest
associated with execution services, such as those required to be
reported in rule 606 disclosures.\653\
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\652\ See supra Section II.B.6 for a discussion of conflicts, or
specific details of conflicts, that would not be required to be
disclosed in the proposed Form CRS.
\653\ See 17 CFR 242.606 (requiring that broker-dealers make
publicly available a quarterly report on order routing information,
including a discussion of the material aspects of their relationship
with venues executing non-directed orders, including arrangements
for payment for order flow and any profit-sharing arrangement).
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We could also require additional details about a firms' and its
financial professionals' disciplinary history. Instead of requiring
firms to disclose whether or not they have currently reportable legal
or disciplinary history, as proposed, we could require firms to
disclose the number of disciplinary events, expressed as a number or as
a percentage of the size of the firm or the number of firm
professionals. We could further differentiate the disclosures by
requiring firms to disclose the existence and numbers of disciplinary
histories within categories of disciplinary history.
More detailed disclosures about fees, compensation, conflicts and
disciplinary history could help retail investors understand better the
differences between types of accounts, and could facilitate the
decision about the most appropriate account for each retail investor.
As noted above, current disclosures on these topics cover only subsets
of firms and relationships and could take different forms. For example,
firms wishing to make investment recommendations to IRAs and
participants of ERISA-covered plans may be subject to certain
disclosure obligations.\654\ This disclosure, however, does not apply
to non-retirement accounts. Investment advisers also prepare a Form ADV
Part 2A narrative brochure but such a retail disclosure document is not
currently required for broker-dealers. As a result, the Commission
preliminary believes that retail investors could benefit from the
proposed relationship summary given its wide coverage, delivery method,
and design.
---------------------------------------------------------------------------
\654\ See supra Section IV.A.1.c (discussing disclosure
obligations under DOL rules and exemptions).
---------------------------------------------------------------------------
In particular, the disclosures about types of fees and costs
included in the relationship summary could help retail investors
understand better the types of fees that they will pay and how those
types of fees and costs affect their accounts. As discussed in the
baseline, the 917 Financial Literacy Study highlighted that
transparency and disclosure about fees charged by financial
intermediaries was one of the most essential elements that investors
would consider in making their decision about which financial
professional to choose.\655\
---------------------------------------------------------------------------
\655\ See supra note 20.
---------------------------------------------------------------------------
Similarly, the information provided about conflicts of interest in
the relationship summary could help retail investors understand how
such conflicts that might be pertinent to their account. The disclosure
about whether the firm or financial professional has currently
reportable legal or disciplinary events could encourage retail
investors to research the extensiveness and nature of the disciplinary
history of a firm, therefore allowing retail investors to further
evaluate firms based on the types of disciplinary events.
Although additional disclosures on account types, fees and
compensation (including a fee/compensation schedule), conflicts of
interest and disciplinary history could enhance retail investors'
understanding of the accounts that are available to them, there are a
number of additional costs associated with these alternatives. As noted
earlier in the release, extensive empirical evidence suggests that as
documents get lengthier and more complex, readers either stop reading
or read less carefully.\656\ Retail investors, therefore, may become
overwhelmed if presented with lengthy disclosure, which could bury the
information that is most important to investors and reduce the
effectiveness of those disclosures.\657\ Further, the compliance and
production costs of additional disclosure would increase significantly
the overall compliance costs to broker-dealers and registered
investment advisers.
---------------------------------------------------------------------------
\656\ See, e.g., 917 Financial Literacy Study, supra note 20.
\657\ See also supra note 50 and accompanying text (discussing
comment letters to the 917 Financial Literacy Study regarding the
length of disclosure documents).
---------------------------------------------------------------------------
As another alternative, the Commission could require a shorter
relationship summary, limited to one page (or equivalent limit for
electronic format) that would highlight important topics for retail
investors and/or including only key questions for retail investors to
ask. This alternative relationship summary would be highly readable,
with prescribed formatting,
[[Page 21499]]
and could highlight the differences between brokerage and advisory
services and fees, and flag for retail investors the existence of
firms' and financial professionals' conflicts of interest without
discussing any specific conflicts. However, the one-page relationship
summary would be the same or very similar across firms, and therefore
likely would not facilitate detailed comparison across firms or provide
enough information to highlight the differences for most retail
investors.
We alternatively could require firms to create separate
relationship summaries for each account type they offer to retail
investors, and require firms to provide a retail investor only the
relationship summary for the service being offered.\658\ This would
result in more detailed disclosures on specific account types, and
would potentially provide retail investors with more relevant
information about account types that they are interested in reviewing
(and less extraneous information about account types that they are not
interested in reviewing). However, providing such focused relationship
summaries could decrease comparability across account types, as the
relationship summary would not present, in one place, the differences
in accounts and services offered.\659\ In addition, this would result
in more costs to firms with multiple advisory and brokerage services,
as they would be required to prepare several relationship summaries,
although they may also have the resources to do this. The Commission
preliminarily believes that, as a tool for layered disclosure, the
relationship summary as proposed facilitates retail investors' ability
to obtain more detailed disclosures on account types by encouraging
retail investors to ask questions and request more information.
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\658\ See Comment letter of Fidelity responding to FINRA's
Regulatory Notice 10-54 (Dec. 27, 2010), available at http://www.finra.org/sites/default/files/NoticeComment/p122723.pdf.
\659\ We note that firms with multiple account types within
brokerage or advisory would not have the flexibility to describe/
distinguish the different account types (e.g., a brokerage firm that
offers a range of accounts--from completely self-directed to mutual-
fund only to full-service).
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d. Delivery
As currently proposed, firms would be required to deliver the
relationship summary before or at the time an investment adviser enters
into an advisory agreement with a retail investor, or, for broker-
dealers, before or at the time the retail investor first engages the
firm's services. Dual registrants would be required to deliver the
relationship summary at the earlier of entering into an investment
advisory agreement with a retail investor or the retail investor
engaging the firm's services. As with other disclosure, a firm would be
permitted to deliver the relationship summary (including updates)
electronically, consistent with the Commission's guidance regarding
electronic delivery. In addition, firms would be required to implement
a one-time delivery of the relationship summary to existing retail
investors as a transition requirement. We are also proposing a
requirement for firms to post their relationship summaries on their
websites in a way that is easy for retail investors to find, if they
maintain a public website. Firms that do not maintain a website would
be required to include in their relationship summaries a toll-free
number for investors to call to obtain documents.
In addition, a firm would be required to provide a relationship
summary to an existing client or customer who is a retail investor
before or at the time a new account is opened or changes are made to
the retail investor's account(s) that would materially change the
nature and scope of the firm's relationship with the retail investor,
as described in more detail in Section III.C.2 above. A firm would also
be required to deliver the relationship summary to a retail investor
within 30 days upon request. Furthermore, firms would be required to
file current relationship summaries with the Commission, which would be
made publicly available, and would be required to post a current
version of their relationship summary on their website, if they
maintain one.
As an alternative regarding delivery, the Commission could require
that the relationship summary would only be available through
electronic delivery, such as an email attachment, an email with the
full text of the relationship summary in the body of the text, or an
email with a hyperlink to the firm's website. Although alternatives
relying exclusively on electronic delivery could reduce costs
associated with the production of those disclosures, the proposed
approach would give the potential benefits of providing information to
retail investors in a timely fashion in order to help retail investors
select a financial professional or firm, while recognizing the
proliferation of the various means of communications, electronic or
otherwise, available to firms and retail investors. Our approach also
recognizes that some retail investors may not have Internet access or
may prefer delivery in paper.
The Commission could have also eliminated the requirement for firms
to post the relationship summary on their websites and file the
disclosure with the Commission. However, we believe that the relatively
minimal cost to firms for posting and filing is outweighed by the
benefit of providing easily accessible information to retail investors
to assist them in deciding among firms and financial professionals.
Another possibility would have been also not to require a one-time
delivery of the relationship summary to existing retail investors. The
Commission believes that since the information in the relationship
summary is potentially valuable to new investors it would be also
potentially valuable for the existing customers of broker-dealers and
investment advisers. While existing retail investors would face higher
costs to change from an existing financial services provider to a new
one than new potential investors would, most existing investors would
be still able to reevaluate their relationships with their current firm
and investment professionals. Furthermore, there is an inherent cost to
retail investors when the services they receive do not meet their
expectations. To the extent delivery of the relationship summary to
existing retail investors fosters greater understanding and decreases
the mismatch, this could mitigate any costs of changing financial
service providers. Distributing the relationship summary to a larger
group of initial investors further increases the group of individuals
that could become familiar with the disclosure indirectly through
interactions with family and friends.
As another alternative, the Commission could have proposed only a
delivery requirement for the relationship summary, like Form ADV Part
2B, instead of also requiring that firms file it with the Commission.
As discussed also in Section III.A above, although not requiring the
summaries to be filed with the Commission could reduce the costs to
firms for preparing the document to be filed, the Commission believes
that public access to relationship summaries benefits prospective
retail investors by allowing them to compare firms when deciding
whether to engage a particular firm or financial professional or open
an advisory or brokerage account, particularly if the summaries can be
located on a single point of access. Further, filing the relationship
summary with the Commission provides public access regardless of
whether a particular firm has a website with which to provide public
access to the disclosure.
[[Page 21500]]
e. Communicating Updated Information
As currently proposed, firms would need to update their
relationship summary within 30 days whenever any information in the
relationship summary becomes materially inaccurate. Our proposal would
also require firms to communicate the information in the amended
relationship summary to retail investors who are existing clients or
customers of the firm within 30 days after the updates are required to
be made and without charge. The communication can be made by delivering
the relationship summary or by communicating the information in another
way to the retail investor.\660\ Each firm would also be required to
post the updated relationship summary prominently on its website (if it
has one) and electronically file the current version of the summary
with the Commission.
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\660\ See supra Section II.C.3.
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Alternatively, the Commission could require that the relationship
summary also be updated and delivered annually, which would be similar
to the current requirements for investment advisers to provide an
updated ``brochure'' derived from Part 2A of Form ADV to their existing
retail investors both annually and upon any changes to the Item 9 of
Part 2A (disciplinary information). The Commission preliminarily
believes that the benefits of preparing and delivering an annual
relationship summary, regardless of the format of that delivery, would
not outweigh the costs to produce and distribute. As noted earlier, the
Commission anticipates that the terms of the business relationship
between most firms and their retail investors would be relatively
stable over time, except when a new account is opened or a significant
amount of assets is moved from one type of account to another that is
different from the retail investor's existing accounts, or other
changes are made that result in a material change to the nature and
scope of the firm's relationship with the retail investor. As a result,
every new delivery would bring relatively small amount of information
to retail investors.
We believe that mere public posting of the updated summary would
not itself adequately inform retail investors about material changes to
the relationship summary, and that firms providing communication of
information about relationship summary updates to investors as
described above is therefore necessary.
Finally, instead of proposing that firms may choose to communicate
information about updated relationship summaries to existing retail
investors instead of delivering an updated relationship summary, the
Commission could have proposed that firms must deliver the updated
relationship summary to each existing retail investor regardless of
whether or not it communicated the information to retail investors in
another way. While delivering the summary would provide retail
investors with the full scope of changes being made to the summary in
the context of existing information, the Commission preliminarily
believes that allowing firms to communicate information about the
updates as well as making the current version of the summary publicly
available, via a firm's website (if the firm has a website) and on the
Commission's website, provides flexibility for firms to utilize
existing communication methods and reduces the costs of delivery on
firms while providing adequate notice to retail investors about the
updates to the relationship summary, as well as access to the updated
summaries.
5. Request for Comments
The Commission requests comment on all aspects of the economic
analysis, including the analysis of: (i) Potential benefits and costs
and other economic effects; (ii) long-term effects of the proposed
relationship summary on efficiency, competition, and capital formation;
and (iii) reasonable alternatives to the proposed regulations. We also
request comments identifying sources of data and that could assist us
in analyzing the economic consequences of the proposed regulations.
In addition to our general request for comment on the economic
analysis, we request specific comment on certain aspects of the
proposal:
Do commenters agree with the overall assessment that the
relationship summary would benefit retail investors and assist them in
making a choice of what type of account matches their preferences? Do
commenters believe there are alternatives to the structure and content
of the relationship summary that we have not considered that could make
it more beneficial to retail investors? Are there any unintended costs
of the relationship summary for retail investors that we have not
considered?
Do commenters believe that the proposed disclosures about
relationships and services and fees are clear and effective enough? How
would you recommend altering the presentation of these disclosures in
order to increase their effectiveness?
Do commenters agree the proposed disclosure of the
categories of conflicts of interest would be beneficial to retail
investors? How would you recommend altering the presentation of the
conflicts of interest information so that costs are minimized?
What additional costs and benefits do you envision with
extending the disclosure of disciplinary history?
Are there alternative key questions we should consider
recommending that retail investors ask their financial professional?
Are there questions we should exclude, and, if so, why? Do commenters
agree with the concern that there could be potential costs associated
with the list of proposed questions, such as anchoring the attention of
retail investors to the list and thereby reducing the likelihood that
they would explore other potential questions that could be important to
them?
What costs do commenters anticipate that firms and
financial professionals will incur in implementing and complying with
the proposed Form CRS, both initial and ongoing? Please provide
estimates of the time and cost burdens for preparing, delivering and
filing the proposed form. What costs do commenters expect firms and
financial professionals will incur to prepare answers to the ``Key
Questions to Ask'' in the proposed Form CRS? Please provide estimates
of the time and cost burden for preparing to answer the questions.
How do commenters anticipate that the benefits and costs
of the proposed rule will be shared between broker-dealers and their
clients; or between investment advisers and their clients?
Do commenters anticipate that the benefits and costs of
the proposed rule would be different across broker-dealers and
investment advisers? What about dually-registered firms?
Are retail investors likely to access and download
relationship summaries of broker-dealers through EDGAR and investment
advisers through IAPD?
Are there other reasonable alternatives that the
Commission should consider? If so, please provide additional
alternatives and how their costs and benefits would compare to the
proposal.
C. Restrictions on the Use of Certain Names and Titles and Required
Disclosures
As discussed above, several studies suggest that retail investors
may lack financial literacy and are confused about the differences
between broker-
[[Page 21501]]
dealers and investment advisers.\661\ Part of this confusion may be
related to the current use of professional names and titles as
indicated by these studies and commenters.\662\ This proposal would
seek to reduce investor confusion related to the use of certain terms
in firm names and professional titles and prevent retail investors from
potentially being misled that their firm or financial professional is
an investment adviser, resulting in investor harm. In particular, our
proposed rule seeks to restrict a broker or dealer, and any natural
person who is an associated person of such broker or dealer, when
communicating with a retail investor, from using as part of its name or
title the words ``adviser'' or ``advisor'' unless such broker or dealer
is registered as an investment adviser under the Advisers Act or with a
state, or such natural person who is an associated person of a broker
or dealer is a supervised person of an investment adviser registered
under section 203 of the Advisers Act or with a state, and such person
provides investment advice on behalf of such investment adviser.\663\
In addition to the restriction on the use of certain names and titles,
we are proposing rules that require both broker-dealers and investment
advisers to prominently disclose their registration status with the
Commission and for their financial professionals to disclose their
association with such firm in all print and electronic retail investor
communications. Dual registrants would be required to disclose both
registration statuses.
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\661\ See Siegel & Gale Study, supra note 549 and RAND Study,
supra note 5. Although these studies do not limit the types of
financial professionals exclusively to broker-dealers or investment
advisers, the majority of the survey questions focus on differences
between advisory services versus brokerage services.
\662\ Id. See supra note 4.
\663\ See section 202(a)(25) of the Advisers Act [15 U.S.C. 80b-
2(a)(25)] defining ``supervised person'' as any partner, officer,
director (or other person occupying a similar status or performing
similar functions), or employee of an investment adviser, or other
person who provides investment advice on behalf of the investment
adviser and is subject to the supervision and control of the
investment adviser.
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This section provides an analysis of the economic effects of the
proposed rules relative to the baseline, including a discussion of the
benefits and costs to the affected parties and the impact on
efficiency, competition and capital formation. We also discuss
reasonable alternatives to the proposed rules.
1. Broad Economic Considerations
The economic tradeoffs involved in the choice of names and titles
by firms and financial professionals are complex and affected by a wide
range of factors. In this section, we discuss under what conditions
firm names and financial professionals' titles may convey information
that is important to retail investors when they are searching for a
provider of financial advice, as well as factors that are likely to
matter for firms and financial professionals when choosing their names
and titles. We also discuss some conditions where investor confusion
over the information conveyed by the names and titles chosen by firms
and financial professionals may lead to investor harm.
We believe that investors fall into a spectrum of knowledge about
the providers in the market for financial advice. On one end of the
spectrum, there are investors who may understand and correctly
distinguish the types of services and standard of conduct provided by
different types of firms and financial professionals. If firms and
financial professionals use names that accurately describe their
regulatory type, these types of investors would understand and expect
that ``broker-dealers,'' or close synonyms thereof, would provide the
services of, and be subjected to the standard of conduct applicable to,
a broker-dealer, while ``investment advisers,'' or similar names and
titles, would provide the services of, and be subject to the standard
of conduct applicable to, an investment adviser. On the other end of
the spectrum there are less knowledgeable investors who do not
understand that there are different types of services that can be
provided by firms or financial professionals, or differing applicable
standards of conduct. These investors may not be able to discern from
the name or title what type of service will be provided by a firm or
financial professional. As a result, these investors may bear costs
associated with their confusion, such as increased time and effort
(``search costs'') to identify the right type of financial
professional,\664\ or harm associated with inadvertently selecting, or
potentially being misled to select, a type of firm and financial
professional that is not consistent with their preferences and
expectations. The harm from a mismatched relationship could be, for
example, a higher-than-expected cost of services or reduced protection
for the investor.
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\664\ According to the 2009 National Survey Initial Report (see
supra note 275), of the 816 survey respondents that used a financial
professional in the last five years, 56% indicated that when looking
for a financial professional, they met or talked with more than one
professional before making their choice.
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In addition to confusion over firm names and professional titles,
and what they may represent, some investors may also have confusion
over the type of brokerage, advisory and other services and standard of
conduct that best match their preferences. Retail investors, therefore,
can also be categorized based on whether they know the type of advice
relationship (and associated payment model) that they would prefer,
regardless of whether they understand the names and titles of firms and
professionals. For instance, some investors may know that they prefer
to receive and pay for advice on a per transaction basis, such as that
provided typically by a broker-dealer, while others know they prefer an
ongoing advisory relationship with an asset-based fee model, such as
that typically provided by an investment adviser. On the other hand,
some other investors may only understand that they are seeking
financial advice but do not understand that there are different types
of advice relationships, and different ways to pay for advice, and may
not correctly identify the type of advice relationship that would be
most consistent with their preferences. This dimension of investor
confusion could also lead to investor harm such as increased search
costs, an overall mismatch in the type of advice relationship, or
paying more than expected for services received.
In principle, firm names and professional titles used by financial
intermediaries, to the extent that names and titles accurately reflect
the financial services provided, may serve as a search tool for some
investors when they initially select which financial professionals to
approach. In particular, for investors that both understand and
correctly interpret company or professional names and titles and also
know the type of investment advice relationship that they prefer, names
and titles of firms and financial professionals that are mainly
associated with one type of financial services could be used as an
initial sorting mechanism that may reduce search costs. For example, to
the extent names and titles accurately reflect the type of firms and
financial professionals, knowledgeable investors that prefer only
brokerage services could lower their search costs by using names and
titles to increase the likelihood they would contact broker-dealers
rather than investment advisers in their search. Similarly,
knowledgeable investors looking to hire an investment adviser would
more easily be able to contact investment advisers and avoid contacting
broker-dealers simply by observing the firm or professional names and
titles. We also note that investors who understand the
[[Page 21502]]
differences between broker-dealers and investment advisers generally
are unlikely to face a mismatch in the selection of a financial
professional, and that the names and titles, in this case primarily
serve to reduce search costs.
Less knowledgeable investors may face confusion over either the
information conveyed by firm or professional names and titles or the
preferred scope of their advice relationship. To the extent that names
or titles used by financial intermediaries accurately reflect services
provided, any reduction in search costs or reduction of the risk of
investors matching with the wrong type of firm and financial
professional will depend on the nature of the investor confusion, as we
discuss in more detail below.
When selecting firm or professional names and titles, financial
services providers may account for the level of investor understanding
(or confusion). For example, they may be aware that some investors are
informed by the use of particular names and titles, and the
implications for the services provided and applicable standard of
conduct, while other investors may face confusion over the use of
particular names and titles or the type of advice relationship they
seek. The incentives of financial intermediaries are two-fold: (1) They
seek to build their client/customer base; and (2) they desire to reduce
the costs associated with building that client/customer base, such as
the time, effort, and marketing costs incurred in the initial client
acquisition process. Therefore, financial intermediaries would
rationally choose titles that effectively attract the attention of
potential investors, while reducing the likelihood of ``false starts''
with investors that are not the right match (and understand what type
of advice that they seek). For example, if investors that fully
understand the differences between different types of financial
intermediaries are a significant majority of the potential investor
pool, then profit maximizing financial intermediaries would likely
choose names and titles that clearly identify the nature of services
provided and applicable standard of conduct. These knowledgeable
investors will then be able to identify from that choice of name or
title whether the firm or financial professional will meet their
preferred type of investment advice relationship, and therefore, the
unambiguous choice of title by the financial professional both reduces
search costs incurred by these investors and reduces the effort
expended by the financial professionals to build their customer base.
Continuing the same example, the remainder of the investor pool
would then consist of less knowledgeable investors, which would
represent a small portion of the aggregate investor pool. These
investors, in particular those who are confused about the differences
among firms and financial professionals and what type of investment
advice relationship they should seek, may be unlikely to understand
from names or titles alone how well the financial intermediary would
match their preferences, and therefore, will bear search costs and the
possibility of mismatch even when names and titles provide little
ambiguity for informed investors. However, we expect that when the
hypothetical investor pool predominantly consists of investors who
fully understand the differences between different financial
intermediaries, as we assumed for this example, overall costs borne by
both investors (e.g., search costs) and financial intermediaries (e.g.,
customer acquisition costs) are minimized by the use of distinct names
and titles clearly identifying financial intermediary type.
As the hypothetical pool of less knowledgeable investors that face
confusion over company names, titles, or services increases, the choice
of names and professional titles by financial intermediaries become
more complex to analyze and depends on a number of factors related to
investors. These factors include, among others: (i) Whether and how
much these investors infer information from titles about the type of
advisory or other services provided; (ii) the source of investors'
confusion, such as (a) a lack of understanding about the type of
service they would prefer, (b) an inability (in the absence of
additional information) to understand the differences in the services
offered and their associated payment models, or (c) a lack of knowledge
about professional titles and information provided therein; (iii) how
easily investors can learn, upon meeting with a financial professional,
about whether the type of advice or other services provided by the
financial professional meets their preferences; (iv) whether investors
could be persuaded to choose a type of advisory service that is not
consistent with the investor's preferences after meeting with a
financial professional; (v) investors willingness or ability to keep
searching for a financial professional until they find one that best
matches their preferences; and (vi) the distribution in the investor
pool of investors with different levels of knowledge and understanding
as described above.
When less knowledgeable investors are confused not only about what
services broker-dealers and investment advisers provide, but also are
confused about the types of services that they would prefer, the
factors noted above may lead firms and financial professionals of
either type to rationally choose generic or common terms in names and
titles. Consider the example where retail investors know they would
benefit from financial advice in a general sense, but are confused
about which type of investment advice relationship and associated
payment model would be best for them.\665\ A portion of these investors
are also persuadable, to some degree, to contract for whatever service
is offered to them by any given financial professional they contact,
regardless of whether that type of service matches the investors'
preferences.
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\665\ The assumptions underlying this hypothetical example are
meant to be illustrative of the incentives of firms and financial
professionals to pick certain names and titles when their pool of
potential customers is relatively uninformed. Should the
relationship summary disclosure be provided to potential and
existing customers, we believe that some of the confusion regarding
the nature of services would be addressed/mitigated; however, some
investors may still, even in the event that the relationship summary
is provided be confused about what type of firm or financial
professional or which particular service is best for their investing
situation.
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In this case, and in order to maximize the number of investors that
a firm or financial professional may be able to contract with, both
broker-dealers and investment advisers facing these less knowledgeable
investors would have incentives to pick names and titles that are the
most effective at getting these investors to approach them, to the
extent that names or titles alone have any impact on the choices made
by these investors.\666\ Once these investors make contact, a firm and
financial professional hypothetically may be able to persuade the
investor to hire them regardless of the type of financial advice
relationship offered, to the extent that the investor cannot
distinguish the characteristics of different types of advice
relationships that best fit their preferences, does not know the most
[[Page 21503]]
cost effective way to pay for that relationship, and cannot easily
distinguish between the types of relationships that are offered by
different firms and their financial professionals. In order to attract
this type of investors, firms may favor titles that indicate their
financial professionals' ability to dispense guidance and advice. For
example, they may select titles that include the word ``adviser'' or
``advisor,'' such as ``financial advisor''.\667\
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\666\ Although a number of studies discussed in the baseline
provide survey evidence that investors are confused about titles, we
are unaware of any direct evidence that titles alone affect the
choice of firms or financial professionals that are contacted or
eventually hired. However, in conjunction with the proposed
relationship summary, we expect that investors would gain better
understanding of the services provided by, and standards of conduct
applicable to, broker-dealers and investment advisers, which could
lead to more informed decision making about choosing the type of
financial intermediary that best matches to the investors' own
expectations regarding services and standard of conduct.
\667\ Alternatively, these firms may choose relatively generic
names or titles that in other ways suggest an advisory service, such
as ``financial planner'' or ``financial consultant,'' which are not
subject to the present rulemaking proposal.
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In addition to potential search costs expended by less
knowledgeable investors, these investors also bear a greater risk of
mismatch between the type of advice relationship that best fits their
preference and the actual advisory service for which they contract.
However, in this example, the mismatch arises because of investor
confusion over the type of relationship that best would meet their
preference, and this confusion itself may lead the investor to, by
chance, seek out a type of firm or financial professional that is
inconsistent with the investor's preference, rather than any confusion
directly related to the firm's or financial professional's use of a
common name or title. Conversely, generic names and titles may make it
easier for less knowledgeable investors to identify a broader class of
firms or financial professionals that can meet their perceived need for
financial advice to some extent.\668\ In situations where the pool of
less knowledgeable investors is likely to be large, one likely outcome
is that many firms and financial professionals could end up using
similar names or titles, which would potentially increase search costs
for those more knowledgeable investors who otherwise may use names and
titles as an initial sorting mechanism.
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\668\ To the extent generic titles in use today such as
``financial planner'' and ``financial consultant'' make it more
likely less knowledgeable investors can identify both investment
advisers and broker-dealers that offer advice, there may be benefits
to some of these investors if they in their contacts with financial
professionals of both types learn about which relationship and
payment models is most consistent with their preferences.
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Other particular kinds of investor confusion, which could impose
costs on some investors, may provide benefits, such as increased
customer flow, to only a certain type of firm or financial
professional. For example, some investors may be fully aware of the
type of advice relationship that they prefer, but are confused about
which firm or professional names and titles are associated with that
type of advice relationship. In particular, consider a situation where
investors know that they would like an advice relationship that is
provided by investment advisers. In this case, some broker-dealers may
have incentives to use titles such as ``advisor'' that suggest such an
advice relationship to maximize their customer flow. As a result, some
less knowledgeable investors may be misled to wrongly approach broker-
dealers rather than investment advisers in their search for advice, and
bear both potentially higher search costs and an increased likelihood
of a mismatch between the type of advice that is received and the type
of advice that is preferred. The risk of a mismatch and associated harm
in this case would be especially large for any of these investors that
primarily base their choice of firm and financial professional on names
and titles, rather than any information they would receive from a firm
or financial professional about the type of services or applicable
standards of conduct.
In addition to the factors related to investors discussed above,
the selection of names and titles by financial intermediaries also
depend on other factors specific to the intermediary. For example,
competitive concerns may cause some financial intermediaries to simply
choose terms in names and titles that are commonly used by other
financial intermediaries of their type. Alternatively, firms may choose
names and titles that distinguish them from their competitors. Some
firms or financial professionals may choose ambiguous generic titles,
such as ``financial consultant,'' in order to capture a larger fraction
of the investor pool, thinking that investors may seek information if
the title does not clearly identify the kinds or levels of services
provided or the applicable standard of conduct. We acknowledge that
these factors could also be important determinants of the choice of
names and titles.
2. Economic Effects of the Proposed Restrictions on the Use of Certain
Titles and Required Disclosures
In this section we discuss the potential economic effects from the
proposed rules to the directly affected parties: Investors, standalone
broker-dealers, standalone investment advisers, dually registered
firms, and financial professionals. Potential economic effects on
indirectly-affected parties, in particular financial intermediaries not
regulated by the Commission, are discussed in the next section.
a. Investors
The objective of the proposed rules is to reduce retail investor
confusion and limit the ability for retail investors to be misled that
a firm or financial professional is an investment adviser as a result
of the use of firm and financial professional names and titles that
contain either ``adviser'' or ``advisor''. Specifically, our proposed
rule seeks to enable retail investors to be able to discern more fully
whether a particular firm or financial professional will offer advisory
or other services provided by investment advisers versus those provided
by broker-dealers. In this section, we discuss the potential benefits
to investors as a result of the proposed rules, while considering the
potential costs that could be borne by investors. In general, we expect
the benefits and costs are unlikely to be evenly distributed among
investors, but will rather depend on both the differences in investors'
preferences for broker-dealer or investment adviser services, and
investors' individual degree of understanding what services any given
firm or financial professional is providing and the standard of conduct
that is applicable.
i. Benefits of Restrictions on the Use of Certain Names or Titles
The proposed restriction on the use of the terms ``adviser'' and
``advisor'' in names and titles of broker-dealers who are not also
dually registered as investment advisers and of financial professionals
who are not supervised persons of investment advisers and who provide
advice on behalf of such advisers, may reduce investor confusion about
what type of firm or financial professional is likely to match with
their preferences for a particular type of investment advice
relationship. The proposed rule may also reduce corresponding search
costs for some investors under certain conditions. Moreover, the
proposed rule may reduce the likelihood that a mismatch between an
investor's preferences and the services offered by a firm or financial
professional occur.\669\ Specifically, to the extent investors looking
for an advice relationship of the type provided by investment advisers,
and believe that
[[Page 21504]]
names or titles containing the terms ``adviser'' or ``advisor'' are
associated with this type of advice relationship, the proposed rule
would make it easier to identify firms and financial professionals that
offer such advice relationships, thereby reducing investor confusion,
search costs, and any mismatch in the advice relationship that may
occur from the potential misleading nature of such names or titles, as
well as any associated harm with such mismatch.\670\
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\669\ We note that a potential mismatch could occur because
investors may contact the wrong type of firm or financial
professional and may not fully understand the type of financial
advice that best match their preferences (even if the proposed
relationship summary is made available), may be persuaded to hire
the wrong type of firm or financial professional, or may be misled
that a firm or financial professional will provide the type of
service that the investor prefers, but in fact, does not.
\670\ See supra discussion in Section IV.C.1.
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As a result of the proposed restriction on the use of certain
terms, we expect the greatest potential reduction in search costs for
retail investors who know that they specifically want the services
provided by investment advisers and also would use names and titles in
their search. The proposed rule would potentially make it easier for
such investors to distinguish firms and professionals providing
investment adviser services from firms and professionals providing
brokerage services. The proposed rules may also reduce search costs for
investors that prefer brokerage services, if standalone registered
broker-dealers and financial professionals who are not supervised
persons of an investment adviser or who are supervised persons but do
not provide investment advice on behalf of such investment adviser are
using names or titles including ``adviser'' and ``advisor,'' would
choose new names and titles due to the proposed rule that more
distinctly indicate the types of services they provide, such as
``broker'' or ``broker representative.''
However, the reduction in search costs for retail investors as a
result of the proposed rule would be limited to the extent the firms
and financial professionals covered by the restriction on the use of
the terms ``adviser'' or ``advisor'' are not currently using the
proposed terms in their names and titles. Further, the potential impact
of the proposed rule on search costs is likely to be mitigated to the
extent the proposed rule is limited to firm names and job titles, and
would not itself affect the use of terms, such as ``advisory services''
in other communications or using those terms in metadata to attract
internet search engines.\671\ Moreover, beyond registered investment
advisers, dual registrants, and their supervised persons, other types
of financial services providers, such as insurance companies and banks,
may also continue to use the terms ``adviser'' and ``advisor'' in their
names and professional titles, and any confusion and search costs borne
by investors related to the use of such names and titles by financial
intermediaries not affected by this proposed rule would not be reduced.
As noted above, the Commission recognizes that terms such as
``financial advisor'' or ``financial consultant'' may be used by banks,
trust companies, insurance companies, and commodities
professionals.\672\
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\671\ As discussed above, these other communications by firms
and financial professionals would continue to be subject to
antifraud rules. See supra note 309.
\672\ See supra note 400. Further, as identified by Commission
staff, as of December 2017, approximately 546 broker-dealers
reported at least one type of non-securities business, such as
insurance, retirement planning, and real estate; see supra note 459.
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As discussed above in Section IV.C.1, some investors may be
confused by names and titles and believe that certain names and titles
are likely to specifically signal the type of advice services provided
by firms and financial professionals that use those names and titles
and the associated standard of conduct.\673\ In particular, investors
that prefer the type of investment advice relationship and the
associated standard of conduct offered by investment advisers may
believe that names or titles containing the terms ``adviser'' or
``advisor'' are only associated with that type of advisory
relationship. If some of these investors are persuaded by financial
professionals associated with broker-dealers (who are not themselves
investment advisers or supervised persons of investment advisers who
provide advice on behalf of such adviser) that they could have a
similar type of advice relationship as they would with an investment
adviser, a potential mismatch between investor preferences and the
advice relationship received may occur, which in turn may lead to
investor harm such as higher payments for the services by the investor
than necessary.\674\ Thus, the proposed prohibition on the use of
``adviser'' or ``advisor'' by certain broker-dealers may reduce the
risk of a mismatch between investors seeking advisory services of the
type provided by investment advisers and the type of services for which
they contract, as these investors under the proposed restriction would
be potentially less likely to be misled or inadvertently approach and
hire a type of firm or financial professional that does not match with
their preferences and expectations.
---------------------------------------------------------------------------
\673\ As discussed in Section IV.A.3.b, survey evidence suggest
that many investors in general do not have a clear understanding
about the differences in the nature of the advisory services
provided by, and standard of conduct applicable to, different types
of financial professionals.
\674\ Broker-dealers may elect to provide some services similar
to those of many investment advisers, such as ongoing monitoring,
thereby potentially mitigating any mismatches between preferred
services and the services provided.
---------------------------------------------------------------------------
Because mismatch in investor preferences and the type of advice
relationship they receive can potentially be very costly for investors
by resulting in inefficient advice relationships, reducing this cost
could be a potential benefit of the proposed rule for some investors.
In particular, if an investor seeks an advice relationship of the type
offered by investment advisers, but mismatches to a brokerage
relationship, then the frequency of advice received may not be the most
appropriate, or the cost for the advice may be too high if it leads to
frequent trading, and could result in suboptimal investment decisions
or lower investment returns net of costs. The Commission preliminarily
believes this reduction in mismatch risk would mainly apply to those
investors seeking a relationship similar to that provided by investment
advisers, as discussed above. However, for at least some investors
requiring advice on a per-transaction basis, the confusion about the
use of titles or the services provided by financial professionals could
potentially lead them to inadvertently select investment advisers even
if they truly want a broker-dealer. To the extent the proposed rule
would also help these investors more clearly distinguish between
broker-dealers and investment advisers, they may avoid inadvertently
hiring an investment adviser and thereby avoid paying potentially
higher fees for that type of advice relationship.
At this time the Commission is unable to estimate how many
investors have contracted for services that do not meet their
preferences, or are paying more than they would have preferred for
services, due to confusion about the names and titles of financial
intermediaries. Further, to the extent that confusion exists among
retail investors regarding the names and titles used by firms and their
financial professionals, surveys of retail investors with brokerage
accounts suggest that they tend to be satisfied with their firms and
financial professionals, and also believe that services provided by
these firms and financial professionals are valuable, which further
complicates any estimate of the incidence or magnitude of harmful
mismatch.\675\
---------------------------------------------------------------------------
\675\ See RAND Study, supra note 5, at 98.
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As discussed above with respect to search costs, any reduction in
mismatch risk associated with investor confusion over names and titles
would be limited to the extent that standalone registered
[[Page 21505]]
broker-dealers and their associated natural persons do not use the
proposed prohibited terms in their names and titles. This would also be
the case to the extent that registered representatives of dually-
registered broker-dealers who are not themselves supervised persons of
an investment adviser or who are supervised persons but do not provide
investment advice on behalf of such investment adviser do not use those
terms. The potential reduction in mismatch risk due to this proposed
rule would also be limited to extent the rule is limited to firm name
and individual job titles, and would not itself affect firms and
financial professionals from using terms such as ``advisory'' in other
content. Moreover, other types of financial intermediaries may use the
terms ``adviser'' and ``advisor'' in their names and titles, such as
banks, trust companies, insurance companies, and commodities
professionals.\676\ Therefore, the potential gains associated with a
reduction in mismatch risk due to the prohibition on certain names and
titles may be limited because some confused investors seeking an advice
relationship from investment advisers could continue to inadvertently
hire these other types of financial intermediaries that also use
``adviser'' or advisor'' in their names and titles.
---------------------------------------------------------------------------
\676\ See supra note 400.
---------------------------------------------------------------------------
Another potential limitation of the proposed restriction on the use
of certain titles is that a dual registrant could still call itself an
``adviser'' or ``advisor,'' but then only offer brokerage services to
investors that may not be legally and financially sophisticated enough
to understand the differences in types of relationships and standards
of conduct available.\677\ Finally, for retail investors that rely on
professional or personal recommendations in their search for financial
professionals, the proposed prohibition on the use of certain titles is
likely to have a limited effect on both search costs and the risk of
mismatch in the advice relationship.
---------------------------------------------------------------------------
\677\ As discussed above, however, financial professionals who
are not themselves investment advisers or supervised persons of
investment advisers and who provide advice on behalf of such
advisers would also not be able to use the terms ``adviser'' or
``advisor'' in their professional titles.
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ii. Costs of the Restriction on the Use of Certain Titles
Although the Commission preliminarily believes that the proposed
rule would decrease investor confusion, search costs, and mismatch for
some segment of the investor pool that search for professionals based
on names or titles, investor confusion and search costs could increase
for those that would have, in the absence of the rule, selected broker-
dealers and associated natural persons that would have to change their
company names or titles as a result of the proposed rule.\678\ For
example, prospective customers familiar with a firm's name or financial
professional's title may be especially confused by a change of either
name or title to the extent that the term ``adviser'' or ``advisor'' is
part of the firm's name brand or the titles of the professionals. Any
increase in confusion as a result of the rule along these lines would
likely be larger if the changed names or titles of broker-dealer firms
that currently contain the words ``adviser'' or ``advisor'' are widely
recognized as brands by investors.\679\ Further, even if the broker-
dealer name or title is unlikely to change, some investors may remove
certain firms from their search list as professional names or titles
change as a result of the rule. If, for example, a prospective investor
is using the search term ``financial advisor'' to search for firms and
financial professionals located in their city, some firms and financial
professionals will be removed from any possible searches by these
investors as a result of the proposed rule, even though these financial
professionals might have been the best match to the preferences and
expectations of the investor. However, these kind of potential costs to
some current investors are likely to be limited to the extent that
proposed rule is limited to firm name or title and individual job name
or title and would not require firms and financial professionals to
remove the restricted terms from other content, if they are not using
such terms as a name or a title.
---------------------------------------------------------------------------
\678\ As discussed in the baseline, several studies indicate
that many investors receive personal or professional referrals in
the selection of their broker-dealer or investment advisor. However,
even these investors may investigate these referrals prior to
undertaking outreach, and therefore, may avoid certain financial
professionals as a result of the name or title change.
\679\ As discussed in the baseline, approximately 87 broker-
dealers that are not dually registered as investment advisers and do
not report non-securities business use the words ``adviser,''
``advisor,'' or ``advisory'' as part of their current company name.
These firms would likely have to change their company name as a
result of this proposed rule. However, any loss in brand value due
to this change could be mitigated to the extent the prohibited terms
are not an important part of the firm's brand.
---------------------------------------------------------------------------
The proposed rule may also increase investor confusion to the
extent some firms and financial professionals invent new names or
titles to substitute for the restricted ones. Studies already indicate
that the wide variety of names and titles used by firms and financial
professionals causes general investor confusion about the market for
investment advice. The magnitude of such costs is hard to predict, but
would likely increase search costs for less knowledgeable retail
investors that use names or titles to search for financial
professionals or firms, and may also increase the likelihood of a
mismatch for some of these investors between the type of advice
relationship they prefer and the type of firm and financial
professional they hire.
