Form CRS

George Michael Gerstein on podcast to discuss fiduciary-related regulatory developments

SEC Updates Form CRS FAQs

On February 11, 2020, the staff of the Securities and Exchange Commission (SEC) updated its Frequently Asked Questions on Form CRS with regard to a number of topics:

Legal Representative:  Similar to the update on Regulation Best Interest, the staff clarified that the term “legal representative” would not cover regulated financial services industry professionals including a workplace retirement plan representative (e.g., plan sponsor, trustee, other fiduciary), except in limited circumstances.  The staff further noted, however, that a formerly regulated financial services industry professional who is not currently regulated, would be considered a “non-professional” and, thus, a covered legal representative.

Delivery requirements: The staff clarified that where one adviser (Firm A) provides advice to another unaffiliated adviser (Firm B) but has no advisory contract (oral or written) with Firm B’s clients, absent other facts or circumstances that would indicate that Firm A provides investment advisory services to Firm B’s retail investor clients, Firm A would not be required to deliver a Form CRS to Firm B’s retail investor clients. The staff also indicated that an amendment to an existing account agreement solely to add another account holder or beneficiary would not trigger a Form CRS delivery requirement but that converting an account at a dual registrant from a brokerage account to advisory account (and presumably vice versa) would require delivery of Form CRS even if the investor initially received Form CRS upon opening the original account. The staff also clarified that a broker-dealer acting solely as a qualified custodian to an investment adviser’s retail investment advisory clients would not need to deliver a Form CRS. Finally, the staff discussed when a state-registered adviser transitioning to SEC registration is required to deliver its Form CRS.

Affiliates: The staff clarified that affiliated investment advisers (or affiliated broker-dealers) may create and deliver a combined Form CRS. The staff also indicated that a firm with multiple affiliates can combine disclosure in one Form CRS, but the staff cautioned that the page limits still apply and that the firm “should be mindful of the potential that additional information from multiple affiliates could “obscure or impede understanding.”  It also should be mindful that it is required “to present brokerage and investment advisory information with equal prominence and in a manner that clearly distinguishes and facilitates comparison.”

Sub-advisers: The staff stated that in circumstances where an adviser replaces a sub-adviser, and there are no changes to the advisory agreement, services, investments, or conflicts of interest that would make the information in the adviser’s Form CRS materially inaccurate, the staff would not object if the firm does not consider this a material change that would require the adviser to amend its Form CRS. The staff did not clarify the types of changes to the advisory agreement, services, investments or conflicts that would be considered material changes.

Disciplinary history: The staff clarified that a firm that reports disciplinary history related to its parent company in response to Item 11 on the firm’s Form ADV and Items 11A-K on the firm’s Form BD must answer “yes” to Item 4 in Form CRS.

Foreign language: Finally, the staff stated that it would not object to the delivery of a complete translation of Form CRS in a foreign language so long as the firm also delivers a separate English Form CRS at the same time.

SEC Releases FAQs on Form CRS

Relationship Summary Format

Q: My firm offers three types of services to our retail investors.  Can my firm prepare and deliver three different relationship summaries, one for each type of service that it offers?

A: No. Each broker-dealer or investment adviser must only prepare one relationship summary summarizing all of the principal relationships and services it offers to retail investors. For example, if an investment adviser offers a wrap fee program, advice to participants in a 401(k) plan, and discretionary asset management for high net worth clients, the investment adviser would be required to prepare a single relationship summary describing all of the firm’s different services. Similarly, if a broker-dealer offers a range of brokerage services to retail investors, including, for example, self-directed, full-service, and employer-sponsored retirement plan options, the broker-dealer would be required to prepare a single relationship summary describing all of the firm’s different services. To the extent a dually registered firm prepares a single relationship summary addressing both brokerage and investment advisory services (rather than two separate relationship summaries), the firm must summarize all of the principal brokerage and investment advisory relationships and services the firm offers to retail investors.

Q: How do I create machine readable headings to comply with General Instruction 7.A.(i) to Form CRS?

