Bates Research | 06-03-21
Regulators Get Tough on Reg BI and Form CRS Phase Two Compliance – Part 1: Form CRS
The honeymoon period in which firms needed to show merely a “good faith” effort at compliance with Regulation Best Interest (“Reg BI”) and Customer Relationship Summary Form (“Form CRS”) requirements has come to an end. At a recent session on Reg BI and Form CRS Observations during FINRA’s 2021 Annual Conference, speakers Peter Driscoll (Director of the SEC Division of Examinations), Emily Westerberg Russell (Chief Counsel of the SEC Division of Trading and Markets) and William “Bill” St. Louis (FINRA Senior VP and Firm Group Leader for Member Supervision) made clear that the regulators are moving to the next, more aggressive examination phase to ensure compliance with the new standard.
On the Transition to Phase Two
Reflecting on the past year, Director Driscoll noted the implementation of Reg BI and Form CRS amid remarkable events—the pandemic, the election, market volatility, SolarWinds, GameStop, Archegos, and even Colonial Pipeline—events that, he said, would have been considered material in any other given year. Against that backdrop, he described the SEC’s approach in “Phase One” as encouraging firms to get to the “right place” in their efforts to establish policies and procedures, identify key risk areas, plan for implementation, and train their staffs during a period of adjustment. Through the publication of risk alerts, FAQs, leadership statements, and the SEC’s October 2020 staff roundtable (and despite the logistical challenges brought by COVID), the SEC and FINRA engaged in a wide variety of efforts to communicate their expectations under the new rules. The regulators referred to these efforts repeatedly and encouraged firms to review resources available on the SEC and FINRA websites for additional understanding of Reg BI and Form CRS requirements.
In this two-part article, Bates examines regulator comments and expectations, and what firms can expect in Phase Two. Today, we will look at developments concerning Form CRS.
On Form CRS
Both SEC Director Driscoll and FINRA’s Mr. St. Louis described earlier efforts at targeted outreach to firms on compliance with the prescriptive requirements of Form CRS. These efforts included reaching out informally to a couple of hundred firms that should have filed CRS forms but had not; many filed their form or a written response thereafter. This provided an opportunity to address confusion on a host of requirements on the form, including: material disclosure omissions, vague descriptions of fee structures, failures to adequately report disciplinary history, submissions that were too general on product offerings, failures to clearly identify affiliates, and failings on “conversation starter” questions. (See Bates post concerning the regulators’ frequently-referenced October 26, 2020 SEC-FINRA roundtable.)
Director Driscoll asserted that there were still a significant number of firms that remained unresponsive after the earlier outreach, and “now they are responding to an exam.” That is not subtle, and it gives a glimpse of how the regulator is viewing this next phase. As to non-filers, Chief Counsel Russell weighed in, drawing several important distinctions between the filing requirements under Reg BI and Form CRS. “Starting off as threshold matters, Reg BI and Form CRS have a different scope of application. Reg BI applies when you are making a recommendation. Form CRS has a broader scope and applies whenever you are offering services to retail investors.” A “retail investor” is any “natural person or legal representative of the natural person” that “receives or is seeking services from a broker dealer,” including “high net worth individuals and financial professionals and their friends and families,” she said.
In response to some of the justifications made for not filing, Ms. Russell stated that for a Form CRS filing, “the trigger has nothing to do with the level of activity, but the type of activity you are engaging in and whether you are offering services to retail investors.” Notably, she referred to a recent SEC FAQ that provided clarity as to what would not be considered “services to retail investors” (e.g. a clearing firm solely providing services to an introducing broker, or a broker dealer serving solely as a principal underwriter to a mutual fund, a variable annuity or for a variable life insurance contract).
Learn more about Form CRS support from Bates Compliance
Mind the Form
Director Driscoll and Mr. St. Louis stated that Form CRS is the first document opened during an examination. Although the form is meant to be for the customer, they said it is also beneficial to the regulator, not only “to review for inclusion of all the required aspects,” but also to help “understand the firm’s business and its core areas.” St. Louis described the initial exam focus, which includes: better practices using automated tracking, solid remote training in the COVID environment and legitimate efforts to comply. He also shared outliers and concerning observations, including unclear disciplinary history, not using the required headers, and “less than clear and arguably confusing” responses, missing or inaccurate fees, costs and conflicts, non-filers, late filings or misfilings (particularly for dual registrants), and failures to address major business or product areas on the Form.
Mr. St. Louis cited numerous issues concerning proper delivery of the Form, including observed failures to post it prominently on the firm’s website (“lots of clicks to find the form”), going over the Form’s page limits, some problems by third-party vendors to handle delivery and tracking, and failures in proving ”to whom it was delivered.” Other issues concerned when the form should be delivered (i.e., “at the earliest of a recommendation, an account opening or the placement of an order”), inadequate WSPs regarding delivery, and instances of a “few firms rely[ing] incorrectly on the electronic delivery of the form where there was no existing framework at the firm for electronic delivery, no notice of retail investors that the Form was electronically available, or information that was electronically available was not compatible with the paper version of the form.” In some cases, “accessing the electronic version of form was burdensome to the retail investors and [there was] no evidence of the e-delivery of the form.” St. Louis said, “the best approach would have the retail investor opt in to e-delivery.”
The regulators pointed to several CRS Form requirements which remain top examination priorities. Director Driscoll expressed concern that affiliate relationships be adequately disclosed and said the Division will examine for conflicts that may result from affiliated transactions and the costs associated with them. He emphasized the importance of disciplinary history disclosure, noting that any disciplinary history that was reported in other forms (Form ADV, Form BD, Forms U4-U6) must be disclosed on Form CRS. “Firms do not have the discretion to leave it blank or cut out the disciplinary section.” said Driscoll.
Ms. Russell also raised the issue of updating Form CRS upon a material change and said that her office published a FAQ on materiality to provide guidance on this issue. As to material change, she relayed that it is "important to take into consideration the law on materiality and whether a reasonable investor would consider the information important." In the FAQ, she explained that firms must “update their relationship summary within 30 days whenever any information in the relationship summary becomes materially inaccurate,” and “communicate these material changes to retail investors who are existing clients or customers within 60 days after the updates are required to be made,” either “by delivering the amended relationship summary or by communicating the information through another disclosure.” Firms need to have the most current version of the CRS Form on their website, and they need to hold onto all previous versions for examination review, she noted.
Continue to Part 2 - Regulators’ remarks concerning Reg BI and their current exam focus.
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