Investors seeking advice from broker-dealers may also face
potential harm if some broker-dealers change their business model as a
result of the proposed rule. As discussed above, we believe that most
broker-dealers that would be subject to the restrictions of the
proposed rule have chosen names and titles to build their customer
base. Given that the market for investment advice overall appears to be
relatively competitive, with respect to the number of firms and
financial professionals, firms and financial professionals likely have
chosen names or titles that they view as effective in marketing their
services to investors. Therefore, being forced to switch names or
titles could reduce the potential customer flow for some broker-dealers
(and registered representatives of dual registrants who are not
supervised persons of an investment adviser or who are supervised
persons but do not provide investment advice on behalf of such
investment adviser) who currently are using name or titles which
include the term ``adviser'' and ``advisor'' and who serve retail
investors. In lieu of adopting a new name or title without ``adviser''
or ``advisor,'' these firms or financial professionals might respond by
exiting the retail investor market, or may bypass the compliance and
other costs associated with this proposed rule by also registering as
investment advisers or becoming supervised persons of an investment
adviser who provide investment advice on behalf of such investment
adviser, which would change their incentives to market their brokerage
services to investors.\680\ Either of these changes to business
practices could reduce the availability of broker-dealer services for
investors.\681\ To the
[[Page 21506]]
extent the costs of exiting the retail investor market or associated
initial and ongoing costs of becoming a registered investment adviser
(or a supervised person of an investment adviser who provides
investment advice on behalf of such investment adviser) are greater
than the costs associated with complying with the proposed rule, the
likelihood of exit from the retail market or a change to the existing
business model from a brokerage to advisory model would be low. In this
case, the anticipated effect on investors from the loss of existing
broker-dealer advice is expected to be limited. However, if it is
costlier to change names or titles than to switch business model for
broker-dealers, we expect some investors may experience a reduction in
supply of broker-dealer advice services. Finally, because the
Commission recognizes that a standalone broker-dealer can provide
advice to retail investors without being regulated as an investment
adviser provided that such advice is merely ``solely incidental to''
its brokerage business and the broker-dealer receives no ``special
compensation'' for the advice, the proposed restriction would not
prevent standalone broker-dealers from conveying the services that they
provide in other content, without using the titles or names ``adviser''
or ``advisor.'' This may also limit the likelihood of exit from the
retail market or a change to the existing business model from a
brokerage to an advisory model.
---------------------------------------------------------------------------
\680\ Some firms could potentially increase their profits by
moving some customers from a brokerage account to an advisory
account (e.g., customers who rarely trade). Such firms would have
incentives to cut back on marketing of existing brokerage services
to such customers and instead market the new advisory services.
\681\ For example, in the event of exit by a broker-dealer,
investors who want broker-dealer services would be forced to
undertake search costs to find another firm and financial
professional to meet their perceived needs, but also bear an
increased cost associated with mismatch if they choose the wrong
type of firm and financial professional. In the event of a switch
from a brokerage model to an advisory model, investors may be forced
to bear the costs associated with an advisory account that could
exceed costs associated with services provided by a broker-dealer,
or face costs associated with search and mismatch if they choose to
change financial intermediaries, as discussed above.
---------------------------------------------------------------------------
The proposed rule could, however, also increase the risk of
mismatch for some investors by removing standalone registered broker-
dealers and registered representatives of dual registrants who are not
supervised persons of an investment adviser from the pool of financial
intermediaries that use the terms ``adviser'' or ``advisor'' in names
and titles, while not affecting the use of these terms by other types
of financial intermediaries, including banks, trust companies,
insurance companies, and commodities professionals. Investors who are
seeking financial services from either investment advisers or broker-
dealers could instead inadvertently hire other types of financial
intermediaries that would continue use these terms ``adviser'' or
``advisor,'' thereby potentially exacerbating the degree of mismatch
between the type of relationship that they seek and what they receive.
Further, neither this rule nor the proposed relationship summary would
address the potential mismatch because these entities and natural
persons are outside of the scope of the Commission rules. The
Commission is not able to estimate the scope of this continuing
potential for mismatch because we do not have access to information on
the extent to which retail investors include these other types of
financial intermediaries (deliberately or inadvertently) in their
search for financial advice, nor the extent to which they see the
services provided by these other financial intermediaries as substitute
for the services provided by investment advisers or broker-dealers.
Another potential cost for investors is that affected broker-
dealers may attempt to directly pass through any costs they would incur
due to the proposed restriction on certain names and titles. A broker-
dealer's incentives for such pass-through behavior would be attenuated
the more competitive the broker-dealer's local market is in the sense
that price sensitivity of demand is high.
Finally, we note that many of the costs and benefits to investors
that we discussed above depend on the extent that titles and names
affect investors' selection of their financial professional. The
evidence discussed in Section IV.A.3.a suggests that between 40% and
50% of investors find their financial professionals through personal
recommendations.\682\ For this set of investors, the proposed rule
would likely have little impact on search costs or potential for
mismatch between their preferences and expectations and the type of
advisory service for which they contract. We also note that we are not
able to provide quantitative estimates of potential changes in search
costs. Search costs for investors as well as costs due to mismatch
would depend on a large set of individual specific factors, such as
exactly what procedures investors use to search for financial
professionals, what restrictions they put on their search (for example,
choice of market, how many firms or professionals they are willing to
sample before making a decision), the method they use to evaluate
different alternative financial professionals they have identified,
etc. The costs will to a large part not be monetary in nature but
rather in the form of time and effort spent. The monetized value of
that time and effort will also be individual specific. We do not have
access to data that would provide us with this type of information,
which we would need to estimate search costs. Similarly, we also are
unable to provide estimates of changes in costs due to changes in the
potential for mismatch as we do not currently have data on the
percentage of the investor population that is mismatched, or the extent
of harm that comes from mismatch.\683\ For example, we don't have an
analysis of how well someone would have done in their portfolio
(especially after costs) if they had been correctly matched.
---------------------------------------------------------------------------
\682\ RAND Study, supra note 5 and 917 Financial Literacy Study,
supra note 20.
\683\ To estimate the potential harm from mismatch we would need
to analyze how well someone could have done in their portfolio
(after costs) if they had been correctly matched. This requires a
rich set of investor characteristics as well as information about
the investment menus and fee structures of potential alternative
firms and financial professionals investors could have hired. We do
not currently have access to such detailed information.
---------------------------------------------------------------------------
iii. Benefits and Costs of the Required Disclosures About Regulatory
Status of a Financial Services Provider
We anticipate the proposed requirements for broker-dealers and
investment advisers and their associated natural persons and supervised
persons to prominently disclose their registration (or firm association
for financial professionals) status in retail investor communications
would reduce investor confusion as well as search costs associated with
locating and hiring a firm, which could reduce the probability of
mismatch for investors seeking advice. In particular, for investors who
understand the meaning of the registration status and know they want to
hire either a registered broker-dealer or a SEC-registered investment
adviser, we expect the search for the correct type of firm will be made
both clearer and less time consuming, as these investors will more
readily observe the registration status. Search costs for investors for
whom the registration status has little meaning, however, are not
expected to experience a decrease in either confusion or search costs
due to these disclosure requirements. Disclosure may also reduce the
possibility of mismatch of hiring the wrong type of firm for investors
who understand the meaning of the registration status and know what
type of financial intermediary they want to hire, although we note that
the likelihood for such mismatch is likely lower in the first place for
such investors compared to less knowledgeable investors. For the pool
of investors that are confused by both the type of advice relationship
that they
[[Page 21507]]
prefer, including how they want to pay for it, as well as
professionals' titles, disclosure of registration status alone may not
be sufficient to alleviate confusion in the type of advisory services
provided by or the standard of conduct applicable to firms or financial
professionals. Finally, for retail investors that rely on professional
or personal recommendations in their search for financial
professionals, the disclosure requirement is likely to have a limited
effect on both search costs and the risk of mismatch in the advice
relationship. As discussed above, we do not have access to information
that would allow us to provide quantitative estimates of the potential
costs and benefits to the investor from these proposed disclosure
requirements.
In general, we do not anticipate any costs to investors from the
proposed rules to disclose registration status. However, it could be
that firms may attempt to pass through any compliance costs to
investors through higher fees, in particular those that operate in
markets where the price sensitivity of demand may be lower. Given that
compliance costs would be of a one-time nature, as discussed above, we
believe the likelihood and magnitude of such pass-through would be low.
b. Standalone Registered Broker-Dealers
The proposed rule would restrict broker-dealers who are not dually
registered as investment advisers and their associated natural persons
who are not themselves investment advisers or supervised persons of
investment advisers that provide advice on behalf of such advisers from
using the terms ``adviser'' or ``advisor'' when communicating with
retail investors. As described previously in Section IV.A.1,
approximately 87% of retail facing broker-dealer firms and 50% of
registered representatives are not dually registered as investment
advisers, and therefore potentially could be affected by the proposed
restriction. The fraction of standalone broker-dealer firms that are
currently using the terms ``adviser'' or ``advisor'' in their firm
names or titles and do not report a non-securities business, is only
approximately 3.5%.\684\ When it comes to names or titles by registered
representatives at standalone broker-dealers, the RAND Study evidence
discussed in Section IV.A.1.f suggests that around 31% of professionals
providing only brokerage services used titles containing the terms
``adviser'' or ``advisor.'' If the evidence presented in the baseline,
is representative of the overall universe of standalone registered
broker-dealers, the fraction of firms and associated natural persons
that would be affected by the proposed prohibition may be relatively
low.\685\
---------------------------------------------------------------------------
\684\ As discussed in supra Section IV.A.1.f, there are 87 (103-
16 = 87) retail facing standalone broker-dealers without non-
securities business that are currently using one of these terms in
their firm names, which represents approximately 3.5% of the 2,497
retail acing standalone broker-dealers (2,857-360 = 2,497; see supra
Table 1, Panel B). If we go beyond firm names and instead look at
how firms' publicly describe themselves on their websites, the
evidence presented in Section IV.A.1.f suggests that of the sampled
standalone broker-dealers, less than 10% describe themselves using
the terms ``adviser'' or ``advisor.'' Although some of these website
descriptions may still be allowed under the proposed rule, it
suggests that the fraction of standalone broker-dealers that rely on
these terms to describe themselves may be relatively low.
\685\ We estimate that approximately 226,132 (942,215 x 0.24 =
226,132; see supra Table 6) registered representatives of broker-
dealers are not also registered as investment advisory
representatives. Among these registered representatives,
approximately 119,729 are employed by dually registered firms
(494,399 x 0.61 x 0.397 = 119,729; see supra Section IV.A.1.e),
which means 106,403 are employed by standalone broker-dealers.
Further, if only 31% of broker-dealer registered representatives
that are not dual-hatted (see supra Table 8) use titles containing
the terms ``adviser'' or ``advisor,'' then we estimate that the
total number of non-dual hatted registered representatives that
would be potentially subject to this proposed prohibition would be
70,101, which is approximately 15.5% of all registered
representatives. Of these representatives, 32,985 (0.31 x 106,403 =
32,985) are employed by standalone broker-dealers and approximately
37,116 (0.31 x 119,729 = 37,116) are employed by dual registrants.
Note, the number of non-dual hatted registered representatives at
dual registrants that would be potentially affected by the rule is
likely lower than the estimated 37,166 because some of these
representatives may be supervised persons providing advisory service
without being dual-hatted. We are not able to estimate how large the
fraction of such registered representatives would be. On the other
hand, we do not have information about how many dual-hatted
registered representatives among dual registrants that they are not
supervised persons providing advisory services despite being dual-
hatted, and therefore would also be subject to the proposed
restriction on the use of certain titles.
---------------------------------------------------------------------------
If the proposed restriction on certain names or titles would reduce
potential investor confusion and prevent retail investors from
potentially being misled, it could have some positive benefits for the
subset of broker-dealers that would be impacted by this restriction but
are not marketing advice services to attract business. In particular,
these broker-dealers may be able to better attract customer flow and
more efficiently target their marketing and advertising campaigns to
reduce the likelihood of ``false starts'' associated with the potential
mismatch with retail investors. Moreover, broker-dealers that are not
dually registered may similarly benefit from the requirement to
prominently display registration status as that may also help reduce
investor confusion. Firms and financial professionals may also realize
a limited benefit from this disclosure such that they can more
effectively signal their type in communications, even when the firm or
professional names or titles are not perfectly aligned with the
registration status.\686\
---------------------------------------------------------------------------
\686\ Note that any such benefits from the proposed rules relies
on an assumption that some broker-dealers are not currently
optimizing to receive such benefits by voluntarily changing names
and titles or prominently display their registration status.
However, as noted above, we expect in an efficient market, firms
have already chosen names and titles that they view as effective
marketing tools. As a result, we expect this benefit will be limited
to the extent firms are currently rationally optimizing their choice
of names and titles.
---------------------------------------------------------------------------
For the segment of broker-dealers that would be affected by a
restriction of using the terms ``adviser'' or ``advisor,'' we
anticipate potentially substantial, one-time costs associated with the
proposed rule. Broker-dealer firms subject to the restrictions on the
use of certain names or titles would be required to change current
company names or titles (if the company name or title contains
``adviser/advisor''), and marketing materials, advertisements (e.g.,
print ads or television commercials), website and social media
appearances that use the current company name or title, among other
items, resulting in direct compliance costs. Similarly, all personal
communications tools used by financial professionals, such as business
cards, letterhead, social media profiles, and signature blocks would
need to be amended to reflect new company and financial professionals'
names or titles. The proposed requirement to prominently disclose
registration status in print or electronic retail investor
communications is also expected to require changes to the same set of
materials and communication tools, and therefore, also would have to be
modified to incorporate the registration status in the manner the rule
prescribes.\687\
---------------------------------------------------------------------------
\687\ See infra Section V.G for estimates of some of these
compliance costs developed for the purpose of the Paperwork
Reduction Act.
---------------------------------------------------------------------------
To the extent that the costs discussed above have a fixed-cost
component (i.e., a print ad would likely cost the same regardless of
the size of the firm), the costs associated with producing new
communication and advertising materials would be disproportionately
higher for smaller broker-dealer firms. Other costs, however, may
increase with the size of the broker-dealer, such as costs associated
with revisions to each individual representative's communication and
advertising materials, and therefore would increase with a broker-
dealer's size.
[[Page 21508]]
In addition to direct compliance costs associated with producing
new materials, broker-dealers would likely bear costs associated with
contacting current and prospective customers, whether by email, mass
mailings, one-on-one meetings, or telephone conversations, to inform
them of changes to names and titles. Such outreach on behalf of the
broker-dealer or the individual representatives would inform existing
and prospective investors of a name or title change, and whether or not
any services have changed and may be necessary in order to minimize any
confusion among current and prospective customers that could
potentially lead to a loss of business during a ``changeover''
period.\688\ This kind of outreach, however, could be costly to
financial professionals and firms if it diverted time and resources
away from the core business of the broker-dealer.\689\ Further, the
greater the name recognition of a current company or the larger the
size of the company, the costlier such an outreach is likely to be as
more current and prospective customers would need to be informed of the
name change. Finally, to the extent that a broker-dealer's company name
is recognized as a brand in the market and therefore represents a
valuable intangible asset to the firm, some of its ``brand value'' may
be lost following a company name change.\690\ We note that the number
of broker-dealer firms whose brand value may be negatively affected by
the rule is relatively limited, as only around 3.5% of the broker-
dealer firms that would be subject to the rule are using any of the
prohibited terms in their company names.\691\
---------------------------------------------------------------------------
\688\ In particular, without outreach, some broker-dealers could
experience a temporary reduction in the flow of prospective
customers that would have relied on the use of titles prohibited by
the proposed rule. In the absence of the prohibitions, these
investors would have ended up contracting with the broker-dealers,
but due to confusion over new company names and titles that would be
required to be used, these investors may avoid broker-dealers
subject to the change in names and titles, and these broker-dealers
could earn less revenue. Only after the potential customer base
becomes familiar with the new names and titles associated with a
given broker-dealer and its financial professionals, or the search
costs associated with these new titles decline, could these firms
potentially recover a portion of the prospective customer base that
was originally lost during the name transition period as a result of
the changeover confusion. The Commission does not have access to the
type of detailed customer information of individual broker-dealers
that would allow us to estimate the percentage of customers that
might be confused as a result of the name change or what fraction of
these customers might eventually be recovered by a broker-dealer.
\689\ Although such outreach is not required by the proposed
rule, we anticipate that at least some percentage of affected
broker-dealers or financial professionals would undertake such
efforts in order to maintain good relationships with existing
customers.
\690\ Academic evidence suggest corporate brands are valuable
intangible assets to firms; see, e.g., M. E. Barth, M. B. Clement,
G. Foster, & R. Kasznik, Brand values and capital market valuation,
Review of Accounting Studies, 3(1), 41-68 (1998).
\691\ See supra note 648. Specifically, 3% refers to the total
number of broker-dealers that do not report non-securities business.
---------------------------------------------------------------------------
Likewise, broker-dealers facing no constraints on their choice of
names and titles may choose the names and titles that they believe are
the most effective at helping attract customers, and may best describe
their business model, and reduce the effort associated with building a
customer base, as described above.\692\ Therefore, a segment of broker-
dealers that are currently using terms that would be restricted under
the proposed rule could experience a reduction in the efficiency of
their marketing efforts, which in turn might lead to fewer customers
and a loss of revenue compared to the baseline. In particular, those
broker-dealers that rely on advice services as an important part of
their value proposition to retail investors and directly compete with
investment advisers may lose competiveness, if names and titles become
less descriptive of this aspect of their business in the eyes of retail
investors. These marketing efficiency costs would be mitigated to the
extent the broker-dealers would use new names and titles that are
equally efficient at conveying they are providing advice, or to the
extent that the proposed restriction would not affect the use of terms
such as ``advisory services'' in other content, or using them in
metadata to attract internet search engines.\693\
---------------------------------------------------------------------------
\692\ See discussion in Section IV.C.1.
\693\ Note that to the extent affected broker-dealers would
choose other names and titles that convey a similar signal to
investors as those containing the terms ``adviser'' or ``advisor,''
it would reduce the efficiency of the proposed prohibition. In
Section IV.C.4.a we discuss an alternative that would prohibit a
broker-dealer from otherwise ``holding out'' as an investment
adviser, which would potentially also prevent the use of some
similar names and titles.
---------------------------------------------------------------------------
Although we recognize that a significant fraction of a broker-
dealer's customer base is attributed to referrals, as noted in the 917
Financial Literacy Study, approximately 25% of survey respondents rely
on broker-dealer or financial professional names or titles in selecting
their current advisor.\694\ Depending on how effective the terms
``adviser'' or ``advisor'' are at attracting customers, costs
associated with the loss of certain titles or names could be
substantial for some broker-dealers.\695\
---------------------------------------------------------------------------
\694\ See supra note 20.
\695\ For example, if investors know that they are seeking
advice related to individual transactions (e.g., the type of mutual
fund or exchange-traded fund in which to invest), they may have a
preference for terms such as ``financial advisor'' compared to terms
such as ``financial planner'' or ``investment strategist,''
depending on their colloquial understanding of what an these terms
might imply for the level of service and standard of conduct. If
certain broker-dealers are restricted from using ``financial
advisor,'' these firms may lose these potential customers. Moreover,
these investors could potentially expend search costs as they sort
through investment advisers that use the term ``financial advisor''
until the investor is able to match with the right type of financial
professional.
---------------------------------------------------------------------------
One way that affected broker-dealers could potentially mitigate the
costs associated with the potential loss of titles or names could be
for these firms to dually register as investment advisers. However,
dual registration imposes an additional layer of regulatory oversight
and compliance and need for training and licensing of employees to work
as investment adviser representatives, which would also be costly. A
broker-dealer would likely pursue such a strategy only if it expected
the costs of regulation as an investment adviser were lower than the
expected costs of modifying names and titles. We do not have access to
data that would allow us to estimate either the total costs for
modifying names and titles for broker-dealers, or the total costs of
becoming an investment adviser for these broker-dealers.
c. Investment Advisers (Including Dual Registrants)
The proposed restriction on the use of the terms ``adviser'' and
``advisor'' in names and titles does not apply to registered investment
advisers, whether they are solely registered as investment advisers or
whether they are dually registered. Consequently, there would be no
compliance costs for registered investment advisers associated with the
restriction on the use of certain terms in names or titles. Some
benefits could accrue to investment advisers at the expense of impacted
broker-dealers. However, supervised persons of investment advisers who
are dually registered but do not provide investment advice on behalf of
such investment adviser would be prohibited from using the terms, which
could lead to costs for those financial professionals or their firms.
Because the proposed restriction would force some standalone
registered broker-dealers to change their names and titles in a way
that may lead to less efficient marketing aimed at attracting potential
investors, as discussed above, some customer flow that might have gone
to these broker-dealers could be permanently diverted to investment
advisers who will not be required to
[[Page 21509]]
change their names.\696\ As a result, some investment advisers could
experience an increase in revenues due to an increase in customer flow.
The benefits may also be larger for investment advisers or dual
registrants that are able to continue to use names or titles that
include the term ``adviser'' or ``advisor'' as these terms could be the
draw that currently attracts customer flow to certain firms and
financial professionals, and that would be diverted due to a
restriction on the use of these terms by standalone registered broker-
dealers. In addition, assuming that small broker-dealers and investment
advisers select geographic areas where competition from larger firms is
low, then, as result of the proposed rule restricting the use of
certain names or titles by broker-dealers, small investment advisers
could especially benefit at the expense of small broker-dealers in
these locations.
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\696\ To the extent that investor confusion about the market for
financial services generally increases during the period when
affected firms and financial professionals remove the term
``adviser'' or ``advisor'' from their names and titles, investment
advisers that are not required to change their names or titles may
see an increase in the diversion of customer flow from broker-
dealers to investment advisers until investor confusion over the
change in titles subsides. To the extent that some investors that
are not currently making an efficient choice of a broker-dealer as
indicated by investor confusion about titles and associated
standards of conduct, and would choose an investment adviser after
the proposed rules were adopted, this proposed rule change may
assist them in making a more efficient choice to a service they
would prefer.
---------------------------------------------------------------------------
In terms of additional potential benefits, investment advisers and
dual registrants, like standalone broker-dealers, will be subject to
the required disclosure of their registration status, as part of the
proposed rules. As we discussed in the case of standalone registered
broker-dealers above, the prominent display of registration status
could help reduce investor confusion, and could be used by both firms
and their financial professionals as a marketing tool. Moreover, firms
may benefit from this disclosure such that they can more effectively
signal their type, even if the firm or professional names or titles are
not perfectly aligned with the registration status. These potential
benefits may be larger for dual registrants, as the prominent display
of both their registrations may help attract investors that are looking
for both types of services or investors who are generally unsure about
which type of services they want.\697\
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\697\ However, as noted previously, all firms and financial
professionals can already voluntarily choose to prominently display
their registration status, therefore implying that the direct
benefits to firms and financial professionals from the proposed rule
requiring disclosure of registration status may be limited.
---------------------------------------------------------------------------
The proposed restriction on the use of certain names and titles
would apply to financial professionals of dual registrant investment
advisers who are not supervised persons of an investment adviser or who
are supervised persons of an investment adviser but who do provide
investment advice on behalf of such investment adviser, which could
lead to costs for those financial professionals or their firms.
Consistent with the discussion of standalone registered broker-dealer
firms above, this segment of persons associated with dual registrants,
and the dual registrants themselves, could bear a potentially
substantial, one-time costs associated with the proposed rule to change
marketing materials and other communications to remove the restricted
terms and to explain the change to their customers. Further, some
financial professionals using the restricted terms could experience a
reduction in the efficiency of their marketing efforts. This could
happen to the extent the terms were optimally chosen in the first place
from a marketing perspective. This, in turn, might lead to fewer
customers for the financial professional and his or her associated firm
and a loss of revenue compared to the baseline. Furthermore, financial
professionals that are not currently supervised persons of an
investment adviser, or cannot immediately qualify to be hired in such a
professional role may become less attractive to retain or hire by dual
registrants, to the extent their services would be less valuable to
dual registrants if they cannot use the terms ``adviser'' or
``advisor'' in their names or titles. These financial professionals
could potentially mitigate the costs associated with the potential loss
of names or titles by becoming a supervised person of an investment
adviser and providing investment advice on behalf of such investment
adviser. A financial professional would likely pursue such a strategy
only if it expected the costs of becoming a supervised person of an
investment adviser who provides investment advice on behalf of such
investment adviser were lower than the expected costs of modifying
their professional names or titles.
We expect the proposed requirements to prominently disclose
registration status to impose one-time direct compliance costs
associated with changes to written and electronic retail investor
communications on both investment advisers and dually registered
financial firms.\698\ Similar to standalone registered broker-dealers,
we expect that to the extent the required changes have a fixed-cost
component, smaller investment adviser firms would incur relatively
higher costs associated with this disclosure. Larger investment
advisers and dual registrants, however, would likely bear an increase
in the variable costs associated with such disclosures, as the amount
of revisions associated with individual representative's and firm's
communications will rise.\699\
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\698\ See infra Section V.H. for estimates of some of these
compliance costs developed for the purpose of the Paperwork
Reduction Act.
\699\ Consistent with this argument, we estimate in the
Paperwork Reduction Act analysis in infra Section V.H.2, that the
initial one-time burden for complying with the disclosure
requirements would be 72 hours per large investment adviser and 15
hours per small investment adviser.
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3. Impact on Efficiency, Competition, and Capital Formation
In addition to the specific benefits and costs discussed in the
previous section, the Commission expects that the proposed disclosure
could cause some broader long-term effects on the market for financial
advice. Below, we elaborate on these possible effects, specifically
discussing the impact on efficiency, competition and capital formation.
a. Efficiency
As discussed above, the proposed rules have the potential to reduce
investor confusion about the meaning of the names and titles used by
firms and their financial professionals and to improve the matching
between investor preferences and types of services they receive. To the
extent retail investors use titles and names in their search for firms
and financial professionals, the potential reduction in search costs
would improve the overall efficiency of the market for financial advice
by making the search process shorter in time and more cost effective.
Moreover, to the extent the proposed rules would reduce the risk of any
mismatch between investor preferences and the type of relationship
their financial professional provides, it could lead to potentially
improved efficiency in retail investors' asset allocation as investors
would be more likely to receive investment advice that is optimal for
their individual situation. A reduced risk of mismatch in the
relationship would also make it less likely that investors pay more
than necessary for the services they receive, which could lead to
higher investment returns net of cost.
[[Page 21510]]
Alternatively, as discussed previously, investor confusion may
increase rather than decrease under certain circumstances, which would
increase search costs for investors. In this case, we would instead
expect a negative effect on efficiency. Moreover, there could also be
negative effects on efficiency to the extent affected broker-dealers
start using new names and titles that potentially convey the same
information to investors as the restricted terms. Under such
circumstances, the proposed rules would then only impose cost increases
on broker-dealers without achieving any reduction of investor
confusion. These costs may or may not be passed through to investors.
In addition, some of the other potential costs outlined previously
could have negative effects on efficiency. For example, this proposed
rule could have a direct negative impact on efficiency in the
registered broker-dealer segment of the market by making marketing less
efficient for any affected broker-dealers (including any affected dual
registrants with affected registered representatives). Further, any
compliance costs or increased marketing costs may be passed through to
investors in local markets where the competitive pressure is relatively
low--for example, due to, a relatively low supply of financial
professionals--and some investors may then face higher costs for
broker-dealer services as a result. Finally, some affected firms and
financial professionals may decide to exit the market if their costs of
doing business go up substantially, which could decrease supply and
increase costs of brokerage services for retail investors in some
segments of the market. Any such increases in costs of broker-dealer
services may also price some investors with limited ability to absorb a
cost increase out of the brokerage market altogether, thereby limiting
their access to advice and investment choices offered by broker-dealers
and potentially hurting the efficiency of their investment allocation.
Because of the complexity associated with the use of names or
titles by firms and their financial professionals, and their potential
importance for investors both with respect to investor confusion and as
a selection mechanism for hiring financial professionals, coupled with
the lack of data on how investors could react to a restriction of the
use of certain names and titles among broker-dealers and their
associated natural persons, we are unable to provide estimates for the
potential effects on efficiency. However, we preliminarily believe that
any potential effects on the overall efficiency in the market for
financial advice, or in segments of this market, are likely to be
limited because of several factors that would mitigate the potential
impact on investor confusion and/or the potential costs imposed on
firms and financial professionals from the proposed restriction: (i)
Only a fraction of standalone registered broker-dealers and their
associated natural persons, as well as registered representatives
working for dual registrants that are not dual-hatted are currently
using the terms ``adviser'' and ``advisor'' in names and titles; \700\
(ii) the extent to which the proposed restriction would not affect the
use of terms such as ``advisory services'' in communications which do
not convey a name or title; (iii) financial intermediaries and
professionals not regulated by the Commission could still use the terms
``adviser'' or advisor'' in their names and titles.\701\
---------------------------------------------------------------------------
\700\ The use of names and titles by firms and financial
professionals is discussed in Section IV.A.1.f. Only around 87
current standalone broker-dealers with retail investors use the
terms ``advisor'' or ``adviser'' in their company names. Further,
around 31% of professionals providing only brokerage services used
titles containing the terms ``adviser'' or ``advisor'' according to
the RAND Study.
\701\ See discussion of other such financial intermediaries and
professionals in supra Section III.B.1.
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The proposed requirements to disclose a firm's regulatory status
and a financial professional's association may increase the efficiency
in the search and matching process in the market for financial advice
to the extent retail investors understand the meaning of the
registration status and would use it in their search for financial
professionals. Among firms, the potential efficiency benefits may be
larger for dual registrants, as the prominent display of both types of
registrations may help attract investors that are looking for both
brokerage services and an investment advice relationship, or investors
who are in general unsure about which type of services they want.
b. Competition
The proposed rules could affect competition in the market for
financial advice through potential effects on both demand and supply in
the market. In terms of potential effects on demand, to the extent
search costs are reduced for investors, it may raise the price
elasticity of demand and consequently we would expect the competition
between firms in this market to increase.\702\ To the extent it is
primarily investors who prefer the services provided by investment
advisers who would experience a reduction in search costs, we would
expect in particular an increase in the average price elasticity of
demand for investment adviser services and therefore greater
competition in the investment adviser market segment. However, a
reduction in search cost may also increase retail investor
participation in the market for financial advice. Investors at the high
end of the search cost distribution who previously may have refrained
from seeking financial advice altogether may enter the market for
financial advice if there is a reduction in search costs. Because these
new entrants to the market for financial advice would likely have
higher search costs than the existing investors in the market, average
investor demand elasticity may go down, which in turn would reduce
competition at the margin.\703\ To the extent it is mainly investors
that prefer investment adviser services who would experience a
reduction in search costs; we expect the new entrants to primarily
belong to this group of investors. Therefore, the average demand
elasticity may potentially decrease in particular for investment
adviser services and reduce competition in the investment adviser
market segment.
---------------------------------------------------------------------------
\702\ All else equal, we would expect customers in a marketplace
with differentiated products to prolong their search for the right
product at the right price if search costs are reduced. The
resulting increase in demand elasticity would increase downward
pressure on prices in the market, see, e.g. S. Anderson & R.
Renault, Pricing, Product Diversity, and Search Costs: A Bertrand-
Chamberlin-Diamond Model, The RAND Journal of Economics, 30, 719-735
(1999).
\703\ For a theoretical model on how lower search costs may
increase the average price elasticity of demand in this manner, see,
e.g., J. L. Moraga-Gonz[aacute]lez, Z. S[aacute]ndor, & M.R.
Wildenbeest, Prices and heterogeneous search costs, The RAND Journal
of Economics, 48, 125-146 (2017). A study of the U.S. mutual fund
industry also provide empirical evidence consistent with this type
of effect; see A. Horta[ccedil]su & C. Syverson, Product
differentiation, search costs, and competition in the mutual fund
industry: A case study of S&P 500 Index funds, The Quarterly Journal
of Economics, Vol. 119, Issue 2, 403-456 (May 2004).
---------------------------------------------------------------------------
Conversely, if investor confusion and associated search costs
instead are increased by the proposed rules, which as we discussed
previously may happen under certain circumstances, it would likely
lower price elasticity of demand among current retail investor market
participants and reduce competition in the market for financial advice.
However, if search costs are increased to the extent that current
investors at the high end of the search cost distribution are induced
to exit the market for financial advice altogether, it could instead
increase average demand elasticity and increase competition among the
firms in this market, as the
[[Page 21511]]
remaining investors would be those at the lower end of the search cost
distribution and consequently would have higher price sensitivity. To
the extent it is mainly investors that prefer broker-dealer services
who would experience an increase in search costs we expect the
investors exiting the market to primarily be such investors. Therefore,
the average demand elasticity may potentially increase in particular
for broker-dealer adviser services and increase competition in the
broker-dealer market segment.
In terms of the effect on the supply of advice services, to the
extent the proposed restriction on the use of certain names or titles
would cause affected broker-dealers to register as investment advisers
and start promoting that side of their business, or perhaps completely
move to an investment adviser model, there would likely be a shift in
the mix of supply of advice services, where the supply of broker-dealer
(and associated registered representative) services could potentially
decrease and the supply of investment adviser services could increase.
Such a shift in the mix of the supply of advice services could
potentially raise brokerage account prices, reduce choice for investors
who prefer to pay for execution of trades on a transactional basis, and
lower the costs of advisory accounts with investment advisers. However,
to the extent some broker-dealers would exit the market for retail
investors altogether, the overall supply of advice services could go
down and we may see a decrease in competition not only in the market
for broker-dealer services but also in the overall market for
investment adviser services, assuming that retail investors view
broker-dealer and investment adviser services as substitutes for one
another, thereby increasing costs and limiting choices for retail
investors. This potential negative effect on competition would be
mitigated to the extent other firms (whether other broker-dealers or
investment advisers) decide to compete for the customers of any broker-
dealers exiting the market.
Further, to the extent the proposed restriction would make
standalone broker-dealers services more costly and marketing less
effective, non-affected standalone broker-dealers (i.e., broker-dealers
that do not use the restricted terms), dual-registrants, investment
advisers, and financial intermediaries that are not registered as
investment advisers (such as banks, trust companies, insurance
companies, commodity trading advisers, and municipal advisors) may to a
varying degree gain business at these affected firms expense. That is,
by only affecting a subset of firms, the proposed restriction on the
use of certain names and titles may change competitive positions among
different suppliers in the market for financial advice. In addition,
the proposed requirement to disclose registration status may benefit
the competitive positon of dual registrants, as the prominent display
of both types of registrations may help attract investors that are
looking for both brokerage services and an investment advice
relationship, or investors who are in general unsure about which type
of services they want.
In addition, assuming that small broker-dealers and investment
advisers select geographic areas where competition from larger firms is
low, then any reduction of competition in the broker-dealer market due
to a switch to an investment adviser business model would be
particularly large in such geographic areas. Similarly, any reduction
in competition due to exit of standalone registered broker-dealer
altogether from the retail market would be particularly large in such
geographic areas, where smaller investment advisers and dual
registrants could especially see competitive benefits at the expense of
small standalone registered broker-dealers.
We are not able to assess the magnitude of the potential demand or
supply related effects as we do not have access to information that
would allow us to do so, such as the distribution of search costs
across the population of retail investors, estimates of the effect of
the proposed rules on search costs, the internal cost functions of
broker-dealers, etc. However, we preliminarily believe that the impact
of any effects on the overall competitive situation in the market for
financial advice is likely to be limited because of the same three
mitigating factors we discussed above regarding the potential impact on
efficiency.\704\
---------------------------------------------------------------------------
\704\ See discussion of mitigating factors in supra Section
IV.C.3.a.
---------------------------------------------------------------------------
c. Capital Formation
Some aspects of the proposed rules could lead to increased capital
formation, if, for example, retail investors are better able to
allocate capital due to a better match with financial professionals or
more retail investors enter the market for financial advice and start
investing in securities. However, as discussed above, if some broker-
dealers exit the market or move to an advisory business model as a
result of the proposed rules, some investors may lose access to the
market for advice serviced by broker-dealers, which may cause them to
exit the market for financial advice altogether and reduce their
(direct or indirect) investments in productive assets, thereby reducing
capital formation. Alternatively, any investors who lose access to
broker-dealers services may switch to an investment adviser
relationship, which could reduce their investment returns net of costs
to the extent the broker-dealer payment model was more optimal for
their investment preferences, thereby also potentially reducing capital
formation. Overall, the Commission is unable to determine how these
countervailing effects could impact capital formation, and what the
likely magnitude of those impacts would be. However, we preliminarily
believe that the proposed rules would have a limited impact on capital
formation because of the same three mitigating factors we discussed
above regarding the potential impact on efficiency.\705\
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\705\ See discussion of mitigating factors in supra Section
IV.C.3.a.
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4. Alternatives to the Proposed Rules
As discussed above, the proposed rule would restrict broker-dealers
and their associated natural persons from using as part of a name or
title the term ``adviser'' or ``advisor,'' unless such broker-dealer is
dually registered as an investment adviser or the associated natural
person is a supervised person of an investment adviser and provides
advice on behalf of such investment adviser. Further, our proposed
rules would also require both broker-dealers and investment advisers to
disclose their registration status in print or electronic retail
investor communications. Finally, the proposed rules would require
associated natural persons of a broker-dealer and supervised persons of
an investment adviser to disclose their association with a particular
firm in print or electronic retail investor communications. Below, the
Commission describes several alternatives to the proposed rules,
including the continued ability of broker-dealers to rely on section
202(a)(11)(C) of the Advisers Act (the ``Solely Incidental''
exclusion), prohibitions on a broker-dealer ``holding out'' as an
investment adviser, disclosure of the registration status only, or
additional requirements for dual registrants.
[[Page 21512]]
a. No ``Solely Incidental'' Exclusion
As an alternative to the proposed rule restricting the use of the
term ``adviser'' or ``advisor'' in names and titles, the Commission
could propose a rule that stated that a broker-dealer cannot be
considered to provide investment advice solely incidental to the
conduct of its business as a broker-dealer under section 202(a)(11)(C)
of the Advisers Act if the broker-dealer used the term ``adviser'' or
``advisor'' in names or titles, and therefore, would not be excluded
from the definition of investment adviser. This alternative would rely
on the assumption that a broker-dealer that uses these terms in its
name to market or promote its services is doing so because its advice
is significant or even instrumental to its brokerage business, and
consequently, the broker-dealer's provision of advice is therefore no
longer solely incidental to its brokerage business. Similarly, it would
also rely on the assumption that if a broker-dealer invests its capital
into marketing, branding, and creating intellectual property in using
the terms ``adviser'' or ``advisor'' in its name or title, the broker-
dealer is indicating that advice is an important part of its broker-
dealer's business.
This alternative, like the proposed rule, would not permit an
associated natural person of a dually registered firm to use the terms
``adviser'' or ``advisor'' in their names or titles unless such person
was a supervised person of a registered investment adviser who provides
investment advice on behalf of such investment adviser. For standalone
broker-dealers, and their associated natural persons as well as
associated natural person of a dually registered firm that are not
supervised persons of a registered investment adviser providing advice
on behalf of such investment adviser, that are currently marketing
their services to retail investors using the terms ``adviser'' and
``advisor,'' in their name or title, the economic effects of this
alternative would be expected to be substantially the same as under the
proposed restriction on the use of the terms in names and titles.
b. Prohibit Broker-Dealers From Holding Themselves Out as Investment
Advisers
Instead of prohibiting a broker-dealer from using certain names or
titles, we could propose a rule to preclude a broker-dealer from
relying on the solely incidental exclusion of section 202(a)(11)(C) if
a broker-dealer ``held itself out'' as an investment adviser to retail
investors. This approach could encompass a broker-dealer and its
associated natural persons representing or implying through any
communication or other sales practice (including through the use of
names or titles) that they are offering investment advice subject to a
fiduciary relationship with an investment adviser.
This approach would reduce the risk that by only proscribing
``adviser'' and ``advisor,'' or any other specific names and titles,
new names and titles could arise with similar, confusing connotations.
Moreover, this alternative could promote informed investor choices by
focusing more comprehensively on broker-dealer marketing and titles
that may confuse or mislead investors into believing that a brokerage
relationship is an advice relationship of the type provided by
investment advisers. Relative to either the baseline or the proposed
rule, the ``holding out'' alternative could have a broader application
because it could capture any communication or other sales practices
that may lead to confusion by investors in believing that their firms
or financial professionals provide more or different services than they
provide. As a result, investor confusion and associated costs may be
reduced more compared to the proposed rule.
This alternative, however, could create uncertainty for broker-
dealers as to which activities (and the extent of such activities)
would be permissible and not considered ``holding out'' as an
investment adviser and therefore triggering the need to register as
such. As a result of a ``holding out'' alternative, broker-dealers may
feel compelled to avoid fully describing even the types of advisory
services they are allowed to provide in their communications and
marketing efforts and may also limit or reduce allowable advice
provided by broker-dealers to avoid any instances where the advice
provided could be misconstrued that such person is ``holding out'' as
an investment adviser. Given that broker-dealers under the current
regulatory environment are permitted to provide incidental advice
related to recommendations of securities or investment strategies,
investor confusion may be increased and some investors may believe that
as a result of the ``holding out'' alternative that this advice could
no longer be offered, and could face a mismatch in their preferences
and expectations if they sub-optimally choose to hire investment
advisers and avoid broker-dealers. Therefore, implementing a rule along
these lines could have significant competitive effects for broker-
dealers, and could reduce the effectiveness in how investors choose
their firms and financial professionals. As a result of increased
investor confusion, both search costs and costs associated with
choosing the wrong type of firm and financial professional could be
increased under this alternative. Moreover, if some broker-dealers
avoid providing advice as a result of this alternative, some retail
investors may be shut out of the advice market entirely or may have to
incur higher costs that may be associated with investment advisory
services.