A: You should consult with the specifications and instructions provided by the software provider of the application that you are using to create the PDF of your relationship summary in order to determine how to make the headings machine readable.  If, for example, you are using Microsoft Word and Adobe, you would complete the following steps:

  1. Enter the text that will become the machine readable heading (e.g. “”What investment services and advice can you provide me?” per Item 2.A of the Instructions to Form CRS).  Highlight this text and on the Home tab, Styles pane, select a Heading Type (e.g. Heading 1).  This highlighted text is now captured as a heading in Microsoft Word.  Repeat this process for each additional heading that is required, as applicable, in the Instructions to Form CRS.
  2. Enter your disclosure responses to the relevant instruction under each heading, as applicable, that was created in Step 1 above.
  3. Save the Microsoft Word file as a PDF file by clicking File/Save as Adobe PDF.  Once saved as a PDF, view the Headings by clicking/expanding the left Bookmarks icon.  Each heading created in the initial Microsoft Word document (Step 1 above) will be displayed as a Bookmark in the PDF.  These PDF Bookmarks comply with the machine readable heading format required by the Instructions to Form CRS.

Delivery Requirements

Q: Can a firm satisfy its relationship summary delivery requirement with respect to its existing retail investor clients or customers by including the relationship summary with the mailing of its June 2020 quarterly account statements (e.g., within one week after June 30, 2020).

A: Yes. In the staff’s view, a firm may deliver the relationship summary separately, in a bulk delivery to clients, or as part of the delivery of information that the firm already provides, such as the annual Form ADV update, account statements or other periodic reports. A firm must initially deliver its relationship summary to each of its existing clients and customers who are retail investors within 30 days after the date by which it is first required to electronically file its relationship summary with the SEC. If the relationship summary is delivered in paper format as part of a package of documents, a firm must ensure that the relationship summary is the first among any documents that are delivered at that time. If the relationship summary is delivered electronically, it must be presented prominently in the electronic medium, for example, as a direct link or in the body of an email or message, and must be easily accessible for retail investors.

Q: My firm is an investment adviser to pooled investment vehicles, such as a hedge funds, private equity funds and venture capital funds.  The investors in these funds include natural persons who may be “retail investors” as defined in Form CRS. Am I required to deliver a relationship summary to these funds?

A:  An investment adviser must initially deliver a relationship summary to each retail investor before or at the time the adviser enters into an investment advisory contract with the retail investor.  “Retail investor” is defined as “a natural person, or the legal representative of such natural person, who seeks to receive or receives services primarily for personal, family or household purposes.” In the staff’s view, the types of pooled investment vehicles described above would not meet this definition and a relationship summary would not be required to be delivered.

Here is the full release: https://www.sec.gov/investment/form-crs-faq

Fiduciary Governance Group members to present on the impact of the SEC standards of conduct rulemaking on fund directors

Larry Stadulis and Sara Crovitz further expand their analysis of Regulation Best Interest, Form CRS and the IA Interpretive Release by hosting a webinar for the Mutual Fund Directors Forum. The webinar is called, “What Directors Need to Know about Regulation Best Interest and the Standards of Conduct Rulemaking Package,” and is scheduled for Thursday, September 12 from 2:00-3:00 pm. Further information, including registration, can be found here.

A Private Fund Manager’s Guide to the SEC’s ‘Standard of Conduct’ Release

The Securities and Exchange Commission recently adopted a package of new rules and interpretations, including Regulation Best Interest (Reg BI), the Form CRS Relationship Summary (Form CRS) and guidance1 on the Investment Advisers Act of 1940 (the Advisers Act Guidance or Release). This Client Alert will focus on the Advisers Act Guidance, which is applicable to both advisers fully registered with the SEC and exempt reporting advisers who manage only private funds.2 The following is a brief discussion of certain aspects that may be relevant to private fund managers.

More information on Reg BI, which is applicable only to broker-dealers, and Form CRS, which is applicable only to broker-dealers and investment advisers3 that enter into advisory contracts with “retail” investors, can be found in separate Client Alerts [Risk&Reward-June Edition and Risk&Reward-July Edition].

With the Advisers Act Guidance, the SEC aims to “reaffirm – and in some cases clarify – certain aspects of” an adviser’s fiduciary duty under the Advisers Act, namely the duty of care and duty of loyalty all advisers owe their clients. Of particular importance to private fund managers are the SEC’s general focus on the duty of loyalty as it relates to disclosure of material facts about conflicts of interest, and the SEC’s specific discussion of conflicts associated with allocation of investment opportunities among clients, including co-investments, each of which we cover below. In addition, we highlight a recent enforcement case involving a U.K.-based hedge fund manager that underscores certain of the themes from the Advisers Act Guidance.

