The Securities and Exchange Commission (SEC) Office of Compliance Inspections and Examinations (OCIE) will be looking for good faith compliance when it conducts examinations of Form CRS after the June 30, 2020 compliance date. The primary purpose of this article is to summarize the areas OCIE may look at, as indicated in a Risk Alert issued on April 7, 2020. OCIE provides information about the scope and content of the SEC’s initial examinations of how firms are complying with Form CRS. (At the same time, OCIE issued a Risk Alert on examinations for overall Reg BI compliance. We discuss this in a separate article.)
In addition, with respect to the delivery and filing of Form CRS, which is one of the examination areas identified by OCIE, on April 6 SEC Staff issued four new FAQs addressing certain key points. This article summarizes those FAQs as well. The full list of Form CRS FAQs (those posted on April 6, as well as previously), which provides clarification on delivery and filing requirements along with several other topical areas, can be read here.
As described in last week’s public statement by Chairman Clayton, the “initial” examinations will focus on whether firms made “a good faith effort to implement Form CRS.” OCIE acknowledges that the coronavirus disease (COVID-19) has created challenges for firms. Those challenges aside, however, as Chairman Clayton announced, the SEC will not be extending the June 30, 2020 compliance date.
OCIE advises that these initial examinations may include assessments of compliance with the following areas of the Form CRS requirements: delivery and filing; relationship summary content; formatting; policies and procedures regarding updating, and recordkeeping. It appears, based on the detailed discussions of delivery, filing and content of the relationship summary that OCIE may devote more resources to the examination of these areas. OCIE says, however, that the Risk Alert is not intended to serve as an explanation of Form CRS requirements.
Regarding delivery and filing, OCIE stated in the Risk Alert that:
Staff may (1) review whether the firm has filed its relationship summary, including any amendments, with the Commission and whether the relationship summary is posted on the firm’s public website, if any; (2) evaluate the process for delivering the relationship summary to existing and new retail investors; and (3) review policies and procedures to assess whether they address the required relationship summary delivery processes and dates.
The first three FAQs relate to filing requirements. Specifically, they explain that:
- Firms are able to begin filing their Forms CRS immediately (as of April 6), as the IARD (for investment advisers) and Web CRD (for broker-dealers) systems are now accepting filings.
- While investment advisers must file through IARD and broker-dealers must file through Web CRD, dual registrants will generally be required to file their relationship summaries (as Part 3 of Form ADV) through IARD only. This streamlined filing process for dual registrants applies whether separate or combined summaries are used. There is one exception: A dually-registered firm whose investment adviser has no retail customers is not considered a dual registrant for this purpose and will file its relationship summary using Web CRD.
- Affiliated firms providing a combined relationship summary will each be required to file the combined summary — under IARD or Web CRD, as applicable. One firm cannot file the combined summary on its own behalf and that of an affiliate.
Turning to customer delivery, OCIE’s Risk Alert continues by providing guidance for how it will examine for compliance as it relates to existing versus new retail investors. It stated:
- Existing Retail Investors. The initial delivery of the relationship summary to existing retail investors by July 30, 2020 (within 30 days after the date the firm must file the relationship summary with the Commission), and before or at the time of:
- The opening of a new account that is different from the retail investor’s existing account;
- A recommendation of a rollover of assets from a retirement account into a new or existing account or investment; or
- A recommendation of a new brokerage or investment advisory service or investment that does not necessarily involve the opening of a new account and would not be held in an existing account (e.g., a first time purchase of a direct-sold mutual fund through a “check and application” process).
- New Retail Investors. The delivery of the relationship summary to new retail investors before or at the earliest of:
- Entering into an investment advisory contract with the retail investor;
- A recommendation to a retail investor of an account type, a securities transaction, or an investment strategy involving securities;
- Placing an order for the retail investor; or
- The opening of a brokerage account for the retail investor.
The fourth FAQ posted on April 6 verifies that firms are permitted to furnish retail customers with Forms CRS prior to the June 30, 2020 compliance date. If a firm chooses to deliver Forms CRS early, the FAQ goes on to state that the firm should also generally (in each case as required by the Form CRS Instructions):
- Post the relationship summary on its public website.
- Comply with the updating and related delivery requirements.
- File the relationship summary with the SEC.
It concludes by reminding firms that all information furnished in Forms CRS must be true, complete and not misleading. Thus, dual registered firms and affiliated firms whose relationship summaries address both advisory and brokerage business are cautioned to ensure that their disclosures, including in particular those relating to standards of conduct, are true as of the time they are made.
Regarding the content of the relationship summary, OCIE shares that it will be examining whether: it includes all of the required information; that the information is true and accurate; and that it does not contain misleading information. In more detail, OCIE stated in the Risk Alert that it may review relationship summaries for:
- How the firm describes the relationships and services it offers to retail investors, including statements regarding account monitoring and investment authority.
- How the firm describes its fees and costs, including disclosures about the principal fees and costs that retail investors will incur, other fees and costs related to services and investments that retail investors will pay directly or indirectly, and examples of the categories of the most common fees and costs applicable to the firm’s retail investors (e.g., custodian fees, account maintenance fees, fees related to mutual funds and variable annuities, and other transactional fees and product level fees).
- Staff may review fee schedules, advisory agreements, and brokerage agreements and compare the fees listed in those documents against the fees listed in the relationship summary.
- How the firm describes the manner in which its financial professionals are compensated, including cash and non-cash compensation, and the conflicts of interest those payments create.
- How the firm describes its conflicts of interest, including incentives related to proprietary products, third-party payments, revenue sharing, and principal trading.
- Whether the firm accurately discloses if the firm or its financial professionals have legal or disciplinary history.
Two of the three remaining points of guidance are straightforward and limited in their detail. The formatting guidance speaks for itself — that firms need to comply with the formatting instructions. The recordkeeping guidance similarly provides a straightforward indication that the firm’s policies and procedures need to allow OCIE to assess how the firm complies with the applicable delivery recordkeeping and other delivery obligations.
The guidance regarding relationship summary updates and the related policies and procedures provides more detailed guidance than the sparse guidance for the above two areas. This guidance in the Risk Alert states that the OCIE may assess:
- How and whether a firm updates and files its relationship summary within 30 days after any information becomes materially inaccurate;
- How and whether a firm communicates said changes to retail investors within 60 days after the updates are required; and
- The firm’s process for highlighting to retail investors the most recent changes and including an exhibit highlighting or summarizing material changes with any filed updates.
OCIE concludes by stating that it is providing this “transparency into its plans regarding Form CRS examinations to empower firms to assess their level of preparedness as the compliance date nears.” Thus, firms are advised to closely examine both their Form CRS documents and implementation processes for reasonable compliance with the SEC’s guidance.
Should you have any questions about this alert or need assistance in your readiness efforts, you may contact us as indicated below.