From a compliance cost perspective, broker-dealers that could be
subject to the ``holding out'' alternative would face costs in revising
their communications and advertisements in order to eliminate any
discussion about them implying they are offering investment advice
subject to a fiduciary relationship with an investment adviser. To the
extent such revisions have a significant fixed cost component or there
are other economies of scale, such as decreasing variable costs for
printed material as the number of copies increase, we would expect
smaller broker-dealers to face relatively higher costs following the
implementation of this alternative. There could also be increased costs
under this alternative from training and monitoring of associated
natural persons to ensure compliance with the rule, as the restrictions
would be more principles-based than prescriptive compared to the
proposed rule.
c. Disclosure of Registration Status Only
The proposed rules both prohibit certain names or titles and
require disclosure of broker-dealer or investment adviser registration
status in all written and electronic retail investor communications of
broker-dealers and SEC-registered investment advisers, including those
of individual representatives, such as business cards, social media
profiles, and signature blocks on paper or electronic correspondence.
As an alternative to the proposed rules, the Commission could not
propose a restriction on the use of certain names or titles by
standalone registered broker-dealers, and solely propose requiring
disclosure of registration status in all written and electronic retail
investor communications given by the firm or its representatives.
Although both broker-dealers and SEC-registered investment advisers
would have to bear the cost of including a disclosure of their
registration status in all written and electronic retail investor
communications under this alternative, they would have to bear this
cost under the proposed rules, as well.
[[Page 21513]]
This alternative, however, would allow broker-dealers to continue to
use titles or names that include ``Adviser/Advisor'' and therefore
would likely result in a lower overall cost of rebranding their
financial professionals or the firm itself in all other communications.
While the costs of compliance with a disclosure of registration
status only requirement would be lower than under the proposed rules,
and would apply uniformly to all broker-dealers and investment
advisers, this alternative could be less effective in reducing investor
confusion over the titles or names used by financial professionals and
firms, and the implications of the types of services provided by, or
standard of conduct applicable to, these professionals to the extent
the registration status is uninformative to retail investors because
they do not understand the regulatory implications of a firm being
registered as either a broker-dealer or an investment adviser.
Another potential, related, alternative would be to limit the
disclosure of registration status only to certain marketing
communications. The overall compliance costs to broker-dealers,
particularly small broker-dealers that are less likely to produce
advertising campaigns in either print media, television/radio
broadcasts, mass mailings, or on websites, would be lower than under
the requirements of the proposed rules for disclosure of registration
status in all communications. This alternative, however, would likely
reduce the potential benefits to retail investors, as only
``advertisements'' would be required to produce the disclosure of
registration status, and could increase both search costs and the
possibility of mismatch associated with choosing the wrong type of
financial firm or professional. To the extent small broker-dealers or
investment advisers are less likely to use these types of marketing
communications to reach potential customers relative to larger broker-
dealers and investment advisers (e.g., because there are fixed costs in
producing an advertisement, the reduction in benefits is more likely to
affect retail investors that use such small broker-dealers or
investment advisers). Therefore, the Commission preliminarily believes
that the potential compliance cost savings for limiting communications
that would require such disclosure do not justify the reduced level of
investor protection under such alternative.
Another ``disclosure only'' alternative to the proposed restriction
on the use of the terms ``adviser'' and ``advisor'' in names and titles
would be to propose a rule that would provide that when any broker-
dealer not registered under the Advisers Act chooses to distribute
advertisements or other communications using the term ``adviser'' or
``advisor'' as part of a name or title, each use of the term would have
to include an asterisked disclaimer clarifying its registration status.
Under this alternative broker-dealers and their associated natural
persons could continue to use these terms in their names and titles in
retail investor communications, but investors would be potentially
alerted by the asterisk to the actual registration status of the
broker-dealer, which may reduce investors confusion about the type of
services provided the associated standard of care to the extent they
understand the meaning of the registration status. One limitation of
this alternative, as well as the other alternatives discussed in this
section, compared to the proposed rule is that some of the evidence on
investor perceptions discussed previously in Section IV.A.3 suggest
that many retail investors may not fully understand the meaning of the
registration status. Moreover, the asterisked declaimer may not be
salient enough to attract investors' attention to the disclaimer.
d. Additional Requirements for Dual Registrants
We estimate that the number of dual registrants represents
approximately 13% of all retail broker-dealer firms and that
approximately 65% of registered representatives of retail broker-
dealers work at these dual registrants.\706\ Although the proposed rule
restricts supervised persons of dual registrants who do not provide
investment advice on behalf of such investment adviser, a percentage of
dually registered firms would not be affected by the proposed
restriction of certain names and titles. To address this issue, we
considered an alternative to the proposed rule which would prohibit the
name or title containing the terms ``adviser'' or ``advisor'' unless a
``a substantial part of the business consists of rendering investment
supervisory services.'' \707\ We also considered limiting dual
registrants' use of the term ``adviser'' or ``advisor'' to when they
provide advice to a retail investor in the capacity as an investment
adviser, and prohibiting dual registrants from using such terms when
acting in the capacity of a broker-dealer to a particular customer.
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\706\ As shown in supra Table 1, Panel B those broker-dealer
firms that were registered in a dual capacity were 360 of
approximately 2,857 firms (about 13%) as of December 31, 2017. Using
data from Form ADV filings, these 360 dually-registered firms had
approximately $4.3 trillion of AUM. As discussed in Section
IV.A,1.e, almost all registered financial professionals at dual
registrants are either dual-hatted or registered representatives.
Because dual registrants employ approximately 61% of all licensed
financial professionals (see supra Table 5) and approximately 94% of
all financial professionals are either dual hatted or registered
representatives (48/51 = 0.94; see supra Table 6), it means that
approximately 65% (0.61/0.94 = 0.65) of all registered
representatives, whether dual hatted or not, work at dual
registrants.
\707\ See section 208(c) of the Advisers Act.
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Under this alternative, some of the investor pool may face reduced
confusion in their communications with their financial professional
with regard to the use of specific names and titles, because these
names and titles containing the term ``adviser'' or ``advisor'' would
be limited only to the accounts or the instances in which the financial
professional actually serves in the capacity as an investment adviser.
However, these alternatives for dual registrants would create
substantial compliance challenges for dual registrants. For example,
dual registrants would have to ensure the appropriate name or title is
being used when the financial professional is engaging in multiple
capacities with investors. Moreover, requiring financial professionals
that are dual registrants to tailor their names or titles based on what
capacity they are acting in could increase confusion to investors,
given that some dual registrants might act in broker-dealer and
investment adviser capacities for a single investor. For example, a
retail investor may have both a brokerage account and an advisory
account, and may receive advice related to both brokerage
recommendations as well as ongoing advice in the advisory account in a
single communication.
5. Request for Comments
The Commission requests comment on all aspects of the economic
analysis, including the analysis of: (i) Potential benefits and costs
and other economic effects; (ii) long-term effects of the proposed
restriction on the use of certain titles and required disclosure of
registration status on efficiency, competition, and capital formation;
and (iii) reasonable alternatives to the proposed regulations. We also
request comments identifying sources of data and that could assist us
in analyzing the economic consequences of the proposed regulations.
In addition to our general request for comment on the economic
analysis, we request specific comment on certain aspects of the
proposal:
Do commenters agree with our assessment that the main
potential
[[Page 21514]]
benefits to retail investors are reduced search costs and a lower risk
of mismatch? Are there other benefits of the proposed rule that have
not been identified in our discussion and that warrant consideration?
Are the assumptions that form the basis of our analysis of the benefits
appropriate? Can commenters provide data that supports or opposes these
assumptions?
Do commenters agree with our characterization of the
costs? Are the assumptions that form the basis of our analysis of the
costs appropriate? Are there other costs to investors of the proposed
rule that have not been identified in our discussion and that warrant
consideration? Can commenters provide data that supports or opposes
these assumptions?
We request additional information on how retail investors
search for financial professionals. In particular, are there studies,
evidence or data available on how investors use company names and
titles of representatives in their search for a financial professional?
We request comments on our characterization of the
benefits and costs to broker-dealers and investment advisers of the
proposed rule. Do commenters agree with our characterization of the
benefits and costs? Are there other benefits or costs of the proposed
rule that have not been identified in our discussion and that warrant
consideration? Are the assumptions that form the basis of our analysis
of the benefits and costs appropriate? Can commenters provide data that
supports or opposes these assumptions?
We specifically request comments on the costs to broker-
dealers from having to change their company names as a result of the
rule. How costly do commenters believe it would be for affected
entities that would be required to their change current company names,
including the costs of marketing materials and advertisements? Do
broker-dealer company names have significant brand value? To what
extent does the brand value lie in terms such as ``adviser'' or
``advisor''?
Do commenters believe standalone broker-dealers that would
be affected by the proposed rule may decide to register as an
investment advisers? Are there any specific types of standalone broker-
dealers that would be more likely to respond in this way? Do you
believe standalone broker-dealers registering as investment advisers
would affect their supply of brokerage services? What are the
compliance and indirect costs for broker-dealers who would seek to
register as an investment adviser? Is there additional data to estimate
such costs, either initially or on an ongoing basis?
Are there any effects on efficiency, competition, and
capital formation that are not identified or are misidentified in our
economic analysis? Please be specific and provide data and analysis to
support your views.
Do commenters believe that the alternatives the Commission
considered are appropriate? Are there other reasonable alternatives
that the Commission should consider? If so, please provide additional
alternatives and how their costs and benefits would compare to the
proposal.
D. Combined Economic Effects of Form CRS Relationship Summary and
Restrictions on the Use of Certain Titles and Required Disclosures
About a Firm's Regulatory Status
Above, we have described the anticipated standalone economic
effects of the proposed Form CRS relationship summary and the proposed
restrictions on the use of certain titles and required disclosures
about a firm's regulatory status relative to the current baseline. In
this section, we discuss how we anticipate these economic effects could
change when considering both these proposed rules in combination.
To the extent that investors may be confused and potentially misled
about what type of investment advice relationship is best for their
investing situation, being provided with the proposed Form CRS, along
with the proposed restriction on names and titles, could incrementally
reduce some of the investor confusion and mismatch risk. In particular,
if a retail investor communicates with a financial professional
associated with a dual registrant and the professional has a name or
title containing either of the terms ``adviser'' or ``advisor'' but
solely provides brokerage services, such investor would likely receive
the dually registered firm's relationship summary. Because Form CRS
would include a description of both business models, without the
restriction on names and titles and the requirement of disclosure of
registration status, some retail investors might incorrectly match the
services they would receive from this financial professional to the
description in the relationship summary of investment advisory
services. In this case, the proposed restriction on names or titles and
the requirement to disclose regulatory status would increase the
effectiveness of Form CRS by reducing the risk of any mismatch between
investor preferences and type of services received due to this kind of
misunderstanding, which in turn may lead to harm such as the investor
paying too much for advice if it if it leads to frequent trading. To
the extent investors who received a relationship summary shares it with
family and friends, the potential importance of having the restriction
on the use of certain names and titles would be increased, because it
could also reduce the risk of this type of misunderstanding being
spread to a greater set of retail investors.
However, for those investors whose confusion about the differences
between broker-dealers' and investment advisers' services and standards
of conduct would be substantially reduced once receiving and reading a
firm's relationship summary we expect a reduced overall incremental
benefit of the proposed restriction on the use of certain names and
titles. Specifically, because such investors would learn about the
differences between broker-dealer and investment adviser services
through the relationship summary, they may be unlikely to hire the
wrong type of firm or financial professional even without the proposed
restriction on the use of certain names or titles.
With respect to the initial search costs borne by investors, we do
not believe that the relationship summary would alter the incremental
effects the proposed restriction on certain names and titles may have
on search costs, because the proposed Form CRS would generally be
provided at a later stage in the search process (e.g., after initial
contact with a financial professional is made) relative to the initial
stage where names and titles of firms and financial professionals may
be a useful search tool to investors. Similarly, we do not believe that
the relationship summary would alter the incremental effects on search
costs from the proposed requirement to disclose registration status in
retail investor communications, because investors would likely
encounter communications disclosing a firm's registration status prior
to being provided a firm's relationship summary.
We believe that the proposed Form CRS and the proposed required
disclosures of registration status would complement each other because
both are designed to reduce investor confusion. In particular, for less
knowledgeable investors, the disclosure of registration status may
raise awareness about the different forms of registration among
financial intermediaries and their associated natural persons and
prompt questions about the difference between registered broker-dealers
and registered investment advisers. The relationship summary
potentially could work in concert with the disclosure of
[[Page 21515]]
registration status to facilitate investors' learning about the
different types of financial firms and professionals because it would
highlight many of the key differences between investment advisers and
broker-dealers in different communications and different times,
consistent with the layered approach to disclosure that the
relationship summary is designed to further. Likewise, if the
disclosure of registration status makes such status more salient to
less knowledgeable investors, such disclosure may induce a more careful
reading of related parts in the relationship summary or provide
incentives to discuss the information contained in disclosure with a
financial professional. Thus, the combination of the disclosure of
registration status and the relationship summary may further help
facilitate the search process also for investors initially confused
about the difference between broker-dealers and investment advisers,
and help them ultimately better match to an appropriate financial
professional.
However, for more knowledgeable investors, there may be some
overlap in function that could reduce the potential benefits to either
the relationship summary or the disclosure of regulatory status without
offsetting anticipated costs. As discussed previously, the disclosure
of registration status may help to reduce search costs for investors
who already understand the meaning of the registration status. These
relatively knowledgeable investors may therefore already be familiar
with some of the information in relationship summary by having
encountered the disclosure of the registration status beforehand. In
this case, the relationship summary may provide fewer additional
benefits for these investors in either reducing search costs or the
likelihood of mismatch, but would impose costs on both broker-dealers
and investment advisers that must produce both the relationship summary
and the disclosures of registration status.
Finally, we note that any complementarities between the proposed
restrictions on the use of certain names and titles, required
disclosures about a firm's regulatory status, and the proposed
relationship summary would be constrained by the fact (1) the
relationship summary does not need to be provided by state-registered
standalone investment advisers and (2) these state-registered
investment advisers (and their supervised persons) would not be
required to provide registration status disclosures in retail investor
communications pursuant to this proposed rule.
V. Paperwork Reduction Act Analysis
Certain provisions of our proposal contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'').\708\ The Commission is submitting
these collections of information to the Office of Management and Budget
(``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR
1320.11. The titles for the existing collections of information that we
are proposing to amend are (i) ``Form ADV'' (OMB control number 3235-
0049), (ii) ``Rule 204-2 under the Investment Advisers Act of 1940''
(OMB control number 3235-0278), (iii) ``Rule 17a-3; Records to be Made
by Certain Exchange Members, Brokers and Dealers'' (OMB control number
3235-0033) and (iv) ``Rule 17a-4; Records to be Preserved by Certain
Exchange Members, Brokers and Dealers'' (OMB control number 3235-0279).
The new collections of information relate to (i) ``Rule 204-5 under the
Investment Advisers Act of 1940,'' (ii) ``Form CRS and rule 17a-14
under the Exchange Act,'' (iii) ``Rule 15l-3 under the Securities
Exchange Act,'' and (iv) ``Rule 211h-1 under the Investment Advisers
Act of 1940.'' An agency may not conduct or sponsor, and a person is
not required to respond to, a collection of information unless it
displays a currently valid control number. The Commission is also
including a short-form tear sheet for investors to provide feedback on
the relationship summary.\709\
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\708\ 44 U.S.C. 3501 et seq.
\709\ See Appendix F. The Commission determines that using this
short-form tear sheet to obtain information from investors is in the
public interest and will protect investors. See Securities Act
section 19(e).
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A. Form ADV
Form ADV (OMB Control No. 3235-0049) is currently a two-part
investment adviser registration form. Part 1 of Form ADV contains
information used primarily by Commission staff, and Part 2 is the
client brochure. We are not proposing amendments to Part 1 or 2. We use
the information to determine eligibility for registration with us and
to manage our regulatory and examination programs. Clients use certain
of the information to determine whether to hire or retain an investment
adviser. The collection of information is necessary to provide advisory
clients, prospective clients and the Commission with information about
the investment adviser and its business, conflicts of interest and
personnel. Rule 203-1 under the Advisers Act requires every person
applying for investment adviser registration with the Commission to
file Form ADV. Rule 204-4 under the Advisers Act requires certain
investment advisers exempt from registration with the Commission
(``exempt reporting advisers'') to file reports with the Commission by
completing a limited number of items on Form ADV. Rule 204-1 under the
Advisers Act requires each registered and exempt reporting adviser to
file amendments to Form ADV at least annually, and requires advisers to
submit electronic filings through IARD. The paperwork burdens
associated with rules 203-1, 204-1, and 204-4 are included in the
approved annual burden associated with Form ADV and thus do not entail
separate collections of information. These collections of information
are found at 17 CFR 275.203-1, 275.204-1, 275.204-4 and 279.1 (Form ADV
itself) and are mandatory. Responses are not kept confidential.
We are proposing to amend Form ADV to add a new Part 3, requiring
certain registered investment advisers to prepare and file a
relationship summary for retail investors. As with Form ADV Parts 1 and
2, we will use the information to determine eligibility for
registration with us and to manage our regulatory and examination
programs. Similarly, clients can use the information required in Part 3
to determine whether to hire or retain an investment adviser, as well
as what types of accounts and services are appropriate for their needs.
The collection of information is necessary to provide advisory clients,
prospective clients and the Commission with information about the
investment adviser and its business, conflicts of interest and
personnel. The proposal requiring investment advisers to deliver the
relationship summary is contained in a new collection of information
under proposed new rule 204-5 under the Advisers Act, which estimates
are discussed in Section V.B below. We are not proposing amendments to
Part 1 or 2 of Form ADV.\710\
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\710\ We are proposing conforming technical amendments to the
General Instructions of Form ADV to add references to the Part 3,
but these amendments would not affect the burden of Part 1 or Part
2. See proposed amendments to Form ADV: General Instructions.
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1. Respondents: Investment Advisers and Exempt Reporting Advisers
The respondents to current Form ADV are investment advisers
registered with the Commission or applying for registration with the
Commission and
[[Page 21516]]
exempt reporting advisers.\711\ As of December 31, 2017, 12,721
investment advisers were registered with the Commission, and 3,848
exempt reporting advisers report information to the Commission.
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\711\ An exempt reporting adviser is an investment adviser that
relies on the exemption from investment adviser registration
provided in either section 203(l) of the Advisers Act because it is
an adviser solely to one or more venture capital funds or 203(m) of
the Advisers Act because it is an adviser solely to private funds
and has assets under management in the United States of less than
$150 million. An exempt reporting adviser is not a registered
investment adviser and therefore would not be subject to the
relationship summary requirements.
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As discussed in Section II above, we propose to adopt amendments to
Form ADV that would add a new Part 3, requiring certain registered
investment advisers to prepare and file a relationship summary for
retail investors. Only those registered investment advisers offering
services to retail investors would be required to prepare and file a
relationship summary. Based on IARD system data, the Commission
estimates that 7,625 investment advisers provide advice to individual
high net worth and individual non-high net worth clients.\712\
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\712\ Based on responses to Item 5.D. of Form ADV. These
advisers indicated that they advise either high net worth
individuals or individuals (other than high net worth individuals),
which includes trusts, estates, and 401(k) plans and IRAs of
individuals and their family members, but does not include
businesses organized as sole proprietorships. The proposed
definition of retail investor would include a trust or other similar
entity that represents natural persons, even if another person is a
trustee or managing agent of the trust. We are not able to
determine, based on responses to Form ADV, exactly how many advisers
provide investment advice to these types of trusts or other
entities; however, we believe that these advisers most likely also
advise individuals and are therefore included in our estimate.
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This would leave 5,096 registered investment advisers that do not
provide advice to retail investors \713\ and 3,848 exempt reporting
advisers that would not be subject to Form ADV Part 3 requirements, but
are included in the PRA analysis for purposes of updating the overall
Form ADV information collection.\714\ We also note that these figures
include the burdens for 366 registered broker-dealers that are dually
registered as investment advisers as of December 31, 2017.\715\
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\713\ 12,721 registered investment advisers--7,625 = 5,096
registered investment advisers not providing advice to retail
investors.
\714\ Based on IARD system data.
\715\ See supra note 457.
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2. Changes in Burden Estimates and New Burden Estimates
Based on the prior revision of Form ADV,\716\ the currently
approved total aggregate annual hour burden estimate for all advisers
of completing, amending and filing Form ADV (Part 1 and Part 2) with
the Commission is 363,082 hours, or a blended average of 23.77 hours
per adviser,\717\ with a monetized total of $92,404,369, or $6,051 per
adviser.\718\ The currently approved annual cost burden is $13,683,500.
This burden estimate is based on: (i) The total annual collection of
information burden for SEC-registered advisers to file and complete
Form ADV (Part 1 and Part 2); and (ii) the total annual collection of
information burden for exempt reporting advisers to file and complete
the required items of Part 1A of Form ADV. Broken down by adviser type,
the current approved total annual hour burden is 29.22 hours per SEC-
registered adviser, and 3.60 hours per exempt reporting adviser.\719\
The proposed amendments would increase the current burden estimate due
in part to the proposed amendments to Form ADV to add Form ADV Part 3:
Form CRS (the relationship summary) and the increased number of
investment advisers and exempt reporting advisers since the last burden
estimate. We are not proposing any changes to Part 1 or Part 2 of Form
ADV.
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\716\ See Form ADV and Investment Advisers Act Rules, Final
Rule, Investment Advisers Act Release No. 4509 (Aug. 25, 2016) [81
FR 60418 (Sep. 1, 2016)] (``2016 Form ADV Paperwork Reduction
Analysis'').
\717\ 363,082 hours/(12,024 registered advisers + 3,248 exempt
reporting advisers) = 23.77 hours.
\718\ $92,404,369 hours/(12,024 registered advisers + 3,248
exempt reporting advisers) = $6,051.
\719\ See 2016 Form ADV Paperwork Reduction Analysis, supra note
716, at 81 FR 60454.
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The proposed amendments to Form ADV to add Part 3 would increase
the information collection burden for registered investment advisers
with retail investors. As discussed above in Section II, we propose to
adopt amendments to Form ADV, under Part 3, that would require certain
registered investment advisers to prepare and file a relationship
summary for retail investors. Only those registered investment advisers
providing services to retail investors would be required to prepare and
file a relationship summary. We propose to require that those
investment advisers file their relationship summaries with the
Commission electronically through IARD in the same manner as they
currently file Form ADV Parts 1 and 2. Investment advisers also would
need to amend and file an updated relationship summary within 30 days
whenever any information becomes materially inaccurate.
As noted in Section V.A.1 above, not all investment advisers would
be required to prepare and file the relationship summary. For those
investment advisers, the per adviser annual hour burden for meeting
their Form ADV requirements would remain the same, in particular, 29.22
hours per registered investment adviser without relationship summary
obligations. Similarly, because exempt reporting advisers also would
not have relationship summary obligations, the annual hour burden for
exempt reporting advisers to meet their Form ADV obligations would
remain the same, at 3.60 hours per exempt reporting adviser. However,
although we are not proposing changes to Form ADV Part 1 and Part 2,
and the per adviser information collection burden would not increase
for those without the obligation to prepare and file the relationship
summary, the information collection burden attributable to Parts 1 and
2 of Form ADV would increase due to an increase in the number of
registered investment advisers and exempt reporting advisers since the
last information collection burden estimate. In this section, we
discuss the increase in burden for Form ADV overall attributable to the
proposed amendments, i.e., new Form ADV Part 3: Form CRS, and the
increase due to the updated number of respondents that would not be
subject to the proposed amendments.
a. Initial Preparation and Filing of Relationship Summary
For investment advisers that provide advice to retail investors, we
estimate that the initial first year burden for preparing and filing
the relationship summary would be five hours per registered adviser. As
discussed above, much of the language of the proposed relationship
summary is prescribed. Furthermore, much of the information proposed to
be required in the relationship summary overlaps with that required by
Form ADV Part 2 and therefore should be readily available to registered
investment advisers because of their existing disclosure obligations.
Investment advisers also already file the Form ADV Part 2 brochure on
IARD, and we have considered this factor in determining our estimate of
the additional burden to file Form ADV Part 3: Form CRS. In addition,
the narrative descriptions required in the relationship summary should
be narrowly tailored and brief, and the relationship summary must be
limited to four pages (or
[[Page 21517]]
equivalent limit if in electronic format). Thus, while we recognize
that different firms may require different amounts of time to prepare
the relationship summary, we believe that this is an appropriate
average number for estimating an aggregate amount for the industry for
purposes of the PRA analysis. Moreover, a considerable amount of
language within each topic area also would be prescribed, thereby
limiting the amount of time required to prepare the relationship
summary. Based on these factors, we believe that the estimate of five
hours to prepare and file the relationship summary is appropriate. We
therefore estimate that the total burden of preparing and filing the
relationship summary would be 38,125 hours.\720\ As with the
Commission's prior Paperwork Reduction Act estimates for Form ADV, we
believe that most of the paperwork burden would be incurred in
advisers' initial preparation and submission of Part 3: Form CRS, and
that over time this burden would decrease substantially because the
paperwork burden would be limited to updating information.\721\ As
under the currently approved collection, the estimated initial burden
associated with preparing the relationship summary would be amortized
over the estimated period that advisers would use the relationship
summary, i.e., over a three-year period.\722\ The annual hour burden of
preparing and filing the relationship summary would therefore be
12,708.\723\ In addition, based on IARD system data, the Commission
assumes that 1,000 new investment advisers will file Form ADV with us
annually. Of these, we estimate that 477 would be required to prepare
and file the relationship summary.\724\ Therefore, the aggregate
initial burden for newly registered advisers to prepare the
relationship summary would be 2,385 \725\ and, amortized over three
years, 795 on an annual basis.\726\ In sum, the annual hour burden for
existing and newly registered investment advisers to prepare and file a
relationship summary would be 13,503 hours,\727\ or 1.67 hours per
adviser.\728\
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\720\ 5.0 hours x 7,625 investment advisers = 38,125 total
aggregate initial hours.
\721\ We discuss the burden for advisers making annual updating
amendments to Form ADV in Section V.A.3 below.
\722\ See 2016 Form ADV Paperwork Reduction Analysis, supra note
716.
\723\ 5.0 hours x 7,625 investment advisers/3 = 12,708 total
annual aggregate hours.
\724\ The number of new investment advisers is calculated by
looking at the number of new advisers in 2016 and 2017 and then
determining the number each year that serviced retail investors.
(455 for 2016 + 499 for 2017)/2 = 477.
\725\ 477 new RIAs required to prepare relationship summary x
5.0 hours = 2,385 hours for new RIAs to prepare relationship
summary.
\726\ 477 x 5.0 hours/3 = 795.
\727\ (38,125 + 2,385)/3 years = 13,503 annual hour burden for
existing and new advisers to prepare and file relationship summary.
\728\ 13, 503 hours/(7,625 existing advisers + 477 new advisers)
= 1.67 hours per year.
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b. Estimated External Costs for Investment Advisers Preparing the
Relationship Summary
The currently approved total annual collection of information
burden estimate for Form ADV anticipates that there will be external
costs, including (i) a one-time initial cost for outside legal and
compliance consulting fees in connection with the initial preparation
of Part 2 of Form ADV, and (ii) the cost for investment advisers to
private funds to report the fair value of their private fund
assets.\729\ We do not anticipate that the amendments we are proposing
today will affect the per adviser cost burden for those existing
requirements but anticipate that some advisers may incur a one-time
initial incremental cost for outside legal and consulting fees in
connection with the initial preparation of the relationship summary. We
do not anticipate external costs to investment advisers in the form of
website set-up, maintenance, or licensing fees because they would not
be required to establish a website for the sole purpose of posting
their relationship summary if they do not already have a website. We
also do not expect other ongoing external costs for the relationship
summary. Although advisers would be required to amend the relationship
summary within 30 days whenever any information becomes materially
inaccurate, given the standardized nature and prescribed language of
the relationship summary, we expect that amendments would be factual
and require relatively minimal wording changes. We believe that the
investment adviser would be more knowledgeable about these facts than
outside legal or compliance consultants and would be able to make these
revisions in-house. Therefore, we do not expect that investment
advisers will need to incur ongoing external costs for the preparation
and review of relationship summary amendments. Although advisers that
would be subject to the relationship summary requirement may vary
widely in terms of the size, complexity and nature of their advisory
business, we believe that the amount of disclosure required would not
vary substantially among advisers. Accordingly, we believe that the
amount of time, and thus cost, required for outside legal and
compliance review is unlikely to vary substantially among those
advisers who elect to obtain outside assistance.\730\
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\729\ See 2016 Form ADV Paperwork Reduction Analysis, supra note
716, at 81 FR 60452. We do not anticipate that the amendments we are
proposing to add Form ADV Part 3 will affect those per adviser cost
burden estimates for outside legal and compliance consulting fees.
The estimated external costs of outside legal and consulting
services for the relationship summary are in addition to the
estimated hour burden discussed above.
\730\ We estimate that an external service provider would spend
3 hours helping an adviser prepare an initial relationship summary.
In estimating the external cost for the initial preparation of Form
ADV Part 2, we estimated that small, medium, and large advisers
would require 8, 11, and 26 hours of outside assistance,
respectively, to prepare Form ADV Part 2. In comparison, as
discussed above, the relationship summary is limited to four pages
in length (or equivalent limit if in electronic format) and is
standardized across investment advisers in terms of the mandated
selection and sequence of topic areas. While we recognize that
different firms may require different amounts of external assistance
in preparing the relationship summary, we believe that this is an
appropriate average number for estimating an aggregate amount for
the industry purposes of the PRA analysis. See Brochure Adopting
Release, supra note 157, at 75 FR at 49257.
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Most of the information proposed to be required in the relationship
summary is readily available to investment advisers from Form ADV Part
2, and the narrative descriptions are narrowly tailored and brief or
prescribed. As a result, we anticipate that a quarter of advisers will
seek the help of outside legal services and half will seek the help of
compliance consulting services in connection with the initial
preparation of the relationship summary. We estimate that the initial
per existing adviser cost for legal services related to the preparation
of the relationship summary would be $1,416.\731\ We estimate that the
initial per existing adviser cost for compliance consulting services
related to the preparation of the relationship summary would be
$2,109.\732\ Thus, the incremental external cost burden for existing
investment advisers is estimated to be $10,739,813, or $3,579,938
annually when amortized over a three-year
[[Page 21518]]
period.\733\ In addition, we assume that 1,000 new advisers will
register with us annually, 477 of which would be required to prepare a
relationship summary. For these 477 new advisers, we estimate that they
will require $671,855 in external costs to prepare the relationship
summary.\734\ In summary, the annual external legal and compliance
consulting cost for existing and new advisers relating to relationship
summary obligations is estimated to total $4,251,792, or $525 per
adviser.\735\
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\731\ External legal fees are in addition to the projected hour
per adviser burden discussed above. $472 per hour for legal services
x 3 hours per adviser = $1,416. The hourly cost estimate of $472 is
based on an inflation-adjusted figure and our consultation with
advisers and law firms who regularly assist them in compliance
matters.
\732\ External compliance consulting fees are in addition to the
projected hour per adviser burden discussed above. Data from the
SIFMA Management and Professional Earnings Report, modified to
account for an 1,800-hour work year and multiplied by 5.35 to
account for bonuses, firm size, employee benefits, and overhead, and
adjusted for inflation (``SIFMA Management and Professional Earnings
Report''), suggest that outside management consulting services cost
approximately $703 per hour. $703 per hour for outside consulting
services x 3 hours per adviser = $2,109.
\733\ 25% x 7,625 existing advisers x $1,416 for legal services
= $2,699,250 for legal services. 50% x 7,625 existing advisers x
$2,109 for compliance consulting services = $8,040,563. $2,699,250 +
$8,040,563 = $10,739,813 in external legal and compliance consulting
costs for existing advisers. $10,739,813/3 = $3,579,938 annually.
\734\ 25% x 477 new advisers x $1,416 for legal services =
$168,858. 50% x 477 new advisers x $2,109 for compliance consulting
services = $502,997. $168,858 + $502,997 = $671,855 annually in
external legal and compliance consulting costs for newly registered
advisers.
\735\ $3,579,938 in external legal and compliance consulting
costs for existing advisers + $671,855 for new advisers = $4,251,792
annually for existing and new advisers. $4,251,792/($7,625 existing
advisers + 477 new advisers) = $525 per adviser.
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c. Amendments to the Relationship Summary and Filing of Amendments
The current approved information collection burden for Form ADV
also includes the hour burden associated with annual and other
amendments to Form ADV, among other requirements. We anticipate that
the proposed relationship summary would increase the annual burden
associated with Form ADV by 0.5 hours \736\ due to amendments to the
relationship summary,\737\ for those advisers required to prepare and
file a relationship summary. We do not expect amendments to be
frequent, but based on the historical frequency of amendments made on
Form ADV Parts 1 and 2, estimate that on average, each adviser
preparing a relationship summary will likely amend the disclosure an
average of 1.80 times per year.\738\ The collection of information
burden of 0.5 hours for amendments to the relationship summary would
include filing it. Based on the number of other-than-annual amendments
filed by investment advisers with retail investors last year, we
estimate that advisers will file an estimated total of 1.80 \739\
relationship summary amendments per year for an estimated total
paperwork burden of 6,878 hours per year.\740\
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\736\ We have previously estimated that investment advisers
would incur 0.5 hours to prepare an interim (other-than-annual)
amendment to Form ADV. See 2016 Form ADV Paperwork Reduction
Analysis, supra note 716, at 81 FR at 60452. We believe that an
amendment to the relationship summary would take a similar amount of
time, if not less.
\737\ Similarly, we estimated that 0.5 hours would be required
for interim updating amendments to Form ADV Part 2. See Brochure
Adopting Release, supra note 157, at 75 FR at 49257.
\738\ This estimate is based on IARD system data regarding the
number of filings of Form ADV amendments.
\739\ Based on IARD data, 7,625 investment advisers with retail
clients filed 13,756 other-than-annual amendments to Form ADV.
13,756 other-than-annual amendments/7,625 investment advisers = 1.80
amendments per investment adviser.
\740\ 7,625 investment advisers amending relationship summaries
x 1.80 amendments per year x 0.5 hours = 6,878 hours.
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d. Incremental Increase to Form ADV Hourly and External Cost Burdens
Attributable to Proposed Amendments
For existing and newly-registered advisers with relationship
summary obligations, the additional burden attributable to amendments
to Form ADV to add Part 3: Form CRS, (including the initial preparation
and filing of the relationship summary and amendments thereto) totals
20,381 hours,\741\ or 2.52 hours per adviser,\742\ and a monetized cost
of $5,248,193, or $648 per adviser.\743\ The incremental external legal
and compliance cost is estimated to be $4,251,792.\744\
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\741\ 13,503 hours for initial preparation and filing of the
relationship summary + 6,878 hours for amendments to the
relationship summary = 20,381 total aggregate annual hour burden
attributable to the Form ADV amendments to add Part 3: Form CRS.
\742\ 20,381 hours/(7,625 existing advisers + 477 newly
registered advisers) = 2.52 hours per adviser.
\743\ 20,381 total aggregate annual hour burden for preparing
and filing a relationship summary. We expect that performance of
this function will most likely be equally allocated between a senior
compliance examiner and a compliance manager. Data from the SIFMA
Management and Professional Earnings Report suggest that costs for
these positions are $229 and $298 per hour, respectively. 20,381
hours x 0.5 x $229 = $2,211,375. 20,381 hours x 0.5 x $298 =
$3,036,819. $2,211,375 + $3,036,819 = $5,248,193. $5,248,193/(7,625
existing registered advisers + 477 newly registered advisers) = $648
per adviser.
\744\ See supra note 735.
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3. Total Revised Burden Estimates for Form ADV
a. Revised Hourly and Monetized Value of Hourly Burdens
As discussed above, the currently approved total aggregate annual
hour burden for all registered advisers completing, amending, and
filing Form ADV (Part 1 and Part 2) with the Commission is 363,082
hours, or a blended average per adviser burden of 23.77 hours, with a
monetized cost of $92,404,369, or $6,051 per adviser. This includes the
total annual hour burden for registered advisers of 351,386 hours, or
29.22 hours per registered adviser, and 11,696 hours for exempt
reporting advisers, or 3.60 hours per exempt reporting adviser. For
purposes of updating the total information collection based on the
proposed amendments to Form ADV, we consider three categories of
respondents, as noted above: (i) Existing and newly-registered advisers
preparing and filing a relationship summary, (ii) registered advisers
with no obligation to prepare and file a relationship summary, and
(iii) exempt reporting advisers.
For existing and newly-registered advisers preparing and filing a
relationship summary, including amendments to the disclosure, the total
annual collection of information burden for preparing all of Form ADV,
updated to reflect the proposed amendments to Form ADV, equals 31.74
hours per adviser, with 2.52 hours attributable to the proposed
amendments.\745\ On an aggregate basis, this totals 257,122 hours for
existing and newly registered advisers, with a monetized value of
$66,208,857.\746\
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\745\ 29.22 hours + 2.52 hours for increase in burden
attributable to initial preparation and filing of, and amendments
to, relationship summary = 31.74 hours total.
\746\ 31.74 hours x 7,625 existing RIAs required to prepare a
relationship summary + 477 newly registered RIAs required to prepare
a relationship summary = 257,122 total aggregate annual hour burden
for preparing, filing and amending a relationship summary. We expect
that performance of this function will most likely be equally
allocated between a senior compliance examiner and a compliance
manager. Data from the SIFMA Management and Professional Earnings
Report suggest that costs for these positions are $229 and $298 per
hour, respectively. 257,122 hours x 0.5 x $229 = $27,897,712.
257,122 hours x 0.5 $298 = $38,311,144. $27,897,712 + $38,311,144 =
$66,208,857.
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As noted above, we estimate 5,096, or approximately 40% of existing
registered advisers, would not have retail investors; therefore, they
would not be obligated to prepare and file relationship summaries, so
their annual per adviser hour burden would remain unchanged.\747\ To
that end, using the currently approved total annual hour estimate of
29.22 hours per registered investment adviser to prepare and amend Form
ADV, we estimate that the updated annual hourly burden for all existing
and newly-registered investment advisers not required to prepare a
relationship summary would be 164,187,\748\ with a monetized value
[[Page 21519]]
of $43,263,322.\749\ The revised total annual collection of information
burden for exempt reporting advisers, using the currently approved
estimate of 3.60 hours per exempt reporting adviser, would be 15,653
hours,\750\ for a monetized cost of $4,124,513, or $949 per exempt
reporting adviser.\751\
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\747\ 12,721 registered investment advisers--7,625 registered
investment advisers with retail investors = 5,096 registered
investment advisers without retail investors.
\748\ 29.22 hours x (5,096 existing and 523 newly-registered
investment advisers without retail investors) = approximately
164,187 total annual hour burden for RIAs not preparing a
relationship summary.
\749\ We expect that performance of this function for registered
advisers will most likely be equally allocated between a senior
compliance examiner and a compliance manager. Data from the 2018
SIFMA Management and Professional Earnings Report suggest that costs
for these positions are $229 and $298 per hour, respectively.
164,187 hours x 0.5 x $229 = $18,799,432. 164,187 hours x 0.5 x $298
= $24,463,890. $18,799,432 + $24,463,890 = $43,263,322.
\750\ 3.60 hours x 3,848 exempt reporting advisers currently +
500 new exempt reporting advisers = 15,653 hours.
\751\ As with preparation of the Form ADV for registered
advisers, we expect that performance of this function for exempt
reporting advisers will most likely be equally allocated between a
senior compliance examiner and a compliance manager. Data from the
2018 SIFMA Management and Professional Earnings Report suggest that
costs for these positions are $229 and $298 per hour, respectively.
15,653 hours x 0.5 x $229 = $1,792,246. 15,653 hours x 0.5 x $298 =
$2,322,267. $1,792,246 + $2,322,267 = $4,124,513. $4,124,513/(3,848
exempt reporting advisers currently + 500 new exempt reporting
advisers) = $949 per exempt reporting adviser.
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In summary, factoring in the proposed amendments to Form ADV to add
Part 3, the revised aggregate burden for Form ADV for all registered
advisers and exempt reporting advisers would be 436,962,\752\ for a
monetized cost of $115,139,422.\753\ This results in a blended average
per adviser burden for Form ADV of 26.37 hours \754\ and $6,949 per
adviser.\755\ This is an increase of 73,880 hours, \756\ or $22,735,053
\757\ in the monetized value of the hour burden, from the currently
approved annual aggregate burden estimates, increases which are
attributable primarily to the proposed burden estimates on the larger
registered investment adviser and exempt reporting adviser population
since the most recent approval, adjustments for inflation, and the
amendments to Form ADV.
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\752\ 257,122 annual hour burden for RIAs preparing relationship
summary + 164,187 annual hour burden for RIAs not preparing
relationship summary + 15,653 annual hour burden for exempt
reporting advisers = 436,962 total updated Form ADV annual hour
burden.
\753\ $66,208,857 for RIAs preparing relationship summary +
$43,263,890 for RIAs not preparing relationship summary + $4,124,513
for exempt reporting advisers = $115,139,422 total updated Form ADV
annual monetized hourly burden.
\754\ 436,962/(12,721 registered investment advisers + 3,843
exempt reporting advisers) = 26.37 hours per adviser.
\755\ $115,139,422/12,721 registered investment advisers + 3,843
exempt reporting advisers) = $6,949 per adviser.