Duty of Loyalty
The Release lays out the SEC’s view that “[u]nder its duty of loyalty, an investment adviser must eliminate or make full and fair disclosure of all conflicts of interest … such that a client can provide informed consent to the conflict.”

Disclosure and Informed Consent
The Release is not prescriptive with respect to how an adviser must disclose any conflicts and obtain informed consent from clients, but it does note that consent need not be in a written agreement. Rather, an adviser’s “client could implicitly consent by entering into or continuing the investment advisory relationship,” after receiving “a combination of Form ADV and other disclosure.” Although offering memoranda are not specifically referenced in the Advisers Act Guidance, SEC staff has suggested in the past4 that such disclosure may include a private fund’s offering memorandum.

Nor is the Release prescriptive in terms of the format and content of the disclosure, although the SEC clearly differentiated between an adviser’s obligations with respect to institutional clients (e.g., a private fund) and “retail” clients, noting that what constitutes full and fair disclosure “can differ, in some cases, significantly” between the two audiences.5 The key, however, is that “regardless of the nature of the client, the disclosure must be clear and detailed enough for the client to make an informed decision to consent to the conflict of interest or reject it.”

Specificity of Disclosure and Appropriateness of Use of ‘May’
The Release does, however, provide examples of disclosure practices that the SEC considers inadequate or inappropriate, with a particular focus on use of the word “may.” Citing past enforcement actions, the SEC points out that “disclosure that an adviser ‘may’ have a particular conflict, without more, is not adequate when the conflict actually exists…. In addition, the use of ‘may’ would be inappropriate if it simply precedes a list of all possible or potential conflicts regardless of likelihood and obfuscates actual conflicts to the point that a client cannot provide informed consent.” In terms of level of detail, the guidance notes that it would be insufficient simply to disclose that an adviser “has ‘other clients’ without describing how the adviser will manage conflicts between clients if and when they arise or to disclose that the adviser has ‘conflicts’ without further description.” Managers should take note of the above and review their firm’s disclosure for appropriate use of the word “may.”

Allocation of Investment Opportunities Including Co-Investments
One specific area of potential conflicts of interest that the Release discussed is an adviser’s allocation policies and the obligation to describe “how the adviser will allocate investment opportunities, such that a client can provide informed consent.” In this way, the Release echoed in part the SEC’s Office of Compliance and Inspections (OCIE) 2019 Examination Priorities,6 which noted that OCIE plans to “review firms’ practices for … fairly allocating investment opportunities among clients,” and for “disclosing critical information to clients….”

For private fund managers, such allocation conflicts could arise in various contexts, for example, trade allocations among client accounts that have overlapping investment mandates, including a managed account run pari passu to a flagship fund, or a long-only fund that has been “carved out” from a flagship long/short fund. In addition, conflicts of interest could arise in the allocation of co-investment opportunities among clients, as suggested by the acting director of OCIE in a 2015 speech: “Co-investment opportunities have a very real and tangible economic value but also can be a source of various conflicts of interest,” and given that, “all investors deserve to know where they stand in the co-investment priority stack.”7 While on the enforcement front the SEC’s recent focus has primarily been on private equity managers’ practices with regard to allocation of fees and expenses associated with co-investments among clients,8 managers should take note of this increasing focus on co-investments more broadly, and should review their practices with respect to allocation of opportunities and relevant disclosure.

In terms of the content of allocation policies, the SEC clearly states that opportunities need not be allocated pro rata, noting further that “[a]n adviser and a client may even agree that certain investment opportunities or categories of investment opportunities will not be allocated or offered to a client” (emphasis added). The SEC’s use of the word “agree” in this context is a reminder of its expectation that an adviser’s “fiduciary duty follows the contours of the relationship … and the adviser and its client may shape that relationship by agreement, provided that there is full and fair disclosure and informed consent.”

Enforcement
In 2016, the SEC brought an enforcement proceeding9 against a U.K.-based hedge fund manager that highlights certain of the themes discussed above. In that case, the SEC alleged that the manager failed to inform investors in its existing flagship fund of the “significant overlap” in trade allocations between that flagship fund and a newer vehicle, which was marketed as having a divergent investment strategy. The SEC cited, among other things, the fact that the manager “never updated” the offering documents of the flagship fund, which disclosed that the manager “may manage additional funds in the future that may invest in the same markets as [the flagship fund] and certain conflicts of interest could result.” Further, the SEC alleged that the manager and its founder “should have, but did not, update the [due diligence questionnaire] response they provided to many existing and prospective [flagship fund] investors about [the new vehicle],” which continued to position the two funds as having separate strategies despite the “high degree of overlap” between their investments.

Duty of Care
In addition to its discussion of advisers’ duty of loyalty, the Release also describes advisers’ duty of care, including the duty to seek best execution and the newly described “duty to provide advice and monitoring.” With respect to best execution, the Release is consistent with prior SEC guidance and serves as a reminder of advisers’ obligations not only to seek best execution in selecting counterparties to execute trades on behalf of clients, but also to “periodically and systematically” evaluate such providers. Further, the Release lays out a newly described obligation to “monitor” client accounts, which should be “at a frequency that is in the best interest of the client, taking into account the scope of the agreed relationship.” While the SEC provides no specific guidance in terms of expectations with respect to private fund clients, all advisers may want to consider how best to document satisfaction of their duty to monitor client accounts. The Release further suggests that registered investment advisers “may consider whether written policies and procedures relating to monitoring would be appropriate.”

Given that the Release is immediately effective, below are certain questions that private fund managers may wish to consider in light of the SEC’s focus on these issues:

  • Have you reviewed the Conflicts of Interest disclosure in your fund offering documents and/or Form ADV, Part 2A, for appropriate use of the word “may”?
  • Do you have a written investment allocation policy, and are you following it and documenting any deviations therefrom?
  • Does your firm participate in co-investments, and if so, have you disclosed your policy (and any updates) to investors?
  • Do you have a process and documentation in place to substantiate your firm’s “duty to monitor” client accounts?

1 Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Investment Advisers Act Release No. IA-5248 (June 5, 2019).

2 The Advisers Act Guidance also applies to any managers relying on the “foreign private adviser” exemption of Section 202(a)(30) of the Advisers Act (Foreign Private Advisers), generally those with fewer than 15 U.S. clients and 15 U.S. investors in private funds as well as less than $25 million attributable to such U.S. clients and investors.

3 Note that Form CRS is also applicable to Foreign Private Advisers, but only to the extent of any advisory contracts with U.S. “retail” investors. A “retail” investor for purposes of Form CRS includes any natural person, without regard to net worth or sophistication. Note, however, that Form CRS does not “look through” to underlying investors in pooled investment vehicles such as hedge funds or mutual funds, such that it will not impact managers of only such vehicles, or those who advise institutional clients, such as separately managed accounts with endowments or pension funds.

4 Julie Riewe, co-chief, Asset Management Unit, Division of Enforcement, SEC, “Conflicts, Conflicts, Everywhere” (Feb. 26, 2015); see also In re James Caird Asset Management LLP and Timothy G. Leslie, Investment Advisers Act Release No. 4413 (June 2, 2016).

5 The Release notes that “institutional clients generally have a greater capacity and more resources than retail clients to analyze and understand complex conflicts and their ramifications.”

6 OCIE, SEC, Examination Priorities for 2019 (Dec. 20, 2018).

7 Marc Wyatt, acting director, Office of Compliance Inspections & Examinations, SEC, “Private Equity: A Look Back and a Glimpse Ahead” (May 13, 2015).

8 In re Lightyear Capital LLC, Investment Advisers Act Release No. 5096 (Dec. 26, 2018); and In re Kohlberg Kravis Roberts & Co. L.P., Investment Advisers Act Release No. 4131 (June 29, 2015).

9 In re Caird (June 2, 2016).

Live Blogging: Form CRS

John Baker begins his discussion on Form CRS. He notes that it applies to SEC-registered investment advisers and broker-dealers. John adds that there is a 2-page limit, whereas dual registrants have 4 pages to work with. There are also a number of requirements and conditions regarding the format of Form CRS, such as use of white space, tables, charts, font size, etc. Layered disclosure is possible.

Live Blogging – SEC standards of conduct rulemaking

Three members of Stradley’s Fiduciary Governance Group are currently presenting on the SEC’s significant rulemaking re. broker-dealer and investment adviser standards of conduct. Larry Stadulis is the first to speak and tackles Reg BI. The policy objectives of Reg BI are:

  • designed to improve consumer protection, particularly against conflicts of interest;
  • designed to help retail investors to better understand and compare investment options and clarity over standards of conduct.

Larry notes that Reg BI does not impose “full blown fiduciary status” on broker-dealers and that there is not a uniform fiduciary standard for investment advisers and broker-dealers.