\756\ 436,962 hours estimated--363,082 hours currently approved
= 73,880 hour increase in aggregate annual hourly burden.
\757\ $115,139,422 monetized hourly burden-$92,404,369 =
$22,735,053 increase in aggregate annual monetized hourly burden.
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b. Revised Estimated External Costs for Form ADV
The currently approved total annual collection of information
burden estimate for Form ADV anticipates that there will be external
costs, including (i) a one-time initial cost for outside legal and
compliance consulting fees in connection with the initial preparation
of Part 2 of Form ADV, and (ii) the cost for investment advisers to
private funds to report the fair value of their private fund
assets.\758\ The currently approved annual cost burden for Form ADV is
$13,683,500, $3,600,000 of which is attributable to external costs
incurred by new advisers to prepare Form ADV Part 2, and $10,083,500 of
which is attributable to obtaining the fair value of certain private
fund assets.\759\ We do not expect any change in the annual external
costs relating to new advisers preparing Form ADV Part 2. Due to the
slightly higher number of registered advisers with private funds,
however, the cost of obtaining the fair value of private fund assets
may be higher. We estimate that 6% of registered advisers have at least
one private fund client that may not be audited. Based on IARD system
data as of December 31, 2017, 4,670 registered advisers advise private
funds. We therefore estimate that approximately 281 registered advisers
may incur costs of $37,625 each on an annual basis, for an aggregate
annual total cost of $10,572,625.\760\
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\758\ See 2016 Form ADV Paperwork Reduction Analysis, supra note
716, at 81 FR 60452. We do not anticipate that the amendments we are
proposing to add to Form ADV Part 3 will affect those per adviser
cost burden estimates for outside legal and compliance consulting
fees. The estimated external costs of outside legal and compliance
consulting services for the relationship summary are in addition to
the estimated hour burden discussed above.
\759\ See 2016 Form ADV Paperwork Reduction Analysis, supra note
716, at 81 FR at 60452-53. The $10,083,500 is based on 4,469
registered advisers reporting private fund activity as of May 16,
2016.
\760\ 6% x 4,760 = 281 advisers needing to obtain the fair value
of certain private fund assets. 281 advisers x $37,625 =
$10,572,625.
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In summary, taking into account (i) a one-time initial cost for
outside legal and compliance consulting fees in connection with the
initial preparation of Part 2 of Form ADV, (ii) the cost for investment
advisers to private funds to report the fair value of their private
fund assets, and (iii) the incremental external legal or compliance
costs for the preparation of the proposed relationship summary, we
estimate the annual aggregate external cost burden of the Form ADV
information collection would be $18,424,417, or $1,448 per registered
adviser.\761\ This represents a $4,740,917 increase from the current
external costs estimate for the information collection.\762\
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\761\ $3,600,000 for preparation of Form ADV Part 2 +
$10,572,625 for registered investment advisers to fair value their
private fund assets + $4,251,792 to prepare relationship summary =
$18,424,417 in total external costs for Form ADV. $18,424,417/12,721
total registered advisers as of December 31, 2017 = $1,448 per
registered adviser.
\762\ $18,424,417 - $13,683,500 = $4,740,917.
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B. Rule 204-2 Under the Advisers Act
Under section 204 of the Advisers Act, investment advisers
registered or required to register with the Commission under section
203 of the Advisers Act must make and keep for prescribed periods such
records (as defined in section 3(a)(37) of the Exchange Act), furnish
copies thereof, and make and disseminate such reports as the
Commission, by rule, may prescribe as necessary or appropriate in the
public interest or for the protection of investors. Rule 204-2 sets
forth the requirements for maintaining and preserving specified books
and records. We are proposing amendments to rule 204-2 that would
require registered advisers to retain copies of each relationship
summary. Investment advisers would also be required to maintain each
amendment to the relationship summary as well as to make and preserve a
record of dates that each relationship summary and each amendment was
delivered to any client or to any prospective client who subsequently
becomes a client, as well as to any retail investor before such retail
investor opens an account. These records would be required to be
maintained in the same manner, and for the same period of time, as
other books and records required to be maintained under rule 204-2(a),
to allow regulators to access the relationship summary during an
examination. Specifically, investment advisers would be required to
maintain and preserve a record of the relationship summary in an easily
accessible place for not less than five years from the end of the
fiscal year during which the last entry was made on such record, the
first two years in an appropriate office of the investment adviser.
This collection of information is found at 17 CFR 275.204-2 and is
mandatory. The Commission staff uses the collection of information in
its examination and oversight program. Requiring maintenance of these
disclosures as part of the firm's books and records would facilitate
the Commission's ability to inspect for and enforce compliance with
firms' obligations with respect to Form CRS.
[[Page 21520]]
The information generally is kept confidential.\763\
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\763\ See section 210(b) of the Advisers Act (15 U.S.C. 80b-
10(b)).
---------------------------------------------------------------------------
The likely respondents to this collection of information are all of
the approximately 12,721 advisers currently registered with the
Commission. We estimate that based on updated IARD data as of December
31, 2017, 7,625 existing advisers will be subject to the amended
provisions of rule 204-2 to preserve the relationship summary as a
result of the proposed amendments.
1. Changes in Burden Estimates and New Burden Estimates
The approved annual aggregate burden for rule 204-2 is currently
2,199,791 hours, with a total annual aggregate monetized cost burden of
approximately $130,316,112, based on an estimate of 12,024 registered
advisers, or 183 hours per registered adviser.\764\ We estimate that
the proposed amendments would result in an increase in the collection
of information burden estimate by 0.2 hours \765\ for each of the
estimated 7,625 registered advisers with relationship summary
obligations,\766\ resulting in a total of 183.2 hours per adviser. This
would yield an annual estimated aggregate burden of 1,396,900 hours
under amended rule 204-2 for all registered advisers with relationship
summary obligations,\767\ for a monetized cost of $85,476,311.\768\ In
addition, the 5,096 advisers \769\ not subject to the proposed
amendments would continue to be subject to an unchanged burden of 183
hours under rule 204-2, or a total aggregate annual hour burden of
932,568,\770\ for a monetized cost of $57,063,836.\771\ In summary,
taking into account the estimated annual burden of registered advisers
that would be required to maintain records of the relationship summary,
as well as the estimated annual burden of registered advisers that do
not have relationship summary obligations and whose information
collection burden is unchanged, the revised annual aggregate burden for
all respondents to rule 204-2, under the proposed amendments, would be
estimated to be 2,329,468 total hours,\772\ for a monetized cost of
$142,540,147.\773\
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\764\ See 2016 Form ADV Paperwork Reduction Analysis, supra note
716, at 81 FR at 60454-55.
\765\ In the Paperwork Reduction Act analysis for amendments to
Form ADV adopted in 2016, we estimated that 1.5 hours would be
required for each adviser to make and keep records relating to (i)
the calculation of performance the adviser distributes to any person
and (ii) all written communications received or sent relating to the
adviser's performance. Because the burden of preparing of the
relationship summary is already included in the collection of
information estimates for Form ADV, and because the relationship is
a short, standardized document, we assume that recordkeeping burden
for the relationship summary would be considerably less than 1.5
hours and estimate that 0.2 hours would be appropriate.
\766\ See supra note 674.
\767\ 7,625 registered investment advisers required to prepare
relationship summary x 183.2 hours = 1,396,900 hours.
\768\ As with our estimates relating to the previous amendments
to rule 204-2 (see 2016 Form ADV Paperwork Reduction Analysis, supra
note 716, at 81 FR at 60454-55, we expect that performance of this
function will most likely be allocated between compliance clerks and
general clerks, with compliance clerks performing 17% of the
function and general clerks performing 83% of the function. Data
from the SIFMA Office Salaries in the Securities Industry Report,
modified to account for an 1,800-hour work year and multiplied by
2.93 to account for bonuses, firm size, employee benefits, and
overhead (``SIFMA Office Salaries Report), suggest that costs for
these positions are $67 and $60, respectively. (17% x 1,396,9001
hours x $67) + (83% x 1,396,900 hours x $60) = $85,476,311.
\769\ See supra note 681.
\770\ 5,096 registered investment advisers not required to
prepare the relationship summary x 183 hours = 932,568.
\771\ As with our estimates relating to the previous amendments
to rule 204-2 (see 2016 Form ADV Paperwork Reduction Analysis, supra
note 716, at 81 FR at 60454-55, we expect that performance of this
function will most likely be allocated between compliance clerks and
general clerks, with compliance clerks performing 17% of the
function and general clerks performing 83% of the function. Data
from the SIFMA Office Salaries Report suggest that costs for these
positions are $67 and $60, respectively. (17% x 932,568 hours x $67)
+ (83% x 932,568 hours x $60) = $57,063,836.
\772\ 7,625 registered investment advisers required to prepare
relationship summary x 183.2 hours = 1,396,900 hours. 5,096
registered investment advisers not required to prepare the
relationship summary x 183 hours = 932,568 hours. 1,396,900 hours +
932,568 hours = 2,329,468 hours.
\773\ $85,476,311 + $57,063,836 = $142,540,147.
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2. Revised Annual Burden Estimates
As noted above, the approved annual aggregate burden for rule 204-2
is currently 2,199,791, hours based on an estimate of 12,024 registered
advisers, or 183 hours per registered adviser.\774\ The revised annual
aggregate hourly burden for rule 204-2 would be 2,329,468 \775\ hours,
represented by a monetized cost of $142,540,147,\776\ based on an
estimate of 7,625 registered advisers with the relationship summary
obligation and 5,096 registered advisers without, as noted above. This
represents an increase of 129,677 \777\ annual aggregate hours in the
hour burden and an annual increase of $12,224,035 from the currently
approved total aggregate monetized cost for rule 204-2.\778\ These
increases are attributable to a larger registered investment adviser
population since the most recent approval and adjustments for
inflation, as well as the proposed rule 204-2 amendments relating to
the relationship summary as discussed in this proposing release.
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\774\ 2,199,791 hours/12,024 registered advisers = 183 hours per
adviser.
\775\ See supra note 772.
\776\ See supra note 773.
\777\ 2,329,467 hours - 2,199,791 hours = 129,677 hours.
\778\ $142,540,073 - $130,316,112 = $12,224,035.
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C. Rule 204-5 Under the Advisers Act
Proposed new rule 204-5 would require an investment adviser to
deliver the relationship summary to each retail investor before or at
the time the adviser enters into an investment advisory agreement (even
if the adviser's agreement with the retail investor is oral) as well as
to existing clients one time within a specified time period after the
effective date of the proposed amendments. The adviser also would
deliver the relationship summary to existing clients before or at the
time (i) a new account is opened that is different from the retail
investor's existing account(s); or (ii) changes are made to the retail
investor's existing account(s) that would materially change the nature
and scope of the adviser's relationship with the retail investor, as
further discussed in Section II.C.2 above. In addition, advisers would
be required to post a current version of their relationship summary
prominently on their public website (if they have one). Investment
advisers would be required to communicate any changes in an updated
relationship summary to retail investors who are existing clients or
customers of the firm within 30 days after the updates are required to
be made and without charge. The communication can be made by delivering
the relationship summary or by communicating the information in another
way to the retail investor.
Proposed new rule 204-5 contains a collection of information
requirement. The collection of information is necessary to provide
advisory clients, prospective clients and the Commission with
information about the investment adviser and its business, conflicts of
interest and personnel. Clients would use the information contained in
the relationship summary to determine whether to hire or retain an
investment adviser and what type of accounts and services are
appropriate for their needs. The Commission would use the information
to determine eligibility for registration with us and to manage our
regulatory and examination programs. This collection of information
would be found at 17 CFR 275.204-5 and would be mandatory. Responses
would not be kept confidential.
1. Respondents: Investment Advisers
The likely respondents to this information collection would be the
approximately 7,625 investment
[[Page 21521]]
advisers registered with the Commission that would be required to
deliver a relationship summary per proposed new rule 204-5. We also
note that these figures include the 366 registered broker-dealers that
are dually registered as investment advisers.\779\
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\779\ See supra note 457 and accompanying text.
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2. Initial and Annual Burdens
a. Posting of the Relationship Summary to Website
Under proposed new rule 204-5, advisers would be required to post a
current version of their relationship summary prominently on their
public website (if they have one). We estimate that each adviser would
incur 0.5 hours to prepare the relationship summary, such as to ensure
proper electronic formatting, and to post the disclosure to the
adviser's website, if the adviser has one.\780\ Based on IARD system
data, 91.1% of investment advisers with individual clients report at
least one public website. Therefore, we estimate that 91.1% of the
7,625 existing and 477 newly-registered investment advisers with
relationship summary obligations would incur a total of 3,690 aggregate
burden hours to post relationship summaries to their websites,\781\
with a monetized cost of $221,428.\782\ As with the initial preparation
of the relationship summary, we amortize the estimated initial burden
associated with posting the relationship summary over a three-year
period.\783\ Therefore, the total annual aggregate hourly burden
related to the initial posting of the relationship summary is estimated
to be 1,230 hours, with a monetized cost of $73,809.\784\ We do not
anticipate external costs to rule 204-5 because investment advisers
without a public website would not be required to establish or maintain
one. External costs for the preparation of the relationship summary are
already included for the collection of information estimates for Form
ADV, in Section V.A, above.
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\780\ This estimate is based upon staff experience. See e.g.,
Enhanced Mutual Fund Disclosure Adopting Release, supra note 47
(``we estimate, as we did in the proposing release, that rule 498
will impose a \1/2\ hour burden per portfolio annually associated
with the compilation of the additional information required on a
cover page or at the beginning of the Summary Prospectus. Rule 498
also imposes annual hour burdens associated with the posting of a
fund's Summary Prospectus, statutory prospectus, SAI, and most
recent report to shareholders on an Internet website. We estimate
that the average hour burden for one portfolio to comply with the
Internet website posting requirements will be approximately one hour
annually.'') Because rule 204-5 pertains to one document, the
relationship summary, which is much shorter than the several
documents to which rule 498 applies, we estimate that each adviser
on average would incur approximately 0.5 hours for the preparation
of the relationship summary for posting, and for the posting itself.
\781\ 0.5 hours to prepare and post the relationship summary x
91.1% x (7,625 existing advisers + 477 newly-registered advisers
with relationship summary obligations) x 0.5 hours = 3,690 hours.
\782\ Based on data from the SIFMA Office Salaries Report, we
expect that requirement for investment advisers to post their
relationship summaries to their websites will most likely be
performed by a general clerk at an estimated cost of $60 per hour.
0.5 hours per adviser x $60 = $30 in monetized costs per adviser.
$30 per adviser x (7,625 existing advisers + 477 newly registered
advisers = $221,428 total aggregate monetized cost.
\783\ See 2016 Form ADV Paperwork Reduction Analysis, supra note
716.
\784\ 43,688 hours/3 years = 1,230 hours annually. $221,428/3
years = $73,809 in annualized monetized costs.
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b. Delivery to Existing Clients
i. One-Time Initial Delivery to Existing Clients
The burden for this proposed rule is based on each adviser with
retail investors having, on average, an estimated 4,461 clients who are
retail investors.\785\ Although advisers may either deliver the
relationship summary separately, in a ``bulk delivery'' to clients, or
as part of the delivery of information that advisers already provide,
such as the annual Form ADV update, account statements or other
periodic reports, we base our estimates here on a ``bulk delivery'' to
existing clients. This is similar to the approach we took in estimating
the delivery costs for amendments to rule 204-3 under the Advisers Act,
which requires investment advisers to deliver their Form ADV Part 2
brochures and brochure supplements to their clients.\786\ As with the
estimates for rule 204-3, we estimate that advisers would require
approximately 0.02 hours to deliver the relationship summary to each
client.\787\ Based on IARD data as of December 31, 2017, we estimate
that advisers with the obligation to deliver the relationship summary
under proposed rule 204-5 have, on average, 4,461 clients who are
retail investors, per adviser. Thus, we estimate the total burden hours
for 7,625 advisers for initial delivery of the relationship to existing
clients to be 89.22 hours per adviser, or 722,860 total aggregate
hours, for the first year after the rule is in effect,\788\ with a
monetized cost of $5,353 \789\ per adviser or $43,339,507 in
aggregate.\790\ Amortized over three years, the total annual hourly
burden is estimated to be 29.74 hours per adviser, or 240,953 annual
hours in aggregate,\791\ with annual monetized costs of $1,784 per
adviser, or $14,457,209 in aggregate.\792\ We do not expect that
investment advisers will incur external costs for the initial delivery
of the relationship summary to existing clients because we assume that
advisers will make such deliveries along with another required
delivery, such as an interim or annual update to the Form ADV Part 2.
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\785\ Based on IARD system data as of December 31, 2017.
\786\ See Brochure Adopting Release, supra note 157, at 75 FR at
49259.
\787\ This is the same estimate we made in the Form ADV Part 2
proposal and for which we received no comment. Brochure Adopting
Release, supra note 157, at 75 FR at 49259 We note that the burden
for preparing relationship summaries is already incorporated into
the burden estimate for Form ADV discussed above.
\788\ (0.02 hours per client x 4,461 retail clients per adviser)
= 89.22 hours per adviser. 89.22 hours per adviser x (7,625 existing
advisers + 477 newly registered advisers) = 722,860 total aggregate
hours.
\789\ Based on data from the SIFMA Office Salaries Report, we
expect that initial delivery requirement to existing clients of rule
204-5 will most likely be performed by a general clerk at an
estimated cost of $60 per hour. 89.22 hours per adviser x $60 =
$5,353 in monetized costs per adviser. We estimate that advisers
will not incur any incremental postage costs because we assume that
they will make such deliveries with another mailing the adviser was
already delivering to clients, such as interim or annual updates to
the Form ADV, or will deliver the relationship summary
electronically.
\790\ $5,353 in monetized costs per adviser x (7,625 existing
advisers + 477 newly registered advisers) = $43,339,507 in total
aggregate costs.
\791\ 89.22 initial hours per adviser/3 = 29.74 total annual
hours per adviser. 722,860 initial aggregate hours/3 = 240,953 total
annual aggregate hours.
\792\ $5,353 in monetized costs per adviser/3 = $1,784
annualized monetized cost per adviser. $43,339,507 initial aggregate
monetized cost/3 = $14,14,457,209 in total annual aggregate
monetized cost.
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ii. Delivery for New Account Types or Material Changes in the Nature or
Scope of the Advisory Relationship
As noted above, investment advisers also would be required to
deliver the relationship summary to existing clients before or at the
time (i) a new account is opened that is different from the retail
investor's existing account(s); or (ii) changes are made to the retail
investor's existing account(s) that would materially change the nature
and scope of the adviser's relationship with the retail investor, as
further discussed in Section II.C.2. With respect to delivery of the
relationship summary in the event new account types are opened or
material changes occur in the nature or scope of the advisory
relationship, we expect that such delivery would take place among 10%
of an adviser's retail investors annually. We would therefore estimate
a total annual hourly burden of 9 hours per adviser and 72,286 hours in
total annual aggregate hours,\793\ with a monetized cost of $535 per
adviser \794\
[[Page 21522]]
and $4,337,163 in aggregate.\795\ We do not expect advisers to incur
external costs related to deliveries of the relationship summary due to
new account type openings, or material changes to the nature or scope
of the relationship, because we assume that advisers will deliver the
relationship summary along with new account agreements and other
information normally required in such circumstances.
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\793\ 10% of 4,461 retail clients per adviser x .02 hours to
deliver the relationship summary = 9 hours per adviser. 9 hours x
(7,625 existing advisers + 477 new advisers) = 72,286 total
aggregate hours.
\794\ Based on data from the SIFMA Office Salaries Report, we
expect that delivery requirements of rule 204-5 will most likely be
performed by a general clerk at an estimated cost of $60 per hour. 9
hours per adviser x $60 = $535 per adviser. We estimate that
advisers will not incur any incremental postage costs in the
delivery of the relationship summary to existing clients for changes
in accounts, because we assume that advisers will make such
deliveries with another mailing the adviser was already delivering
to clients, such as new account agreements and other documentation
normally required in such circumstances.
\795\ $535 in monetized costs per adviser x (7,625 existing
advisers + 477 newly registered advisers) = $4,337,163 in total
aggregate costs.
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iii. Posting of Amended Relationship Summaries to Websites and
Communicating Changes to Amended Relationship Summaries, Including by
Delivery
Investment advisers would be required to amend their relationship
summaries within 30 days when any of the information becomes materially
inaccurate. We do not expect amendments to be frequent, but based on
the historical frequency of amendments made on Form ADV Parts 1 and 2,
estimate that on average, each adviser preparing a relationship summary
will likely amend the disclosure and average of 1.81 times per
year.\796\ As above, we estimate that preparation of the relationship
summary for posting to the web and the posting itself will require 0.5
hours. Therefore, once again using the same percentage of investment
advisers reporting public websites, 91.1% of 7,625 advisers would incur
a total annual burden of 0.91 hours per adviser, or 6,286 hours in
aggregate,\797\ to post the amended relationship summaries to their
website. This translates into an annual monetized cost of $54.30 per
adviser, or $377,188 in the aggregate for existing registered advisers
with relationship summary obligations.\798\ Investment advisers also
will be required to communicate any changes in an amended relationship
summary to existing clients who are retail investors. The communication
can be made by delivering the relationship summary or by communicating
the information in another way. For this requirement, we estimate that
50% of advisers will choose to deliver the relationship summary to
communicate the updated information, and that the delivery will be made
along with other disclosures already required to be delivered, such as
an interim or annual Form ADV update. We therefore estimate a burden of
615,674 \799\ hours, or 161.5 hours per adviser,\800\ at a monetized
cost of $36,940,426 in aggregate,\801\ or $9,689 per adviser,\802\ for
the 50% of advisers that choose to deliver amended relationship
summaries in order to communicate updated information. Similar to the
other delivery requirements discussed above for proposed rule 204-5, we
do not expect investment advisers to incur external costs in delivering
amended relationship summaries because we assume that they will make
this delivery with other disclosures required to be delivered, such as
an interim or annual update to Form ADV.
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\796\ This estimate is based on IARD system data regarding the
number of filings of Form ADV amendments. See also supra note 702
and accompanying text.
\797\ 0.5 hours to post the amendment x 1.81 amendments annually
= 0.91 hours per adviser annually to post amendments to the website.
0.91 x 7,625 existing advisers amending the relationship summary x
91.1% of advisers with public websites = 6,286 aggregate annual
hours to post amendments of the relationship summary.
\798\ Based on data from the SIFMA Office Salaries Report, we
expect that the posting requirements of rule 204-5 will most likely
be performed by a general clerk at an estimated cost of $60 per
hour. 0.91 hours per adviser x $60 = $54.30 per adviser. $54.30 per
adviser x 91.1% x 7,625 existing advisers = $377,188 in annual
monetized costs.
\799\ 7,625 advisers amending the relationship summary x 4,461
retail clients per adviser x 50% delivering the amended relationship
summary to communicate updated information x 0.02 hours per delivery
x 1.81 amendments annually = 615,674 hours to deliver amended
relationship summaries.
\800\ 4,461 retail clients per adviser x 0.02 hours per delivery
x 1.81 amendments annually = 161.5 hours per adviser.
\801\ Based on data from the SIFMA Office Salaries Report, we
expect that delivery requirements of rule 204-5 will most likely be
performed by a general clerk at an estimated cost of $60 per hour.
615,674 hours x $60 = $36,940,426. We estimate that advisers will
not incur any incremental postage costs to deliver the relationship
summary for communicating updated information by delivering the
relationship summary, because we assume that advisers will make the
delivery along with other documents already required to be
delivered, such as an interim or annual update to Form ADV, or will
deliver the relationship summary electronically.
\802\ Based on data from the SIFMA Office Salaries Report,
modified to account for an 1,800-hour work-year and multiplied by
2.93 to account for bonuses, firm size, employee benefits and
overhead, we expect that delivery requirements of rule 204-5 will
most likely be performed by a general clerk at an estimated cost of
$60 per hour. 161.5 hours per adviser x $60 per hour = $9,689 per
adviser.
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c. Delivery to New Clients or Prospective New Clients
Data from the IARD system indicate that of the 12,721 advisers
registered with the Commission, 7,625 have retail investors, and on
average, each has 4,461 clients who are retail investors.\803\ Based on
IARD system data from 2015 to 2017, we estimate that the client base
for investment advisers will grow by approximately 4.5% annually.\804\
Based on our experience with Form ADV Part 2, we estimate the annual
hour burden for initial delivery of a relationship summary would be the
same by paper or electronic format, at 0.02 hours for each relationship
summary,\805\ or 4 annual hours per adviser.\806\ Therefore, we
estimate that the aggregate annual hour burden for initial delivery of
the relationship summary to new clients would be 30,614 hours,\807\ at
a monetized cost of $1,836,817, or $241 per adviser.\808\ We do not
expect that advisers will incur external costs to deliver the
relationship summary to new or prospective clients because we assume
that advisers will make the delivery along with other documentation
normally provided in such circumstances, such as Form ADV Part 2, or
will deliver the relationship summary electronically.
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\803\ This average is based on advisers' responses to Item 5 of
Part 1A of Form ADV as of December 31, 2017.
\804\ The number of retail clients reported by RIAs changed by
6.7% between December 2015 and 2016, and by 2.3% between December
2016 and 2017. (6.7% + 2.3%)/2 = 4.5% average annual rate of change
over the past two years.
\805\ This is the same as the estimate for the burden to deliver
the brochure required by Form ADV Part 2. See Brochure Adopting
Release, supra note 157.
\806\ 4,461 clients per adviser with retail clients x 4.5% = 201
new clients per adviser. 201 new clients per adviser x .02 hours per
delivery = 4.0 hours per adviser for delivery of a relationship
summary to new or prospective new clients.
\807\ 4.0 hours per adviser for delivery obligation to new or
prospective clients x 7,625 advisers = 30,614 hours.
\808\ Based on data from the SIFMA Office Salaries Report,
modified to account for an 1,800-hour work-year and multiplied by
2.93 to account for bonuses, firm size, employee benefits and
overhead, we expect that delivery requirements of rule 204-5 will
most likely be performed by a general clerk at an estimated cost of
$60 per hour. 7,625 hours x $60 = $1,836,817. We estimate that
advisers will not incur any incremental postage costs to deliver the
relationship summary to new or prospective clients because we assume
that advisers will make the delivery along with other documentation
normally provided in such circumstances, such as Form ADV Part 2.
$1,835,371/7,625 investment advisers = $241 per adviser.
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d. Total New Initial and Annual Burdens
Altogether, we estimate the total collection of information burden
for proposed new rule 204-5 to be 967,044 annual aggregate hours per
year,\809\ or
[[Page 21523]]
126.8 hours per respondent,\810\ for a total annual aggregate monetized
cost of $58,022,611,\811\ or $7,610 \812\ per adviser. We request
comment on the estimated hourly and cost burdens for the new collection
of information under proposed rule 204-5.
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\809\ 1,230 annual hours for posting initial relationship
summaries to adviser websites + 240,953 annual hours for initial
delivery to existing clients + 72,286 hours for delivery to existing
clients based on material changes to accounts or scope of
relationship + 6,286 annual hours to post amended relationship
summary to website + 615,674 hours for delivery to existing clients
to communicate updated information in amended relationship summaries
+ 30,614 hours for delivery to new or prospective clients = 967,044
annual total hours for investment advisers to post and deliver the
relationship summary under proposed rule 204-5.
\810\ 967,044 hours (initial and other deliveries)/7,625
advisers = 126.8 hours per adviser.
\811\ $73,809 for posting initial relationship summaries to
adviser websites + $14,457,209 for initial delivery to existing
clients + $4,337,162 for delivery to existing clients based on
material changes to accounts or scope of relationship + $377,188 to
post amended relationship summary to website + $36,940,426 for
delivery to existing clients to communicate updated information in
amended relationship summaries + $1,836,817 for delivery to new or
prospective clients = $58,022,611 in total annual aggregate
monetized cost for investment advisers to post and deliver the
relationship summary under proposed rule 204-5.
\812\ $58,022,611/7,625 advisers = $7,610 per adviser.
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D. Form CRS and Rule 17a-14 Under the Exchange Act
New proposed rule 17a-14 under the Exchange Act [17 CFR 240.17a-14]
and Form CRS [17 CFR 249.640] would require a broker-dealer that offer
services to retail investors to prepare, file with the Commission, post
to the broker-dealer's website (if it has one), and deliver to retail
investors a relationship summary, as discussed in greater detail in
Section II above. Broker-dealers would file the relationship summary
with EDGAR and deliver the relationship summary to both existing
customers and new or prospective new customers who are retail
investors. New proposed rule 17a-14 under the Exchange Act [17 CFR
240.17a-14] and Form CRS [17 CFR 249.640] contain a collection of
information requirement. We will use the information to manage our
regulatory and examination programs. Clients can use the information
required in Form CRS to determine whether to hire or retain a broker-
dealer, as well as what types of accounts and services are appropriate
for their needs. The collection of information is necessary to provide
broker-dealer customers, prospective customers, and the Commission with
information about the broker-dealer and its business, conflicts of
interest and personnel. This collection of information would be found
at 17 CFR 249.640 and would be mandatory. Responses would not be kept
confidential.
1. Respondents: Broker-Dealers
The respondents to this information collection would be the broker-
dealers registered with the Commission that would be required to
deliver a relationship summary in accordance with proposed new rule
17a-14 under the Exchange Act [17 CFR 240.17a-14]. As of December 31,
2017, there were 2,857 broker-dealers registered with the Commission
that reported sales to retail customer investors,\813\ and therefore
likely would be required to prepare and deliver the relationship
summary.\814\ We also note that these include 366 broker-dealers that
are dually registered as investment advisers.\815\ To a great extent,
the burden for dual registrants to prepare and deliver the relationship
summary and post it to a website is already accounted for in the
estimated burdens for investment advisers under the proposed amendments
to Form ADV and proposed new rule 204-5, discussed in Sections V.A and
V.C above. However, dually registered broker-dealers will incur burdens
related to their business as an investment adviser that standalone
broker-dealers will not incur, such as the requirement to file the
relationship summary with IAPD (in addition to EDGAR as a broker-
dealer), and to deliver to both investment advisory clients and
brokerage customers, to the extent those groups of retail investors do
not overlap. Therefore, although treating dually registered broker-
dealers in this way may be over-inclusive, we base our burden estimates
for proposed rule 17a-14 and Form CRS on 2,857 broker-dealers with
relationship summary obligations, including those dually registered as
broker-dealers. \816\
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\813\ See supra note 461 and accompanying text. Retail sales
activity is identified from Form BR (see supra note 280, which
categorizes retail activity broadly (by marking the ``sales'' box)
or narrowly (by marking the ``retail'' or ``institutional'' boxes as
types of sales activity). We use the broad definition of sales as we
preliminarily believe that many firms will just mark ``sales'' if
they have both retail and institutional activity. However, we note
that this may capture some broker-dealers that do not have retail
activity, although we are unable to estimate that frequency.
\814\ For purposes of Form CRS, a ``retail investor'' would be
defined as: a prospective or existing client or customer who is a
natural person (an individual) and would include a trust or other
similar entity that represents natural persons, even if another
person is a trustee or managing agent of the trust.
\815\ See supra note 457 and accompanying text.
\816\ See supra note 457 and accompanying text.
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2. Initial and Annual Burdens
a. Initial Preparation, Filing, and Posting of Relationship Summary
Unlike investment advisers, broker-dealers currently are not
required to disclose in one place all of the information required by
the relationship summary or to file a narrative disclosure document
with the Commission. We estimate, therefore, that the initial first
year burden for preparing and filing the relationship summary would be
15.0 hours per registered broker-dealer. The narrative descriptions
required in the relationship summary should be narrowly tailored and
brief, and the relationship summary must be limited to four pages (or
equivalent limit if in electronic format). The relationship summary
would be standardized across broker-dealers given the mandated set and
sequence of topic areas, and moreover, a considerable amount of
language within each topic area also would be prescribed, thereby
limiting the amount of time required to prepare the disclosure.
Therefore, we believe that the time needed to prepare the relationship
summary should not vary significantly based on the size of the broker-
dealer. However, unlike investment advisers, which already prepare Form
ADV Part 2 brochures and have information readily available to prepare
the relationship summary, broker-dealers would be required for the
first time to prepare disclosure that contains all the information
proposed to be required by the relationship summary. In addition,
investment advisers already file their brochures on IARD, while broker-
dealers may incur new burdens to file their relationship summaries on
EDGAR. Therefore, we believe that each broker-dealer respondent would
incur 15 hours on a one-time basis, instead of five hours for
investment advisers, for the initial preparation and filing of the
relationship summary. However, we believe that the amount of time
needed to post the relationship summary on the broker-dealer's website,
if it has one, would not vary significantly from the time needed by
investment advisers because the time required to prepare and post
disclosure that is standardized in length and content should not vary
significantly across firms. As with investment advisers, we estimate
that each broker-dealer would incur 0.5 hours to prepare the
relationship summary for posting to its website, if it has one, such as
to ensure proper electronic formatting, and to perform the actual
posting.\817\
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\817\ See supra note 780.
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Given these assumptions, we estimate the total one-time initial
hourly burden for broker-dealers to prepare the relationship summary
and file it with the Commission would be 42,855
[[Page 21524]]
hours,\818\ for a monetized value of $11,292,293.\819\ We estimate that
the initial burden of posting the relationship summary to their
websites, if they have one, would be 1,428 hours,\820\ for a monetized
value of $85,710.\821\ To arrive at an annual burden for preparing,
filing, and posting the relationship summary, as for advisers, the
initial burden would be amortized over a three-year period. Therefore,
the total annual aggregate hour burden for registered broker-dealers to
prepare, file, and post a relationship summary to their website, if
they have one, would be 14,761 hours, or 5.17 hours per broker-
dealer,\822\ for an annual monetized cost of $3,792,668, or $1,328 per
broker-dealer.\823\
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\818\ 15.0 hours x 2,857 broker-dealers with retail accounts =
42,855 total hours.
\819\ 42,855 total aggregate initial hour burden for preparing
and filing a relationship summary. We expect that performance of
this function will most likely be equally allocated between a senior
compliance examiner and a compliance manager. Data from the SIFMA
Management and Professional Earnings Report suggest that costs for
these positions are $229 and $298 per hour, respectively. (21,427.5
hours x $229 + (21,427.5 hours x $298 = $11,292,293).
\820\ 0.5 hours x 2,857 broker-dealers = 1,248 hours to prepare
and post relationship summary to the website.
\821\ Based on data from the SIFMA Office Salaries Report,
modified to account for an 1,800-hour work-year and multiplied by
2.93 to account for bonuses, firm size, employee benefits and
overhead, we expect that performance of this function will most
likely be performed by a general clerk at an estimated cost of $60
per hour. 1,429 hours x $60 = $85,710 total aggregate monetized
cost.
\822\ 42,855 hours/3 years = 14,761 total aggregate annual hour
burden to prepare and file relationship summary. 14,761 hours/2,857
broker-dealers with retail accounts = 5.17 hours annually per
broker-dealer.
\823\ ($11,292,293 total initial aggregate monetized cost for
preparation and filing + $85,710 for posting to the website)/3 =
$3,792,668 total annual monetized cost for preparation, filing and
posting the relationship summary. $3,792,668/2,857 broker-dealers
subject to relationship summary obligations = $1,328 per broker-
dealer.
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b. Estimated External Costs for Initial Preparation of Relationship
Summary
Under proposed new rule 17a-14, broker-dealers would be required to
prepare and file a relationship summary, as well as post it to their
website if they have one. We do not anticipate external costs in the
form of website set-up, maintenance, or licensing fees because broker-
dealers would not be required to establish a website for the sole
purpose of posting their relationship summary if they do not already
have a website. We do anticipate that some broker-dealers may incur a
one-time initial cost for outside legal and consulting fees in
connection with the initial preparation of the relationship summary.
Although broker-dealers subject to the relationship summary requirement
may vary widely in terms of the size, complexity and nature of their
businesses, the amount of disclosure required would not vary
substantially among broker-dealers. Accordingly, the amount of time,
and thus cost, required for outside legal and compliance review is
unlikely to vary substantially among those broker-dealers who elect to
obtain outside assistance.\824\ The relationship summary is short,
standardized, and contains largely prescribed language. Because the
information required in the relationship summary pertains largely to
the broker-dealer's own business practices, the information is likely
more readily available to the broker-dealer than to an external legal
or compliance consultant. As a result, we anticipate that only a
quarter of broker-dealers will seek the help of outside legal services
and half will seek the help of compliance consulting services in
connection with the initial preparation of the relationship summary. We
estimate that the initial per broker-dealer cost for legal services
related to the preparation of the relationship summary would be
$1,416.\825\ We estimate that the initial per broker-dealer cost for
compliance consulting services related to the preparation of the
relationship summary would be $2,109.\826\ Accordingly, we estimate
that 715 broker-dealers will use outside legal services, for a total
initial aggregate cost burden of $1,011,378,\827\ and 1,429 broker-
dealers will use outside compliance consulting services, for a total
initial aggregate cost burden of $3,012,707,\828\ resulting in a total
initial aggregate cost burden among all respondents of $4,024,085, or
$1,409 per broker-dealer, for outside legal and compliance consulting
fees related to preparation of the relationship summary.\829\ Annually,
this represents $1,341,362, or $470 per broker-dealer, when amortized
over a three-year period.\830\
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\824\ We estimate that an external service provider would spend
3 hours helping a broker-dealer prepare an initial relationship
summary.
\825\ External legal fees are in addition to the projected hour
per broker-dealer burden discussed above. $472 per hour for legal
services x 3 hours per broker-dealer = $1,416. The hourly cost
estimate of $472 is adjusted for inflation and based on our
consultation with broker-dealers and law firms who regularly assist
them in compliance matters.
\826\ External compliance consulting fees are in addition to the
projected hour per broker-dealer burden discussed above. Data from
the SIFMA Management and Professional Earnings Report suggest that
outside management consulting services cost approximately $703 per
hour. $703 per hour for outside consulting services x 3 hours per
adviser = $2,109.
\827\ 25% x 2,857 SEC registered broker-dealers = 715 broker-
dealers. $1,416 for legal services x 715 broker-dealers =
$1,011,378.
\828\ 50% x 2,857 SEC registered broker-dealers = 1,429 broker-
dealers. $2,109 for compliance consulting services x 1,429 broker-
dealers = $3,012,707.
\829\ $1,011,378 + $3,012,707 = $4,024,085. $4,024,085/2,857
broker-dealers = $1,409 per broker-dealer.
\830\ $4,024,085 initial aggregate hours/3 years = $1,341,362
annually. $1,409 initial hours per broker-dealer/3 years = $469.50.
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We do not expect ongoing external legal or compliance consulting
costs for the relationship summary. Although broker-dealers would be
required to amend the relationship summary within 30 days whenever any
information becomes materially inaccurate, given the standardized
nature and prescribed language of the relationship summary, we expect
that amendments would be factual and require relatively minimal wording
changes. We believe that broker-dealers would be more knowledgeable
about these facts than outside legal or compliance consultants and
would be able to make these revisions in-house. Therefore, we do not
expect that broker-dealers will need to incur ongoing external costs
for the preparation and review of relationship summary amendments.
c. Amendments to the Relationship Summary and Filing and Posting of
Amendments
As with our estimates above for investment advisers, we do not
expect broker-dealers to amend their relationship summaries frequently.
Based on staff experience, we believe that many broker-dealers, as a
matter of best practices, would update their relationship summary at a
minimum once a year, after conducting an annual supervisory review, for
example.\831\ We also estimate that on average, each broker-dealer
preparing a relationship summary may amend the disclosure once more
during the year, due to emerging issues. Therefore, we assume that
broker-dealers would update their relationship summary, on average,
twice a year, and as with investment advisers, we estimate that broker-
dealers would require 0.5 hours to amend and file the updated
relationship summary, and 0.5 hours to post it to their website. Thus,
we estimate that broker-dealers would incur a total annual aggregate
hourly
[[Page 21525]]
burden of 5,714 hours per year, to prepare and file, and post to their
websites an estimated total of 5,714 amendments per year.\832\
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\831\ FINRA rules set an annual supervisory review as a minimum
threshold for broker-dealers, for example in FINRA Rules 3110
(requiring an annual review of the businesses in which the broker-
dealer engages), 3120 (requiring an annual report detailing a
broker-dealer's system of supervisory controls, including compliance
efforts in the areas of antifraud and sales practices); and 3130
(requiring each broker-dealer's CEO or equivalent officer to certify
annually to the reasonable design of the policies and procedures for
compliance with relevant regulatory requirements).
\832\ 2,857 broker-dealers amending relationship summaries x 2
amendments per year = 5,714 amendments per year. 5,714 amendments x
(0.5 hours to amend and file + 0.5 hours to post to website) = 5,714
hours.
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d. Delivery of the Relationship Summary
Proposed rule 17a-14 under the Exchange Act would require a broker-
dealer to deliver the relationship summary, with respect to a retail
investor that is a new or prospective customer, before or at the time
the retail investor first engages the broker-dealer's services. Broker-
dealers also would make a one-time, initial delivery of the
relationship summary to all existing customers within a specified time
period after the effective date of the proposal. Also with respect to
existing customers, broker-dealers would deliver the relationship
summary before or at the time (i) a new account is opened that is
different from the retail investor's existing account(s); or (ii)
changes are made to the retail investor's account(s) existing
account(s) that would materially change the nature and scope of the
broker-dealer's relationship with the retail investor, as further
discussed in II.C.2 above.
i. One-Time Initial Delivery to Existing Customers
We estimate the burden for broker-dealers to make a one-time
initial delivery of the relationship summary to existing customers
based on an estimate of the number of accounts held by these broker-
dealers. Based on FOCUS data, we estimate that the 2,857 broker-dealers
that report retail activity have approximately 128 million customer
accounts, and that approximately 79%, or 101.248 million, of those
accounts belong to retail customers.\833\ We estimate that, under the
proposed rule, broker-dealers would send their relationship summary
along with other required disclosures, such as periodic account
statements, in order to comply with initial delivery requirement for
the relationship summary. As with investment advisers, we estimate that
a broker-dealer will require no more than 0.02 hours to send the
relationship summary to each customer, or an aggregate initial burden
of 2,024,960 hours, or approximately 709 hours per broker-dealer for
the first year after the rule is in effect.\834\ We would therefore
expect the aggregate monetized cost for broker-dealers to make a one-
time initial delivery of relationship summaries to existing customers
to be $121,497,600.\835\ Amortized over three years, the total annual
hourly burden is estimated to be 674,987 hours, or approximately 236.3
hours per broker-dealer,\836\ with annual monetized costs of
$40,499,200 and $14,175, respectively.\837\ We do not expect that
broker-dealers will incur external costs for the initial delivery of
the relationship summary to existing clients because we assume that
they will make such deliveries along with another required delivery,
such as periodic account statements.
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\833\ See supra notes 428-437 and accompanying text. 2,857
broker-dealers (including dual registrants) report 128 million
customer accounts. We are aware that, based on data from IARD,
investment advisers reporting retail activity have approximately
79.1% retail clients and 21.9% non-retail clients. While
acknowledging the differences between the investment adviser and
broker-dealer models, we apply the 79.1% in estimating the
proportion of broker-dealer accounts that belong to retail
customers. Therefore, 79.1% x 128 million accounts = 101.248 million
accounts. This number likely overstates the number of deliveries to
be made due to the double-counting of deliveries to be made by dual
registrants to a certain extent, and the fact that one customer may
own more than one account.
\834\ (0.02 hours per customer account x 101.248 million
customer accounts) = 2,024,960 hours. We note that the burden for
preparing updated relationship summaries is already incorporated
into the burden estimate for Form CRS discussed above. 2,024,960
hours/2,857 broker-dealers = approximately 709 hours per broker-
dealer.
\835\ Based on data from SIFMA's Office Salaries Report, we
expect that initial delivery requirement to existing clients of rule
17a-14 will most likely be performed by a general clerk at an
estimated cost of $60 per hour. 2,024,960 hours x $60 =
$121,497,600. We estimate that broker-dealers will not incur any
incremental postage costs because we assume that they will make such
deliveries with another mailing the broker-dealer was already
delivering to clients, such as periodic account statements.
\836\ 2,024,960 initial aggregate hours/3 = 674,987 total annual
aggregate hours. 709 initial hours per broker-dealer/3 = 236.3 total
annual hours per broker-dealer.
\837\ $121,497,600 initial aggregate monetized cost/3 =
$40,499,200 annual aggregate monetized cost. $40,499,200/2,857
broker-dealers = $14,175 annual monetized cost per broker-dealer.
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ii. Delivery for New Account Types or Material Changes in the Nature or
Scope of the Brokerage Relationship
Broker-dealers would be required to deliver the relationship
summary to existing customers before or at the time (i) a new account
is opened that is different from the retail investor's existing
account(s); or (ii) changes are made to the retail investor's existing
account(s) that would materially change the nature and scope of the
adviser's relationship with the retail investor, as further discussed
in Section II.C.2. With respect to delivery of the relationship summary
in the event of material changes in the nature or scope of the
brokerage relationship, as with investment advisers, we estimate that
this would take place among 10% of a broker-dealer's retail investors
annually. We would therefore estimate broker-dealers to incur a total
annual aggregate burden of 202,496 hours, or 71 hours per broker-
dealer,\838\ at an annual aggregate monetized cost of $12,149,760, or
approximately $4,253 per broker-dealer.\839\ We do not expect broker-
dealers to incur external costs related to deliveries of the
relationship summary due to new account type openings, or material
changes to the nature or scope of the relationship, because we assume
that broker-dealers will deliver the relationship summary along with
new account agreements and other documentation normally required in
such circumstances, or with periodic account statements.
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\838\ 10% of 101.248 million customers x .02 hours = 202,496
hours. 202,496 hours/2,857 broker-dealers = 71 hours per broker-
dealer.
\839\ Based on data from the SIFMA Office Salaries Report,
modified to account for an 1,800-hour work-year and multiplied by
2.93 to account for bonuses, firm size, employee benefits and
overhead, we expect that delivery requirements of rule 17a-14 will
most likely be performed by a general clerk at an estimated cost of
$60 per hour. 202,496 hours x $60 = $12,149,760. $12,149,760/2,857
broker-dealers = $4,253 per broker-dealer. We estimate that broker-
dealers will not incur any incremental postage costs in these
deliveries of the relationship summary to existing customers,
because we assume that broker-dealers will make such deliveries with
another mailing the broker-dealer was already delivering to clients,
such as periodic account statements, or new account agreements and
other similar documentation.
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iii. Communicating Changes to Amended Relationship Summaries, Including
by Delivery
As discussed above, broker-dealers must communicate any changes in
an updated relationship summary to retail investors who are existing
customers of the firm within 30 days after the updates are required to
be made and without charge. The communication can be made by delivering
the relationship summary or by communicating the information in another
way to the retail investor. Consistent with our discussion on broker-
dealers' amendments to the relationship summary we are assuming that
the 2,857 broker-dealers with relationship summaries will amend them
twice each year. We also assume that 50% will choose to deliver the
relationship summary to communicate the update information. As with
investment advisers, we estimate that broker-dealers would require 0.02
hours to make a delivery to each customer. Therefore, the estimated
burden for those broker-dealers choosing to deliver an amended
relationship summary to meet this communication requirement
[[Page 21526]]
would be approximately 2,024,960 hours, or 709 hours per broker-
dealer,\840\ translating into a monetized cost of $121,497,600 in
aggregate, or $42,526 per broker-dealer.\841\ Similar to the other
delivery requirements relating to proposed rule 17a-14, we do not
expect broker-dealers to incur external costs in delivering amended
relationship summaries because we assume that they will make this
delivery with other documents required to be delivered, such as
periodic account statements.
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\840\ 2 amendments per year x 101.248 million customer accounts
x 50% delivering the amended relationship summary to communicate
updated information x 0.02 hours per delivery = 2,024,960 hours to
deliver amended relationship summaries. 2,024,960 hours/2,857
broker-dealers = 709 hours per broker-dealer.
\841\ Based on data from the SIFMA Office Salaries Report,
modified to account for an 1,800-hour work year and multiplied by
2.93 to account for bonuses, firm size, employee benefits and
overhead, we expect that delivery requirements of rule 17a-14 will
most likely be performed by a general clerk at an estimated cost of
$60 per hour. 2,024,960 hours x $60 = $121,497,600. $121,467,600/
2,857 broker-dealers = $42,526 per broker-dealer. We estimate that
broker-dealers will not incur any incremental postage costs to
deliver these relationship summaries, because we assume that
advisers will make the delivery along with other documentation they
normally would provide, such as account opening documents.
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e. Delivery to New Clients or Prospective New Customers
To estimate the delivery burden for broker-dealers' new or
prospective new customers, as discussed above, we estimate that the
2,857 standalone broker-dealers with retail activity have approximately
101.248 million retail customer accounts.\842\ Based on FOCUS data over
the past five years, we estimate that broker-dealers grow their
customer base and enter into new agreements with, on average, 8% more
new retail investors each year.\843\ We estimate the hour burden for
initial delivery of a relationship summary would be the same by paper
or electronic format, at 0.02 hours for each relationship summary, as
we have estimated above. Therefore, the aggregate annual hour burden
for initial delivery of the relationship summary by broker-dealers to
new or prospective new customers would be 161,917 hours, or 56.7 hours
per broker-dealer.\844\ at a monetized cost of $9,715,001 at an
aggregate level, or $3,400 per broker-dealer.\845\
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\842\ See supra notes 429-439 and accompanying text.
\843\ This represents the average annual rate of growth from
2012-2016 in the number of accounts for all broker-dealers reporting
retail activity.
\844\ 101.248 million customer accounts x 8% increase =
8,095,834 new customers. 8,095,834 new customers x 0.02 hours per
delivery = 161,917 total annual aggregate hours. 161,917/2,857
broker-dealers = 56.7 hours per broker-dealer for delivery to new
customers.
\845\ Based on data from the SIFMA Office Salaries Report,
modified to account for an 1,800-hour work-year and multiplied by
2.93 to account for bonuses, firm size, employee benefits and
overhead, we expect that these functions will most likely be
performed by a general clerk at an estimated cost of $60 per hour.
161,917 hours x $60 = $9,715,001. $9,715,001/2,857 broker-dealers =
$3,400 per broker-dealer for delivery to new customers. We estimate
that broker-dealers will not incur any incremental postage costs to
deliver the relationship summary to new or prospective clients
because we assume that broker-dealers will make the delivery along
with other documentation, such as periodic account statements.
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f. Total New Initial and Annual Burdens
As discussed above, we estimate the total annual collection of
information burden for proposed new rule 17a-14 in connection with
obligations relating to the relationship summary, including (i) initial
preparation, filing, and posting to a website; (ii) amendments to the
relationship summary for material updates and related filing and
website posting burdens; (iii) one-time initial delivery to existing
customers; (iv) delivery to existing customers who are opening new
accounts or materially changing the nature or scope of their
relationship with the broker-dealer; (v) delivery of amended
relationship summaries; and (vi) delivery to new and prospective
customers. Given these proposed requirements, we estimate the total
annual aggregate hourly burden to be approximately 3,084,835 hours per
year, or 1,080 hours on a per broker-dealer basis.\846\ This translates
into an aggregate annual monetized cost of $188,578,462, or $66,066 on
a broker-dealer basis per year.\847\ In addition, we estimate that
broker-dealers would incur external legal and compliance costs in the
initial preparation of the relationship summary of approximately
$4,024,085 in aggregate, or $1,409 per broker-dealer, translating into
$1,341,362 annually, or $470 per broker-dealer, when amortized over a
three year period.
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\846\ 14,761 hours per year for initial preparation, filing, and
posting of relationship summary + 5,714 hours per year for
amendments, filing, and posting of amendments + 674,987 hours for
one-time initial delivery to existing customers + 202,496 hours for
delivery to existing customers making material changes to their
accounts + 2,024,960 hours for delivery of amendments + 161,917
hours for delivery to new customers = 3,084,835 total annual
aggregate hours. 3,084,835 hours/2,857 broker-dealers = 1,080 hours
per broker-dealer.
\847\ $3,792,668 per year for initial preparation, filing, and
posting of relationship summary + $924,240 per year for amendments,
filing, and posting of amendments + $40,499,200 for one-time initial
delivery to existing customers (amortized over three years) +
$12,149,760 for delivery to existing customers making material
changes to their accounts + $121,497,600 for delivery of amendments
+ $9,715,001 for delivery to new customers = $188,578,468 in total
annual aggregate monetized cost. $188,578,468/2,857 broker-dealers =
$66,066 per broker-dealer.
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E. Recordkeeping Obligations Under Rule 17a-3 of the Exchange Act \848\
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\848\ In a concurrent release, we are proposing additional
burden adjustments to rules 17a-3 and 17a-4 of the Exchange Act. See
Regulation Best Interest Proposal, supra note 24.
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The proposed requirement to make a record indicating the date that
a relationship summary was provided to each customer and to each
prospective customer who subsequently becomes a customer would contain
a collection of information that would be found at 17 CFR 240.17a-
3(a)(24) and would be mandatory. The Commission staff would use this
collection of information in its examination and oversight program, and
the information generally is kept confidential.\849\ The likely
respondents to this collection of information requirement are the
approximately 2,857 broker-dealers currently registered with the
Commission that offer services to retail investors, as defined
above.\850\
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\849\ See section 24(b) of the Exchange Act (15 U.S.C. 78x-
24(b)).
\850\ See supra note 29 and accompanying text.
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Exchange Act section 17(a)(1) requires registered broker-dealers to
make and keep for prescribed periods such records as the Commission
deems ``necessary or appropriate in the public interest, for the
protection of investors or otherwise in furtherance of the purposes
of'' the Exchange Act.'' \851\ Exchange Act rules 17a-3 and 17a-4
specify minimum requirements with respect to the records that broker-
dealers must make, and how long those records and other documents must
be kept, respectively.
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\851\ See section 17(a) of the Exchange Act.
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The amendments to rule 17a-3 that we are proposing today would
require SEC-registered broker-dealers to make a record indicating the
date that a relationship summary was provided to each customer and to
each prospective customer who subsequently becomes a customer.
Commission staff has estimated that the proposed amendments to rule
17a-3(a)(24) would result in an incremental burden increase of 0.1
hours annually for each of the estimated SEC-registered broker-dealers
that would be required to prepare and preserve the initial relationship
summary and any amendments.\852\
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\852\ We apply the same 0.2 hour estimate as with investment
advisers, but divided equally between creating a record of the
relationship summary and its deliveries and the maintenance of those
records.
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The incremental hour burden for broker-dealers to maintain the
relationship summary would therefore
[[Page 21527]]
be 286 hours,\853\ for a monetized cost of 17,481 in aggregate, or
$6.00 per broker-dealer.\854\
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\853\ 2,857 broker-dealers x 0.1 hours annually = 286 annual
hours for recordkeeping.
\854\ As with our estimates relating to the proposed amendments
to rule 204-2 under the Advisers Act (see, e.g., supra note 771 and
accompanying text), we expect that performance of this function will
most likely be allocated between compliance clerks and general
clerks, with compliance clerks performing 17% of the function and
general clerks performing 83% of the function. Data from the SIFMA
Office Salaries Report suggest that costs for these position are $67
and $60, respectively. (17% x 286 hours x $67) + (83% x 286 hours x
$60) = $17,481. $17,481/2,857 broker-dealers = $6.00 per broker-
dealer.
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F. Record Retention Obligations Under Rule 17a-4 of the Exchange Act
Exchange Act section 17(a)(1) requires registered broker-dealers to
make and keep for prescribed periods such records as the Commission
deems ``necessary or appropriate in the public interest, for the
protection of investors or otherwise in furtherance of the purposes
of'' the Exchange Act.'' \855\ Exchange Act rule 17a-4 specifies
minimum requirements with respect to how long records created under
Exchange Act rule 17a-3 and other documents must be kept. We are
proposing amendments to rule 17a-4 that would require broker-dealers to
retain copies of each relationship summary, including amendments, and
to preserve the record of dates that each relationship summary and each
amendment thereto was delivered to any existing customer or to any new
or prospective customer, pursuant to the proposed new requirements
under amended rule 17a-3, discussed above. These records would be
required to be maintained in an easily accessible place for at least
six years after such record or relationship summary is created. This
collection of information would be found at 17 CFR 240.17a-4 and would
be mandatory. The Commission staff would use the collection of
information in its examination and oversight program. Requiring
maintenance of these disclosures as part of the broker-dealer's books
and records would facilitate the Commission's ability to inspect for
and enforce compliance with firms' obligations with respect to Form
CRS. The information generally is kept confidential.\856\
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\855\ See section 17(a) of the Exchange Act.
\856\ See section 24(b) of the Exchange Act (15 U.S.C. 78x-
24(b)).
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The likely respondents to this collection of information
requirement are the approximately 2,857 broker-dealers that report
retail activity, as described above.
1. Changes in Burden Estimates and New Burden Estimates
The approved annual aggregate burden for rule 17a-4 is currently
1,042,416 hours, with a total annual aggregate monetized cost burden of
approximately $67.8 million, based on an estimate of 4,104 broker-
dealers and 150 broker-dealers maintaining an internal broker-dealer
system.\857\ The currently approved external cost estimate to
respondents is $20,520,000.\858\ We estimate that the proposed
amendments would result in an increase in the collection of information
burden estimate by 0.10 hours \859\ for each of the estimated 2,857
currently registered broker-dealers that report retail sales activity
and would have relationship summary obligations.\860\ This would yield
an annual estimated aggregate burden of 754,964 hours for all broker-
dealers with relationship summary obligations to comply with rule 17a-
4,\861\ for a monetized cost of approximately $48.6 million.\862\ In
addition, the 984 broker-dealers \863\ not subject to the proposed
amendments would continue to be subject to an unchanged burden of 254
hours per broker-dealer, or 249,936 hours for these broker-
dealers.\864\ In addition, those maintaining an internal broker-dealer
system would continue to be subject to an unchanged burden of 450 hours
annually, under rule 17a-4. In summary, taking into account the
estimated annual burden of broker-dealers that would be required to
maintain records of the relationship summary, as well the estimated
annual burden of broker-dealers that do not have relationship summary
obligations and whose information collection burden is unchanged, the
revised annual aggregate burden for all broker-dealer respondents to
the recordkeeping requirements under rule 17a-4 is estimated to be
976,350 total annual aggregate hours,\865\ for a monetized cost of
approximately $65.4 million.\866\
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\857\ (4,104 broker-dealers x 254 hours per broker-dealer) +
(150 broker-dealers maintaining internal broker-dealer systems x 3
hours) = (1,042,416 hours + 450 hours ) = 1,042,866 hours each year.
The monetized cost was based on these functions being performed by a
compliance clerk earning an average of $65 per hour, resulting in a
total internal cost of compliance of (1,042,416 x $65) + (450 x $65)
= $67,786. See 17a-4 Supporting Statement, available at https://www.reginfo.gov/public/do/PRAViewDocument?ref_nbr=201607-3235-007.
\858\ 4,104 broker-dealers x $5,000 annual recordkeeping cost
per broker-dealer = $20,520,000. See id.
\859\ We apply the same 0.2 hour estimate as with investment
advisers, but divided equally between creating a record of the
relationship summary and its deliveries and the maintenance of those
records.
\860\ See supra note 616.
\861\ 2,857 broker-dealers required to prepare relationship
summary x (254 hours + 0.1 hour) = 725,964 hours.
\862\ Consistent with our prior paperwork reduction analyses for
rule 17a-4, we expect that performance of this function will most
likely be performed by compliance clerks. Data from the SIFMA Office
Salaries Report suggest that costs for these positions are $67 per
hour. 725,964 hours x $67 = $48,639,568.
\863\ See supra note 618.
\864\ 984 broker-dealers x 254 hours = 249,936 hours for broker-
dealers not preparing a relationship summary.
\865\ 725,964 + 249,936 + 450 = 976,350 total aggregate hours.
\866\ Consistent with our prior paperwork reduction analyses for
rule 17a-4, we expect that performance of this function will most
likely be performed by compliance clerks. Data from the SIFMA Office
Salaries Report suggest that costs for these positions are $67 per
hour. 976,650 hours x $67 = $65,415,430.
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2. Revised Annual Burden Estimates
As noted above, the approved annual aggregate burden for rule 17a-4
is currently 1,042,416 hours, with a total annual aggregate monetized
cost burden of approximately $67.8 million, based on an estimate of
4,104 broker-dealers and 150 broker-dealers maintaining an internal
broker-dealer system. The revised annual aggregate hourly burden for
rule 17a-4 would be 976,350 \867\ hours, represented by a monetized
cost of approximately $65.4 million,\868\ based on an estimate of 2,857
broker-dealers with the relationship summary obligation and 984 broker-
dealers without, as noted above. This represents a decrease of 66,516
\869\ annual aggregate hours in the hour burden and an annual decrease
of approximately $2.37 million from the currently approved total
aggregate monetized cost for rule 17a-4.\870\ These changes are
attributable to the proposed amendments to rule 17a-4 relating to the
relationship summary as discussed in this proposing release and the
decline in the number of registered broker-dealer respondents. The
revised external cost to respondents is estimated at approximately
$19.2 million, or a reduction of $1.3 million from the currently
approved external cost burden of $20,520,000.\871\
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\867\ See supra note 865.
\868\ See supra note 739.
\869\ 1,042,866 hours - 976,350 hours = 66,516 hours.
\870\ $67,786,290 - $65,415,430 = $2,370,860.
\871\ 3,841 registered broker-dealers as of December 31, 2017 x
$5,000 per broker-dealer in record maintenance costs = $19,205,000.
$20,520,000-$19,205,000 = $1,315,000.
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G. Rule 151-3 Under the Exchange Act
Proposed new rule 151-3 would require broker-dealers and their
associated natural persons to prominently disclose that it is, or in
the case of a natural person that such person is associated with a
broker-
[[Page 21528]]
dealer that is, registered with the Commission as a broker-dealer in
print or electronic retail investor communications. For print
communications, we propose to require that such registration status be
displayed in a type size at least as large as and of a font style
different from, but at least as prominent as, that used in the majority
of the communication. In addition, such disclosure must be presented in
the body of the communication and not in a footnote. For electronic
communications, or in any publication by radio or television, we
propose to require that such disclosure be presented in a manner
reasonably calculated to draw retail investor attention to it.
Rule 151-3 contains a collection of information requirement. This
collection of information would be found at [17 CFR 240.15l-3] and
would be mandatory. The likely respondents to this information
collection would be all broker-dealers and their associated natural
persons that distribute print or electronic retail investor
communications.
The Commission believes that the collection of information is
necessary to provide retail investors and the Commission with
information to better determine whether a communication is from a
broker-dealer or investment adviser, and, for retail investors
specifically, to allow them to better identify which type of firm is
more appropriate for their specific investment needs. Additionally, by
requiring an affirmative identification, retail investors would also be
better informed whether a financial professional is an associated
person of a broker-dealer rather than a supervised person of an
investment adviser, allowing them to make a more informed choice as to
which type of professional is appropriate for their financial goals.
1. Respondents: Broker-Dealers and Associated Natural Persons
Currently, there are 3,841 registered broker-dealers and 435,071
associated natural persons licensed with FINRA.\872\ Of these
registered broker-dealers, we estimate that approximately 74% or 2,857
distribute print or electronic retail investor communications \873\
while 435,071 associated natural persons distribute print or electronic
retail investor communications at standalone broker-dealers or dually
registered firms.\874\ Of these broker-dealers that distribute print or
electronic retail investor communications, 1,388 are large broker-
dealers and 1,469 are small broker-dealers.\875\ Accordingly, the
Commission estimates that 2,857 broker-dealers and 435,071 associated
natural persons would be required to comply with proposed rule 15l-3.
For the purposes of this analysis of the paperwork burden associated
with the proposed rules, the Commission preliminarily estimates that
there would be approximately 2,857 broker-dealer respondents and
435,071 associated natural person respondents. \876\
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\872\ The number of broker-dealers is as of Dec. 31, 2017. Such
associated natural persons are registered as registered
representatives with FINRA through Form U4 as of Dec. 31, 2017. We
took the total 494,399 registered representatives across standalone
broker-dealers, dually registered firms, and standalone investment
advisers and isolated those registered representatives that act on
behalf of standalone broker-dealers and dually registered firms
(i.e. 88%). See supra Section IV.A.1.e, Economic Analysis:
Registered Representatives of Broker-Dealers, Investment Advisers
and Dually Registered Firms.
\873\ See Section IV.A, supra note 460 and accompanying text. As
noted above, as of December 2017, 3,841 broker-dealers filed Form
BD. Retail sales by broker-dealers were obtained from Form BR.
\874\ See supra Section IV.A.1.e, at Table 5. For the purposes
of the Paperwork Reduction Act analysis applicable to proposed rules
15l-3 and 211h-1, we are defining a ``dually registered firm'' in
the same manner as ``dual registrant'' is defined in the baseline of
the Economic Analysis. See supra Section IV, note 453.
We assume for the purposes of this rule that all 435,071
registered representatives engage retail investors. This estimate is
based on the following calculation: (494,399 total licensed
registered representatives) x (12% (the percentage of pure
investment adviser representatives)) = 59,328 representatives at
standalone investment advisers. Then, to isolate the number of
representatives at standalone broker-dealers and dually registered
firms, subtract 59,328 from 494,399 = 435,071 retail-facing,
licensed registered representatives at standalone broker-dealers or
dually registered firms.
\875\ For the purposes of this proposed rule, we define large
broker-dealers as those with total assets greater than 1 million and
small broker-dealers as those with less than 1 million in total
assets. See Table 1, Panel B supra Section IV.A.1.a. We note that
this distinction differs from the distinction used for proposed rule
211h-1 below because historically we have used the number of
employees rather than total assets to distinguish small and large
investment advisers. See cf. Rules Implementing Amendments to the
Investment Advisers Act of 1940, Investment Advisers Act Release No.
3221 (Jun. 22, 2011), at n.727 (``Release 3221''). Additionally, we
believe that because broker-dealer services encompass a small set of
large broker-dealers and thousands of smaller broker-dealers
competing for niche or regional segments of the market, the number
of employees would not provide the best estimate for how firms would
be impacted by our proposed rule based on the number of
communications produced. Instead, we believe that total assets
properly account for the varying sizes of these smaller broker-
dealers and are a better indicator as to how many communications
would be impacted in proportion to a firm's size. More specifically,
we assume that the greater the total assets, the larger the firm and
associated number of customer accounts which in turn would lead to a
greater number of communications with retail investors.
\876\ We note that we are not analyzing new broker-dealers or
associated natural persons because there has been a downward trend
in broker-dealer registration and the number of associated natural
persons has not shown signs of a noticeable increase over the past
few years. From 2016 through 2018 the number of broker-dealers
registered with the Commission decreased by 160. (4064 - 3904) =
160. See also FINRA Statistics, available at https://www.finra.org/newsroom/statistics#reps.
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2. Initial and Annual Burdens
We estimate that the initial one time burden for complying with the
disclosure requirements would be 72 hours per large broker-dealer \877\
and 15 hours per small broker-dealer.\878\ We note that we are staging
the compliance date to ensure that firms can phase out certain older
communications from circulation through the regular business lifecycle
rather than having to retroactively change them.\879\ As a result of
this staged compliance, our burden estimates do not reflect the burdens
that would have been imposed had these firms had to replace all
outstanding communications.
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\877\ (8 hours for print communications per large broker-dealer
+ 64 hours for electronic communications per large broker-dealer).
\878\ (5 hours for print communications per small broker-dealer
+ 10 hours for electronic communications per small broker-dealer).
\879\ Similarly, we are not requiring firms to send new
communications to replace all older print communications as this
would be overly burdensome and costly for firms.
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Aside from certain anticipated outside legal costs, as discussed
below, we preliminary estimate that to comply with our proposed rule
with respect to print communications,\880\ broker-dealers would need to
review their communications, identify which would need to be amended,
make the changes, and verify that all firm communications comply with
the rule's requirements including its technical specifications such as
the type size, font, and prominence. Therefore, for existing print
communications for large broker-dealers, we preliminarily estimate that
the total burden for broker-dealers would be 8 hours for compliance and
business operations personnel to review, identify, and make changes
across all print communications.\881\ For
[[Page 21529]]
smaller broker-dealers, we preliminarily estimate that the total burden
for broker-dealers would be 5 hours for compliance and business
operations personnel to review, identify, and make changes across all
print communications.\882\ We note that there is a difference between
large broker-dealers and smaller broker-dealers. We assume that large
broker-dealers will have to review, identify and change more print
communications and in turn have their compliance staff verify more
print communications as being compliant with our proposed rule as
compared to small broker-dealers which will have fewer print
communications.
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\880\ Such communications could include business cards,
letterheads, newspaper advertisements, and article reprints from an
unaffiliated magazine or newspaper.
\881\ This estimate is based upon staff experience and industry
sources more generally. See e.g., Self-Regulatory Organizations;
Financial Industry Regulatory Authority, Inc.; Notice of Filing of a
Proposed Rule Change to Amend FINRA Rule 2210, Exchange Act Release
No. 34-75377 (Jul. 7, 2015), at Economic Impact Assessment (``FINRA
2015-22 Notice'') (stating with reference to adding BrokerCheck
links to mid-size and smaller firm communications, which we believe
is analogous to the manual changes made to print communications,
that ``mid-size and small members typically have less complex
websites, which they manage and maintain with nontechnical staff.
These members would use personnel in non-technical roles to
accomplish the required updates to their websites . . . [I]t would
take mid-size or small members approximately eight hours of non-
technical staffs' time to make the required updates . . .'').
To compute the 8 hours internal initial burden we assume 2 hours
by compliance personnel and 6 hours by business operations personnel
of the broker-dealer.
\882\ This estimate is based upon staff experience and industry
sources more generally. See e.g., FINRA 2015-22 Notice, supra note
881. To compute the 5 hours internal initial burden we assume 1 hour
by compliance personnel and 4 hours by business operations personnel
of the broker-dealer.
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With respect to electronic communications,\883\ we preliminarily
anticipate that it would take large broker-dealers approximately 64
hours \884\ to review, identify and make the required updates coupled
with verifying that such communications (present and future) would be
compliant with the proposed rule. Our estimates take into account that
larger firms likely have full-featured websites that generate other
webpages based on complex system code and logic.\885\ In order to make
changes to comply with our proposed rule, we assume that business
operations and information technology personnel would likely be
required to update the underlying code and logic to automate the
implementation of the required language to populate across all
associated electronic media. Additionally, we assume that these teams
would need to test to ensure that such changes were implemented
correctly.
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\883\ We believe such communications could include websites,
smart phone apps, social media, emails, and blogs.
\884\ This estimate is based upon staff experience and industry
sources more generally. See e.g., FINRA 2015-22 Notice, supra note
881. (``These estimates are based on FINRA's assumption that large
members typically have full-featured websites that dynamically
generate webpages based on data and logic. The technology personnel
at these members would be required to update the underlying
information in order to automate the implementation of references
and hyperlinks to BrokerCheck across all applicable webpages. FINRA
estimates that on average it would take large members approximately
60 hours of technology staffs' time to make the required updates . .
.''). To compute the 64 hours internal initial burden we assume 4
hours by compliance personnel and 60 hours by business operations
and information technology personnel of the broker-dealer.
\885\ This is based upon staff experience and industry sources
more generally. See e.g., FINRA 2015-22 Notice, supra note
(discussing the burdens associated with the inclusion of a
BrokerCheck reference and hyperlink across all firm communications
for certain firms).
---------------------------------------------------------------------------
With respect to smaller broker-dealers, we preliminarily anticipate
that it would take approximately 10 hours \886\ to review, identify and
make the required updates coupled with verifying that such
communications (present and future) would be compliant with the
proposed rule. Our estimate for smaller broker-dealers assumes that
smaller broker-dealers have fewer electronic communications that would
be subject to our proposed rule as compared to larger firms, resulting
in a lower burden preliminary estimate.
---------------------------------------------------------------------------
\886\ This estimate is based upon staff experience and industry
sources more generally. See e.g., FINRA 2015-22 Notice, supra note
881 (stating with reference to adding BrokerCheck links to firm
communications that ``mid-size and small members typically have less
complex websites, which they manage and maintain with nontechnical
staff. These members would use personnel in non-technical roles to
accomplish the required updates to their websites . . . [I]t would
take mid-size or small members approximately eight hours of non-
technical staffs' time to make the required updates . . .'').
To compute the 10 hours internal initial burden, we assume 2
hours by compliance personnel and 8 hours by business operations and
information technology personnel of the broker-dealer.
---------------------------------------------------------------------------
We preliminarily estimate that the total initial burden for broker-
dealers is 121,971 hours.\887\ We preliminarily estimate a cost of
approximately $33,179,514 for broker-dealers.\888\ This would be an
annual average burden of 43 hours per broker-dealer \889\ (as
monetized, is an average annual burden per broker-dealer of
$11,613).\890\
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\887\ (8 hours for print communications per large broker-dealer
+ 64 hours for electronic communications per large broker-dealers) =
72 hours per large broker-dealer. (72 hours x 1,388 large broker-
dealers) = 99,936 total initial burden for large broker-dealers.
(5 hours for print communications per small broker-dealer + 10
hours for electronic communications per small broker-dealer) = 15
hours per small broker-dealer. (15 hours x 1,469 small broker-
dealers) = 22,035 total initial burden for small broker-dealers.
(99,936 total initial burden large broker-dealers + 22,035 total
initial burden small broker-dealers) = 121,971 total broker-dealer
initial burden.
\888\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
The average technology and business rate is ($268 business rate +
$270 technology rate)/2 = $269 average rate.
This figure was calculated as follows: (6 compliance hours x
$298 compliance rate) + (66 technology/business hours x $269
averaged technology/business rate) x 1,388 large broker-dealers =
$27,124,296 total initial costs for large broker-dealers.
(3 compliance hours x $298 compliance rate) + (12 technology/
business hours x $269 averaged technology/business rate) x 1,469
small broker-dealers = $6,055,218 total initial costs for small
broker-dealers.
$27,124,296 total initial cost for large broker-dealers +
$6,055,218 total initial cost for small broker-dealers = $33,179,514
total initial costs for all broker-dealers.
\889\ (8 hours for print communications per large broker-dealer
+ 64 hours for electronic communications per large broker-dealers) =
72 hours per large broker-dealer. (72 hours x 1,388 large broker-
dealers) = 99,936 total initial burden for large broker-dealers.
(5 hours for print communications per small broker-dealer + 10
hours for electronic communications per small broker-dealer) = 15
hours per small broker-dealer. (15 hours x 1,469 small broker-
dealers) = 22,035 total initial burden for small broker-dealers.
99,936 total initial burden large broker-dealers + 22,035 total
initial burden small broker-dealers = 121,971 total broker-dealer
initial burden/2,857 total broker-dealers = 43 total initial burden
per broker-dealer.
\890\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
The average technology and business rate is ($268 business rate +
$270 technology rate)/2 = $269 average rate.
This figure was calculated as follows: (6 compliance hours x
$298 compliance rate) + (66 technology/business hours x $269
averaged technology/business rate) x 1,388 large broker-dealers =
$27,124,296 total initial costs for large broker-dealers.
(3 compliance hours x $298 compliance rate) + (12 technology/
business hours x $269 averaged technology/business rate) x 1,469
small broker-dealers = $6,055,218 total initial costs for small
broker-dealers.
$27,124,296 total initial cost for large broker-dealers +
$6,055,218 total initial cost for small broker-dealers = $33,179,514
total initial costs for all broker-dealers/2,857 total number of
broker-dealers = $11,613 total initial cost per broker-dealer.
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We further preliminarily anticipate that associated natural persons
would have an initial one-time burden of 0.5 hours for each associated
natural person respondent to review, identify, and make changes to
their individual communications, both print and electronic.\891\ Based
on staff experience,
[[Page 21530]]
we anticipate that many firms will make many communication changes for
their associated natural persons, including their business cards and
letterheads, leaving only certain responsibilities to the individual
such as changes to their individual social media profile(s) and email
signatures. Therefore, we preliminarily estimate that the total initial
one-time burden for associated natural persons is 217,536 hours.\892\
We preliminarily estimate a monetized cost of approximately
$31,107,576.50 for associated natural persons.\893\ This would be an
annual average burden of 0.5 hours per associated natural person \894\
(as monetized, is an average annual burden per associated natural
person of $71.50).\895\
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\891\ This estimate is based upon staff experience. See e.g.,
Custody of Funds or Securities of Clients by Investment Advisers,
Investment Advisers Act Release No. 2968 (Dec. 30, 2009) (``Release
2968'') (``We further estimate that the adviser will spend 10
minutes per client drafting and sending the notice.''); Enhanced
Mutual Fund Disclosure Adopting Release, supra note 47 (``we
estimate, as we did in the proposing release, that rule 498 will
impose a \1/2\ hour burden per portfolio annually associated with
the compilation of the additional information required on a cover
page or at the beginning of the Summary Prospectus. Rule 498 also
imposes annual hour burdens associated with the posting of a fund's
Summary Prospectus, statutory prospectus, SAI, and most recent
report to shareholders on an Internet website. We estimate that the
average hour burden for one portfolio to comply with the Internet
website posting requirements will be approximately one hour
annually.'').
\892\ (0.5 hours x 435,071 associated natural persons) = 217,536
total initial burden for associated natural persons.
\893\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per associated natural person.
(0.5 x $143 total cost per associated natural person x 435,071
associated natural persons) = $31,107,576.50 total initial cost for
associated natural persons.
\894\ (0.5 hours x 435,071 associated natural persons) = 217,536
total initial burden for associated natural persons.
(217,536 total initial burden/435,071 total associated natural
persons) = 0.5 total initial burden per associated natural person.
\895\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per associated natural person.
(0.5 x $143 total cost per associated natural person x 435,071
associated natural persons) = $31,107,576.50 total initial cost for
associated natural persons.
($31,107,576.50 total initial cost for associated natural
persons/435,071 total number of associated natural persons) = $71.50
total initial cost per associated natural person.
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Aside from the internal initial burden, we anticipate that there
will be certain associated outside costs as well. We believe that
broker-dealers and their associated natural persons may engage outside
counsel to assist them in understanding our proposed rule should it be
adopted.\896\ We assume that the amount of outsourced legal assistance
would vary among various sizes of broker-dealers and their number of
associated natural persons. As a result, we preliminarily estimate that
large broker-dealers together with their associated natural persons may
initially outsource approximately 8 hours of legal time in order to
understand the implications of our proposed rule, including which
communications are subject to the proposed rule and how best to comply
with the technical specifications.\897\ For small broker-dealers, we
anticipate that such firms will outsource 4 hours of legal time.\898\
Our preliminary estimates take into account that large firms have more
communications affected by our proposed rule and more associated
natural persons to supervise than smaller firms. We estimate initial
outside legal costs associated with the proposed rule of $8,014,560 for
broker-dealers \899\ or $2,805 per broker-dealer.\900\
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\896\ We are assuming that associated natural persons would not
independently seek outside counsel and would instead rely on the
advice received from outside counsel to the firm. Therefore, we are
not including a separate estimate for associated natural persons.
\897\ This estimate is based upon staff experience. See e.g.
Disclosure of Order Handling Information Proposed Rule, Securities
Exchange Act Release No. 34-78309 (July 13, 2016) (``Release 34-
78309'') (estimating 4 hours for legal burden ``to assign each order
routing strategy for institutional orders into passive, neutral, and
aggressive categories and establish and document its specific
methodologies for assigning order routing strategies as required by
Rule 606(b)(3)(v)''); Regulation of NMS Stock Alternative Trading
Systems Proposed Rule, Securities Exchange Act Release No. 34-76474
(Nov. 18, 2015) (``Release 34-76474'') (estimating 7 legal hours
``to put in writing its safeguards and procedures to protect
subscribers' confidential trading information and the oversight
procedures to ensure such safeguards and procedures are followed . .
.'').
\898\ This estimate is based upon staff experience. See supra
note 897.
\899\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for legal services is $472/hour.
($472 x 8 legal hours = $3,776 x 1,388 large broker-dealers =
$5,241,088) + ($472 x 4 legal hours = $1,888 x 1,469 small broker-
dealers = $2,773,472).
($5,241,088 large broker-dealers + $2,773,472 small broker-
dealers) = $8,014,560 total cost.
\900\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for legal services is $472/hour.
($472 x 8 legal hours = $3,776 x 1,388 large broker-dealers =
$5,241,088) + ($472 x 4 legal hours = $1,888 x 1,469 small broker-
dealers = $2,773,472).
$5,241,088 large broker-dealers + $2,773,472 small broker-
dealers = $8,014,560 total cost/2,857 broker-dealers = $2,805 total
cost per broker-dealer.
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Additionally, we anticipate that firms will also have one-time
outside cost associated with the cost of printing new communications
including new business cards, envelopes, pitch books, and letterheads.
As part of these costs, we anticipate that both large and small broker-
dealers will have to work with printers to set the disclosure on, for
example, business cards. We estimate initial costs to amend certain
communications associated with the proposed rule of $617,848,307 for
broker-dealers \901\ (or $216,258 per broker-dealer).\902\ We assume
that because small broker-dealers have fewer associated natural persons
there will be less communications that will require printing.
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\901\ Our estimates are based on staff experience and industry
sources. In particular, staff factored in its cost estimate the
costs associated with printing envelopes, pitch books, letterheads,
and business cards. For large broker-dealers, the staff assumes a
printing cost of $445,121. For small broker-dealers, the staff
assumes a printing cost of $20,359.
($445,121 x 1,388 large broker-dealers = $617,827,948) +
($20,359 x 1,469 small broker-dealers = $29,907,371) = $617,848,307
total broker-dealer outside costs.
\902\ ($445,121 x 1,388 large broker-dealers = $617,827,948) +
($20,359 x 1,469 small broker-dealers = $29,907,371) = $617,848,307
total broker-dealer outside costs/2,857 broker-dealers = $216,258
total cost per broker-dealer.
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For the ongoing burden of new communications for broker-dealers, we
preliminarily estimate that the burden for legal, compliance, business
operations, and technology services for adding a registration status
statement would be 0.5 hours annual hours per broker-dealer.\903\ We
anticipate that broker-dealers will need to add the registration
disclosure to each new communication which they create, however we
anticipate the burdens associated with this task to be minimal and
therefore we do not believe there is a material difference between
large and small broker-dealers.\904\ We
[[Page 21531]]
preliminarily estimate that the total ongoing annual aggregate burden
for broker-dealers is 1,429 hours.\905\ We preliminarily estimate a
total ongoing monetized cost of approximately $204,275.50 for broker-
dealers.\906\ This would be an annual average burden of 0.5 hours per
broker-dealer \907\ (as monetized, is an average annual burden per
broker-dealer of $71.50).\908\
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\903\ This estimate is based upon staff experience. See e.g.,
Release 2968, supra note 891; Enhanced Mutual Fund Disclosure
Adopting Release, supra note 47.
In this estimate we are not calculating the print and
technological associated burdens of updating communications which we
analyzed earlier as we are assuming those burdens to be a one-time
initial burden for a firm seeking compliance with the proposed rule.
\904\ Our assumption of no material difference between large and
small rests on the fact that all major systems changes would already
have been implemented as part of the initial one-time burden.
Therefore, any new electronic communications would have the
disclosure statement required by our proposed rule built in at the
outset which should take minimal time rather than having to
retroactively insert it into the systems logic which is a more
onerous task. We note that such communications will need to be
reviewed by compliance staff for compliance with applicable
securities laws and associated self-regulatory agency rules,
including FINRA Rule 2210. We anticipate that compliance with
proposed rule 151-3's requirements will be reviewed as part of this
larger compliance check.
\905\ (0.5 hours x 2,857 broker-dealers) = 1,429 total ongoing
burden for broker-dealers.
\906\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per broker-dealer.
(0.5 hours x $143 total cost per broker-dealer x 2,857 broker-
dealers) = $204,275.50 total ongoing cost for broker-dealers.
\907\ (0.5 hours x 2,857 broker-dealers) = 1,429 total ongoing
burden for broker-dealers.
(1,429 total ongoing burden for broker-dealers/2,857 total
broker-dealers) = 0.5 total initial burden per broker-dealer.
\908\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per broker-dealer.
(0.5 hours x $143 total cost per broker-dealer x 2,857 broker-
dealers) = $204,275.50 total ongoing cost for broker-dealers/2,857
total number of broker-dealers = $71.50 total ongoing cost per
broker-dealer.
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For the ongoing burden of new communications for associated natural
persons of a broker-dealer, we preliminarily estimate that the burden
for compliance, business operations, and technology services for adding
a registration status statement would be 0.5 hours.\909\ Therefore, we
preliminarily estimate that the total ongoing annual aggregate burden
for associated natural persons is 217,536 hours.\910\ We preliminarily
estimate a total ongoing monetized cost of approximately $31,107,576.50
for associated natural persons.\911\ This would be an ongoing annual
average burden of 0.5 hours per associated natural person \912\ (as
monetized, is an average ongoing annual burden per associated natural
person of $71.50).\913\
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\909\ This estimate is based upon staff experience. See e.g.,
Release 2968, supra note 891; Enhanced Mutual Fund Disclosure
Adopting Release, supra note 47.
In this estimate we are not calculating the print and
technological associated burdens of updating communications which we
analyzed earlier as we are assuming those burdens to be a one-time
initial burden for an associated natural person of a broker-dealer
seeking compliance with the proposed rule.
\910\ (0.5 hours x 435,071 associated natural persons) = 217,536
total ongoing burden for associated natural persons.
\911\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per associated natural person.
(0.5 hours x $143 total cost per associated natural person x
435,071 associated natural person) = $31,107,576.50 total ongoing
cost for associated natural persons.
\912\ (0.5 hours x 435,071 associated natural persons) = 217,536
total ongoing annual burden for associated natural persons.
(217,536 total ongoing burden/435,071 total associated natural
persons) = 0.5 total ongoing annual burden per associated natural
person.
\913\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per associated natural person.
(0.5 hours x $143 total cost per associated natural person x
435,071 associated natural person) = $31,107,576.50 total ongoing
cost for associated natural persons/435,071 total number of
associated natural persons) = $71.50 total ongoing annual cost per
associated natural person.
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H. Rule 211h-1 Under the Advisers Act
Proposed rule 211h-1 would require investment advisers registered
under section 203 and their supervised persons to prominently disclose
that it is, or in the case of supervised persons that such persons are
supervised by an investment adviser that is, registered with the
Commission as an investment adviser in print or electronic retail
investor communications. For print communications, we propose to
require that such registration status be displayed in a type size at
least as large as and of a font style different from, but at least as
prominent as, that used in the majority of the communication. In
addition, such disclosure must be presented in the body of the
communication and not in a footnote. For electronic communications, or
in any publication by radio or television, we propose to require that
such disclosure be presented in a manner reasonably calculated to draw
retail investor attention to it. This collection of information would
be found at [17 CFR 240.15l-3] and would be mandatory. The likely
respondents to this information collection would be all investment
advisers and their supervised persons that distribute print or
electronic retail investor communications.
The Commission believes that the collection of information is
necessary to provide retail investors and the Commission with
information to better determine whether a communication is from a
broker-dealer or investment adviser, and, for retail investors
specifically, to allow them to better identify which type of firm is
more appropriate for their specific investment needs. Additionally, by
requiring an affirmative identification, retail investors would also be
better informed whether a financial professional is a supervised person
of an investment adviser rather than an associated person of a broker-
dealer. For similar reasons, we believe that because retail investors
interact with a firm primarily through financial professionals, it is
important that financial professionals disclose the firm type with
which they are associated.
1. Respondents: Investment Advisers and Supervised Persons
Currently, there are 12,721 registered investment advisers and
approximately 942,215 supervised persons.\914\ Of these, 7,625
investment advisers distribute print or electronic retail investor
[[Page 21532]]
communications while 245,408 supervised persons distribute print or
electronic retail investor communications at standalone investment
advisers or dually registered firms.\915\ Additionally, of these
investment advisers 2,738 are large advisers and 4,887 are small
advisers.\916\ Accordingly, the Commission estimates that 7,625
investment advisers and 245,408 supervised persons would be required to
comply with proposed rule 211h-1. There are also 477 new SEC registered
investment advisers per year on average and 3,000 new supervised
persons per year.\917\
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\914\ The investment adviser and supervised person numbers are
as of December 31, 2017. See supra Section IV.A.1.b, at Table 3,
Panel A. We note that our estimate of supervised persons is based on
those supervised persons identified in the baseline in the Economic
Analysis. See Section IV.A.1.e, at Table 6.
\915\ We estimate the number of supervised persons who
distribute print or electronic retail investor communications using
several data points. First, we analyzed those supervised persons who
only hold a series 65 at a dual registrant or an investment adviser
firm, totaling 27,879. Next we analyzed those supervised persons at
dual registrants or investment advisers holding a combination of
either a series 6 and 65 or a series 7 and 65, totaling 15,381 and
172,304 respectively. Finally, we analyzed those supervised persons
at dual registrants or investment advisers holding a series 6, 7,
and 65, totaling 29,944. (27,879 + 15,281 + 172,304 + 29,944) =
245,408 total supervised persons who engage retail investors through
print or electronic communications. We note that our estimate does
not reflect supervised persons who hold various designations (e.g.
Chartered Financial Analyst) in lieu of the licenses we used to
identify supervised persons of investment advisers who distribute
print or electronic retail investor communications. Finally, our
estimate does not employ rounding as compared to Table 6 in the
Economic Analysis Baseline. See Table 6: Number of Employees at
Retail Facing Firms who are Registered Representatives, Investment
Adviser Representatives, or Both, Section I.V.A.1.e. These numbers
are as of December 31, 2017.
\916\ For purposes of this estimate, we categorize small
advisers as advisers with 10 or fewer employees and large advisers
as those with 10 or more employees. See cf. Release 3221, supra note
875, at n.727.
\917\ The number of new investment advisers is calculated by
looking at the number of new advisers in 2016 and 2017 and then
isolating the number each year that services retail investors. (455
for 2016 + 499 for 2017)/2) = 477.
The number of new supervised persons is calculated by looking
at the difference in the number of supervised persons in 2017 as
compared to 2016 at firms which service retail investors.
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2. Initial and Annual Burdens
We estimate that the initial one-time burden for complying with the
disclosure requirements would be 72 hours per large investment adviser
\918\ and 15 hours per small investment adviser.\919\ We note that we
are staging the compliance date to ensure that firms can phase out
certain older communications from circulation through the regular
business lifecycle rather than having to retroactively change
them.\920\ As a result of this staged compliance, our burden estimates
do not reflect the burdens that would have been imposed had these firms
had to replace all outstanding communications.
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\918\ (8 hours for print communications per broker-dealer + 64
hours for electronic communications per broker-dealer).
\919\ (5 hours for print communications per broker-dealer + 10
hours for electronic communications per broker-dealer).
\920\ Similarly, we are not requiring firms to send new
communications to replace all older print communications as this
would be overly burdensome and costly for firms.
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Aside from certain anticipated outside legal costs, as discussed
below, we preliminary estimate that to comply with our proposed rule
with respect to print communications,\921\ investment advisers would
need to review their communications, identify which would need to be
amended, make the changes, and verify that all firm communications
comply with the rule's requirements including its technical
specifications such as the type size, font, and prominence. Our
preliminary estimates differ for large and small investment advisers.
We drew these distinctions because we assume that the larger an adviser
is the more communications it would need to review, identify and change
and in turn have its compliance staff verify that such communications
are compliant with our proposed rule.
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\921\ Such communications could include business cards,
letterheads, newspaper advertisements, and article reprints from an
unaffiliated magazines or newspaper.
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For existing print communications for large investment advisers we
preliminarily estimate that the total burden for investment advisers
would be 8 hours for compliance and business operations personnel to
review, identify, and make changes across all print
communications.\922\ For small investment advisers, we preliminarily
estimate that the total burden for investment advisers would be 5 hours
for compliance and business operations personnel to review, identify,
and make changes across all print communications.\923\
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\922\ This estimate is based upon staff experience and industry
sources more generally. See e.g., FINRA 2015-22 Notice, supra note
881.
To compute the 8 hours internal initial burden we assume 2 hours
by compliance personnel and 6 hours by business operations personnel
of the broker-dealer.
\923\ This estimate is based upon staff experience and industry
materials more generally. See e.g., FINRA 2015-22 Notice, supra note
881. To compute the 5 hours internal initial burden we assume 1 hour
by compliance personnel and 4 hours by business operations personnel
of the investment adviser.
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With respect to electronic communications \924\ we preliminarily
anticipate that it would take large investment advisers approximately
64 hours \925\ to review, identify and make the required updates
coupled with verifying that such communications (present and future)
would be compliant with the proposed rule. Our estimates take into
account that larger firms likely have full-featured websites that
generate other webpages based on complex system code and logic.\926\ In
order to make changes to comply with our proposed rule, we assume that
business operations and information technology personnel would likely
be required to update the underlying code and logic to automate the
implementation of the required language to populate across all
associated electronic media. Additionally, we assume that these teams
would need to test to ensure that such changes were implemented
correctly.
---------------------------------------------------------------------------
\924\ We believe such communications could include websites,
smart phone apps, social media, emails, and blogs.
\925\ This estimate is based upon staff experience and industry
materials more generally. See e.g., FINRA 2015-22 Notice, supra note
881. To compute the 64 hours internal initial burden we assume 4
hours by compliance personnel and 60 hours by business operations
and information technology personnel of the investment adviser.
\926\ This is based upon staff experience and industry materials
more generally. See e.g., FINRA 2015-22 Notice, supra note 881
(discussing the burdens associated with the inclusion of a
BrokerCheck reference and hyperlink across all firm communications
for certain firms).
---------------------------------------------------------------------------
With respect to small investment advisers, we preliminarily
anticipate that it would take approximately 10 hours \927\ to review,
identify and make the required updates coupled with verifying that such
communications (present and future) would be compliant with the
proposed rule. Our estimate for small investment advisers assumes that
small investment advisers have fewer electronic communications that
would be subject to our proposed rule as compared to larger firms,
resulting in a lower burden preliminary estimate.
---------------------------------------------------------------------------
\927\ This estimate is based upon staff experience and industry
materials more generally. See e.g., FINRA 2015-22 Notice, supra note
881.
To compute the 10 hours internal initial burden, we assume 2
hours by compliance personnel and 8 hours by business operations and
information technology personnel of the investment adviser.
---------------------------------------------------------------------------
We preliminarily estimate that the total initial burden for
investment advisers is 270,441 hours.\928\ We
[[Page 21533]]
preliminarily estimate a cost of approximately $73,650,210 for
investment advisers.\929\ This would be an annual average burden of 35
hours per investment adviser \930\ (as monetized, an annual average
cost of $9,659 per investment adviser).\931\
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\928\ (8 hours for print communications per large investment
adviser + 64 hours for electronic communications per large
investment adviser) = 72 hours per large investment adviser.
(72 hours x 2,738 large investment advisers) = 197,136 total
initial burden for large investment advisers.
(5 hours for print communications per small investment adviser +
10 hours for electronic communications per small investment adviser)
= 15 hours per small investment adviser. (15 hours x 4887 small
investment advisers) = 73,305 total initial burden for small
investment advisers.
(197,136 total burden large investment advisers + 73,305 total
burden small investment advisers) = 270,441 hours.
\929\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services in the securities industry is
$298, for business services is $268, and for technology services is
$270. The average technology and business rate is ($270 technology
rate + $268 business rate)/2 = $269 average rate.
This figure was calculated as follows: (6 compliance hours x
$298 compliance rate) + (66 technology/business hours x $269
averaged technology/business rate) x 2,738 large investment advisers
= $53,505,996 total initial costs for large investment advisers.
(3 compliance hours x $298 compliance rate) + (12 technology/
business hours x $269 averaged technology/business rate) x 4,887
small investment advisers = $20,144,214 total initial costs for
small investment advisers.
($53,505,996 total initial costs for large investment advisers +
$20,144,214 total initial costs for small investment advisers) =
$73,650,210 total initial costs for investment advisers.
\930\ (8 hours for print communications per large investment
adviser + 64 hours for electronic communications per large
investment adviser) = 72 hours per large investment adviser.
(72 hours x 2,738 large investment advisers) = 197,136 total
initial burden for large investment advisers.
(5 hours for print communications per small investment advisers
+ 10 hours for electronic communications per small investment
adviser) = 15 hours per small investment adviser. (15 hours x 4887
small investment advisers) = 73,305 total initial burden for small
investment advisers.
197,136 total burden large investment advisers + 73,305 total
burden small investment advisers = 270,441 hours/7,625 total
investment advisers = 35 hours average initial burden per investment
adviser.
\931\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
The average technology and business rate is ($268 business rate +
$270 technology rate)/2 = $269 average rate.
This figure was calculated as follows: (6 compliance hours x
$298 compliance rate) + (66 technology/business hours x $269
averaged technology/business rate) x 2,738 large investment advisers
= $53,505,996 total initial costs for large investment advisers.
(3 compliance hours x $298 compliance rate) + (12 technology/
business hours x $269 averaged technology/business rate) x 4,887
small investment advisers = $20,144,214 total initial costs for
small investment advisers.
$53,505,996 total initial cost large investment advisers +
$20,144,214 total initial costs small investment advisers =
$73,650,210 total initial cost investment advisers/7,625 total
number of investment advisers = $9,659 average initial cost per
investment adviser.
---------------------------------------------------------------------------
We further preliminarily anticipate that supervised persons would
have an initial burden of 0.5 hours for each supervised person
respondent to review, identify, and make changes to their individual
communications, both print and electronic.\932\ Based on staff
experience, we anticipate that many firms will make many communication
changes for their supervised persons, including their business cards
and letterheads, leaving only certain responsibilities to the
individual such as changes to their individual social media profile(s)
and email signatures. Therefore, we preliminarily estimate that the
total initial one-time burden for supervised persons is 122,704
hours.\933\ We preliminarily estimate a monetized cost of approximately
$17,546,672 for supervised persons.\934\ This would be an annual
average burden of 0.5 hours per supervised person \935\ (as monetized,
is an annual average cost of $71.50 per supervised person).\936\
---------------------------------------------------------------------------
\932\ This estimate is based upon staff experience. See e.g.,
Release 2968, supra note 891; Enhanced Mutual Fund Disclosure
Adopting Release, supra note 47.
\933\ (0.5 hours x 245,408 supervised persons) = 122,704 total
initial burden for supervised persons.
\934\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per supervised person.
(0.5 hours x $143 total cost per supervised person x 245,408
supervised persons) = $17,546,672 total initial cost for supervised
persons.
\935\ (0.5 hours x 245,408 supervised persons) = 122,704 total
initial burden for supervised persons.
(122,704 total initial burden for supervised persons/245,408
total supervised persons) = 0.5 hours average initial burden per
investment adviser.
\936\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per supervised person.
(0.5 hours x $143 total cost per supervised person x 245,408
supervised persons) = $17,546,672 total initial cost for supervised
persons/245,408 total number of supervised persons) = $71.50 average
initial cost per supervised person.
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Aside from the internal initial burden, we anticipate that there
would be certain associated outside costs as well. We believe that
investment advisers and their supervised persons may engage outside
counsel to assist them in understanding our proposed rule should it be
adopted.\937\ We assume that the amount of outsourced legal assistance
would vary among various sizes of investment advisers and their number
of supervised persons. As a result, we preliminarily estimate that
large investment advisers together with their supervised persons may
initially outsource approximately 8 hours of legal time in order to
understand the implications of our proposed rule and how best to comply
with the technical specifications.\938\ For small investment advisers,
we anticipate that such firms will outsource 4 hours of legal
time.\939\ The hour differences in our preliminary estimates take into
account that larger firms have more communications affected by our
proposed rule and more supervised persons to supervise than small
firms. We estimate initial outside legal costs associated with the
proposed rule of $19,565,344 for investment advisers \940\ (or $2,566
on average per investment adviser.) \941\
---------------------------------------------------------------------------
\937\ We are assuming that supervised persons would not
independently seek outside counsel and would instead rely on the
advice received from outside counsel to the firm. Therefore, we are
not including a separate estimate for supervised persons.
\938\ This estimate is based upon staff experience. See e.g.,
Release 34-78309, supra note 897; Release 34-76474, supra note 897.
\939\ This estimate is based upon staff experience. See supra
note 938.
\940\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for legal services is $472/hour.
($472 x 8 legal hours) = $3,776 x 2,738 large investment
advisers = $10,338,688.
($472 x 4 legal hours) = $1,888 x 4,887 small investment
advisers = $9,226,656.
($10,338,688 total large investment advisers costs + $9,226,656
total small investment advisers costs) = $19,565,344.
\941\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for legal services is $472/hour.
($472 x 8 legal hours) = $3,776 x 2,738 large investment
advisers = $10,338,688.
($472 x 4 legal hours) = $1,888 x 4,887 small investment
advisers = $9,226,656.
$10,338,688 total large investment advisers costs + $9,226,656
total small investment advisers costs = $19,565,344/7625 total
investment advisers = $2,566 total cost per investment adviser.
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Additionally, we anticipate that firms will also have one-time
outside costs associated with the cost of printing new communications
including new business cards, envelopes, pitch books, and letterheads.
As part of these costs, we anticipate that both large and small
investment advisers will have to work with printers to set the
disclosure on, for example, business cards. We
[[Page 21534]]
estimate initial costs to amend certain communications associated with
the proposed rule of $346,787,187 for investment advisers \942\ (or
$45,480 per investment adviser.) \943\ We assume that because small
investment advisers have fewer supervised persons there will be less
communications that will require printing.
---------------------------------------------------------------------------
\942\ Our estimates are based on staff experience and industry
materials. In particular, staff factored in its cost estimate the
costs associated with printing envelopes, pitch books, letter heads,
and business cards. For large investment advisers, we assume
printing costs of $65,973. For small investment advisers, we assume
printing costs of $33,999.
($65,973 x 2,738 large investment advisers = $180,634,074) +
($33,999 x 4,887 small investment advisers = $166,153,113) =
$346,787,187 total investment adviser outside costs.
\943\ ($65,973 x 2,738 large investment advisers = $180,634,074)
+ ($33,999 x 4,887 small investment advisers = $166,153,113) =
$346,787,187 total investment adviser outside costs/7,625 investment
advisers = $45,480 total cost per investment adviser.
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For the ongoing burden of new communications for investment
advisers, we preliminarily estimate that the burden for compliance,
business operations, and technology services for adding a registration
status statement would be 0.5 hours annual hours per investment
adviser.\944\ We anticipate that investment advisers will need to add
the registration disclosure to each new communication which they
create, however we anticipate the burdens associated with this task to
be minimal and therefore we do not believe there is a material
difference between large and small investment advisers.\945\ We
preliminarily estimate that the total ongoing annual aggregate burden
for investment advisers is 3,812.50 hours.\946\ We preliminarily
estimate a total ongoing monetized cost of approximately $545,187.50
for investment advisers.\947\ This would be an annual average burden of
0.5 hours per investment advisers \948\ (as monetized, is an annual
average cost of $71.50 per investment adviser).\949\
---------------------------------------------------------------------------
\944\ This estimate is based upon staff experience. See e.g.,
Release 2968, supra note 891; Enhanced Mutual Fund Disclosure
Adopting Release, supra note 47.
In this estimate we are not calculating the print and
technological associated burdens of updating communications which we
analyzed earlier as we are assuming those burdens to be a one-time
initial burden for a firm seeking compliance with the proposed rule.
\945\ Our assumption of no material difference between large and
small investment advisers rests on the fact that all major systems
changes would already have been implemented as part of the initial
burden. Therefore, any new electronic communications would have the
disclosure statement required by our proposed rule built in at the
outset which should take minimal time rather than having to
retroactively insert it into the systems logic which is a more
onerous task. We note that such communications would likely be
reviewed by compliance staff for compliance with applicable
securities laws including rule 206(4)-1 of the Advisers Act. We
anticipate that compliance with proposed rule 211h-1's requirements
would be reviewed as part of this larger compliance check.
\946\ (0.5 hours x 7,625 investment advisers) = 3,812.50 total
ongoing burden for investment advisers.
\947\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per investment adviser.
(0.5 hours x $143 total cost per investment adviser x 7,625
investment advisers) = $545,187.50 total ongoing cost for investment
advisers.
\948\ (0.5 hours x 7,625 investment advisers) = 3,812.50 total
ongoing burden for investment advisers.
(3,812.5/7,625 total investment advisers) = 0.5 hours average
initial burden per investment adviser.
\949\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per investment adviser.
(0.5 hours x $143 total cost per investment adviser x 7,625
investment advisers) = $545,187.50 total ongoing cost for investment
advisers/7,625 total number of investment advisers = $71.50 average
annual ongoing cost per investment adviser.
---------------------------------------------------------------------------
For the ongoing burden of new communications for supervised persons
of an investment adviser, we preliminarily estimate that the burden for
compliance, business operations, and technology services for adding a
registration status statement would be 0.5 hours.\950\ Therefore, we
preliminarily estimate that the total ongoing annual aggregate burden
for supervised persons is 122,704 hours.\951\ We preliminarily estimate
a total ongoing monetized cost of approximately $17,546,672 for
supervised persons.\952\ This would be an annual average burden of 0.5
hours per supervised person \953\ (as monetized, is an annual average
cost of $71.50 per supervised person).\954\
---------------------------------------------------------------------------
\950\ This estimate is based upon staff experience. See e.g.,
Release 2968, supra note 891; Enhanced Mutual Fund Disclosure
Adopting Release, supra note 47.
In this estimate we are not calculating the print and
technological associated burdens of updating communications which we
analyzed earlier as we are assuming those burdens to be a one-time
initial burden for a supervised person of an investment adviser
seeking compliance with the proposed rule.
\951\ (0.5 hours x 245,408 supervised persons) = 122,704 total
ongoing burden for supervised persons.
\952\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per supervised person.
(0.5 hours x $143 total cost per supervised person x 245,408
supervised persons) = $17,546,672 total ongoing cost for supervised
persons.
\953\ (0.5 hours x 245,408 supervised persons) = 122,704 total
ongoing annual burden for supervised persons.
(122,704 total initial burden for supervised persons/245,408
total supervised persons) = 0.5 hours average ongoing annual burden
per supervised person.
\954\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per supervised person.
(0.5 hours x $143 total cost per supervised person x 245,408
supervised persons) = $17,546,672 total ongoing cost for supervised
persons/245,408 total number of supervised persons = $71.50 average
ongoing annual cost per supervised person.
---------------------------------------------------------------------------
Additionally, we believe that any new investment advisers and their
supervised persons would likely only incur the same ongoing annual
burden estimate rather than the initial burden because they would
incorporate the proposed registration status in all communications at
their inception and not have to conduct a review and identification of
outstanding communications nor make changes to their already existing
communications. We do anticipate that such persons would also incur
similar outside legal
[[Page 21535]]
costs, depending on their size, as discussed above. We do not believe
that such new investment advisers would incur outside printing costs as
a result of our proposed rule because these new firms would have their
print communications produced with the appropriate disclosure initially
as part of other materials they seek to have printed. Therefore, we
preliminarily estimate that the total burden for new investment
advisers is 238.50 hours.\955\ Additionally, we preliminarily estimate
a cost of approximately $34,105.50 for new investment advisers.\956\
This would be an initial average burden of 0.5 hours per new investment
adviser \957\ (as monetized, is an initial average cost of $71.50 per
new investment adviser).\958\ Additionally, we anticipate 1,500 hours
\959\ for new supervised persons of an investment adviser and costs of
approximately $214,500 for new supervised persons \960\ of an
investment adviser resulting from these requirements. This would be an
initial average burden of 0.5 hours per new supervised person \961\ (as
monetized, is an initial average cost of $71.50 per supervised
person).\962\
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\955\ (0.5 hours x 477 new investment advisers) = 238.50 total
burden for new investment advisers.
\956\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per investment adviser.
(0.5 hours x $143 total cost per investment adviser x 477 new
investment advisers) = $34,105.50 total initial cost for new
investment advisers.
\957\ (0.5 hours x 477 new investment advisers) = 238.50 total
initial burden for new investment advisers.
(238.50 total initial burden for new investment advisers/477
total new investment advisers) = 0.5 hours average initial burden
per investment adviser.
\958\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per investment adviser.
(0.5 hours x $143 total cost per investment adviser x 477 new
investment advisers) = $34,105.50 total cost for new investment
advisers/477 total number of new investment advisers = $71.50
average initial cost per new investment adviser.
\959\ (0.5 hours x 3,000 new supervised persons) = 1,500 total
burden for new supervised persons.
\960\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per supervised person.
(0.5 hours x $143 total cost per supervised person x 3,000 new
supervised persons) = $214,500 total cost for new supervised
persons.
\961\ (0.5 hours x 3,000 new supervised persons) = 1,500 total
initial burden for new supervised persons.
(1,500 total initial burden for new supervised persons/3000
total new supervised persons) = 0.5 hours average initial burden per
new supervised person.
\962\ Based on the SIFMA Management and Professional Earnings
Report, Commission staff preliminarily estimates that the average
hourly rate for compliance services is $298, for business operation
services is $268, and for information technology services is $270.
This figure was calculated as follows: 0.5 hours/3 firm staff
categories (i.e., compliance, business operations, and information
technology) = 0.17 hours per staff category
($298 compliance/hour x 0.17) = $51 per 0.17 of an hour.
($268 business operations rate/hour x 0.17) = $46 per 0.17 of an
hour.
($270 information technology rate/hour x 0.17) = $46 per 0.17 of
an hour.
$51 + $46 + $46 = $143 total cost per supervised person.
(0.5 hours x $143 total cost per supervised person x 3,000 new
supervised persons) = $214,500 total cost for new supervised
persons/3,000 total number of new supervised persons = $71.50
average initial cost per new supervised person.
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I. Request for Comment
We request comment on our estimates for the new estimated burden
hours and change in current burden hours, and their associated costs
described above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission
solicits comments in order to: (i) Evaluate whether the proposed
collections of information are necessary for the proper performance of
the functions of the Commission, including whether the information will
have practical utility; (ii) evaluate the accuracy of the Commission's
estimate of the burden of the proposed collections of information;
(iii) determine whether there are ways to enhance the quality, utility,
and clarity of the information to be collected; and (iv) determine
whether there are ways to minimize the burden of the collections of
information on those who are to respond, including through the use of
automated collection techniques or other forms of information
technology.
The agency has submitted the proposed collections of information to
OMB for approval. Persons wishing to submit comments on the collection
of information requirements of the proposed amendments should direct
them to the Office of Management and Budget, Attention Desk Officer for
the Securities and Exchange Commission, Office of Information and
Regulatory Affairs, Washington, DC 20503, and should send a copy to
Brent J. Fields, Secretary, Securities and Exchange Commission, 100 F
Street NE, Washington, DC 20549, with reference to File No. S7-08-18.
As OMB is required to make a decision concerning the collections of
information between 30 and 60 days after publication of the proposal, a
comment to OMB is best assured of having its full effect if OMB
receives it within 30 days of publication. Requests for materials
submitted to OMB by the Commission with regard to these collections of
information should be in writing, refer to File No. S7-08-18, and be
submitted to the Securities and Exchange Commission, Office of FOIA
Services, 100 F Street NE, Washington, DC 20549.
VI. Initial Regulatory Flexibility Analysis
The Commission has prepared the following Initial Regulatory
Flexibility Analysis (``IRFA'') in accordance with section 3(a) of the
Regulatory Flexibility Act (``RFA'').\963\ It relates to: (i) Proposed
new rule 204-5 under the Advisers Act and proposed amendment to, Form
ADV (17 CFR 279.1), to add a new Part 3: Form CRS; (ii) proposed
amendments to rule 203-1 under the Advisers Act; (iii) proposed
amendments to rule 204-1 under the Advisers Act; (iv) proposed
amendments to rule 204-2 under the Advisers Act; (v) proposed new rule
17a-14 under the Exchange Act and new Form CRS (17 CFR 249.640); (vi)
proposed amendments to rules 17a-3 and 17a-4 under the Exchange Act;
(vii) proposed new rules 15l-2 and 15l-3 under the Exchange Act; and
(viii) proposed new rule 211h-1 under the Advisers Act.
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\963\ 5 U.S.C. 603(a).
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[[Page 21536]]
A. Reason for and Objectives of the Proposed Action
Individual investors rely on the services of broker-dealers and
investment advisers when making and implementing investment decisions.
Such ``retail investors'' can receive investment advice from a broker-
dealer, an investment adviser, or both, or decide to make their own
investment decisions. Broker-dealers, investment advisers and dually
registered firms all provide important services for individuals who
invest in the markets. Studies show that retail investors are confused
about the differences among them.\964\ These differences include the
scope and nature of the services they provide, the fees and costs
associated with those services, conflicts of interest, and the
applicable legal standards and duties owed to investors. Studies also
indicate that retail investors are confused about whether their firm
and financial professional are broker-dealers or investment advisers,
or both.\965\ Based on these studies, it appears that certain names or
titles used by broker-dealers, including ``financial advisor,''
contribute to this confusion and could mislead retail investors into
believing that they are engaging with an investment adviser--and are
receiving services commonly provided by an investment adviser and
subject to an adviser's fiduciary duty, which applies to the retail
investors' entire relationship--when they are not.\966\
---------------------------------------------------------------------------
\964\ See Siegel & Gale Study, supra note 5; Rand Study, supra
note 5; and CFA Survey, supra note 5.
\965\ See Siegel & Gale Study, supra note 5; Rand Study, supra
note 5; and 913 Study, supra note 3.
\966\ See supra note 375.
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We recognize the benefits of retail investors having access to
diverse business models and of preserving investor choice among
brokerage services, advisory services, or both. However, we believe
that retail investors need clear information in order to understand the
differences and key characteristics of each type of service. Providing
this clarity is intended to assist investors in making an informed
choice when choosing an investment firm and professional and type of
account to help to ensure they receive services that meet their needs
and expectations. We also believe it is important to mitigate the risk
that certain names or titles could result in retail investors being
misled, including believing that the financial professional is a
fiduciary, leading to uninformed decisions regarding which firm or
financial professional to engage, which may in turn result in investors
being harmed.
The Commission considered ways to address investor confusion and
preserve investor choice, including reviewing studies, comment letters,
and committee recommendations.\967\ We believe it is important to
ensure that retail investors receive the information they need to
clearly understand the services, standard of conduct, fees, conflicts,
and disciplinary history of firms and financial professionals they are
considering. We also believe it is important for retail investors to
better understand the distinction between investment advisers and
broker-dealers and to have access to the information necessary to make
an informed decision about which firm type and financial professional
they are engaging or seeking to engage and avoid potential harm.
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\967\ See supra notes 6-22 and accompanying text, referring to
the Siegel & Gale Study, the RAND Study, the 913 Study, commenters
responding to the 2013 Request for Data, the 917 Financial Literacy
Study, comment letters of commenters providing input for these
studies, the recommendation of the Commission's Investor Advisory
Committee, and comment letters of commenters responding to Chairman
Clayton's Request for Comment.
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1. Proposed Form CRS Relationship Summary
We are proposing new rules and rule amendments to require broker-
dealers and investment advisers to deliver a Form CRS (or relationship
summary) to retail investors that would include general information
about each of these topics, including where to find additional
information. We preliminarily believe that providing this information
before or at the time a retail investor enters into an investment
advisory agreement or first engages a brokerage firm's services, as
well as at certain points during the relationship (e.g., switching or
adding account types), as further discussed above, is appropriate and
in the public interest and will improve investor protection, and will
deter potentially misleading sales practices by helping retail
investors to make a more informed choice among the types of firms and
services available to them.\968\
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\968\ See supra note 36 and accompanying text.
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As discussed above in Section II.A, the relationship summary would
be short, with a mix of tabular and narrative information, and contain
sections covering: (i) Introduction; (ii) the principal relationships
and services the firm offers to retail investors; (iii) the standard of
conduct applicable to those services; (iv) the fees and costs that
retail investors will pay; (v) comparisons of brokerage and investment
advisory services (for standalone broker-dealers and investment
advisers); (vi) conflicts of interest; (vii) where to find additional
information, including whether the firm or its financial professionals
currently have reportable legal or disciplinary events and who to
contact about complaints; and (viii) key questions for retail investors
to ask the firm's financial professional.
The proposed rules and rule amendments would require advisers and
broker-dealers to deliver their relationship summaries to retail
investors, to file them electronically with the Commission, and to post
them electronically on their public websites (if they have a public
website). If they do not have a public website, they would be required
to include in their relationship summary a toll-free number that retail
investors may call to request documents. We are also proposing to
require firms to update their relationship summaries within 30 days
whenever any information in the relationship summary becomes materially
inaccurate. Firms would be required to file the updated version
electronically with the Commission, and post them on their firms'
websites (if they have a public website). Firms would be required to
communicate any changes in an updated relationship summary to retail
investors who are existing clients or customers of the firm within 30
days after the updates are required to be made and without charge. The
communication could be made by delivering the relationship summary or
by communicating the information in another way to the retail investor.
The proposal would require a firm to maintain a copy of the
relationship summary and each amendment or revision as part of its
books and records and make them available to Commission staff upon
request, as discussed in Section II.E above. All of these requirements
are discussed in detail above in Sections I through IV. The burdens of
these requirements on small advisers and broker-dealers are discussed
below as well as above in our Economic Analysis and Paperwork Reduction
Act Analysis, which discuss the burdens on all advisers and broker-
dealers.\969\
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\969\ See, e.g., Sections IV.B.2.b and V.
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As discussed in Section II above, the relationship summary would be
in addition to, and not in lieu of, current disclosure and reporting
requirements for broker-dealers and investment
[[Page 21537]]
advisers.\970\ The relationship summary would alert retail investors to
important information for them to consider when choosing a firm and a
financial professional and prompt retail investors to ask informed
questions. In addition, the content of the relationship summary would
facilitate comparisons across firms. As discussed in Section II above,
while the information required by the relationship summary is generally
already provided in greater detail for investment advisers by Form ADV
Part 2, the relationship summary would provide in one place information
about the services, fees, conflicts, and disciplinary history for
broker-dealers.\971\
---------------------------------------------------------------------------
\970\ See, e.g., supra note 33 and accompanying text.
\971\ See supra text accompanying note 316. In addition, under
Regulation Best Interest, broker-dealers would be required to
disclose, in writing, the material facts relating to the scope and
terms of the relationship with the retail customer and all material
conflicts of interest that are associated with the recommendation.
See supra note 296.
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2. Proposed Rules Relating to Restrictions on the Use of Certain Terms
and Required Disclosure of Regulatory Status and a Financial
Professional's Firm Association
We are also proposing a rule under the Exchange Act that would
restrict broker-dealers and their associated natural persons, when
communicating with a retail investor, from using as part of a name or
title the term ``adviser'' or ``advisor'' unless any such (1) broker or
dealer is an investment adviser registered under section 203 of the
Advisers Act or with a state, or (2) natural person who is an
associated person of a broker or dealer is a supervised person of an
investment adviser registered under section 203 of the Advisers Act or
with a state, and such person provides investment advice on behalf of
such investment adviser. We are also proposing rules under the Exchange
Act and Advisers Act that would require broker-dealers and investment
advisers and their associated natural persons and supervised persons,
respectively, to prominently disclose the firm's registration status
with the Commission and the financial professional's association with
such firm in print and electronic retail investor communications. As
discussed above in Section III, the proposed restriction is designed to
address the risk that retail investors could be misled by the term
``adviser'' or ``advisor'' and, as a result, make an uninformed
decision regarding which firm or financial professional they are
engaging or seeking to engage, resulting in investors being harmed.
Additionally, as discussed above in Section III, we believe that
requiring firms and their associated natural persons or supervised
persons, respectively, to disclose whether a firm is a broker-dealer or
investment adviser and requiring a financial professional to disclose
his or her association with such firm would assist retail investors in
determining which type of firm is more appropriate for their specific
investment needs. Similarly, our proposed rules to require a firm to
disclose whether it is a broker-dealer or an investment adviser in
print or electronic communications to retail investors would help to
facilitate investor understanding, even if investors currently may not
understand the differences between investment advisers and broker-
dealers. For similar reasons, we preliminarily believe that because
retail investors interact with a firm primarily through financial
professionals, it is important that financial professionals disclose
the firm type with which they are associated.
B. Legal Basis
The Commission is proposing the following new rule and rule
amendments under the authority set forth in section 19(a) of the
Securities Act of 1933 [15 U.S.C. 77s(a)], sections 23(a) and 28(e)(2)
of the Securities Exchange Act of 1934 [15 U.S.C. 78w(a) and
78bb(e)(2)], section 319(a) of the Trust Indenture Act of 1939 [15
U.S.C. 7sss(a)], section 38(a) of the Investment Company Act of 1940
[15 U.S.C. 80a-37(a)], and sections 203(c)(1), 204, 206A, 206(4),
211(a) and 211(h), and of the Investment Advisers Act of 1940 [15
U.S.C. 80b-3(c)(1), 80b-4, 80b-6a, 80b-6(4), 80b-11(a) and 80b-11(h)],
and section 913(f) of Title IX of the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (the ``Dodd-Frank Act''): (i) Proposed
new rule 204-5 under the Advisers Act ; (ii) amendments to rule 279.1,
Form ADV, to create Form CRS for investment advisers; (iii) amendments
to rule 203-1 under the Advisers Act; (iv) amendments to rule 204-1
under the Advisers Act; and (v) amendments to rule 204-2 under the
Advisers Act. The Commission is proposing the following rule amendments
under the authority set forth in section 913(f) of Title IX of the
Dodd-Frank Act, sections 3, 10, 15, 23 and 36 of the Exchange Act [15
U.S.C. 78c, 78j, 78o, 78q, 78w and 78mm]: (i) Proposed new rule 17a-14
under the Exchange Act; (ii) proposed Form CRS (17 CFR 249.640) under
the Exchange Act; and (iii) amendments to rule 17a-3 and 17a-4 under
the Exchange Act. The Commission is also proposing the following new
rules under the authority set forth in sections 15(l), 23(a), and 36 of
the Securities Exchange Act of 1934 (78o(l), 78w(a), and 78mm),
sections 211(h), 206A, 211(a) of the Investment Advisers Act of 1940,
15 U.S.C. 80b-1 et seq., (80b-11(h), 80b-6a, 80b-11(a), sections 913(f)
and 913(g)(2) of Title IX of the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010; (i) proposed new rule 15l-2 under the
Exchange Act; (ii) proposed new rule 15l-3 under the Exchange Act; and
(iii) proposed new rule 211h-1 under the Advisers Act.
C. Small Entities Subject to the Rule and Rule Amendments
In developing these proposals, we have considered their potential
impact on small entities that would be subject to the proposed
amendments. The proposed amendments would affect many, but not all,
broker-dealers and investment advisers registered with the Commission,
including some small entities.
1. Investment Advisers
Under Commission rules, for the purposes of the Advisers Act and
the RFA, an investment adviser generally is a small entity if it: (1)
Has assets under management having a total value of less than $25
million; (2) did not have total assets of $5 million or more on the
last day of the most recent fiscal year; and (3) does not control, is
not controlled by, and is not under common control with another
investment adviser that has assets under management of $25 million or
more, or any person (other than a natural person) that had total assets
of $5 million or more on the last day of its most recent fiscal
year.\972\ As discussed in Section V, above, the Commission estimates
that based on IARD data as of December 31, 2017, approximately 7,625
investment advisers would be subject to the proposed new rule 204-5
under the Advisers Act, Form CRS (required by a new Part 3 of Form
ADV), the proposed amendments to rules 203-1, 204-1, and rule 204-2
under the Advisers Act, and the proposed new rule 211h-1 under the
Advisers Act.\973\ Our proposed new
[[Page 21538]]
rules and amendments would not affect most investment advisers that are
small entities (``small advisers'') because they are generally
registered with one or more state securities authorities and not with
the Commission. Under section 203A of the Advisers Act, most small
advisers are prohibited from registering with the Commission and are
regulated by state regulators. Based on IARD data, we estimate that as
of December 31, 2017, approximately 618 SEC-registered advisers are
small entities under the RFA.\974\ Of these, 179 provide advice to
individual high net worth and individual non-high net worth clients,
and would therefore be subject to the proposed Form CRS requirements
and the related new and amended rules under the Advisers Act, and
proposed new rule 211h-1 under the Advisers Act requiring disclosure of
Commission registration status and a financial professional's
association in certain communications with retail investors.\975\
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\972\ Advisers Act rule 0-7(a).
\973\ See supra Section V, at note 712 and accompanying text.
Based on responses to Item 5.D. of Form ADV. These advisers
indicated that they advise either high net worth individuals or
individuals (other than high net worth individuals), which includes
trusts, estates, and 401(k) plans and IRAs of individuals and their
family members, but does not include businesses organized as sole
proprietorships. The proposed definition of retail investor would
include a trust or other entity similar entity that represents of
natural persons, even if another person is a trustee or managing
agent of the trust. We are not able to determine, based on responses
to Form ADV, exactly how many advisers provide investment advice to
these types of trusts or other entities; however, we believe that
these advisers most likely also advise individuals and are therefore
included in our estimate.
\974\ Based on SEC-registered investment adviser responses to
Items 5.F. and 12 of Form ADV.
\975\ Based on SEC-registered investment adviser responses to,
Items 5.D.(a), 5.D.(b), 5.F. and 12 of Form ADV, which indicate that
the adviser has clients that are high net worth individuals and/or
individuals (other than high net worth individuals) and that the
adviser is a small entity. Of these, 3 firms are dually registered
as a broker-dealer and an investment adviser and may offer services
to retail investors as both a broker-dealer and investment adviser
(e.g., ``dual registrants'' for purposes of the relationship
summary). See supra note 25. Dual registrants would file Form CRS on
both IARD and EDGAR describing their retail advisory and retail
brokerage businesses. In this RFA, dual registrants are counted in
both the total number of small entity investment advisers and
broker-dealers that would be subject to Form CRS and the proposed
related rules and rule amendments. We believe that counting these
firms twice is appropriate because of their additional burdens of
complying with the rules with respect to both their advisory and
brokerage businesses and filing Form CRS with IARD and EDGAR.
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2. Broker-Dealers
For purposes of a Commission rulemaking in connection with the RFA,
a broker-dealer will be deemed a small entity if it: (1) Had total
capital (net worth plus subordinated liabilities) of less than $500,000
on the date in the prior fiscal year as of which its audited financial
statements were prepared pursuant to rule 17a-5(d) under the Exchange
Act,\976\ or, if not required to file such statements, had total
capital (net worth plus subordinated liabilities) of less than $500,000
on the last day of the preceding fiscal year (or in the time that it
has been in business, if shorter); and (2) is not affiliated with any
person (other than a natural person) that is not a small business or
small organization.
---------------------------------------------------------------------------
\976\ See 17 CFR 240.0-10(c).
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As discussed in Sections IV and V, above, the Commission estimates
that as of December 31, 2017, approximately 2,857 retail broker-dealers
would be subject to the proposed Form CRS requirements and new rule
17a-14 under the Exchange Act, and proposed amendments to rule 17a-3
and 17a-4 under the Exchange Act, and proposed new rules 15l-2 and 15l-
3 under the Exchange Act.\977\ Further, based on FOCUS Report data, the
Commission estimates that as of December 31, 2017, approximately 1,040
broker-dealers may be deemed small entities under the RFA.\978\ Of
these, approximately 802 have retail business, and would be subject to
the proposed Form CRS requirements and related proposed new and amended
rules, the proposed rule requiring disclosure of Commission
registration status in certain communications with retail investors,
and the proposed rule regarding the prohibition of certain terms in
names or titles in certain communications with retail investors.\979\
---------------------------------------------------------------------------
\977\ See supra note 461 and accompanying text. Retail sales
activity is identified from Form BD, which categorizes retail
activity broadly (by marking the ``sales'' box) or narrowly (by
marking the ``retail'' or ``institutional'' boxes as types of sales
activity). We use the broad definition of sales as we preliminarily
believe that many firms will just mark ``sales'' if they have both
retail and institutional activity. However, we note that this may
capture some broker-dealers that do not have retail activity,
although we are unable to estimate that frequency.
\978\ The Commission's estimate is obtained from Form BD
filings. Although Form BD filings are updated on a more frequent
basis than annually, FOCUS data, which also informs this baseline
with respect to broker-dealers, is only sparsely updated throughout
the year. Moreover, instead, broker-dealers tend to make their most
complete updates in the fourth calendar quarter of each year.
Therefore, in order to minimize discrepancies in the broker-dealer
data between Form BD and FOCUS data, we have normalized all of the
data to the most recently complete FOCUS data, which is for December
2017.
\979\ Id.
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D. Projected Reporting, Recordkeeping and Other Compliance Requirements
1. Initial Preparation of Form CRS Relationship Summary
Proposed Form CRS and the proposed rules and rule amendments would
impose certain reporting and compliance requirements on certain
advisers and broker-dealers, including those that are small entities,
requiring them to create and update relationship summaries containing
specified information regarding their advisory and brokerage
businesses, as applicable. The proposed rules and rule amendments,
including new recordkeeping requirements, are summarized in this RFA
(Section VI.A., above). All of these proposed requirements are also
discussed in detail, above, in Sections II.A-E., and these requirements
and the burdens on advisers and broker-dealers, including those that
are small entities, are discussed above in Sections IV and V (the
Economic Analysis and Paperwork Reduction Act Analysis) and below.
The proposed amendments to Form ADV that would require each
registered investment adviser that offers advisory services to retail
investors to prepare, file and deliver Form CRS would impose additional
costs on many registered advisers, including some small advisers. Our
Economic Analysis, discussed in Section IV, above, discusses these
costs and burdens for investment advisers, which include small
advisers.\980\ In addition, as discussed in our Paperwork Reduction
Analysis, above, we anticipate that some advisers may incur a one-time
initial cost for outside legal and consulting fees in connection with
the initial preparation of the relationship summary.\981\ Generally,
all advisers, including small advisers that advise retail investors are
currently required to prepare and distribute Part 2 of Form ADV (the
firm brochure). Because advisers already provide disclosures about
their services, fees, conflicts and disciplinary history in their firm
brochures,\982\ they would be able to use some of this information to
respond to the disclosure requirements of the relationship summary.
They would, however, have to draft completely new disclosure to comply
with the proposed new format of Form CRS. As discussed above,
approximately 179 small advisers currently registered with us would be
subject to the proposed new Form ADV
[[Page 21539]]
Part 3.\983\ As discussed above in our Paperwork Reduction Act
Analysis, we expect these 179 small advisers to spend, on average, an
additional total of 23,152 annual hours, or approximately 129.34 hours
per adviser,\984\ which translates into an approximate monetized cost
of $1,478,055, or $8,257 per adviser, attributable to the initial
preparation, filing, posting, and delivery related to Form CRS.\985\ We
expect the incremental external legal and compliance cost for small
entity investment advisers to be estimated at $525 per adviser, or
$93,936 in aggregate for small advisers.\986\
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\980\ See supra notes 621-637 and accompanying text (discussing
the direct costs of Form CRS and related requirements on broker-
dealers and investment advisers, including costs associated with
delivery, preparation, and firm-wide implementation of the
relationship summary, as well as training and monitoring for
compliance).
\981\ See supra notes 729-730 and accompanying text (stating,
however, that we do not anticipate external costs to investment
advisers in the form of website set-up, maintenance, or licensing
fees because they would not be required to establish a website for
the sole purpose of posting their relationship summary if they do
not already have a website, and we also do not expect other ongoing
external costs for the relationship summary).
\982\ Much of the disclosure in Part 2A addresses an investment
adviser's conflicts of interest with its clients, and is disclosure
that the adviser, as a fiduciary, must make to clients in some
manner regardless of the form requirements. See supra note 314.
\983\ See supra note 975 and accompanying text.
\984\ See supra Sections V.A.2, V.B, and V.C. 2.52 hours for
preparing and filing of the relationship summary + 126.8 hours for
posting to the website and delivery = 129.3 hours per adviser.
\985\ See supra Sections V.A.2, V.B, and V.C. 129.3 hours x 179
small advisers = $23,152 in total annual aggregate hours for small
advisers. $8,257 x 179 small advisers = $1,478,055 in total annual
aggregate monetized cost for small advisers.
\986\ See supra Section V.A.2.b.
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Similarly, requiring each broker-dealer that offers brokerage
services to retail investors to prepare, file and deliver Form CRS
would impose additional costs on many broker-dealers, including some
small broker-dealers. Our Economic Analysis, discussed in Section IV,
above, discusses these costs and burdens for broker-dealers, which
include small broker-dealers.\987\ In addition, as discussed in our
Paperwork Reduction Analysis, above, we anticipate that some broker-
dealers may incur a one-time initial cost for outside legal and
consulting fees in connection with the initial preparation of the
relationship summary.\988\ As discussed above,\989\ unlike investment
advisers, broker-dealers are not currently required to deliver to their
retail investors written disclosures covering their services, fees,
conflicts, and disciplinary history in one place such as the investment
advisory firm brochure.\990\ Under existing provisions of the Exchange
Act and self-regulatory organization rules, however, a broker-dealer is
required to disclose certain information to its customers.\991\ To the
extent that some of the new Form CRS disclosure burdens would apply to
small broker-dealers, these broker-dealers are therefore already
obligated to make certain of these disclosures to retail investors,
although the disclosure is not currently required to be included in one
comprehensive document such as Form ADV. As discussed above,\992\
approximately 802 broker-dealers that are small entities would be
subject to the proposed Form CRS requirements and proposed new and
amended rules. As discussed above, we expect these 802 small broker-
dealers to spend, on average, 1,080 hours per broker-dealer,\993\ for a
monetized value of $66,006 per broker-dealer,\994\ or 865,956 aggregate
annual hours to respond to the proposed new Form CRS requirements,\995\
for an annual monetized burden of approximately $52,936,812. We expect
the aggregate annual external third-party cost to small broker-dealers
associated with this process would be $376,940.\996\
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\987\ See supra notes 621-637 and accompanying text (discussing
the direct costs of Form CRS and related requirements on broker-
dealers and investment advisers, including costs associated with
delivery, preparation, and firm-wide implementation of the
relationship summary, as well as training and monitoring for
compliance).
\988\ See supra Section V.D.1. (stating, however, that we do not
expect ongoing external legal or compliance consulting costs for the
relationship summary).
\989\ See supra Section IV, at note 629 and accompanying text.
\990\ Broker-dealers are required under certain circumstances,
such as when effecting certain types of transactions, to disclose
certain conflicts of interest to their customers in writing, in some
cases at or before the time of the completion of the transaction.
See 913 Study, supra note 3, at nn.256-259 and accompanying text.
See supra note 311 and accompanying text. Under Regulation Best
Interest, broker-dealers would also be required to disclose the
material facts relating to the scope and terms of the relationship.
Regulation Best Interest Proposal, supra note 24.
\991\ See supra Section II, at notes 309-312 and accompanying
text. See also Regulation Best Interest Proposal, supra note 24.
\992\ See supra note 979.
\993\ See supra note 846.
\994\ See supra note 847.
\995\ See supra note 823 and accompanying text. 802 small
broker-dealers x 1,080 hours per broker-dealer = 865,956 annual
aggregate hours. 802 small broker-dealers x $66,006 in monetized
cost per broker-dealer = 52,936,812 annual aggregate hours.
\996\ See supra note 829 and accompanying text. 802 small
broker-dealers x $470 in external legal and compliance costs on
average per broker-dealer = $376,940.
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The costs associated with preparing the new relationship summaries
will be limited for investment advisers and broker-dealers, including
small entities, for several reasons. First, the disclosure document is
concise (no more than four pages in length or equivalent limit if in
electronic format), and much of the information is already provided by
the broker-dealers and investment advisers as part of current
disclosure practices. Second, the disclosure will be uniform across
retail investors and would not be customized or personalized to
potential investors. Third, the disclosure would involve a certain
degree of standardization across firms. In particular, firms would be
required to use the same headings, prescribed wording, and present the
information under the headings in the same order. Additionally, firms
would be prohibited from adding any items to those prescribed by the
Commission and any information other than what the Instructions require
or permit. These standardized elements allow for potential economies of
scale for entities that may have subsidiaries that would also be
required to produce the disclosure. The compliance costs could,
however, be different across firms with relatively smaller or larger
numbers of retail investors as customers or clients.\997\
---------------------------------------------------------------------------
\997\ See supra note 628 and accompanying text (discussing the
Commission's preliminary belief that compliance costs could be
different across firms with relatively smaller or larger numbers of
retail investors as customers or clients).
---------------------------------------------------------------------------
Filing, Delivery, and Updating Requirements Related to Form CRS. As
discussed above, a firm would be required to give a relationship
summary to each retail investor, if the firm is an investment adviser,
before or at the time the firm enters into an investment advisory
agreement with the retail investor, or if the firm is a broker-dealer,
before or at the time the retail investor first engages the services of
the broker-dealer.\998\ A firm would be required to deliver the
relationship summary even if the firm's agreement with the retail
investor is oral. A dual registrant would deliver the relationship
summary at the earlier of entering into an investment advisory
agreement with the retail investor or the retail investor engaging the
firm's services. In order to ensure that existing retail investors
receive the disclosures in the relationship summary, the Commission
proposes that firms would deliver the relationship summary to retail
investors who are existing clients and customers on an initial one-time
basis within 30 days after the date the firm is first required to file
its relationship summary with the Commission.\999\ In addition, firms
would be required to deliver the relationship summary to a retail
investor who is an existing client or customer before or at the time a
new account is opened or changes are made to the retail investor's
account(s) that would materially change the nature and scope of the
firm's relationship with the retail investor. This would include, for
example, before or at the time the firm recommends that the retail
investor transfers from an investment advisory account to a brokerage
account or from a brokerage account to an investment advisory account,
or moves assets from one type of account to another in a
[[Page 21540]]
transaction not in the normal, customary or already agreed course of
dealing.
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\998\ See supra Section II.C for a discussion of the delivery
requirements.
\999\ See supra Section II.D for a discussion of the delivery
requirements during the proposed transition period following the
effectiveness of the proposed new rule.
---------------------------------------------------------------------------
As discussed above, firms would be required to update the
relationship summary within 30 days whenever any information in the
relationship summary becomes materially inaccurate.\1000\ Firms also
would be required to post the latest version on its website (if it has
one), and electronically file the relationship summary with the
Commission. Firms would be required to communicate any changes in the
updated relationship summary to retail investors who are existing
clients or customers of the firm within 30 days after the updates are
required to be made and without charge. The firm could communicate the
information by delivering the amended relationship summary or by
communicating the information in another way to the retail investor. We
believe that this flexibility would minimize the burden of the
communication requirement for all firms, including small advisers and
broker-dealers. Firms also would also be required to deliver the
relationship summary to a retail investor upon the retail investor's
request.
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\1000\ See supra Section II.C.3 for a discussion of updating
requirements.
---------------------------------------------------------------------------
In addition, firms would be permitted to deliver the relationship
summary, as well as updates, electronically consistent with the
Commission's prior guidance regarding electronic delivery. We believe
that this would further minimize the burden of delivery for all firms,
including small advisers and broker-dealers. To the extent that small
advisers and broker-dealers are more likely to have fewer retail
investors than larger advisers and broker-dealers, the proposed
delivery requirements should impose lower variable costs on small
advisers and broker-dealers than on larger firms. The additional hours
per adviser and broker-dealer, the monetized cost per adviser and
broker-dealer, and the incremental external legal and compliance cost
for small entity investment advisers and broker-dealers, attributable
to the initial preparation, filing, posting, delivery, and
recordkeeping related to Form CRS, are estimated above and in the
Paperwork Reduction Analysis.\1001\
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\1001\ See supra Sections V.A.-F.
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Recordkeeping Requirements Related to Form CRS. The proposed
amendments would impose new recordkeeping requirements on many
investment advisers and broker-dealers, including some small advisers
and broker-dealers. We are proposing amendments to Advisers Act rule
204-2 and Exchange Act rules 17a-3 and 17a-4, which set forth
requirements for maintaining, making and preserving specified books and
records, to require SEC-registered investment advisers and broker-
dealers to retain copies of each relationship summary. Firms would also
be required to maintain each amendment and revision to the relationship
summary and a record of dates that each relationship summary and each
amendment was delivered.
These proposed changes are designed to update the books and records
rules in light of proposed Form CRS, and they mirror the current
recordkeeping requirements for the Form ADV brochure and brochure
supplement. The records for investment advisers would be required to be
maintained in the same manner, and for the same period of time, as
other books and records required to be maintained under rule 204-2(a)
under the Advisers Act, and the records for broker-dealers would be
required to maintained for six years after the record was created in
accordance with rule 17a-4(e)(10) under the Exchange Act.\1002\ As
discussed in the Paperwork Reduction Act Analysis in Section IV above,
the proposed amendments to rule 204-2 under the Advisers Act would
increase the annual burden by approximately 0.2 hours per adviser, or
35.80 hours in aggregate for small advisers.\1003\ We therefore expect
the annual monetized aggregate cost to small advisers associated with
our proposed amendments would be $2,148.\1004\ Also as discussed in the
Paperwork Reduction Act Analysis in Section IV above, the proposed
amendments to rules 17a-3 and 17a-4 under the Exchange Act would
increase the burden by approximately 0.2 annual hours per broker-
dealer, or 160.4 annual hours in the aggregate.\1005\ We expect the
aggregate cost to small broker-dealers associated with our proposed
amendments would be $9,624.\1006\
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\1002\ See supra note 371 (referencing Advisers Act rule 204-
2(e)(1) and Exchange Act rule 17a-4(e)(10), and stating that
pursuant to Advisers Act rule 204-2(e)(1), investment advisers will
be required to maintain the relationship summary for a period of
five years, while Exchange Act rule 17a-4(e)(5) will require broker-
dealers to maintain the relationship summary for a period of six
years).
\1003\ See supra note 765. 0.2 hours x 179 small entity retail
investment advisers = 35.8.
\1004\ See supra note 768.
\1005\ 0.2 hours x 802 small broker-dealers = 160.4 hours.
\1006\ See supra note 854 and accompanying text. $12 per broker-
dealer x 802 small broker-dealers = $9,624.
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2. Rule 15l-2 Relating to Restrictions on the Use of Certain Terms in
Names and Titles
As discussed above in Section III, we are proposing to restrict
broker-dealers and associated natural persons of broker-dealers, when
communicating with a retail investor, from using as part of a name or
title the term ``adviser'' or ``advisor'' unless any such (1) broker or
dealer is an investment adviser registered under section 203 of the
Advisers Act or with a state, or (2) natural person who is an
associated person of a broker or dealer is a supervised person of an
investment adviser registered under section 203 of the Advisers Act or
with a state, and such person provides investment advice on behalf of
such investment adviser.
This would include such names or titles as, for example, financial
advisor (or adviser), wealth advisor (or adviser), and trusted advisor
(or adviser), and advisory (e.g., ``Sample Firm Advisory'') when
communicating with any retail investor.
The proposed rule would permit firms that are registered both as
investment advisers and broker-dealers to use the term ``adviser'' or
``advisor'' in their name or title. The proposed rule would, however,
only permit an associated natural person of a dually registered firm
\1007\ to use these terms where such person is also a supervised person
of an investment adviser registered with the Commission or with a state
and provides investment advice on behalf of such investment adviser.
This would limit the ability of natural persons associated with a
broker-dealer that do not typically provide investment advisory
services to retail investors from continuing to use the term
``adviser'' or ``advisor'' by virtue of the fact that they are
affiliated with a dually registered firm.
---------------------------------------------------------------------------
\1007\ For purposes of rules 15l-2, 15l-3 and 211h-1, we are
defining a ``dually registered firm'' in the same manner as a ``dual
registrant'' is defined in the baseline of the Economic Analysis.
See supra Section IV, note 453. See also supra note 411. We use the
more narrowly defined ``dual registrant'' for purposes of the
relationship summary discussion only.
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Proposed rule 15l-2 would impose certain compliance requirements on
broker-dealers, including small broker-dealers, but would not impose
reporting or recordkeeping requirements on broker-dealers. The
compliance burdens on broker-dealers, including small broker-dealers,
are described above in our Economic Analysis in Section IV. They would
need to change their names or titles where their names or titles
include ``adviser'' or ``advisor'' in violation of the proposed rule.
As
[[Page 21541]]
discussed in Section IV above, the Commission estimates that as of
December 31, 2017, approximately 2,857 broker-dealers would be subject
to the proposed rule 151-2 under the Exchange Act.\1008\ As discussed
in Section IV, above, approximately 103 broker-dealers that are not
dually registered as investment advisers use the term ``adviser,''
``advisor,'' or ``advisory'' as part of their current company name. To
the extent these broker-dealers, some of which may be small entities,
advise retail investors and would be subject to proposed rule 151-2,
they would be subject to potentially substantial, one-time costs
associated with the proposed rule. Broker-dealer firms subject to the
restriction on the use of certain names or titles would be required to
change current company names (if the company name contains ``adviser/
advisor''), marketing materials, advertisements (e.g., print ads or
television commercials), website and social media appearance, among
other items, resulting in direct compliance costs.
---------------------------------------------------------------------------
\1008\ See supra Section IV.A.1.a.
---------------------------------------------------------------------------
In addition, as discussed in Section IV, as a result of the
proposed rule 151-2, broker-dealers would need to assess whether their
associated natural persons use as part of a name or title the term
``adviser'' or ``advisor.'' As discussed in Section IV, financial
professionals providing brokerage services use a large variety of names
or titles to describe their business and the services that they offer,
including ``financial advisor,'' ``financial consultant,'' ``banker,''
and ``broker.'' \1009\ To the extent their associated natural persons
use the terms adviser'' or ``advisor'' when communicating with a retail
investor, firms would need to assess whether to require their
associated natural persons to change their names or title to comply
with the proposed rule and modify their retail investor communications.
We request comment on how many associated natural persons of broker-
dealers, including small entity broker-dealers, are currently using the
terms ``adviser'' or ``advisor'' in their names or titles, and how many
of these associated natural persons are supervised persons of an
investment adviser registered with the Commission or with a state and
who provide investment advice on behalf of such investment adviser.
---------------------------------------------------------------------------
\1009\ As discussed in Section IV, approximately 39 percent of
the 103 broker-dealers described above used a proper name coupled
with the term ``advisor'' alone, and an additional 31 percent used a
proper name coupled with the term ``capital advisor.'' Additionally,
as discussed in the RAND Study, professionals providing advisory
services or both brokerage and advisory services similarly also use
a wide variety of titles, but the proportion of professionals who
use titles containing the terms ``adviser'' or ``advisor'' are
somewhat larger at 35%. See supra Section IV, Table 8: Replication
of Table 6.3 of the RAND Study--Professional Titles Most Commonly
Reported by Respondents, and accompanying text.
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The proposed restriction on the use of the term ``adviser'' and
``advisor'' in a name or title does not apply to registered investment
advisers, whether they are solely registered as investment advisers or
whether they are dually registered as broker-dealers. Consequently,
there would be no compliance costs for registered investment advisers
associated with the restriction on certain terms in names or titles.
However, as discussed in Sections III and IV, supervised persons of
dually registered investment advisers who do not provide investment
advice on behalf of such investment adviser would be restricted from
using these terms when communicating with a retail investor, which
could lead to costs for those financial professionals or their firms.
3. Rules 15l-3 and 211h-1 Relating to Disclosure of Commission
Registration Status and Financial Professional Association
As discussed above, we are proposing rule 15l-3 under Exchange Act
and rule 211h-1 under the Advisers Act that would require broker-
dealers and investment advisers and their associated natural persons
and supervised persons, respectively, to disclose the firm's
registration status with the Commission and such financial
professional's relationship with the firm in print or electronic retail
investor communications. These rules would impose certain compliance
requirements on many broker-dealers and investment advisers but would
not impose separate reporting or recordkeeping requirements on
investment advisers and broker-dealers. The compliance burdens on
broker-dealers and investment advisers, including small broker-dealers
and investment advisers, are described above in our Economic Analysis
in Section IV and the Paperwork Reduction Act discussion in Section V.
These include the requirement for investment advisers and broker-
dealers that would be subject to the proposed rule to prominently
disclose their registration status in print or electronic retail
investor communications. In addition, associated natural persons would
need to prominently disclose that they are associated persons of a
broker-dealer registered with the Commission, and supervised persons
would need to prominently disclose that they are supervised persons of
an investment adviser registered with the Commission.
As discussed in Sections IV and V above, the Commission estimates
that as of December 31, 2017, approximately 2,857 broker-dealers would
be subject to the proposed rule 15l-3 under the Exchange Act. As
discussed above, of these, approximately 802 are small entities. These
broker-dealers would be subject to the rule's requirements described in
the previous paragraph. As discussed above, the Commission estimates
that as of December 31, 2017, approximately 7,625 investment advisers
would be subject to the proposed rule 211h-1 under the Advisers Act.
Based on IARD data, we estimate that as of December 31, 2017,
approximately 618 advisers are small entities under the RFA. Of these,
approximately 179 advise retail investors, and would therefore be
subject to the proposed rule 211h-1 under the Advisers Act.
Compliance with these proposed rules would require changes to
retail investor communications, which would have to be modified to
incorporate the registration status in the manner the rule prescribes.
As discussed above in Sections IV and V, to comply with our proposed
rule with respect to print communications, broker-dealers and
investment advisers would need to review their print and electronic
retail investor communications, identify which would need to be
amended, make the changes, and verify that all firm retail investor
communications comply with the rule's requirements including its
technical specifications such as the type size, font, and prominence.
As discussed above in Section V, we preliminarily anticipate that the
costs associated with complying with the proposed rule with respect to
print communications would be larger for large broker-dealers than for
small broker-dealers, because we assume large broker-dealers will have
to review, identify and change more print communications and in turn
have their compliance staff verify more print communications as being
compliant with our proposed rule as compared to small broker-dealers
which will have fewer print communications. With respect to electronic
communications, broker-dealers would need to review, identify and make
the required updates coupled with verifying that such retail investor
communications (present and future) would be compliant with the
proposed rule.\1010\ We preliminarily
[[Page 21542]]
estimate that the costs associated with complying with the proposed
rule regarding electronic communications would similarly be lower for
small broker-dealers than for large broker-dealers, because we assume
that small broker-dealers have fewer electronic communications that are
subject to our proposed rule as compared to large firms. For investment
advisers, as discussed above in Section V, we preliminarily estimate
that large firms would require larger costs than small firms to comply
with the proposed rule (e.g., large firms have a greater amount of
retail investor communications subject to our proposed rule that would
need to be reviewed, changed, and verified).
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\1010\ As stated in Section III.D above, we are not requiring
firms to send new communications to replace all older print
communications as this would be overly burdensome and costly for
firms. Instead, we are staging the compliance date to ensure that
firms can phase out certain older communications from circulation
through the regular business lifecycle rather than having to
retroactively change them.
---------------------------------------------------------------------------
The Commission also preliminarily estimates that the costs
associated with complying with the proposed rules' disclosure
requirements for broker-dealers, investment advisers, and their
associated natural persons and supervised persons, respectively, would
also be smaller for small firms than for large firms. With respect to
broker-dealers, we estimate that the costs would increase with the size
of the broker-dealer, such as costs associated with revisions to each
individual representative's communication and advertising
materials.\1011\ Specifically, large broker-dealers would have to
review, identify and change more print and electronic communications
and in turn have their compliance staff verify more communications as
being compliant with our proposed rules as compared to small broker-
dealers which would have fewer communications. Similarly, with respect
to investment advisers, we estimate that small investment advisers
would have fewer print and electronic communications that would be
subject to our proposed rule as compared to large firms, resulting in a
lower burden preliminary estimate. In addition, the Commission
estimates that small entity advisers have fewer employees performing
investment advisory functions than large advisers.\1012\ Therefore, we
anticipate that small entity retail investment advisers would require
fewer resources to oversee their employees' compliance with the
proposed rule.
---------------------------------------------------------------------------
\1011\ See Section IV.
\1012\ Based on adviser responses to Item 5.B.(1) of Form ADV,
we estimate that as of September 30, 2017, the median small entity
retail investment adviser employed 1 person performing investment
advisory functions, and the median non-small entity retail
investment advisers employed 5 persons performing investment
advisory functions.
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E. Duplicative, Overlapping, or Conflicting Federal Rules
As noted above, broker-dealers and investment advisers have other
disclosure obligations under the federal securities laws and other
federal laws.\1013\ For example, the information required by the
relationship summary is generally already provided in greater detail
for investment advisers by Form ADV Part 2. The current disclosure
requirements and obligations result in varying degrees and kinds of
information to investors, but we believe that all retail investors
would benefit from a short summary that focuses on certain key aspects
of the firm and its services. By requiring both investment advisers and
broker-dealers to deliver a relationship summary that discusses both
types of services and their differences, the relationship summary would
help all retail investors, whether they are considering an investment
adviser or a broker-dealer. A relationship summary would help retail
investors to understand their relationship with a particular firm, to
compare different types of accounts, and to compare that firm with
other firms. The relationship summary would provide in one place, for
the first time, summary information about the services, fees,
conflicts, and disciplinary history for broker-dealers.
---------------------------------------------------------------------------
\1013\ See supra notes 308-316.
---------------------------------------------------------------------------
Under our proposed rules, firms would be required to file their
relationship summary with the Commission, and the relationship summary
will be available on the Commission's public disclosure website. Dual
registrants would be required to file Form CRS on both IARD and EDGAR.
We are proposing IARD and EDGAR because they are familiar filing
systems for investment advisers and broker-dealers.\1014\ By having
firms file the relationship summaries with the Commission, the
Commission can more easily monitor the filings for compliance with Form
CRS. We believe that requiring dual registrants to file on both EDGAR
and IARD is appropriate and in the public interest and will improve
investor protection. This is because retail investors seeking brokerage
services (but not investment advisory services) would be likely to
search EDGAR, and retail investors seeking investment advisory services
(but not brokerage services) would be likely to search IARD.
---------------------------------------------------------------------------
\1014\ See supra Section II.C.1.
---------------------------------------------------------------------------
F. Significant Alternatives
The RFA directs the Commission to consider significant alternatives
that would accomplish our stated objectives, while minimizing any
significant adverse impact on small entities. We considered the
following alternatives for small entities in relation to the proposed
Form CRS required by Part 3 of Form ADV, the proposed amendments to
Form ADV (17 CFR 279.1) and rules 203-1, 204-1, and 204-2 under the
Advisers Act, the proposed new rule 204-5 under the Advisers Act, the
proposed amendments to rules 17a-3 and 17a-4 under the Exchange Act,
the proposed new rule 17a-14 and new Form CRS (17 CFR 249.640) under
the Exchange Act, the proposed new rules 15l-2 and 15l-3 under the
Exchange Act, and the proposed new rule 211h-1 under the Advisers Act:
(i) The establishment of differing compliance or reporting requirements
that take into account the resources available to small entities; (ii)
the clarification, consolidation, or simplification of compliance and
reporting requirements under the proposed Form CRS, and proposed new
rules and rule amendments for such small entities; (iii) the use of
performance rather than design standards; and (iv) an exemption from
coverage of the proposed Form CRS, and proposed rules and rule
amendments, or any part thereof, for such small entities.
1. Form CRS Relationship Summary
Regarding the first alternative, the Commission believes that
establishing different compliance or reporting requirements for small
advisers and broker-dealers would be inappropriate under these
circumstances. Because the protections of the Advisers Act and Exchange
Act are intended to apply equally to retail investor clients and
customers of both large and small firms, it would be inconsistent with
the purposes of the Advisers Act and the Exchange Act to specify
differences for small entities under the proposed rules and rule
amendments. As discussed above, we believe that the proposed new Form
CRS, and the proposed rules and rule amendments would result in
multiple benefits to all retail investors, including alerting retail
investors to certain information to consider when choosing a firm and a
financial professional and prompting retail investors to ask informed
questions. In addition, the content of the relationship summary would
facilitate comparisons across firms. We believe that these benefits
should apply to retail investors of smaller firms as well as retail
[[Page 21543]]
investors of larger firms.\1015\ To establish different disclosure
requirements for small entities would diminish this investor protection
for clients of small advisers.
---------------------------------------------------------------------------
\1015\ See supra Section I (discussing the benefits of retail
investors having access to diverse business models and of preserving
investor choice among brokerage services, advisory services, or
both).
---------------------------------------------------------------------------
It would also be inappropriate to establish different recordkeeping
requirements for small entities, because requiring maintenance of Form
CRS and related records as part of the firm's books and records would
facilitate the Commission's ability to inspect for and enforce
compliance with firms' obligations with respect to Form CRS, which is
important for retail investors clients of both large and small firms.
In addition, as discussed above in Section II, we are proposing to
require that investment advisers and dual registrants file their
relationship summaries with the Commission electronically through IARD
in the same manner as they currently file Form ADV Parts 1 and 2. We
are proposing to require that broker-dealers file their relationship
summaries with the Commission electronically on EDGAR. As discussed
above, there are several reasons we propose having the relationship
summaries filed with the Commission, including that the public would
benefit by being able to use a central location to find any firm's
relationship summary, and that easy access to various relationship
summaries through one source may facilitate simpler comparison across
firms.\1016\ In addition, as also discussed below, some firms may not
maintain a website, and therefore their relationship summaries would
not otherwise be accessible to the public.\1017\ We do not believe that
proposing different filing requirements for large and small firms would
be appropriate given our belief that the benefits of electronic filing
are important for retail investors clients and customers of both large
and small firms. Furthermore, almost all advisers, including small
advisers, have Internet access and use the Internet for various
purposes.\1018\
---------------------------------------------------------------------------
\1016\ See supra note 320 and accompanying text.
\1017\ Id.
\1018\ See 2000 Brochure Proposing Release, supra note 271, at
n.304 and accompanying text. However, an adviser that is a small
business may be eligible for a continuing hardship exemption for
Form ADV filings, which would include proposed Form CRS, if it can
demonstrate that filing electronically would impose an undue
hardship. See Instruction 17 of General Instructions to Form ADV.
---------------------------------------------------------------------------
Finally, the proposal to require investment advisers and broker-
dealers post their relationship summary on their public websites, if
they have a public website, in a way that is easy for retail investors
to find, already incorporates the flexibility to permit different
compliance and reporting requirements for small entities, if
applicable. To the extent that broker-dealers and investment advisers
that are small entities are less likely to have public websites and do
not have them, they would not be required under our proposal to post
the relationship summary on their websites.\1019\ In other ways, as
well, the proposal incorporates flexibility for smaller broker-dealers
and investment advisers to comply with the proposed requirements. For
instance, we are proposing to require firms to communicate the
information in an amended relationship summary to retail investors who
are existing clients or customers of the firm within 30 days after the
updates are required to be made and without charge.\1020\ This
requirement provides firms the ability to disclose changes without
requiring them to duplicate disclosures and incur additional costs.
---------------------------------------------------------------------------
\1019\ See supra note 320 (we are proposing that firms without a
website include a toll-free telephone number in their relationship
summaries that retail investors can call to obtain up-to-date
information).
\1020\ Advisers Act proposed rule 204-5(b)(4) and Exchange Act
proposed rule 17a-14(c)(2)(iv4); proposed General Instruction 6.(b)
to Form CRS. See supra Section II.C.3. Firms could communicate this
information by delivering the amended relationship summary or by
communicating the information another way to the retail investor.
Id.
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Regarding the second alternative, we believe the current proposal
is clear and that further clarification, consolidation, or
simplification of the compliance requirements is not necessary. The
proposed Instructions are designed to present requirements for
advisers' and broker-dealers' relationship summaries clearly and simply
to all such firms, including small entities. In addition, to aid firms
in understanding the type of disclosures we propose to require, we have
created mock-ups of a relationship summary for an investment advisory
firm, a brokerage firm, and a dual registrant, and have included them
as appendices to this release. These mock-ups examples are designed to
illustrate the application of the proposed requirements. We also
believe that the delivery and filing requirements are clear. As further
discussed above, our proposal would require: Delivery of the
relationship summary to each retail investor before or at the time of
beginning a relationship with a firm,\1021\ updating the relationship
summary within 30 days whenever any information in the relationship
summary becomes materially inaccurate,\1022\ and delivery of the
relationship summary to an existing retail investor client or customer
at certain points during the relationship.\1023\ Firms would also be
required to file their relationship summaries with the Commission and
post them on their firm websites, if they have a public website.
---------------------------------------------------------------------------
\1021\ See supra Section II.C.2. We are proposing different
triggers for initial delivery of the relationship summary by
investment advisers (before or at the time the firm enters into an
investment advisory agreement with the retail investor) and by
broker-dealers (before or at the time the retail investor first
engages the firm's services). These proposed requirements are
intended to make the relationship summary readily accessible to
retail investors at the time when they are choosing investment
services and are generally consistent with the approach many
commenters recommended. Id.
\1022\ See supra Section II.C.3.
\1023\ See supra Section II.C.2. For example, our proposal would
require firms to communicate the information in an amended
relationship summary to retail investors who are existing clients or
customers of the firm within 30 days after the updates are required
to be made and without charge.
---------------------------------------------------------------------------
Regarding the third alternative, the Commission believes that
proposed Form CRS and the related new rules and amendments
appropriately use a combination of performance and design standards. We
are proposing to standardize the relationship summaries among firms by
specifying the headings, sequence, and content of the topics;
prescribing language for firms to use as applicable; and limiting the
length of the relationship summary. We believe that the standardization
will provide comparative information in a user-friendly format that
helps retail investors with informed decision making. For example, we
are prescribing the use of graphical formats in specified
circumstances, based on studies that indicate the effectiveness of
graphical presentation for retail investors.\1024\ Also, as discussed
above, we are requiring firms to use prescribed wording in many items,
and we are proposing that firms may not include disclosure in the
relationship summary other than disclosure that is required or
permitted by the Instructions.\1025\ We believe that allowing only the
proposed mandatory or permissible information would promote consistency
of
[[Page 21544]]
information presented to investors, and allow investors to focus on
information that we believe is particularly helpful in deciding among
firms.\1026\
---------------------------------------------------------------------------
\1024\ For example we are proposing to require dual registrants
to present all of the information required by Items 2 through 4 and
Item 6 in a tabular format, comparing advisory services and
brokerage services side-by-side, with prescribed headings. See
proposed General Instruction 1.(e) to Form CRS. Similarly,
standalone broker-dealers and investment advisers would be required
to provide general information about fee types in tabular format, in
a separate comparison section. See proposed Item 5 of Form CRS.
\1025\ See supra notes 54-55 and accompanying text.
\1026\ It would also encourage impartial information by
preventing firms from adding information commonly used in marketing
materials, such as performance.
---------------------------------------------------------------------------
Within the framework of standardization, we are proposing that for
certain disclosure Items in Form CRS, firms would have some flexibility
in how they include the required information.\1027\ In addition, we
have proposed permitting, but not requiring, the use of graphical
formats where doing so does not unduly constrain effective description
of a range of information. With respect to the prescribed wording, we
are proposing that if a prescribed statement is inapplicable to a
firm's business or would be misleading to a reasonable retail investor,
the firm would be permitted to omit or modify that statement.\1028\
---------------------------------------------------------------------------
\1027\ See supra note 56.
\1028\ See proposed General Instruction 3 to Form CRS. Firms may
omit or modify prescribed wording or other statements required to be
part of the relationship summary if such statements are inapplicable
to a firm's business or would be misleading to a reasonable retail
investor.
---------------------------------------------------------------------------
We believe that this approach of using both performance and design
standards balances the need to provide firms flexibility in making the
presentation of information consistent with their particular business
model while ensuring that all investors receive certain information
regardless of the firm in a manner that promotes comparability. In the
sections above, we request comment on whether the proposed mix of
design and performance standards would work for investment advisers and
broker-dealers, including small entities, and what the impact of such
standards would be on firms.\1029\
---------------------------------------------------------------------------
\1029\ See requests for comment in Sections II.A and II.B with
respect to the proposed prescribed wording in places throughout the
relationship summary, and the proposed prescribed headings, order
and format.
---------------------------------------------------------------------------
Regarding the fourth alternative, we believe that, similar to the
first alternative, it would be inconsistent with the purposes of the
Advisers Act and the Exchange Act to exempt small advisers and broker-
dealers from the proposed rule and form amendments, or any part
thereof. Because the protections of the Advisers Act and Exchange Act
are intended to apply equally to retail investors that are clients and
customers of both large and small advisers and broker-dealers, it would
be inconsistent with the purposes of the Advisers Act and Exchange Act
to specify differences for small entities under the proposed
amendments. As discussed above, the information in the relationship
summary would alert retail investors to important information for them
to consider when choosing a firm and a financial professional, and
would prompt retail investors to ask informed questions. In addition,
the content of the relationship summary would facilitate comparisons
across firms that offer the same or substantially similar services. We
preliminarily believe that providing this information before or at the
time a retail investor enters into an investment advisory agreement or
first engages a brokerage firm's services, as well as at certain points
during the relationship (e.g., switching account types) is appropriate
and in the public interest and will improve investor protection, and
will deter potentially misleading sales practices by helping retail
investors to make a more informed choice among the types of firms and
services available to them. Since we view investor confusion about
brokerage and advisory services as an issue for many retail investors
who are clients and customers of advisers and broker-dealers, it would
be inconsistent with the purpose of the relationship summary to specify
different requirements for small entities.\1030\
---------------------------------------------------------------------------
\1030\ See supra note 3, citing studies that show retail
investor confusion about the differences among broker-dealers and
investment advisers.
---------------------------------------------------------------------------
2. Rule 15l-2 Relating to Restrictions on the Use of Certain Terms in
Names and Titles
Regarding the first alternative, the Commission preliminarily
believes that establishing different compliance or reporting
requirements for small broker-dealers would be inappropriate under
these circumstances. We believe it is important to address the risk
that retail investors are confused and potentially misled based on the
names or titles of their firms and financial professionals and as a
result, make uninformed decisions regarding which firm or financial
professional they are engaging or seeking to engage. Because the
protections of the Exchange Act are intended to apply equally to retail
investor clients of both large and small firms, the Commission
preliminarily believes it would be inconsistent with the purposes of
the Exchange Act to specify differences for small entities under the
proposed rule.
Regarding the second alternative, we believe that the current
proposal is clear and that further clarification, consolidation, or
simplification is not necessary. As discussed in Section III above, the
restriction is limited to use of the terms ``adviser'' and ``advisor.''
As discussed above in Section III, we considered whether we should
restrict broker-dealers from using additional terms, such as, for
example, ``financial consultant.'' We believe, however, that the term
``adviser'' or ``advisor'' is more closely related to the statutory
term ``investment adviser,'' which makes it more likely than these
other terms that retail investors would associate such terms with an
investment adviser and its advisory activities than with a broker-
dealer and its brokerage activities. We preliminarily believe that the
use of the terms ``adviser'' and ``advisor'' by broker-dealers and
their associated natural persons has particularly contributed to
investor confusion about the typical services, fee structures,
conflicts of broker-dealers and investment advisers, and legal
standards of conduct to which broker-dealers and investment advisers
are subject. Therefore, we believe that the current proposal is clear
in its limited scope of restricted terms.
Regarding the third alternative, we believe that using performance
rather than our proposed design standards would be less effective in
addressing the issue of investor confusion based on the names or titles
of their firms and financial professionals. As discussed in Section
III, the proposed rule would restrict broker-dealers' or its associated
natural persons' use of the term ``adviser'' or ``advisor'' as part of
a name or title when communicating with a retail investor. We believe
that the use of the terms ``adviser'' and ``advisor'' has particularly
contributed to investor confusion about the typical services, fee
structures, conflicts of interest, and legal standards of conduct to
which broker-dealers and investment advisers are subject and as a
result has potentially misled retail investors as to the type of firm
or financial professional they are engaging or seeking to engage.
Accordingly, we believe that restricting these terms appropriately
addresses these issues based on a broker-dealer's or its associated
natural persons' use of the term ``adviser'' or ``advisor'' as part of
a name or title. As discussed above in Section III, we preliminarily
believe that without restricting a broker-dealer or its associated
natural person(s) from using ``adviser'' or ``advisor'' in a name or
title, a retail investor may be misled into believing and expecting
that their ``financial advisor,'' who may, for example, solely provide
brokerage services at a broker-dealer, is an
[[Page 21545]]
investment adviser (i.e., a fiduciary) on the basis of his name or
title.
Additionally, we considered two performance-based standards, as
discussed above in Section III.C.\1031\ However, we believe that either
performance standard would be less effective than our proposed design
standard in addressing investor confusion stemming from their
association with the statutory term investment adviser. In the first
alternative approach, we considered proposing a rule which would have
stated that a broker-dealer that uses the term ``adviser'' or
``advisor'' as part of a name or title would not be considered to
provide investment advice solely incidental to the conduct of its
brokerage business and therefore would not be excluded from the
definition of investment adviser under section 202(a)(11)(C) of the
Advisers Act. For the second alternative approach, we considered
precluding a broker-dealer from relying on the solely incidental
exclusion of section 202(a)(11)(C) if it ``held itself out'' as an
investment adviser to retail investors such as by representing or
implying through any communication or other sales practice (including
through the use of names or titles) that they are offering investment
advice subject to a fiduciary relationship with an investment adviser.
Under this second approach, there would be a prohibition on certain
broker-dealer and its associated natural person communications that
suggest, or could reasonably be understood as suggesting, that such
broker-dealer or its associated natural persons are performing
investment advisory services in a manner that would subject them to the
Advisers Act rather than as solely incidental to their business as a
broker-dealer. For the reasons we set out in Section III above, we
believe that our proposed restriction on the use of ``adviser'' and
``advisor'' in combination with the requirement to deliver a
relationship summary is a simpler, more administrable approach to
address the confusion about the difference between investment advisers
and broker-dealers, and to prevent investors from being potentially
misled. As a result, we believe that our proposed approach is more
tailored toward creating greater clarity than our alternative
approaches.
---------------------------------------------------------------------------
\1031\ See supra Section III.C.
---------------------------------------------------------------------------
Regarding the fourth alternative, we preliminarily believe that,
similar to the first alternative, it would be inconsistent with the
purposes of the Exchange Act to exempt small broker-dealers from the
proposed rule, or any part thereof.
3. Rule 15l-3 Relating to Disclosure of Commission Registration Status
and Financial Professional Association
Regarding the first alternative, the Commission believes that
establishing different compliance or reporting requirements for small
advisers and broker-dealers would be inappropriate under these
circumstances. We believe it is important to assist retail investors in
determining which type of firm is more appropriate for their specific
investment needs and promote better informed decisions regarding which
firm or financial professional they are engaging or seeking to engage.
Because the protections of the Advisers Act and Exchange Act are
intended to apply equally to retail investor clients of both large and
small firms, we preliminarily believe it would be inconsistent with the
purposes of the Exchange Act and the Advisers Act to specify
differences for small entities under the proposed rule.
Regarding the second alternative, we believe that the current
proposal is clear and that further clarification, consolidation, or
simplification of the compliance requirements is not necessary. As
discussed in Section III.D, we are proposing rules under the Exchange
Act and Advisers Act that would require broker-dealers and investment
advisers and their associated natural persons and supervised persons,
respectively, to prominently disclose the firm's registration status
with the Commission and the associated natural persons and supervised
person's relationship with the firm in print and electronic retail
investor communications. As discussed above in Section III, our
proposal would subject broker-dealers and investment advisers to the
same requirements, adding to the clarity and consolidation of the
compliance requirements. Finally, we note that our proposed rules
contain specific presentation and prominence requirements, as discussed
above in Section III, for both print and electronic communications.
Regarding the third alternative, we believe that using performance
rather than design standards would be less effective in assisting
retail investors in determining which type of firm is more appropriate
for their specific investment needs. Specifically, we are concerned
that in the absence of the specific prominence and formatting
requirements, firms and financial professionals may disclose their
registration status in a footnote or at the bottom of a website and in
small print as they do today with other regulatory mandated disclosures
(e.g., member of Securities Investor Protection Corporation). In such
cases, retail investors would be unable to readily discern whether a
firm is a broker-dealer or investment adviser and thus avoid making an
uniformed choice of which firm or financial professional to engage or
seek to engage, undermining a key purpose of our proposed rules.
Therefore, we believe that our proposed design standards would
facilitate the presentation of required information to retail
investors. Specifically, as we noted above, disclosures as important as
a firm's registration status or a financial professional's association
with such firm should not be disclosed inconspicuously or placed in
fine print. Accordingly, we are proposing to require a firm and its
financial professionals to disclose their registration statuses in
print communications in a type size at least as large as and of a font
style different from, but at least as prominent as, that used in the
majority of the communication. In addition, we are proposing to require
the disclosure to be presented in the body of the communication and not
in a footnote. Finally, we are also proposing that if a communication
is delivered through an electronic communication or in any publication
by radio or television, the disclosure must be presented in a manner
reasonably calculated to draw retail investors' attention to it. We
believe that through these design standards retail investors would have
the information necessary to facilitate an informed choice of financial
firm and its professionals.
Regarding the fourth alternative, we preliminarily believe that,
similar to the first alternative, it would be inconsistent with the
purposes of the Advisers Act and the Exchange Act to exempt small
advisers and broker-dealers from the proposed rule, or any part
thereof.
G. Solicitation of Comments
We encourage written comments on the matters discussed in this
IRFA. We solicit comment on the number of small entities subject to the
proposed Form CRS, and the proposed rules and rule amendments as well
as the potential impacts discussed in this analysis; and whether the
proposal could have an effect on small entities that has not been
considered. We request that commenters describe the nature of any
impact on small entities and provide empirical data to support the
extent of such impact.
[[Page 21546]]
VII. Consideration of the Impact on the Economy
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996, or ``SBREFA,'' \1032\ we must advise OMB whether a
proposed regulation constitutes a ``major'' rule. Under SBREFA, a rule
is considered ``major'' where, if adopted, it results in or is likely
to result in (1) an annual effect on the economy of $100 million or
more; (2) a major increase in costs or prices for consumers or
individual industries; or (3) significant adverse effects on
competition, investment or innovation.
---------------------------------------------------------------------------
\1032\ Public Law 104-121, Title II, 110 Stat. 857 (1996)
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note
to 5 U.S.C. 601).
---------------------------------------------------------------------------
We request comment on the potential effect of the proposed
amendments on the U.S. economy on an annual basis; any potential
increase in costs or prices for consumers or individual industries; and
any potential effect on competition, investment or innovation.
Commenters are requested to provide empirical data and other factual
support for their views to the extent possible.
VIII. Statutory Authority
The Commission is proposing amendments to rule 203-1 under the
Advisers Act pursuant to authority set forth in sections 203(c)(1),
204, and 211(a) of the Investment Advisers Act of 1940 [15 U.S.C. 80b-
3(c)(1), 80b-4, and 80b-11(a)].
The Commission is proposing amendments to rule 204-1 under the
Advisers Act pursuant to authority set forth in sections 203(c)(1) and
204 of the Investment Advisers Act of 1940 [15 U.S.C. 80b-3(c)(1) and
80b-4].
The Commission is proposing new rule 204-5 under the Advisers Act
pursuant to authority set forth in sections 204, 206A, 206(4), 211(a),
and 211(h) of the Investment Advisers Act of 1940 [15 U.S.C. 80b-4,
80b-6a, 80b-6(4), 80b-11(a), 80b-11(h)], and section 913(f) of Title IX
of the Dodd-Frank Wall Street Reform and Consumer Protection Act of
2010 (the ``Dodd-Frank Act'').
The Commission is proposing amendments to rule 279.1, Form ADV,
under section 19(a) of the Securities Act of 1933 [15 U.S.C. 77s(a)],
sections 23(a) and 28(e)(2) of the Securities Exchange Act of 1934 [15
U.S.C. 78w(a) and 78bb(e)(2)], section 319(a) of the Trust Indenture
Act of 1939 [15 U.S.C. 7sss(a)], section 38(a) of the Investment
Company Act of 1940 [15 U.S.C. 80a-37(a)], and sections 203(c)(1), 204,
206A, 211(a) and 211(h), and of the Investment Advisers Act of 1940 [15
U.S.C. 80b-3(c)(1), 80b-4, 80b-6a, 80b-11(a) and 80b-11(h)], and
section 913(f) of Title IX of the Dodd-Frank Act.
The Commission is proposing to amend rule 204-2 under the Advisers
Act pursuant to authority set forth in sections 204 and 211 of the
Advisers Act [15 U.S.C. 80b-4 and 80b-11].
The Commission is proposing new rule 17a-14 under the Exchange Act,
Form CRS, and amendments to rules 17a-3 and 17a-4 under the Exchange
Act pursuant to the authority set forth in the Exchange Act and
particularly sections 3, 10, 15, 17, 23 and 36 thereof 15 U.S.C. 78c,
78j, 78o, 78q, 78w and 78mm, and section 913(f) of Title IX of the
Dodd-Frank Act.
The Commission is proposing new rules 15l-2 and 15l-3 under the
authority set forth in sections 10, 15, 23, and 36 of the Securities
Exchange Act of 1934 [15 U.S.C. 78j, 78o, 78w, and 78mm] and new rule
211h-1 under the authority set forth in sections 211(h), 206A, 211(a)
of the Investment Advisers Act of 1940 [15 U.S.C. 80b-11(h), 80b-6a,
80b-11(a)].
IX. Text of Rule and Form
List of Subjects
17 CFR Parts 240 and 249
Brokers, Reporting and recordkeeping requirements, Sales practice
and disclosure requirements, Securities.
17 CFR Parts 275 and 279
Investment advisers, Reporting and recordkeeping requirements,
Securities.
Text of Proposed Rules
For the reasons set out in the preamble, title 17, chapter II of
the Code of Federal Regulations is proposed to be amended as follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
1. The general authority citation for part 240 continues to read as
follows and sectional authorities for 240.15l-2, 240.15l-3, and
240.17a-14 are added to read as follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4,
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20,
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et seq.; and
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; and
Pub. L. 111-203, 939A, 124 Stat. 1887 (2010); and secs. 503 and 602,
Pub. L. 112-106, 126 Stat. 326 (2012), unless otherwise noted.
* * * * *
Section 240.15l-2 is also issued under Public Law 111-203, sec.
913, 124 Stat. 1376 (2010).
Section 240.15l-3 is also issued under Public Law 111-203, sec.
913, 124 Stat. 1376 (2010).
Section 240.17a-14 is also issued under Public Law 111-203, sec.
913, 124 Stat. 1376 (2010).
* * * * *
0
2. Section 240.15l-2 is added to read as follows:
Sec. 240.15l-2 Use of the Term ``Adviser'' or ``Advisor''.
(a) A broker or dealer, or a natural person who is an associated
person of a broker or dealer shall be restricted, when communicating
with a retail investor, from using as part of a name or title the term
``adviser'' or ``advisor'' unless any such:
(1) Broker or dealer is an investment adviser registered under
Section 203 of the Investment Advisers Act of 1940 or with a State, or
(2) Natural person who is an associated person of a broker or
dealer is a supervised person of an investment adviser registered under
Section 203 of the Investment Advisers Act of 1940 or with a State, and
such person provides investment advice on behalf of such investment
adviser.
(b) The term retail investor has the meaning set forth in Sec.
240.17a-14.
0
3. Section 240.15l-3 is added to read as follows:
Sec. 240.15l-3 Disclosure of Registration Status.
(a) A broker or dealer shall prominently disclose that it is
registered with the Commission as a broker-dealer in print or
electronic retail investor communications.
(b) A natural person who is an associated person of a broker or
dealer shall prominently disclose that he or she is an associated
person of a broker-dealer registered with the Commission in print or
electronic retail investor communications.
(c) Such disclosures in paragraphs (a) and (b) shall be provided in
the following manner:
(1) For print communications, such status must be displayed in a
type size at least as large as and of a font style different from, but
at least as prominent as, that used in the majority of the
communication. In addition, such disclosure must be presented in the
body of the communication and not in a footnote.
(2) For electronic communications, or in any publication by radio
or television, such disclosure must be presented in a manner reasonably
calculated to draw retail investor attention to it.
[[Page 21547]]
(d) The term retail investor has the meaning set forth in Sec.
240.17a-14.
0
4. Section 240.17a-3 is amended by adding paragraph (a)(24) to read as
follows:
Sec. 240.17a-3 Records to be made by certain exchange members,
brokers and dealers.
(a) * * *
(24) A record of the date that each Form CRS was provided to each
retail investor, including any Form CRS provided before such retail
investor opens an account.
* * * * *
0
5. Section 240.17a-4 is amended by adding paragraph (e)(10) to read as
follows:
Sec. 240.17a-4 Records to be preserved by certain exchange members,
brokers and dealers.
* * * * *
(e) * * *
(10) All records required pursuant to Sec. 240.17a-3(a)(24), as
well as a copy of each Form CRS, until at least six years after such
record or Form CRS is created.
* * * * *
0
6. Section 240.17a-14 is added to read as follows:
Sec. 240.17a-14 Form CRS, for preparation, filing and delivery of
Form CRS.
(a) Scope of Section. This section shall apply to every broker or
dealer registered with the Commission pursuant to section 15 of the Act
that offers services to a retail investor.
(b) Form CRS. You must:
(1) Prepare Form CRS 17 CFR 249.640, by following the instructions
in the form.
(2) File your current Form CRS electronically with the Commission
through the Commission's EDGAR system, and thereafter, file an amended
Form CRS in accordance with the instructions in the form.
(3) Amend your Form CRS as required by the instructions in the
form.
(c) Delivery of Form CRS. You must:
(1) Deliver to each retail investor your current Form CRS before or
at the time the retail investor first engages your services.
(2) Deliver to each retail investor who is an existing customer
your current Form CRS before or at the time (i) a new account is opened
that is different from the retail investor's existing account(s); or
(ii) changes are made to the retail investor's existing account(s) that
would materially change the nature and scope of the relationship with
the retail investor, including before or at the time you recommend that
the retail investor transfers from an advisory account to a brokerage
account, transfers from a brokerage account to an advisory account, or
moves assets from one type of account to another in a transaction not
in the normal, customary or already agreed course of dealing. Whether a
change would require delivery of the Form CRS would depend on the
specific facts and circumstances.
(3) Post the current Form CRS prominently on your website, if you
have one, in a location and format that is easily accessible for retail
investors.
(4) Communicate any changes made to Form CRS to each retail
investor who is an existing customer within 30 days after the
amendments are required to be made and without charge. The
communication can be made by delivering the current Form CRS or by
communicating the information in another way to the retail investor.
(5) Deliver a current Form CRS to each retail investor within 30
days upon request.
(d) Other disclosure obligations. Delivering a Form CRS in
compliance with this section does not relieve you of any other
disclosure obligations arising under the federal securities laws and
regulations or other laws or regulations (including the rules of a
self-regulatory organization).
(e) Definitions. For purposes of this section:
(1) Current Form CRS means the most recent version of the Form CRS.
(2) Retail investor means a customer or prospective customer who is
a natural person (an individual). This term includes a trust or other
similar entity that represents natural persons, even if another person
is a trustee or managing agent of the trust.
(f) Transition rule. (1) You must begin to comply with this section
by [INSERT DATE SIX MONTHS AFTER EFFECTIVE DATE OF RULES/FORM],
including by filing your Form CRS in accordance with paragraph (b)(2)
of this section by that date.
(2) Within 30 days after the date by which you are first required
by paragraph (f)(1) of this section to electronically file your Form
CRS with the Commission, you must deliver to each of your existing
customers who is a retail investor your current Form CRS.
(3) After [INSERT DATE SIX MONTHS AFTER EFFECTIVE DATE OF RULES/
FORM], if you are a newly registered broker or dealer that is subject
to this section, you must begin to comply with this section by the date
on which your registration with the Commission becomes effective
pursuant to Section 15(b) of the Act, including by filing your Form CRS
in accordance with paragraph (b)(2) of this section by that date.
Editorial Note: For Federal Register citations affecting Form
CRS, see the List of CFR Sections Affected, which appears in the
Finding Aids section of the printed volume and at www.fdsys.gov.
PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934
0
7. The authority citation for part 249 is amended by adding sectional
authorities to read as follows:
Authority: 15 U.S.C. 78a et seq. and 7201 et seq.; 12 U.S.C.
5461 et seq.; 18 U.S.C. 1350; Sec. 953(b), Pub. L. 111-203, 124
Stat. 1904; Sec. 102(a)(3), Pub. L. 112-106, 126 Stat. 309 (2012);
Sec. 107, Pub. L. 112-106, 126 Stat. 313, (2012), and Sec. 72001,
Pub. L. 114-94, 129 Stat. 1312 (2015), unless otherwise noted.
* * * * *
Section 249.640 is also issued under Public Law 111-203, sec.
913, 124 Stat. 1376 (2010).
* * * * *
0
8. Section 249.640 is added to read as follows:
Sec. 249.640 Form CRS, Relationship Summary for Broker-Dealers
Providing Services to Retail Investors, pursuant to Sec. 240.17a-14 of
this chapter.
This form shall be prepared and filed by broker-dealers registered
with the Securities and Exchange Commission pursuant to Section 15 of
the Act that offer services to a retail investor pursuant to Sec.
240.17a-14 of this chapter.
PART 275--RULES AND REGULATIONS, INVESTMENT ADVISERS ACT OF 1940
0
9. The general authority citation for part 275 continues to read as
follows and sectional authorities for 275.204-5 and 275.211h-1 are
added to read as follows:
Authority: 15 U.S.C. 80b-2(a)(11)(G), 80b-2(a)(11)(H), 80b-
2(a)(17), 80b-3, 80b-4, 80b-4a, 80b-6(4), 80b-6a, and 80b-11, unless
otherwise noted.
* * * * *
Section 275.204-5 is also issued under sec. 913, Public Law 111-
203, sec. 124 Stat. 1827-28 (2010).
Section 275.211h-1 is also issued under sec. 913, Public Law
111-203, sec. 124 Stat. 1827-28 (2010).
* * * * *
0
10. Amend Sec. 275.203-1 by revising paragraph(a) to read as follows:
Sec. 275.203-1 Application for investment adviser registration.
(a) Form ADV. (1) To apply for registration with the Commission as
an investment adviser, you must complete Form ADV (17 CFR 279.1) by
following the instructions in the form and you
[[Page 21548]]
must file Part 1A of Form ADV, the firm brochure(s) required by Part 2A
of Form ADV and Form CRS required by Part 3 of Form ADV electronically
with the Investment Adviser Registration Depository (IARD) unless you
have received a hardship exemption under Sec. 275.203-3. You are not
required to file with the Commission the brochure supplements required
by Part 2B of Form ADV.
(2) After [INSERT DATE SIX MONTHS AFTER EFFECTIVE DATE OF RULES/
FORM] the Commission will not accept any initial application for
registration as an investment adviser that does not include a Form CRS
that satisfies the requirements of Part 3 of Form ADV.
Note to paragraph (a)(1): Information on how to file with the
IARD is available on the Commission's Web site at http://www.sec.gov/iard. If you are not required to deliver a brochure or
Form CRS to any clients, you are not required to prepare or file a
brochure or Form CRS, as applicable, with the Commission. If you are
not required to deliver a brochure supplement to any clients for any
particular supervised person, you are not required to prepare a
brochure supplement for that supervised person.
* * * * *
0
11. Amend Sec. 275.204-1 by revising paragraphs (a) and (b) to read as
follows:
Sec. 275.204-1 Amendments to Form ADV.
(a) When amendment is required. You must amend your Form ADV (17
CFR 279.1):
(1) Parts 1 and 2:
(i) At least annually, within 90 days of the end of your fiscal
year; and
(ii) More frequently, if required by the instructions to Form ADV.
(2) Part 3 at the frequency required by the instructions to Form
ADV.
(b) Electronic filing of amendments. (1) Subject to paragraph
(b)(3) of this rule, you must file all amendments to Part 1A, Part 2A
and Part 3 of Form ADV electronically with the IARD, unless you have
received a continuing hardship exemption under Sec. 275.203-3. You are
not required to file with the Commission amendments to brochure
supplements required by Part 2B of Form ADV.
(2) If you have received a continuing hardship exemption under
Sec. 275.203-3, you must, when you are required to amend your Form
ADV, file a completed Part 1A, Part 2A and Part 3 of Form ADV on paper
with the SEC by mailing it to FINRA.
(3) Transition to filing Form CRS. You must amend your Form ADV by
electronically filing with the IARD Form CRS that satisfies the
requirements of Part 3 of Form ADV (as amended effective [INSERT
EFFECTIVE DATE OF RULES/FORM]) as part of the next annual updating
amendment you are required to file after [INSERT DATE SIX MONTHS AFTER
EFFECTIVE DATE OF RULES/FORM].
Note to paragraphs (a) and (b): Information on how to file with
the IARD is available on our Web site at http://www.sec.gov/iard.
For the annual updating amendment: Summaries of material changes
that are not included in the adviser's brochure must be filed with
the Commission as an exhibit to Part 2A in the same electronic file;
and if you are not required to prepare a brochure, a summary of
material changes, an annual updating amendment to your brochure, or
Form CRS you are not required to file them with the Commission. See
the instructions for Part 2A and Part 3 of Form ADV.
* * * * *
0
12. Section 275.204-2 is amended by revising paragraph (a)(14)(i) as
follows:
Sec. 275.204-2 Books and records to be maintained by investment
advisers.
(a) * * *
(14)
(i) A copy of each brochure, brochure supplement and Form CRS, and
each amendment or revision to the brochure, brochure supplement and
Form CRS, that satisfies the requirements of Part 2 or Part 3 of Form
ADV, as applicable [17 CFR 279.1]; any summary of material changes that
satisfies the requirements of Part 2 of Form ADV but is not contained
in the brochure; and a record of the dates that each brochure, brochure
supplement and Form CRS, each amendment or revision thereto, and each
summary of material changes not contained in a brochure was given to
any client or to any prospective client who subsequently becomes a
client.
* * * * *
0
13. Section 275.204-5 is added to read as follows:
Sec. 275.204-5 Delivery of Form CRS.
(a) General requirements. If you are registered under the Act as an
investment adviser, you must deliver Form CRS, required by Part 3 of
Form ADV [17 CFR 279.1], to each retail investor.
(b) Delivery requirements. You (or a supervised person acting on
your behalf) must:
(1) Deliver to each retail investor your current Form CRS before or
at the time you enter into an investment advisory contract with that
retail investor.
(2) Deliver to each retail investor who is an existing client your
current Form CRS before or at the time (i) a new account is opened that
is different from the retail investor's existing account(s); or (ii)
changes are made to the retail investor's existing account(s) that
would materially change the nature and scope of the relationship with
the retail investor, including before or at the time you recommend that
the retail investor transfers from an advisory account to a brokerage
account, transfers from a brokerage account to an advisory account, or
moves assets from one type of account to another in a transaction not
in the normal, customary or already agreed course of dealing. Whether a
change would require delivery of the Form CRS would depend on the
specific facts and circumstances.
(3) Post the current Form CRS prominently on your website, if you
have one, in a location and format that is easily accessible for retail
investors.
(4) Communicate any changes made to Form CRS to each retail
investor who is an existing client within 30 days after the amendments
are required to be made and without charge. The communication can be
made by delivering the amended Form CRS or by communicating the
information in another way to the retail investor.
(5) Deliver a current Form CRS to each retail investor within 30
days upon request.
(c) Other disclosure obligations. Delivering Form CRS in compliance
with this section does not relieve you of any other disclosure
obligations you have to your retail investors under any federal or
state laws or regulations.
(d) Definitions. For purposes of this section:
(1) Current Form CRS means the most recent version of the Form CRS.
(2) Retail investor means a client or prospective client who is a
natural person (an individual). This term includes a trust or other
similar entity that represents natural persons, even if another person
is a trustee or managing agent of the trust.
(3) Supervised person means any of your officers, partners or
directors (or other persons occupying a similar status or performing
similar functions) or employees, or any other person who provides
investment advice on your behalf.
(e) Transition rule.
(1) Within 30 days after the date by which you are first required
by Sec. 275.204-1(b)(3) to electronically file your Form CRS with the
Commission, you must deliver to each of your existing clients who is a
retail investor your current Form CRS as required by Part 3 of Form
ADV.
(2) As of the date by which you are first required to
electronically file your Form CRS with the Commission, you must begin
using your Form CRS as required by Part 3 of Form ADV to
[[Page 21549]]
comply with the requirements of paragraph (b) of this section.
0
14. Section 275.211h-1 is added to read as follows:
Sec. 275.211h-1 Disclosure of Registration Status.
(a) An investment adviser registered under section 203 of the Act
shall prominently disclose that it is registered with the Commission as
an investment adviser in print or electronic retail investor
communications.
(b) A supervised person of an investment adviser registered under
section 203 of the Act shall prominently disclose that he or she is a
supervised person of an investment adviser registered with the
Commission in print or electronic retail investor communications.
(c) Such disclosures in paragraphs (a) and (b) of this section
shall be provided in the following manner:
(1) For print communications, such status must be displayed in a
type size at least as large as and of a font style different from, but
at least as prominent as, that used in the majority of the
communication. In addition, such disclosure must be presented in the
body of the communication and not in a footnote.
(2) For electronic communications, or in any publication by radio
or television, such disclosure must be presented in a manner reasonably
calculated to draw retail investor attention to it.
(d) The term retail investor has the meaning set forth in Rule 204-
5 (Sec. 275.204-5 of this chapter).
PART 279--FORMS PRESCRIBED UNDER THE INVESTMENT ADVISERS ACT OF
1940
0
15. The authority citation for part 279 is revised to read as follows:
Authority: The Investment Advisers Act of 1940, 15 U.S.C. 80b-1,
et seq., Pub. L. 111-203, 124 Stat. 1376.
0
16. Form ADV [referenced in Sec. 279.1] is amended by:
0
a. In the instructions to the form, revising the section entitled
``Form ADV: General Instructions.'' The revised version of Form ADV:
General Instructions is attached as Appendix A;
0
b. In the instructions to the form, adding the section entitled ``Form
ADV, Part 3: Instructions to Form CRS.'' The new version of Form ADV,
Part 3: Instructions to Form CRS is attached as Appendix B.
By the Commission.
Dated: April 18, 2018.
Brent J. Fields,
Secretary.
Note: The text of Form ADV does not and the amendments will not
appear in the Code of Federal Regulations.
Appendices
APPENDIX A
FORM ADV (Paper Version)
UNIFORM APPLICATION FOR INVESTMENT ADVISER REGISTRATION AND
REPORT FORM BY EXEMPT REPORTING ADVISERS
Form ADV: General Instructions
Read these instructions carefully before filing Form ADV.
Failure to follow these instructions, properly complete the form, or
pay all required fees may result in your application or report being
delayed or rejected.
In these instructions and in Form ADV, ``you'' means the
investment adviser (i.e., the advisory firm).
If you are a ``separately identifiable department or division''
(SID) of a bank, ``you'' means the SID, rather than your bank,
unless the instructions or the form provide otherwise.
If you are a private fund adviser filing an umbrella
registration, ``you'' means the filing adviser and each relying
adviser, unless the instructions or the form provide otherwise. The
information in Items 1, 2, 3 and 10 (including corresponding
schedules) should be provided for the filing adviser only.
Terms that appear in italics are defined in the Glossary of
Terms to Form ADV.
1. Where can I get more information on Form ADV, electronic filing, and
the IARD?
The SEC provides information about its rules and the Advisers
Act on its website: <http://www.sec.gov/iard>.
NASAA provides information about state investment adviser laws
and state rules, and how to contact a state securities authority, on
its website: <http://www.nasaa.org>.
FINRA provides information about the IARD and electronic filing
on the IARD website: <http://www.iard.com>.
2. What is Form ADV used for?
Investment advisers use Form ADV to:
Register with the Securities and Exchange Commission
Register with one or more state securities authorities
Amend those registrations;
Report to the SEC as an exempt reporting adviser
Report to one or more state securities authorities as an
exempt reporting adviser
Amend those reports; and
Submit a final report as an exempt reporting adviser
3. How is Form ADV organized?
Form ADV contains five parts:
Part 1A asks a number of questions about you, your business
practices, the persons who own and control you, and the persons who
provide investment advice on your behalf.
[cir] All advisers registering with the SEC or any of the state
securities authorities must complete Part 1A.
[cir] Exempt reporting advisers (that are not also registering
with any state securities authority) must complete only the
following Items of Part 1A: 1, 2, 3, 6, 7, 10, and 11, as well as
corresponding schedules. Exempt reporting advisers that are
registering with any state securities authority must complete all of
Form ADV.
Part 1A also contains several supplemental schedules. The items of
Part 1A let you know which schedules you must complete.
[cir] Schedule A asks for information about your direct owners
and executive officers.
[cir] Schedule B asks for information about your indirect
owners.
[cir] Schedule C is used by paper filers to update the
information required by Schedules A and B (see Instruction 18).
[cir] Schedule D asks for additional information for certain
items in Part 1A.
[cir] Schedule R asks for additional information about relying
advisers.
[cir] Disclosure Reporting Pages (or DRPs) are schedules that
ask for details about disciplinary events involving you or your
advisory affiliates.
Part 1B asks additional questions required by state
securities authorities. Part 1B contains three additional DRPs. If
you are applying for SEC registration or are registered only with
the SEC, you do not have to complete Part 1B. (If you are filing
electronically and you do not have to complete Part 1B, you will not
see Part 1B).
Part 2A requires advisers to create narrative brochures
containing information about the advisory firm. The requirements in
Part 2A apply to all investment advisers registered with or applying
for registration with the SEC, but do not apply to exempt reporting
advisers. Every application for registration must include a
narrative brochure prepared in accordance with the requirements of
Part 2A of Form ADV. See Advisers Act Rule 203-1.
Part 2B requires advisers to create brochure supplements
containing information about certain supervised persons. The
requirements in Part 2B apply to all investment advisers registered
with or applying for registration with the SEC, but do not apply to
exempt reporting advisers.
Part 3 requires advisers to create a relationship summary
(Form CRS) containing information for retail investors. The
requirements in Part 3 apply to all investment advisers registered
or applying for registration with the SEC, but do not apply to
exempt reporting advisers. Every adviser that has retail investors
to whom it must deliver a relationship summary must include in the
application for registration a relationship summary prepared in
[[Page 21550]]
accordance with the requirements of Part 3 of Form ADV. See Advisers
Act Rule 203-1.
4. When am I required to update my Form ADV?
SEC- and State-Registered Advisers:
[cir] Annual updating amendments: You must amend your Form ADV
each year by filing an annual updating amendment within 90 days
after the end of your fiscal year. When you submit your annual
updating amendment, you must update your responses to all items,
including corresponding sections of Schedules A, B, C, and D and all
sections of Schedule R for each relying adviser. You must submit
your summary of material changes required by Item 2 of Part 2A
either in the brochure (cover page or the page immediately
thereafter) or as an exhibit to your brochure.
[cir] Other-than-annual amendments: In addition to your annual
updating amendment, if you are registered with the SEC or a state
securities authority, you must amend Part 1 and Part 2 of your Form
ADV, including corresponding sections of Schedules A, B, C, D, and
R, by filing additional amendments (other-than-annual amendments)
promptly, if:
[ssquf] you are adding or removing a relying adviser as part of
your umbrella registration;
[ssquf] information you provided in response to Items 1 (except
1.O. and Section 1.F. of Schedule D), 3, 9 (except 9.A.(2), 9.B.(2),
9.E., and 9.F.), or 11 of Part 1A or Items 1, 2.A. through 2.F., or
2.I. of Part 1B or Sections 1 or 3 of Schedule R becomes inaccurate
in any way;
[ssquf] information you provided in response to Items 4, 8, or
10 of Part 1A, or Item 2.G. of Part 1B, or Section 10 of Schedule R
becomes materially inaccurate; or
[ssquf] information you provided in your brochure becomes
materially inaccurate (see note below for exceptions).
Notes: Part 1: If you are submitting an other-than-annual
amendment, you are not required to update your responses to Items 2,
5, 6, 7, 9.A.(2), 9.B.(2), 9.E., 9.F., or 12 of Part 1A, Items 2.H.
or 2.J. of Part 1B, Section 1.F. of Schedule D or Section 2 of
Schedule R even if your responses to those items have become
inaccurate.
Part 2: You must amend your brochure supplements (see Form ADV,
Part 2B) promptly if any information in them becomes materially
inaccurate. If you are submitting an other-than-annual amendment to
your brochure, you are not required to update your summary of
material changes as required by Item 2. You are not required to
update your brochure between annual amendments solely because the
amount of client assets you manage has changed or because your fee
schedule has changed. However, if you are updating your brochure for
a separate reason in between annual amendments, and the amount of
client assets you manage listed in response to Item 4.E. or your fee
schedule listed in response to Item 5.A. has become materially
inaccurate, you should update that item(s) as part of the interim
amendment.
If you are an SEC-registered adviser, you are required to
file your brochure amendments electronically through IARD. You are
not required to file amendments to your brochure supplements with
the SEC, but you must maintain a copy of them in your files.
If you are a state-registered adviser, you are required to
file your brochure amendments and brochure supplement amendments
with the appropriate state securities authorities through IARD.
[cir] Part 3 amendments: You must amend your relationship
summary and file your relationship summary amendments in accordance
with the Form ADV, Part 3 (Form CRS), General Instructions, 6.
Exempt reporting advisers:
[cir] Annual Updating Amendments: You must amend your Form ADV
each year by filing an annual updating amendment within 90 days
after the end of your fiscal year. When you submit your annual
updating amendment, you must update your responses to all required
items, including corresponding sections of Schedules A, B, C, and D.
[cir] Other-than-Annual Amendments: In addition to your annual
updating amendment, you must amend your Form ADV, including
corresponding sections of Schedules A, B, C, and D, by filing
additional amendments (other-than-annual amendments) promptly if:
[ssquf] information you provided in response to Items 1 (except
Item 1.O. and Section 1.F. of Schedule D), 3, or 11 becomes
inaccurate in any way; or
[ssquf] information you provided in response to Item 10 becomes
materially inaccurate.
Failure to update your Form ADV, as required by this instruction, is a
violation of SEC rules or similar state rules and could lead to your
registration being revoked.
5. What is SEC umbrella registration and how can I satisfy the
requirements of filing an umbrella registration?
An umbrella registration is a single registration by a filing
adviser and one or more relying advisers who advise only private
funds and certain separately managed account clients that are
qualified clients and collectively conduct a single advisory
business. Absent other facts suggesting that the filing adviser and
relying adviser(s) conduct different businesses, umbrella
registration is available under the following circumstances:
i. The filing adviser and each relying adviser advise only
private funds and clients in separately managed accounts that are
qualified clients and are otherwise eligible to invest in the
private funds advised by the filing adviser or a relying adviser and
whose accounts pursue investment objectives and strategies that are
substantially similar or otherwise related to those private funds.
ii. The filing adviser has its principal office and place of
business in the United States and, therefore, all of the substantive
provisions of the Advisers Act and the rules thereunder apply to the
filing adviser's and each relying adviser's dealings with each of
its clients, regardless of whether any client of the filing adviser
or relying adviser providing the advice is a United States person.
iii. Each relying adviser, its employees and the persons acting
on its behalf are subject to the filing adviser's supervision and
control and, therefore, each relying adviser, its employees and the
persons acting on its behalf are ``persons associated with'' the
filing adviser (as defined in section 202(a)(17) of the Advisers
Act).
iv. The advisory activities of each relying adviser are subject
to the Advisers Act and the rules thereunder, and each relying
adviser is subject to examination by the SEC.
v. The filing adviser and each relying adviser operate under a
single code of ethics adopted in accordance with SEC rule 204A-1 and
a single set of written policies and procedures adopted and
implemented in accordance with SEC rule 206(4)-7 and administered by
a single chief compliance officer in accordance with that rule.
To satisfy the requirements of Form ADV while using umbrella
registration the filing adviser must sign, file, and update as
required, a single Form ADV (Parts 1 and 2) that relates to, and
includes all information concerning, the filing adviser and each
relying adviser (e.g., disciplinary information and ownership
information), and must include this same information in any other
reports or filings it must make under the Advisers Act or the rules
thereunder (e.g., Form PF). The filing adviser and each relying
adviser must not be prohibited from registering with the SEC by
section 203A of the Advisers Act (i.e., the filing adviser and each
relying adviser must individually qualify for SEC registration).
Unless otherwise specified, references to ``you'' in Form ADV
refer to both the filing adviser and each relying adviser. The
information in Items 1, 2, 3 and 10 (including corresponding
schedules) should be provided for the filing adviser only. A
separate Schedule R should be completed for each relying adviser.
References to ``you'' in Schedule R refer to the relying adviser
only.
A filing adviser applying for registration with the SEC should
complete a Schedule R for each relying adviser. If you are a filing
adviser registered with the SEC and would like to add or delete
relying advisers from an umbrella registration, you should file an
other-than-annual amendment and add or delete Schedule Rs as needed.
Note: Umbrella registration is not available to exempt reporting
advisers.
6. Where do I sign my Form ADV application or amendment?
You must sign the appropriate Execution Page. There are three
Execution Pages at the end of the form. Your initial application,
your initial report (in the case of an exempt reporting adviser),
and all amendments to Form ADV must include at least one Execution
Page.
If you are applying for or are amending your SEC
registration, or if you are reporting as an exempt reporting adviser
or amending your report, you must sign and submit either a:
[cir] Domestic Investment Adviser Execution Page, if you (the
advisory firm) are a resident of the United States; or
[[Page 21551]]
[cir] Non-Resident Investment Adviser Execution Page, if you
(the advisory firm) are not a resident of the United States.
If you are applying for or are amending your registration
with a state securities authority, you must sign and submit the
State-Registered Investment Adviser Execution Page.
7. Who must sign my Form ADV or amendment?
The individual who signs the form depends upon your form of
organization:
For a sole proprietorship, the sole proprietor.
For a partnership, a general partner.
For a corporation, an authorized principal officer.
For a ``separately identifiable department or division''
(SID) of a bank, a principal officer of your bank who is directly
engaged in the management, direction, or supervision of your
investment advisory activities.
For all others, an authorized individual who participates
in managing or directing your affairs.
The signature does not have to be notarized, and in the case of
an electronic filing, should be a typed name.
8. How do I file my Form ADV?
Complete Form ADV electronically using the Investment Adviser
Registration Depository (IARD) if: