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Form CRS Relationship Summary; Amendments to Form ADV

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Start Preamble

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

The Securities and Exchange Commission (the “Commission” or the “SEC”) is adopting new rules and forms as well as amendments to its 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. The relationship summary is intended to inform retail investors about: The types of client and customer relationships and services the firm offers; the fees, costs, conflicts of interest, and required standard of conduct associated with those relationships and services; whether the firm and its financial professionals currently have reportable legal or disciplinary history; and how to obtain additional information about the firm. The relationship summary will also reference Investor.gov/CRS, a page on the Commission's investor education website, Investor.gov, which offers educational information to investors about investment advisers, broker-dealers, and individual financial professionals and other materials. Retail investors will receive a relationship summary at the beginning of a relationship with a firm, communications of updated information following a material change to the relationship summary, and an updated relationship summary upon certain events. The relationship summary is subject to Commission filing and recordkeeping requirements.

DATES:

Effective dates: The rules and form are effective September 10, 2019.

Compliance dates: The applicable compliance dates are discussed in section II.D.

Start Further Info

FOR FURTHER INFORMATION CONTACT:

: Gena Lai, James McGinnis, Elizabeth Miller, Sirimal R. Mukerjee, Olawalé Oriola, Alexis Palascak, Benjamin Tecmire, Roberta Ufford, Jennifer Porter (Branch Chief), Investment Adviser Regulation Office at (202) 551-6787 or IArules@sec.gov; Benjamin Kalish and Parisa Haghshenas (Branch Chief), Chief Counsel's Office at (202) 551-6825 or IMOCC@sec.gov, Division of Investment Management; Alicia Goldin, Emily Westerberg Russell, Lourdes Gonzalez (Assistant Chief Counsel), Office of Chief Counsel, Division of Trading and Markets, at (202) 551-5550 or tradingandmarkets@sec.gov, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549.

End Further Info End Preamble Start Supplemental Information

SUPPLEMENTARY INFORMATION:

The Commission is adopting new rule 17 CFR 275.204-5 [rule 204-5] under the Investment Advisers Act of 1940 [15 U.S.C. 80b] [1] and is adopting amendments to Form ADV to add a new Part 3: Form CRS [17 CFR 279.1] under the Advisers Act. The Commission is also adopting amendments to rules 17 CFR 275.203-1 [rule 203-1], 17 CFR 275.204-1 [rule 204-1], and 17 CFR 275.204-2 [rule 204-2] under the Advisers Act. The Commission is adopting new rule 17 CFR 240.17a-14 [rule 17a-14] [2] under the Securities Start Printed Page 33493Exchange Act of 1934 and new Form CRS [17 CFR 249.641] under the Exchange Act. The Commission is also adopting amendments to rules 17 CFR 240.17a-3 [rule 17a-3] and 17 CFR 240.17a-4 [rule 17a-4] under the Exchange Act. The Commission is also adopting amendments to rule 17 CFR 200.800 [rule 800].

Table of Contents

I. Introduction

II. Form CRS Relationship Summary

A. Presentation and Format

1. Limited Prescribed Wording

2. Standard Question-and-Answer Format and Other Presentation Instructions

3. Electronic and Graphical Formats, and Layered Disclosure

4. Conversation Starters

5. Presentation of Relationship Summaries by Dual Registrants and Affiliated Firms

B. Items

1. Introduction

2. Relationships and Services

3. Summary of Fees, Costs, Conflicts, and Standard of Conduct

4. Disciplinary History

5. Additional Information

6. Proposed Items Omitted in Final Instructions

C. Filing, Delivery, and Updating Requirements

1. Definition of Retail Investor

2. Filing Requirements

3. Delivery Requirements

4. Updating Requirements

D. Transition Provisions

E. Recordkeeping Amendments

III. Disclosures About a Firm's Regulatory Status and a Financial Professional's Association

IV. Economic Analysis

A. Introduction

B. Baseline

1. Providers of Financial Services

2. Investor Perceptions about the Marketplace for Financial Services and Disclosures

3. Investor Responses to Disclosures About Financial Professionals and Firms

C. Broad Economic Considerations

D. Economic Effects of the Relationship Summary

1. Retail Investors

2. Broker-Dealers and Investment Advisers (Registrants)

3. Impact on Efficiency, Competition, and Capital Formation

4. Alternatives to the Relationship Summary

V. Paperwork Reduction Act Analysis

A. Form ADV

1. Respondents: Investment Advisers and Exempt Reporting Advisers

2. Changes in Average 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 Exchange Act Rule 17a-3

F. Record Retention Obligations Under Exchange Act Rule 17a-4

1. Changes in Burden Estimates and New Burden Estimates

2. Revised Annual Burden Estimates

VI. Final Regulatory Flexibility Analysis

A. Need for and Objectives of the Amendments

B. Significant Issues Raised by Public Comments

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 and Filing of the Relationship Summary

2. Delivery and Updating Requirements Related to the Relationship Summary

3. Recordkeeping Requirements Related to the Relationship Summary

E. Agency Action To Minimize Effect on Small Entities

VII. Statutory Authority

Text of the Rule and Form

I. Introduction

Individual investors rely on the services of broker-dealers and investment advisers when making and implementing investment decisions. Research continues to show that retail investors are confused about the services, fees, conflicts of interest, and the required standard of conduct for particular firms, and the differences between broker-dealers and investment advisers.[3] We are adopting a new set of disclosure requirements designed to reduce retail investor confusion in the marketplace for brokerage and investment advisory services and to assist retail investors with the process of deciding whether to engage, or to continue to engage, a particular firm [4] or financial professional and whether to establish, or to continue to maintain, an investment advisory or brokerage relationship.[5] Firms will deliver to retail investors a customer or client relationship summary (“relationship summary” or “Form CRS”) that provides succinct information about the relationships and services the firm offers to retail investors, fees and costs that retail investors will pay, specified conflicts of interest and standards of conduct, and disciplinary history, among other things.[6] The relationship summary will also link to Investor.gov/CRS on the Commission's investor education website, Investor.gov, which offers educational information to investors about investment advisers, broker-dealers, and individual financial professionals and other materials.

We proposed a version of a relationship summary on April 18, 2018.[7] The proposed relationship summary would have required information separated into the following sections: (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); [8] (vi) conflicts of Start Printed Page 33494interest; (vii) where to find additional information, including whether the firm and its financial professionals currently have reportable legal or disciplinary history and who to contact about complaints; and (viii) key questions for retail investors to ask the firm's financial professional. The proposed instructions required firms to use standardized headings in a prescribed order throughout the disclosure and respond to the required items by using a mix of language prescribed in the instructions as well as their own wording in describing their services and offerings. The proposal limited the relationship summary to four pages or an equivalent length if in electronic format and also included three examples of how the relationship summary might look for a standalone broker-dealer, a standalone investment adviser, and a dual registrant.

To better understand retail investors' views about the disclosures designed for them, the Commission engaged in broad outreach to investors and other market participants. As described further throughout the release, the Commission received substantial feedback on the proposed relationship summary in several forms. We received comment letters in connection with the Proposing Release from a variety of commenters including individual investors, consumer advocacy groups, financial services firms, investment professionals, industry and trade associations, state securities regulators, bar associations, and others.[9] Several of those commenters provided alternative mock-ups to illustrate their suggestions. Additionally, some commenters submitted reports of surveys or studies that they had conducted or engaged third parties to conduct in connection with the proposal. The Commission also received input and recommendations from its Investor Advisory Committee (“IAC”) on the proposed relationship summary to improve its effectiveness.[10]

The Commission also solicited comments from individual investors through a number of forums in addition to the traditional requests for comment in the Proposing Release. The Commission used a “feedback form” designed specifically to solicit input from retail investors with a set of questions requesting both structured and narrative responses, and received more than 90 responses from individuals who reviewed and commented on the sample proposed relationship summaries published in the proposal.[11] Seven investor roundtables were held in different locations across the country to solicit further comment from individual investors on the proposed relationship summary, and we received in-person feedback from almost 200 attendees in total.[12]

Further, the Commission's Office of the Investor Advocate engaged the RAND Corporation (“RAND”) to conduct investor testing of the proposed relationship summary.[13] RAND conducted a survey of over 1,400 individuals through a nationally representative panel to collect information on the opinions, preferences, attitudes, and level of self-assessed comprehension regarding the sample dual-registrant relationship summary in the proposal. RAND also conducted qualitative interviews of a smaller sample of individuals to ascertain comprehension of the relationship summary and gain feedback from interview participants, which allowed RAND to obtain insights to complement its survey.[14] On November 7, 2018, the Office of the Investor Advocate made the report on that testing available in the comment file to allow the public to consider and comment on the supplemental information.[15] The Commission received several letters in response to the inclusion of the RAND 2018 report in the comment file.[16]

As noted, some commenters submitted reports of surveys and studies to the comment file, and the design and scope of these varied considerably. Two reports described online surveys of Start Printed Page 33495larger sample sizes—one based on the sample proposed dual-registrant relationship summary [17] and another based on the proposed sample standalone investment adviser relationship summary.[18] A group of commenters submitted two reports of usability testing of the sample proposed dual-registrant relationship summary based on a small number of long-form interviews.[19] One of the two surveys, and the two interview-based studies, included questions designed to ascertain comprehension and tested alternate relationship summary designs with changes to some of the proposed prescribed wording and presentation from the proposal.[20] Finally, two different commenters submitted surveys of retail investors' views about disclosure communications provided by firms and their relationships with financial professionals, which did not test any version of the proposed relationship summary.[21]

The Commission appreciates the time and effort of these commenters who submitted surveys and studies. The Commission has carefully considered this input. The varying designs and scope of these surveys and studies limits us from drawing definitive conclusions, and we do not view any one of the surveys and studies submitted by commenters, or the RAND 2018 report, as dispositive. However, these surveys and studies submitted by commenters, together with the results of the RAND 2018 report, input from individual investors at our roundtables and on Feedback Forms, and other information offered by other commenters, have informed our policy choices. Throughout this release we discuss observations reported in the RAND 2018 report and in surveys and studies submitted by commenters, and how these observations informed our policy choices as well as the costs and benefits of such choices.

Overall, we believe that feedback we have received from or on behalf of retail investors through the RAND 2018 report, surveys and studies submitted by commenters, and input received at roundtables and on Feedback Forms, demonstrate that the proposed relationship summary would be useful for retail investors and provide information, e.g., about services, fees and costs, and standard of care, that would help investors to make more informed choices when deciding among firms and account options. For example, among the RAND 2018 survey respondents, nearly 90% said that the relationship summary would help them make more informed decisions about types of accounts and services and more than 80% said it would help them compare accounts offered by different firms.[22] RAND 2018 survey participants rated information about the firm's relationship and services and fees and costs to be among the most informative.[23] In other surveys, large majorities of respondents also reacted positively to the relationship summary and the types of information that would be provided.[24] In the RAND 2018 qualitative interviews, it was observed that participants could learn new information from the proposed relationship summary.[25] Similarly, other surveys and studies that assessed investor comprehension observed that investors learned important information by reviewing the relationship summary.[26] Over 70% of individuals submitting Feedback Forms commented that they found the relationship summary to be “useful,” with more than 80% rating the relationship summary sections describing relationships and services, obligations, and fees and costs as “very useful” or “useful.” [27] Investor roundtable participants also reacted Start Printed Page 33496positively and indicated that they found the relationship summary to be useful.[28] A significant percentage of RAND 2018 survey participants agreed that the relationship summary would facilitate conversations between retail investors and their financial professionals, and other surveys and studies reported similar observations.[29] Investor roundtable participants and comments on Feedback Forms also indicated that the relationship summary could facilitate conversations between retail investors and their financial professionals in a beneficial way.[30]

Many other commenters supported the concept of a short disclosure document for retail investors that would serve as part of a layered disclosure regime,[31] and agreed that that the relationship summary would facilitate conversations between retail investors and their financial professionals in a beneficial way.[32] However, some commenters argued that the relationship summary is duplicative of other disclosures and is unnecessary.[33] Others cautioned against over-reliance on disclosure efforts to address all issues related to the different business models and the applicable standard of conduct for broker-dealers and investment advisers.[34]

Nearly all commenters (including commenters on Feedback Forms) and investors participating in roundtables, suggested modifications to the proposed relationship summary, as did observations reported in the RAND 2018 report and surveys and studies submitted to the comment file. Suggested changes generally pertained to: Appropriate placement of educational material; length and format; use of prescribed wording; comprehensibility; additional flexibility for firms; and delivery requirements (including electronic delivery). For example, some commenters and observations from the RAND 2018 survey and other surveys and studies indicated that the proposed relationship summary could be difficult to understand, particularly the proposed disclosures on fees, conflicts of interest, and standards of conduct.[35] Many commenters preferred a shorter, one-to-two page document relying more heavily on layered disclosure, such as by using more hyperlinks and other cross-references to more detailed disclosure.[36] Many commenters from both industry and investor groups argued that some of the prescribed wording would not be accurate or applicable in relation to the different services and business models of all firms or could lead to confusing or Start Printed Page 33497misleading disclosures.[37] Various commenters advocated for more flexibility for firms to use their own wording to describe their services more accurately.[38] Many commenters favored the use of a question-and-answer format, suggesting, for example, that focusing a document on investors' questions helps them to feel that the document is relevant to them and encourages them to read it.[39] Some commenters viewed parts of the relationship summary as educational, such as the sections comparing broker-dealers and investment advisers, describing the applicable standard of conduct, and containing key questions investors should ask, and advocated that the Commission should develop and provide educational material separately from firm-specific disclosures, such as in an additional disclosure layer or on the Commission's website.[40] Several individuals submitting Feedback Forms also were supportive of links to additional educational information.[41]

Although some commenters argued that the relationship summary is duplicative of other disclosures and is unnecessary,[42] we believe that the relationship summary has a distinct purpose and will provide a separate and important benefit relative to other disclosures. The relationship summary is designed to help retail investors select or determine whether to remain with a firm or financial professional by providing better transparency and summarizing in one place selected information about a particular broker-dealer or investment adviser. The format of the relationship summary also allows for comparability among the two different types of firms in a way that is distinct from other required disclosures. Both broker-dealers and investment advisers must provide disclosures on the same topics under standardized headings in a prescribed order to retail investors, which should benefit retail investors by allowing them to more easily compare services by comparing different firms' relationship summaries.[43] We do not believe that existing disclosures provide this level of transparency and comparability across investment advisers, broker-dealers, and dual registrants. The relationship summary also encourages retail investors to ask questions and highlights additional sources of information. All of these features should make it easier for investors to get the facts they need when deciding among investment firms or financial professionals and the accounts and services available to them. As noted above, the relationship summary will complement additional rules and guidance that the Commission is adopting concurrently to enhance protections for retail investors and is not designed to address all investor protection issues related to different business models and legal obligations of broker-dealers and investment advisers.[44]

Further to this purpose, in response to the comment letters and other feedback, we modified the instructions to reorganize and streamline the relationship summary, to enable more accurate descriptions tailored to what firms offer, and to help improve investor understanding of the disclosures provided. The instructions we are adopting are consistent with and designed to fulfill the original goals of the proposal, including the creation of relationship summaries that will highlight certain information in one place for retail investors in order to help them select or decide whether to remain with a firm or financial professional, encourage retail investors to engage in meaningful and individualized conversations with their financial professionals, and empower them to easily find additional information. Although certain prescribed generalized Start Printed Page 33498comparisons between brokerage and investment advisory services have been removed from the final instructions, we believe the revised instructions will result in more meaningful comparisons among firms.

The key changes of the relationship summary and instructions we are adopting include the following: [45]

  • Standardized Question-and-Answer Format and Less Prescribed Wording. Instead of declarative headings as proposed, the final instructions for the relationship summary will require a question-and-answer format, with standardized questions serving as the headings in a prescribed order to promote consistency and comparability among different relationship summaries. The headings will be structured and machine-readable, to facilitate data aggregation and comparison. Under the standardized headings, firms will generally use their own wording to address the required topics. Thus, the final instructions contain less prescribed language, which creates more flexibility in providing accurate information to investors. Investment advisers and broker-dealers will be limited to two pages and dual registrants will be limited to four pages (or an equivalent length if in electronic format).[46]
  • Use of Graphics, Hyperlinks, and Electronic Formats. To help retail investors easily digest the information, the instructions will specifically encourage the use of charts, graphs, tables, and other graphics or text features in order to explain or compare different aspects of the firm's offerings. If the chart, graph, table, or other graphical feature is self-explanatory and responsive to the disclosure item, additional narrative language that may be duplicative is not required. For electronic relationship summaries, the instructions encourage online tools that populate information in comparison boxes based on investor selections. The instructions permit, and in some instances require, a firm to cross-reference additional information (e.g., concerning services, fees, and conflicts), and will require embedded hyperlinks in electronic versions to further facilitate layered disclosures. Firms must use text features to make the required cross-references more noticeable and prominent in relation to other discussion text.
  • Introduction With Link to Commission Information. The relationship summary will include a more streamlined introductory paragraph that will provide a link to Investor.gov/CRS, a page on the Commission's investor education website, Investor.gov, which offers educational information about investment advisers, broker-dealers, and individual financial professionals and other materials. In order to highlight the importance of these materials, the introduction also will note that brokerage and advisory services and fees differ and that it is important for the retail investor to understand the differences.
  • Combined Fees, Costs, Conflicts of Interest, and Standard of Conduct Section. We are integrating the proposed fees and costs section with the sections discussing the conflicts of interest and standards of conduct. We are also expanding the discussion of fees and making several other changes to help make the disclosures clearer for retail investors. The relationship summary will cover the same broad topics as proposed, including a summary of fees and costs, a description of ways the firm makes money, certain conflicts of interest, and standards of conduct. In addition, firms will include disclosure about financial professionals' compensation.
  • Separate Disciplinary History Section. Firms will be required to indicate under a separate heading whether or not they or any of their financial professionals have reportable disciplinary history and where investors can conduct further research on these events, instead of including this information under the Additional Information section as proposed.
  • Conversation Starters. The proposed Key Questions to Ask have generally been integrated into the relationship summary sections either as question-and-answer headings or as additional “conversation starters” to provide clearer context for the questions. Retail investors can use these questions to engage in dialogue with their financial professionals about their individual circumstances. The discussion topics raised by certain other proposed key questions have been incorporated into the relationship summary through otherwise-required disclosure.
  • Elimination of Proposed Comparisons Section. We are eliminating the proposed requirement that broker-dealers and investment advisers include a separate section using prescribed wording that in a generalized way described how the services of investment advisers and broker-dealers, respectively, differ from the firm's services. We encourage, but do not require, dual registrants to prepare a single relationship summary that discusses both brokerage and investment advisory services. Whether dual registrants prepare a single or two separate relationship summaries to describe their brokerage and investment advisory services, they must present information on both services with equal prominence and in a manner that clearly distinguishes and facilitates comparison between the two. The material provided on Investor.gov offers educational information about investment advisers, broker-dealers, and individual financial professionals and other materials.
  • Delivery. As proposed, investment advisers must deliver a relationship summary to each new or prospective client who is a retail investor before or at the time of entering into an investment advisory contract with the retail investor. In a change from the proposal, broker-dealers must deliver the relationship summary to each new or prospective customer who is a retail investor before or at the earliest of: (i) A recommendation of an account type, a securities transaction, or an investment strategy involving securities; (ii) placing an order for the retail investor; or (iii) the opening of a brokerage account for the retail investor. We also are revising the instructions to provide greater clarity on the use of electronic delivery, while generally maintaining the guidelines that were proposed.

We designed the final disclosure requirements in light of comments, input from individual investors through roundtables and on Feedback Forms, and observations reported in the RAND 2018 report and other surveys and studies, that suggest retail investors benefit from receiving certain information about a firm before the beginning of a relationship with that firm, but they prefer condensed disclosure so that they may focus on information that they perceive as salient to their needs and circumstances, and prefer having access to other “layers” of additional information rather than receiving a significant amount of information at once. Together, all of the required disclosures will assist a retail investor to make an informed choice regarding whether a brokerage or investment advisory relationship, as well as whether a particular broker-dealer or investment adviser, best suits his or her particular needs and Start Printed Page 33499circumstances. The relationship summary will complement additional rules and guidance that the Commission is adopting concurrently to enhance protections for retail investors.[47]

Some commenters responding to the RAND 2018 report noted that the RAND 2018 survey and qualitative interviews did not objectively test investor comprehension, and they pointed to observations from RAND 2018 interviews that suggested that some interview participants failed to understand differences in the legal standards that apply to brokerage and advisory accounts and did not understand the meaning of the word “fiduciary” for example.[48] They argued that we should conduct more usability testing before adopting Form CRS and Regulation Best Interest.[49]

We disagree. The amount of information available from the various investor surveys and investor testing described in this release, including those submitted by commenters, as well as the comment letters and other input submitted to the Commission for this rulemaking, is extensive. We considered all of this information thoroughly, leveraging our decades of experience with investor disclosures, when evaluating changes to the relationship summary from the proposal. The perceived usefulness of the relationship summary, as shown by observations in the RAND 2018 report, surveys and studies submitted by commenters, and input from individual investors at our roundtables and in Feedback Forms, demonstrates that, even as proposed, the relationship summary would benefit investors by providing information that would help investors make more informed choices when deciding among firms and account options.[50] Large majorities of participants in the RAND 2018 survey and in other surveys supported the specific topics, such as services, fees, conflicts and standards of conduct, that we require firms to address in the relationship summary.[51] Even though the RAND 2018 qualitative interviews and another interview-based study observed that interview participants could have some gaps in understanding, these studies still observed that interview participants could learn new important information from the relationship summary as proposed.[52]

In addition, as noted above and discussed in further detail below, we are making a number of modifications designed to improve the relationship summary relative to the proposal, which are informed by these and other observations reported by RAND 2018 and other surveys and studies, as well as by investor feedback at roundtables and in Feedback Forms and the other comment letters we have received. For example, we are substantially revising our approach to disclosing standard of conduct and conflicts of interest to make this information clearer to retail investors, including (among other changes) eliminating the word “fiduciary” and requiring firms—whether broker-dealers, investment advisers, or dual registrants—to use the term “best interest” to describe their applicable standard of conduct.[53] Further, as compared to the proposal, modifications adopted in the final relationship summary instructions require less prescribed wording, and instead, firms will generally use their own wording to address required topics, which creates flexibility in providing accurate information to investors. We believe that this modification substantially limits the practicability and benefit of additional usability testing because there is no single version of the relationship summary (or a limited set of form versions) that may be used to gauge investor comprehension given firms' flexibility to tailor their relationship summary.54 Start Printed Page 33500Therefore, we believe that any anticipated benefit from continued rounds of investor usability testing does not justify the cost to investors of delaying a rulemaking designed to increase investor protection.

Accordingly, we believe that the totality of input received through comments (including Feedback Forms), outreach at roundtables and through the OIAD/RAND and RAND 2018 reports, as well as surveys and studies submitted by commenters, fully supports our consideration and adoption of the relationship summary, with modifications informed by this input as discussed more fully below. However, to help ensure that the relationship summary fulfills its intended purpose, we have directed our staff to review a sample of relationship summaries that are filed with the Commission beginning after June 30, 2020, when firms first file their relationship summaries, and to provide the Commission with the results of this review. The Commission and its staff are also reviewing educational materials provided on Investor.gov and intend to develop additional content in order to continue to improve the information available to investors about working with investment advisers, broker-dealers, individual financial professionals, and investing.

In the Proposing Release, we proposed certain disclosures to be included in all print or electronic retail investor communications by broker-dealers, investment advisers, and their financial professionals (the “Affirmative Disclosures”). We have determined not to adopt the Affirmative Disclosures, as we discuss further below. In our view, the combination of the disclosure requirements in Form CRS and Regulation Best Interest should adequately address the objectives of the proposed Affirmative Disclosures.

II. Form CRS Relationship Summary

A. Presentation and Format

The relationship summary is designed to be a short and accessible disclosure for retail investors that helps them to compare information about firms' brokerage and/or investment advisory offerings and promotes effective communication between firms and their retail investors.[55] The proposed instructions included requirements on length, formatting, and content. The proposal also provided three examples of what a relationship summary might look like for a standalone broker-dealer, standalone investment adviser, and dual registrant. In providing feedback on the proposed sample relationship summaries, commenters on Feedback Forms and participants in the RAND 2018 survey and other surveys and studies provided by commenters indicated that the proposed relationship summary could be too dense and difficult to read.[56] They suggested using simpler terms and more white space, among other changes.[57] Commenters also encouraged the use of design principles that would result in a more visually appealing and accessible disclosure.[58] In addition, the IAC recommended, through a majority vote, uniform, simple, and clear summary disclosures to retail investors.[59] We have incorporated many of these suggestions into the instructions.

We are changing the instructions to require a question-and-answer format, give additional support for electronic formats, provide guidance that firms should include white space, and implement other design features to make the relationship summary easier to read.[60] We are requiring firms to use standardized headings in a prescribed order to preserve comparability, while permitting greater flexibility in other aspects of the relationship summary's wording and design to enhance the relationship summary's accuracy, usability, and effectiveness.[61] The final instructions will require limited prescribed wording compared to the Start Printed Page 33501proposal and will permit firms to use their own wording to describe most topics. We also are not requiring firms to discuss the sub-topics required within each section in a prescribed order, as proposed.[62] Dual registrants [63] and affiliated brokerage and investment advisory firms also will have flexibility to decide whether to prepare separate or combined relationship summaries. These changes are intended to enhance the relationship summary's clarity, usability, and design, and to promote effective communication and understanding between retail investors and their firms and financial professionals. We describe these changes in more detail below.

We are also adopting some parts of the instructions that address presentation and formatting as proposed. The instructions state that the relationship summary should be concise and direct, and firms must use plain English and take into consideration retail investors' level of financial experience, as proposed.[64] Firms also are not permitted to use multiple negatives, or legal jargon or highly technical business terms unless firms clearly explain them, as proposed. In a change from the proposal, the instructions will not permit use of legal jargon or technical terms without explaining them in plain English, even if the firm believes that reasonable retail investors will understand those terms.[65] Several commenters suggested that the relationship summary avoid the use of jargon (e.g., terms like “asset-based fee” and “load” in the fees section),[66] and several roundtable participants and participants in the RAND 2018 interviews and another study said that they did not understand certain technical terms.[67] Roundtable participants and commenters on Feedback Forms asked that the relationship summary include definitions or a glossary.[68] In addition, the IAC recommended that a document such as the relationship summary use plain English and a concise format.[69] As a result, we are instructing firms to avoid using legal jargon and highly technical terms in the relationship summary unless they are able to explain the terms in the space of the relationship summary. We believe this simpler approach obviates the need for firms to justify what they believe a reasonable retail investor would or would not understand. Firms would have the flexibility to use their own wording, including legal or highly technical terms as long as they explain them, or may prefer to use simpler terms, given the space limitations of the relationship summary. Additionally, we have added a cover page for Form CRS under the Exchange Act (17 CFR 249.640) only, displaying a currently valid OMB control number and including certain statements relating to federal information law and requirements, and the SEC's collection of information.[70]

1. Limited Prescribed Wording

The proposed instructions would have required firms to include prescribed wording throughout many sections of the relationship summary. In particular, the fees and costs, standard of conduct, and the comparison section for standalone broker-dealers and investment advisers included a number of required statements, many that differed for broker-dealers, investment advisers, and dual registrants.[71] The introduction, conflicts of interest, and key questions sections also included some required statements.[72] In response to comments (as described more fully below) we are largely eliminating the prescribed wording and replacing those statements with instructions that generally allow firms to describe their own offerings with their own wording.

For example, the proposed instructions would have required broker-dealers to state, “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” and “The fee you pay is based on the specific transaction and not the value of your account.” [73] Broker-dealers also would have stated “The more transactions in your account, the more fees we charge you. We therefore have an incentive to encourage you to engage in transactions.” [74] Instead the final instructions will require broker-dealers to describe the principal fees and costs that retail investors will incur, including their transaction-based fees, and summarize how frequently the fees are assessed and the conflicts of interest they create.[75]

Many commenters requested more flexibility for firms to provide accurate descriptions of their services.[76] Some Start Printed Page 33502argued that the mix of prescribed and firm-authored wording required by the proposed instructions would be inaccurate, contribute to investor confusion, or be ineffective for investors, particularly language that some commenters considered “boilerplate.” [77] Observations reported in the RAND 2018 qualitative interviews and other surveys and studies also showed that investors had difficulty understanding, were confused by, or misinterpreted some of the prescribed wording.[78] A range of commenters asserted that the proposed prescribed wording could be inaccurate or inapplicable.[79] For example, various providers of insurance products explained that references to brokerage or investment advisory accounts were not consistent with their business models and could confuse retail investors because customers generally purchase insurance products directly from the issuer, without needing to open a brokerage account.[80] One commenter expressed concern that some of the prescribed wording could constitute impermissible compelled speech that could raise First Amendment concerns.[81] That same commenter, with others, also opposed providing firms with more flexibility than proposed to implement the relationship summary, arguing that more flexibility could impair comparability.[82]

We recognize that extensive use of prescribed wording in certain contexts could add to investor confusion and may not accurately or appropriately capture information about particular firms. Accordingly, the final instructions permit firms, within the parameters of the instructions, to describe their services, investment offerings, fees, and conflicts of interest using their own wording. This approach should enable firms to reflect accurately what they offer to retail investors, should result in disclosures that are more useful to retail investors, and should mitigate concerns relating to the mix of prescribed and firm-authored wording, and the extensive use of prescribed wording, that the proposed instructions required.

Although we are allowing more flexibility so that firms can describe their offerings more accurately, firms still will be required to discuss required topics within a prescribed order, as discussed below.[83] This approach will facilitate transparency, consistency, and comparability of information across the relationship summaries of different firms, helping retail investors to focus on information that we believe would be particularly helpful in deciding among firms, financial professionals, services, and accounts—namely: Relationships and services; fees, costs, conflicts, and required standard of conduct; disciplinary history; and how to get additional information. We believe that more tailored, specific, and distinct information in the required topic areas also will better serve the educational purpose by facilitating more robust substantive comparisons across firms.

This approach addresses—and mitigates—First Amendment concerns. Generally, the instructions no longer require any specific speech.[84] Rather, they permit firms to use their own words to impart accurate information to investors. In certain circumstances, however, we are continuing to require firms to use prescribed wording. For example, the final instructions require firms to use standardized headings and conversation starters, which are in the form of questions that investors are encouraged to ask.[85] These elements are organizational (the headings) or intended to prompt a discussion by the investor (the conversation starters).[86] The final instructions also require firms to include prescribed statements describing their required standard of conduct when providing recommendations or advice.[87] Requiring firms to provide a consistent articulation of their required legal obligations in this regard will reduce and minimize investor confusion, as compared with allowing firms to state their required standard of conduct using their own wording.[88] These statements are designed to require the disclosure of purely factual information about the standard of conduct that applies to the provision of recommendations by broker-dealers and the provision of advice by investment advisers under their respective legal regimes.[89] Finally, the instructions require firms to include a prescribed, factual statement regarding the impact of fees and costs on investments, and a prescribed statement encouraging retail investors to understand what fees and costs they are paying.[90] As explained further below, Start Printed Page 33503the final instructions provide that if a required disclosure or conversation starter is inapplicable to a firm's business or specific wording required by the instructions is inaccurate, firms may omit or modify it.[91]

As in the proposal, the final instructions include parameters for the scope of information expected within the relationship summary, though we are modifying the requirements to clarify the scope further in light of commenter concerns. First, all information in the relationship summary must be true and may not omit any material facts necessary in order to make the disclosures, in light of the circumstances under which they were made, not misleading.[92] The proposed instructions required all information in the relationship summary to be true and prohibited firms from omitting any material facts necessary to make the disclosures required by the instructions and the applicable item not misleading, but did not include the clause “in light of the circumstances under which they were made.” [93] Commenters raised concerns with respect to the applicability of this standard to a short document with strict page limits that is meant to provide only a brief summary of information.[94]

We continue to believe that firms should include only as much information as is necessary to enable a reasonable investor [95] to understand the information required by each item.[96] As discussed below, we believe that investors will benefit from receiving a relationship summary containing high-level information that they will be more likely to read and understand, with the ability to access more detailed information.[97] As a result, we recognize a firm's relationship summary by itself is a summary of the information required to inform retail investors about the services a firm provides along with its fees, costs, conflicts of interest, and standard of conduct. We also believe that the disclosure provided in the relationship summary should be responsive and relevant to the topics covered by the final instructions,[98] and not omit information that is required to be disclosed or necessary to make the required disclosure not misleading.[99] We are sensitive to commenters' concerns, however, regarding expectations for the scope of required information within page limits. In this regard, the instructions continue to provide, as proposed, that firms may not include a disclosure in the relationship summary other than a disclosure that is required or permitted by the instructions and the applicable item,[100] and that all the information contained in the relationship summary must be true.[101]

In a change from the proposal, and to address commenters' concerns, the final instructions provide that the information contained in the relationship summary may not omit any material facts necessary in order to make the disclosures, in light of the circumstances under which they were Start Printed Page 33504made, not misleading.[102] We have added the phrase “in light of the circumstances under which they were made” to clarify that the content included or not included in the relationship summary should be viewed, for example, in light of the fact that the disclosure is intended to be a summary, that firms must adhere to the page limit, and that there will be links to additional information. Any information contained in the relationship summary or omitted facts will not be viewed in isolation in respect of determining whether such information would have been viewed by a reasonable investor as having significantly altered the total mix of information available.[103] As discussed below, firms will provide additional detail and context through layered disclosure. For example, the instructions require firms to include specific references or a link to additional information as part of the relationships and services and fees and conflicts sections.[104] In other instances, the instructions encourage firms to reference or link to additional information to supplement their required disclosures.[105] While this change from the proposal is drawn from other areas of the federal securities laws,[106] Form CRS is not intended to create a private right of action.

Second, firms may omit or modify required disclosures or conversation starters that are inapplicable to their business, or specific wording required by the final instructions that is inaccurate.[107] The proposed instructions permitted firms to omit or modify required disclosures that were inapplicable to their business or would be misleading to a reasonable retail investor.[108] We modified the proposed instruction to provide a more concrete requirement allowing firms to omit or modify prescribed wording, rather than using a broader standard referencing a reasonable retail investor. This instruction is intended to ensure that no statements are misleading or inaccurate in the context of a firm's particular services or business. Rather, the objective of the Commission is to ensure that required disclosures are purely factual and provide investors with an accurate portrayal of the firm's services and operations.

Finally, given that firms will use mostly their own wording, we are adding instructions that remind firms that their responses must be factual and provide balanced descriptions to help retail investors evaluate the firm's services.[109] For example, firms may not include exaggerated or unsubstantiated claims, vague and imprecise “boilerplate” explanations, or disproportionate emphasis on possible investments or activities that are not made available to retail investors.[110] The relationship summary is designed to serve as disclosure, rather than marketing material, and should not unduly emphasize aspects of firms' offerings that may be favorable to investors over those that may be unfavorable.

2. Standard Question-and-Answer Format and Other Presentation Instructions

As with the proposed instructions, the final instructions require firms to present information under standardized headings and to respond to all the items in the final instructions in a prescribed order.[111] Instead of using declarative headings as proposed, however, the headings will be in the form of questions.[112] This change responds to feedback from surveys and studies [113] and commenters,[114] including many submitting their own mock-ups of the relationship summary that suggested or used a question-and-answer format in their own documents. Several commenters noted that the question-and-answer format is a more effective design for consumer disclosures because it focuses on questions to which a consumer wants answers and allows a consumer to skim quickly and understand where to get more information.[115] Based on consideration of these comments, we are both incorporating the format generally and are utilizing several of the question headings suggested by commenters in mock-ups, as discussed in each item below.

In addition to the standardized headings, we continue to believe that a prescribed order of topics facilitates comparability of different firms' relationship summaries. Commenters generally supported or did not oppose the premise of a prescribed order of topics.[116] Some commenters did, however, suggest changes to the organization or inclusion of topics, either explicitly in their comment letters, implicitly by the design of their own mock-ups, or both.[117] Results of Start Printed Page 33505surveys and studies that assessed comprehension of the sample proposed relationship summaries demonstrated the importance of context and revealed confusion caused by the placement of some information. For example, the RAND 2018 qualitative interviews suggested that investors were confused by and had difficulty reconciling the conflicts and standard of conduct sections, which were separated by the fees and comparisons sections.[118] Another study suggested that the appearance of fee information in three separate sections and separation of the fees and conflicts sections by the comparisons section inhibited understanding of the connection between fees and conflicts.[119] As discussed further below, we are combining the proposed Fees and Costs, Conflicts of Interest, and Standard of Conduct sections into one, to address these comments.[120] In addition, in response to suggestions that we provide more flexibility for how firms describe their services so that they can more accurately convey the information, the final instructions do not require firms to present the information within each section in the order listed.[121] Therefore, firms are free to discuss the required sub-topics within each item in an order that they believe best promotes accurate and readable descriptions of their business.

The final instructions provide for page limits to promote brevity, as proposed. The proposed instructions limited the length of the relationship summary to four pages for both standalone firms and dual registrants.[122] The final instructions provide that for dual registrants that include their brokerage services and advisory services in a single relationship summary, the relationship summary must not exceed four pages in paper format, or the equivalent if delivered electronically.[123] For broker-dealers [124] and investment advisers [125] a relationship summary in paper format must not exceed two pages, or the equivalent if delivered electronically.[126] Dual registrants that prepare separate relationship summaries for their brokerage and advisory services are limited to two pages each, or the equivalent if delivered electronically.[127] Unlike the proposed instructions, the final instructions do not prescribe paper size, font size, and margin width, providing instead that they should be reasonable.[128] For example, we believe that 81/2″ x 11″ paper size, at least an 11 point font size, and a minimum of 0.75″ margins on all sides, as proposed, could be considered reasonable, but other parameters could also be reasonable. The objective of the proposed paper, font, and margin size limitations was to make the relationship summary easy to read. We expect that a visually engaging and effective design, including in electronic format, could achieve the same objective without the prescriptive limitations.

Many commenters preferred a shorter, one-to-two page document more heavily relying on layered disclosure with increased use of hyperlinks and other cross-references to more detailed disclosure.[129] Commenters also said that investors are more likely to read a shorter document.[130] Several commenters submitted mock-ups that were shorter than four pages.[131] Others indicated that the length of Form CRS was acceptable but should not exceed four pages.[132] On the other hand, certain commenters suggested that the length of the relationship summary may be too short to appropriately describe firms' insurance services or products.[133] One commenter said that it would be challenging for dual registrants to summarize all of their offerings within the four-page limit.[134] Investor feedback from surveys, studies, roundtables, and Feedback Forms also did not show consistent results. For example, 57% of the RAND 2018 survey respondents indicated that the proposed relationship summary was too long, 41% said it was about right, and roughly 2% said it was too short.[135] In section-by-section questioning, however, the most common response from RAND 2018 survey respondents was to keep the section length as is.[136] Similarly, some roundtable participants provided feedback that the proposed length was right at the maximum, “about right,” or “good,” [137] whereas others would have preferred a shorter document.[138] About Start Printed Page 3350640% of commenters on Feedback Forms said that relationship summary was an appropriate length, while about 30% indicated a preference for a shorter document.[139]

In light of commenter and investor feedback, we have determined that the relationship summary should be no more than four pages, and that in many cases a document shorter than four pages is appropriate. As proposed, both standalone firms and dual registrants were subject to a four-page limit, even though a dual registrant may have to include more disclosures discussing its advisory business and brokerage business as compared with standalone firms. Upon further consideration of the comments advocating for a more streamlined disclosure that includes more white space, we are adopting a four-page limit for dual registrants that prepare one combined relationship summary, to permit them to capture all of the required information within twice as much space as for standalone firms. If dual registrants and affiliated [140] standalone firms choose to prepare separate relationship summaries for their brokerage and investment advisory services, each relationship summary should not exceed two pages.[141] The two-page limit will help to facilitate comparison of the dual registrant's services, as investors can easily review the separate relationship summaries side-by-side, and will encourage firms to focus on succinctly and clearly explaining the required information. Some commenters, including providers of insurance products, supported a longer relationship summary or expressed concern that four pages would not be enough to allow for a summary of all of their offerings.[142] We believe that the elimination of certain sections (such as the comparison section) [143] and most of the prescribed wording from the relationship summary, along with the flexibility firms will have under the final instructions to describe services with their own wording, and to omit or modify required disclosures or conversation starters that are inapplicable to their business or specific wording that is inaccurate, should help to alleviate the concerns of those who advocated for the relationship summary to be longer.

3. Electronic and Graphical Formats, and Layered Disclosure

We are adding instructions that clarify our support for firms wishing to use electronic media in preparing the relationship summary for retail investors.[144] The proposed instructions would have permitted firms to add embedded hyperlinks within the relationship summary in order to supplement required disclosures [145] and would have required firms to use hyperlinks for any document that is cross-referenced in any electronic relationship summary.[146] The proposed instructions also permitted firms to use various graphics or text features to explain the required information but did not reference whether they should be electronic- or paper-based.[147]

Many commenters supported electronic formats, including in connection with layered disclosure.[148] One commenter endorsed electronic, including mobile, formats as inherently easier to navigate and use in a layered approach and asserted that the relationship summary would be more engaging to investors, and thus more effective as a disclosure, if the Commission encouraged more creative use of electronic formats.[149] Research submitted by commenters and feedback from our investor roundtables indicated that investors preferred a more visually appealing disclosure.[150] Commenters recommended a more visually-focused and designed experience, and many mock-ups that commenters submitted used graphics and other design features extensively.[151] In addition, the IAC has recommended exploring the use of layered disclosure in certain contexts.[152] The IAC has also recommended that the Commission “continue to explore methods to encourage a transition to electronic delivery that respect investor preferences and that increase, rather than reduce, the likelihood that investors will see and read important disclosure documents.” [153] Some commenters also expressed support for the IAC's recommendation relating to electronic delivery.[154]

Accordingly, we are adopting and adding provisions to the proposed Start Printed Page 33507instructions to encourage the use of electronic formatting and graphical, text, online features and layered disclosures in preparing their relationship summaries.[155] Key elements of the final instructions include the following:

  • The instructions encourage (rather than just permit, as proposed) firms to use graphics or text features to respond to the required disclosures, or to make comparisons among their offerings, including by using charts, graphs, tables, text colors, and graphical cues, such as dual-column charts.[156] If the chart, graph, table, or other graphical feature is self-explanatory and responsive to the disclosure item, additional narrative language that may be duplicative is not required. For a relationship summary provided electronically, the instructions further encourage online tools that populate information in comparison boxes based on investor selections.[157]
  • The instructions reference a non-exhaustive list of electronic media, communications, or tools that firms may use in their relationship summary.[158] We are including an instruction that, in a relationship summary that is posted on a firm's website or otherwise provided electronically, firms must provide a means of facilitating access (e.g., hyperlinking) to any information that is referenced in the relationship summary if the information is available online.[159] For relationship summaries delivered in paper format, firms may include URL addresses, QR codes, or other means of facilitating access to such information.[160] This instruction permits layered disclosure through paper disclosures and hybrid paper and electronic deliveries, while supporting some investors' preference for paper.
  • The instructions provide guidance that firms may include instructions on the use and interpretation of interactive graphics or tools, as proposed.[161] We believe that these features can make the relationship summary more engaging, accessible, and effective in communicating to retail investors.[162]
  • The instructions replace the term “hyperlink” with the more evergreen concept of “a means of facilitating access,” which will include hyperlinks as well as website addresses, QR Codes, or other equivalent methods or technologies.[163] Expanding the types of technology referenced in the instructions will make them more relevant as new technologies continue to be developed.

A number of commenters suggested different approaches for whether we would treat the relationship summary as “incorporating by reference” information provided in additional disclosures or materials that are hyperlinked to or otherwise accessible from the relationship summary.[164] Some of these commenters suggested that we treat certain hyperlinked information as “incorporated by reference.” [165] Other commenters recommended that firms should be permitted, but not necessarily required, to incorporate in the relationship summary additional information provided in other documents.[166]

Start Printed Page 33508

As discussed above, we support the use of layered disclosure and believe that investors will benefit greatly from receiving a relationship summary containing high-level information that they will be more likely to read and understand, with the ability to access more detailed information. Layered disclosure is an approach that can balance the goal of keeping the relationship summary short and accessible with the goal of providing retail investors with fulsome and specific information. The relationship summary is intended to be a self-contained document, however, and firms should be able to meet the instructions' requirements by providing generalized and summary responses to each item, without relying on incorporation by reference to other documents providing additional information. In contrast with other disclosure obligations such as prospectuses and registration statements, a firm could not satisfy the disclosure requirements set forth in the relationship summary instructions by incorporating another document (such as the Form ADV Part 2A brochure) by reference.

At the same time, we recognize the communicative value of layered disclosure. The instructions provide, as discussed above, that firms may [167] (and in some cases must) [168] cross-reference other documents and use hyperlinks or other tools to give more details about the topic. Where firms link to content outside the relationship summary disclosure, whether on a permissive or mandatory basis, the information may not substitute for providing any narrative descriptions that the instructions require, and the additional information should be responsive and relevant to the topic covered by the instruction. Firms should be mindful that the antifraud standards under the federal securities laws apply to linked information, as with other securities law disclosures.

All together we believe encouraging the use of electronic and graphical formatting online features, and layered disclosures will permit firms to create innovative disclosures that engage investors.

4. Conversation Starters

Consistent with the proposal, the relationship summary will be required to contain suggested follow-up questions for retail investors to ask their financial professional. The relationship summary, however, will not include a separate section of “Key Questions to Ask,” at the end of the relationship summary, as proposed. Instead, firms will be required to integrate those “key questions” for retail investors to ask their financial professionals throughout the relationship summary as headings to items or as “conversation starters.”

The proposed relationship summary would have required firms to include ten questions, as applicable to their particular business, under the heading “Key Questions to Ask” after a statement that the retail investors should ask their financial professional the key questions about a firm's investment services and accounts.[169] In addition, we proposed to allow firms to include up to four additional frequently asked questions.[170]

Most comment letters that discussed the “Key Questions to Ask” section generally did not support the proposed approach of including a separate section of up to fourteen questions at the end of the relationship summary. Commenters who proposed keeping a key questions section typically suggested significant substantive or stylistic alterations.[171] In a separate approach, many commenter mock-ups included topics and questions from “Key Questions to Ask” in a question-and-response format throughout the relationship summary.[172] Several commenters suggested that the key questions be removed from the relationship summary and placed on the Commission's website with other educational materials.[173]

Observations reported in the RAND 2018 report and other surveys and studies, and individual investor feedback at roundtables and on Feedback Forms generally indicated, that retail investors found the key questions helpful, however. In the RAND 2018 survey, the “Key Questions to Ask” section received the highest support of all sections to “keep as is” when investors were asked if they would add more detail, keep as is, shorten, or delete the section, and a majority of RAND 2018 survey respondents also indicated that they were either “very comfortable” or “somewhat comfortable” with asking each of the key questions.[174] Surveys and studies submitted by commenters also indicated that most investors who reviewed one of the proposed sample relationship summaries found the suggested questions to be useful and said they were likely to ask the questions.[175] In addition, the “Key Questions to Ask” section received the most “very useful” ratings from commenters who submitted Feedback Forms, and narrative comments on several Feedback Forms specifically indicated that the questions would encourage discussion with financial professionals.[176] Similarly, investors at Start Printed Page 33509Commission-held roundtables indicated that they viewed the questions as helpful.[177]

In light of comments, we believe that including questions for investors to ask their financial professionals is an important component of the relationship summary. Several commenter mock-ups showed questions throughout the relationship summary grouped by subject matter rather than at the end of the document. Investor studies showed that proximity and context are important for questions an investor may have for a financial professional.[178] In addition, some commenters' Feedback Forms requested that questions be placed earlier in the relationship summary document; one specifically suggested that we put the questions with “the appropriate section [with] each section to which it applies.” [179] We have determined to follow a similar approach by replacing the Key Questions to Ask section with specified “conversation starters” throughout the document. We are also using some of the proposed questions as topic headings.

There are required questions as conversation starters in each section other than the Introduction.[180] These conversation starters are intended to cover the same topics as the proposed key questions and in many cases are substantially similar in wording to the proposed key questions.[181] For each conversation starter, firms must use text features to make the conversation starters more noticeable and prominent in relation to the other discussion text. For example, they may use larger or different font; a text box around the heading or questions; bolded, italicized, or underlined text; or lines to offset the questions from other sections.[182] We believe the questions will be more helpful to investors when included throughout the document with formatting highlighting the conversation starters and organizing the conversation starters together with the firm's disclosures about a particular topic, providing retail investors clearer context for each question. However, if a required conversation starter is inapplicable to the firm's business, the firm may omit or modify that conversation starter.[183] With these changes, we believe that the conversation starters will better help retail investors initiate and engage in useful and informative conversations with their investment professionals.

As proposed, investment advisers that provide only automated investment advisory services or broker-dealers that provide services only online without a particular individual with whom a retail investor can discuss the conversation starters must include a section or page on their website that answers each of the conversation starter questions and must provide in the relationship summary a means of facilitating access (e.g., by providing a hyperlink) to that section or page.[184] For example, a firm could include a hyperlink, QR Code, or some other equivalent methods or technologies that would enable a retail investor to access that information. One commenter requested clarification that all firms could provide retail investors with the answers to each key question in writing, and then investors could call a call center for follow-up questions.[185] All firms could choose to provide written answers to conversation starters, but the final instructions will only require written responses in these limited circumstances to ensure that retail investors receive responses when they do not have access to a financial professional to ask questions. We continue to believe that the requirement as adopted will encourage investor engagement and make the conversation starters useful where there is no firm representative to answer the question in-person (or by telephone) for the retail investor. In addition, as proposed, if the firm provides automated investment advisory or brokerage services, but also makes a financial professional available to discuss the firm's services with a retail investor, the firm must make the financial professional available to discuss the conversation starters with the retail investor.[186]

Six of the proposed key questions will continue to have analogous “conversation starter” questions in the final Form CRS, which we discuss in each applicable section below.[187] These questions cover services, fees and costs, conflicts, disciplinary information, and information about appropriate contact persons. As described below, we revised the wording for all of these questions.

We did not replace four of the key questions with analogous “conversation starter” questions; the topics raised by these key questions will be addressed in other ways in the relationship summary. First, we have replaced the question requesting financial professionals to “do the math for me” with a different conversation starter.[188] Commenters raised specific concerns about this question for operational and recordkeeping reasons.[189] We are Start Printed Page 33510instead requiring that firms include a conversation starter question prompting retail investors to ask their financial professional to help them understand how the fees and costs might affect their investments and the potential impact of fees and costs on a $10,000 investment.[190] As we note below, our intent with the proposed “Do the math for me” question was that it serve as a prompt to encourage retail investors to ask about the hypothetical amount they would pay per year for an account, what would make the fees more or less, and what services they would receive for those fees. The question was not intended to require firms to generate individualized cost estimates for each particular retail investor. We believe that the newly worded conversation starter makes that more clear. Additionally, the required discussion of fees, costs, and conflicts, together with the conversation starter question, will better serve as an initial basis for understanding how fees affect investment returns and the fees that they will pay than the “Do the math for me” key question.[191]

Two other proposed key questions regarding costs associated with an account and how firms make money [192] covered information that the relationship summary as adopted requires to be disclosed under the section on fees, costs, conflicts, and standard of conduct.[193] Specifically, firms must (i) summarize the principal fees and costs that retail investors will incur from their services (including how frequently they are assessed and the conflicts of interest they create) and (ii) describe any other fees related to their brokerage or investment advisory services in addition to those principal fees that the retail investor will incur.[194] Additionally, the new conversation starter question included in Item 3 is intended to elicit similar points of discussion with the following wording: “Help me understand how these fees and costs might affect my investments. If I give you $10,000 to invest, how much will go to fees and costs, and how much will be invested for me?” Finally, unlike the proposal, the relationship summary must include a description of the ways in which the firm and its affiliates make money from brokerage or investment advisory services and investments it provides to retail investors as well as material conflicts of interest.[195] As a result of these disclosure requirements, the separate questions from the proposal are not necessary.

Finally, we are not adopting a conversation starter question analogous to the proposed key question asking “How often will you monitor my account's performance and offer investment advice?”, because the Relationships and Services section of the adopted relationship summary requires disclosure about the services and advice or recommendations that firms offer and whether or not they monitor accounts, including the frequency and any material limitations on any such monitoring.[196]

5. Presentation of Relationship Summaries by Dual Registrants and Affiliated Firms

We are modifying the proposed instructions in order to encourage a dual registrant to prepare one combined relationship summary discussing both its brokerage and advisory services, but a dual registrant will be permitted to provide two separate relationship summaries, each describing one type of service.[197] The proposal would have required a dual registrant to prepare one relationship summary, presenting most of the required items under standardized headings and in a tabular format, with brokerage services described in one column and advisory services described in another.[198] We also are adding a new instruction permitting affiliates to prepare a single relationship summary describing both brokerage and investment advisory services that they offer or to prepare separate relationship summaries, one for each type of service.[199] In comparison, the proposed instructions did not permit affiliates to deliver one combined relationship summary, but did allow them to state that they offer retail investors their affiliates' brokerage or advisory services, as applicable.[200]

We are not adopting the definitions of “standalone broker-dealer” and “standalone investment adviser” as proposed, because they are no longer necessary given the streamlining of the instructions relative to the proposal.[201] Under the final instructions, however, we are defining a dual registrant as “[a] firm that is dually registered as a broker-dealer under section 15 of the Exchange Act and an investment adviser under section 203 of the Advisers Act and offers services to retail investors as both a broker-dealer and an investment adviser”, substantially as proposed. To clarify, a firm that is dually registered as both a broker-dealer and an investment adviser but does not offer both brokerage and investment advisory services to retail investors would not fall within the definition of dual registrant. For example, a firm that is dually registered and offers investment advisory services to retail investors, but offers brokerage services only to institutional customers, would be required to prepare, file, and deliver the relationship summary only in accordance with the obligations of an investment adviser offering services to retail investors.[202]

Dual Registrants. Investor studies and surveys showed mixed results in connection with the dual-column, combined relationship summary. For example, when presented with screen shots of each separate section in dual-column format, 85% of RAND 2018 survey respondents indicated that the side-by-side comparison format helped them decide whether a broker-dealer or investment adviser account would be right for them, but during qualitative interviews, some participants had difficulty with the two column Start Printed Page 33511format.[203] On Feedback Forms, some indicated that they liked the side-by-side or grid presentation.[204] One Feedback Form commenter said the dual-column format was confusing, however.[205] An interview-based study also indicated that both the formatting and the language in the dual-column format in our proposed sample relationship summary contributed to investor confusion about differences between broker-dealers' and investment advisers' services.[206] Both industry representatives and commenters representing investors also expressed concerns about the proposed formatting requirements for dual registrants' relationship summaries.[207] Two commenters supported using visual formatting to help investors understand the options dual registrants provide, but argued that the proposed content or design should be changed.[208]

Several commenters suggested letting dual registrants choose whether to prepare one combined relationship summary or two separate ones.[209] Commenters argued that providing information about both brokerage and investment advisory services as proposed would confuse investors.[210] Another suggested requiring dual registrants to prepare and deliver different relationship summaries to retail investors depending on whether the investors enter into an advisory or brokerage relationship, and to highlight the availability and link to the relationship summary of the other type of service.[211] One commenter argued that dual registrants needed flexibility to maintain two separate disclosures to allow each financial professional associated with the dual registrant to provide a tailored disclosure to his/her customer, without including services that he/she is not licensed to provide.[212]

We encourage dual registrants to prepare a single disclosure, designed in a manner that facilitates comparison between their brokerage and advisory services. Informed by comments, we have determined that two separate disclosures might be appropriate, depending on the different ways firms and their financial professionals offer services and on the particular facts and circumstances. For example, financial professionals with licenses to offer services as a representative of a broker-dealer and investment adviser may offer services through a dual registrant, affiliated firms, or unaffiliated firms, or only offer one type of service notwithstanding their dual licensing.[213] Financial professionals who are not dually licensed may offer one type of service through a firm that is dually registered. Accordingly, the final instructions permit dual registrants and affiliates to prepare a single relationship summary, or alternatively, two separate ones, to describe their brokerage and investment advisory services in a way that accurately reflects their business models and will be the most helpful to retail investors. The instructions explicitly encourage preparation of a single relationship summary, however, given that a number of investors and commenters reacted positively to this presentation.[214]

A firm preparing a single relationship summary will be required to employ design elements of its own choosing to promote comparability; however, we are not prescribing the two-column format, as proposed. We agree that making retail investors aware of a range of options is important to help them make an informed choice,[215] but we recognize the potential limits of a tabular format, as illustrated by results from some investor studies and surveys,[216] and we have concluded that firms are generally in a better position than the Commission to determine a format and design that facilitates comparison of their specific brokerage and investment advisory services. Whether a firm prepares a single relationship summary or two separate ones, the final instructions require a firm to present the information with equal prominence and in a manner that clearly distinguishes and facilitates comparison of the two types of services.[217] For example, a firm could use a tabular format; text features such as text boxes; bolded, italicized, or underlined text; or lines to clearly indicate similarities and differences in its services.

While we are providing this flexibility, we believe investors should see a range of options. Accordingly, the final instructions provide that a firm preparing two separate relationship summaries must provide a means of facilitating access to each relationship summary (e.g., include cross-references or hyperlinks) and deliver both with equal prominence and at the same time to each retail investor, whether or not that retail investor qualifies for those retail services or accounts.[218] We disagree with commenters suggesting that dual registrants should have the option to deliver to retail investors a relationship summary describing only one type of service if, for example, that Start Printed Page 33512investor does not qualify for one of the services.[219] Retail investors should be able to learn about and compare the range of options a firm offers to retail investors, even if the financial professional does not believe that the retail investor meets the requirements for or is considering certain services at that time. For example, a retail investor may initially seek ongoing advice through an advisory account, but after learning about both brokerage and advisory services and speaking with a financial professional, may decide that a brokerage account is a better choice. Or a retail investor may not qualify for certain accounts at the time of receiving the relationship summary, e.g., by not being able to meet an account opening minimum, but may qualify for them in the future, or may qualify for a particular service at one firm but not another. Furthermore, a retail investor may initially make the financial professional aware of only certain asset holdings (for example, he or she approaches a firm to rollover an IRA). On that basis, the firm may believe the investor only qualifies for certain of the firm's services. However, the investor may also have substantial other asset holdings and thus qualify for a variety of accounts that the firm offers. Knowing about the alternative brokerage and investment advisory options that a firm offers will help retail investors to compare firms' offerings and consider whether to adjust the relationship or services as investors' financial circumstances change.

Affiliate Services. As discussed above, the proposed instructions did not permit affiliates to prepare a combined relationship summary, but did permit firms with affiliates offering retail investors brokerage or advisory services to disclose these services.[220] Several commenters recommended that affiliates should have the same flexibility to prepare one or two relationship summaries as dual registrants.[221] We agree that this flexibility is appropriate for affiliates and are modifying the instructions to permit, but not require, delivery of a single relationship summary. Affiliates preparing a single relationship summary will provide the same comparative benefits for investors as dual registrants doing so. As with dual registrants, some affiliated firms market their services together and have financial professionals who hold licenses through each firm. We recognize, however, that not all affiliates operate in the same way. Some affiliated firms operate independently, do not market their services together, and do not share financial professionals. The different ways in which financial professionals affiliate with firms to provide services also warrant this flexibility. For example, some commenters noted that many financial professionals are licensed representatives of a brokerage firm and are also licensed through an affiliated investment advisory firm or an unaffiliated investment advisory firm (sometimes as a sole proprietor) separately registered with the Commission or one or more States.[222] Depending on the relationship among affiliates and their financial professionals, a single relationship summary or two separate summaries may be more appropriate.[223]

Many dually licensed financial professionals offer services on behalf of two affiliates, similar to dually licensed financial professionals offering services for a dual registrant. One commenter requested that the Commission provide clarity that all references to dual registrants apply to broker-dealers and investment advisers organized under a single corporate structure as affiliated entities.[224] Consistent with our discussion above, we believe that retail investors seeking services from dually licensed financial professionals should receive information about all of the services the financial professional offers, even if the services are through two affiliated SEC-registered firms. As a result, if two affiliated SEC-registered firms prepare separate relationship summaries, and they provide brokerage and investment advisory services through dually licensed financial professionals, the final instructions require the firms to deliver to each retail investor both firms' relationship summaries with equal prominence and at the same time, without regard to whether the particular retail investor qualifies for those retail services or accounts. To provide clarity, we have added a definition for dually licensed professionals in the final instructions that was not included in the proposal.[225] The final instructions also provide that each of the relationship summaries must cross-reference and link to the other.[226] If the affiliated firms are not providing brokerage and investment advisory services through dually licensed financial professionals, they may choose whether or not to reference each other's relationship summary and whether or not to deliver the affiliate's relationship summary with equal prominence and at the same time.[227]

Finally, we modified the instructions to explicitly permit a firm to acknowledge other financial services the firm provides in addition to its services as a broker-dealer or investment adviser registered with the SEC, such as insurance, banking, or retirement services, or investment advice pursuant to state registration or licensing.[228] Start Printed Page 33513Firms may include a means of facilitating access (e.g., cross-references or hyperlinks) to additional information about those services.[229] Some commenters encouraged the SEC to allow firms to disclose services of other affiliates, even if those services are not regulated by the SEC, such as investment advisory services offered by an affiliated thrift savings institution.[230] In response to our request for comment asking whether we should permit firms to include wording regarding other types of services and lines of businesses, several commenters submitting mock-ups of relationship summaries included language referencing banking and insurance services or products.[231] We found these comments persuasive and believe that permitting firms to reference financial services not necessarily regulated by the Commission so that retail investors can see the range of options available to them can benefit their decision-making, as discussed above.[232] This new instruction supports and expands upon the commenters' suggestions. Given that the focus of the relationship summary is on brokerage and/or advisory services, however, information pertaining to other services should not obscure or impede understanding of the information that must be disclosed in accordance with the Form CRS instructions.[233]

We believe that, together, these requirements for dually registered firms, financial professionals, and affiliates will enhance comparability while providing flexibility for them to present their services and relationships in the way the firm believes to be the clearest.

B. Items

The relationship summary is principally designed to provide succinct information about (i) relationships and services the firm offers to retail investors; (ii) fees and costs that retail investors will pay, conflicts of interest, and the applicable standard of conduct; and (iii) disciplinary history. The proposed relationship summary included this information as well as additional topics that we are eliminating, as explained further below. In determining the scope of the relationship summary, we balanced the need for robust disclosures with the risk of “information overload” and reader disengagement, a theme in comment letters, investor feedback at roundtables and in the Feedback Forms, and observations reported in the RAND 2018 report and other surveys and studies.

Some of the key changes from the proposal include:

  • We have modified the sections to place substantively related information generally together. We believe this will facilitate comprehension, leading to a better-informed decision-making process and selection of a firm, financial professional, account type, services, and investments.
  • The final instructions simplify the introduction; highlight disciplinary history in a separate section; and integrate key questions, now characterized as “conversation starters,” among the remaining sections of the relationship summary.
  • After reviewing the comments and observations reported in the RAND 2018 report and other surveys and studies, we have determined to remove prescribed generalized comparisons between brokerage and investment advisory services.

1. Introduction

The relationship summary will include a standardized introductory paragraph. The instructions will require a firm to: (i) State the name of the broker-dealer or investment adviser and whether the firm is registered with the Securities and Exchange Commission as a broker-dealer, investment adviser, or both; (ii) indicate that brokerage and investment advisory services and fees differ and that it is important for the retail investor to understand the differences; and (iii) state that free and simple tools are available to research firms and financial professionals at the Commission's investor education website, Investor.gov/CRS, which also provides educational materials about broker-dealers, investment advisers, and investing.[234]

The introduction's instructions as adopted differ from the proposal, which would have required prescribed wording in the introduction that differed for broker-dealers, investment advisers, and dual registrants. Specifically, the prescribed wording in the proposed introduction was intended to highlight in a generalized sense and make investors aware that broker-dealers and investment advisers are different, and that investors needed to carefully consider this choice. We received one comment specifically addressing the introduction. It stated that the prescribed wording would not capture the attention of retail investors and failed to adequately convey information regarding differences between investment advisers and broker-dealers.[235] In addition, several of the mock-ups commenters submitted included other suggestions for beginning the relationship summary, many of which had an introduction that was generally shorter and included less discussion about generalized business models than the proposed relationship summary.[236] In response to the comment and the mock-ups, a number of which we found conveyed useful information in a more concise manner than the proposed prescribed wording, we simplified and standardized the introductory paragraph, eliminating or replacing most of the prescribed wording we proposed, as discussed further below. In addition, we added a requirement to provide a link to Investor.gov/CRS in the Introduction to highlight the tools and educational resources available to retail investors. This dedicated page on Investor.gov will provide information specifically tailored to educate retail investors about financial professionals, including search tools in order to research firms and financial professionals and information about broker-dealers and investment advisers and their different services, fees, and conflicts. We believe the changes and the new page will better focus retail investors on how the relationship summary can be most helpful to them, while providing a link to resources to more general investor education information at the front of the relationship summary.

We made the following specific changes to the introduction: First, the final instructions require all firms to include certain information without prescribing the specific words that firms Start Printed Page 33514must use.[237] The proposed relationship summary would have required prescribed wording that differed for standalone investment advisers, standalone broker-dealers, and dual registrants.[238] These changes correspond with the general approach throughout the final instructions of permitting more flexibility for firms to tailor the wording of their relationship summaries to enhance the relationship summary's accuracy, clarity, usability, and design.[239]

Second, we eliminated the proposed requirement that standalone investment advisers state that they do not provide brokerage services, and vice versa.[240] We believe this information is more succinctly conveyed by including the firm's registration status.[241] Additionally, commenters pointed out that the choice of financial services providers is not binary—there are more than two types of services offered that could apply.[242] We agree that the proposed wording could be viewed as unduly constricting and potentially misleading.

Third, we excluded the statement for dual registrants that, depending on an investor's needs and investment objectives, the firm can provide services in a brokerage account, investment advisory account, or both at the same time. We believe that this information is conveyed more effectively by the statement of a firm's registration status and the information provided elsewhere in the relationship summary, such as in the description of services that the firm provides.[243] In addition, requiring a statement of a firm's registration status at the beginning of the relationship summary helps obviate a need for the Affirmative Disclosures under the Exchange Act and the Advisers Act proposed specifically to require a broker-dealer and an investment adviser 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.[244] As discussed below, we are not adopting the Affirmative Disclosures.[245] In response to our request for comment relating to the Affirmative Disclosures,[246] several commenters stated that the proposed rules were duplicative of other disclosure obligations (e.g., Form ADV, Regulation Best Interest, Form CRS) [247] and that such rules were costly and difficult to implement and supervise.[248]

Fourth, we have included an instruction that allows (but does not require) reference to FINRA or Securities Investor Protection Corporation (“SIPC”) membership in a manner consistent with other rules and regulations (e.g., FINRA rule 2210).[249]

We are not adopting the proposed requirements to include statements that: (i) There are different ways an investor can get help with investments; (ii) an investor should carefully consider which types of accounts and services are right for him or her; (iii) the relationship summary gives an investor a summary of the types of services the firm provides and how the investor pays; and (iv) an investor should ask for more information with a specific reference to the key questions.[250] We believe that this information is not necessary in the introduction and is better conveyed through the revised question-and-answer structure of the relationship summary and a more streamlined introduction highlighting that it is important for retail investors to understand the difference between brokerage and investment advisory services and fees and referencing Investor.gov/CRS.[251] The conversation starters more directly prompt discussion between retail investors and their investment professionals than a generalized statement to ask for more information, and the conversation starters relating to the Relationships and Services item convey that an investor should carefully consider which types of accounts and services are appropriate. In addition, several commenter mock-ups demonstrated that removing the prescribed wording from each of these changes results in a shorter introduction and promotes additional white space in the relationship summary. Our adopted instructions remove required text that might be unnecessary for investors, similar to introductions in mock-ups that were typically shorter with less discussion about generalized business models than the proposed relationship summary.[252] As a result, we believe these changes will enhance the relationship summary's clarity, usability, and design.

Finally, we added a requirement to provide a link to Investor.gov/ CRS and state that free and simple search tools are available at Investor.gov/CRS in order to research firms and financial professionals. Firms also will state that the page provides educational materials about broker-dealers, investment advisers, and investing. These materials include information about the different services and fees that broker-dealers and investment advisers offer. We believe a focus on Investor.gov and specifically the Investor.gov/CRS page at the beginning of the relationship summary will be more helpful to retail investors than the proposed relationship summary introduction. Investor.gov provides various resources that can assist with investor education relating to firms and their professionals. Among other components, Investor.gov currently provides resources prepared by Commission staff for retail investors to:

  • Review the background of their investment professional;
  • Educate themselves about investment products, including the risks and unique characteristics of many products;
  • Perform fee calculations;
  • Review Investor Alerts and Bulletins;
  • Find contact information for the Commission; andStart Printed Page 33515
  • Review educational information regarding broker-dealers and investment advisers.[253]

The Investor.gov/CRS page will bring together these types of educational materials about investment professionals, along with broader tools and other content specifically tailored for retail investors on Investor.gov, which will help them to more easily learn about different types of firms and find information about specific firms and financial professionals.

As discussed further below, we are removing discussions in the proposed relationship summary that were more generalized or educational in nature, including the comparison sections for standalone broker-dealers and investment advisers and other statements comparing these two different types of financial services and fees. Many commenters indicated that the Commission is generally better-positioned to provide investor education materials as compared to firms.[254] As a result, the revised introduction provides the Investor.gov/CRS link at the beginning of the relationship summary to direct retail investors to the Commission staff's resources and highlights the importance of investor education.[255]

Investors and commenters also supported highlighting Investor.gov more generally. Investor feedback at roundtables generally indicated that Investor.gov was a useful website for retail investors and should be prominent in the relationship summary.[256] Comment letters were supportive of the Commission providing educational materials to retail investors generally and Investor.gov specifically.[257] Observations in surveys and studies also indicated that many retail investors would seek information at Investor.gov and would trust that information because it is a government site.[258] Some investor studies, however, indicated that retail investors did not understand what information was available at Investor.gov.[259] Moving the link to Investor.gov/CRS and the related explanation to the front of the relationship summary (from the “Additional Information” section at the end of the relationship summary, as proposed) will address this issue by making the website more prominent and by concentrating information helpful to retail investors on one dedicated page on Investor.gov.

2. Relationships and Services

As proposed, after the introduction firms will be required to summarize the relationships and services that they offer to retail investors. They will use a revised heading, “What investment services and advice can you provide me? ”, which follows the new question-and-answer format.[260] Several commenters used this question or a similar heading in mock-ups they provided.[261] Generally as proposed, we are requiring firms to provide information about specific aspects of their brokerage and investment advisory services, with modifications from the proposal to permit firms to use their own wording to cover these topics.

We proposed separate instructions for firms to describe brokerage account services and investment advisory account services. Firms would have used a mix of prescribed wording and their own wording to provide a summary overview of fees and certain required topics, including the scope of advice services, investment discretion, monitoring, and significant limitations on investments available to retail investors.[262] We received feedback from the observations in the RAND 2018 report, other surveys and studies and on Feedback Forms that relationships and services is an important area to cover,[263] and that investors learned important information from the prescribed wording on relationships and services.[264] In addition, the IAC recommended that the Commission adopt a uniform, plain English disclosure for retail investors that would include basic information “about the nature of services offered,” among other Start Printed Page 33516things.[265] However, some commenters expressed concern that, without more educational content, this approach would not sufficiently inform or would confuse retail investors.[266] One commenter pointed out that the proposed instructions dictated different ways for broker-dealers and investment advisers to describe similar services.[267] These commenters suggested including more explanatory wording or definitions to cover what services are typically associated with brokerage accounts and investment advisory accounts, to provide more background information to help retail investors understand the firm-specific disclosures.[268] At the same time, commenters noted that summary, prescribed wording for this section may not accurately describe the services of every broker-dealer or investment adviser.[269] Results of the RAND 2018 survey reflected these concerns and showed that almost a quarter of survey respondents (22.2%) described the relationships and services section as “difficult” or “very difficult” to understand.[270] Comments from participants in qualitative interviews reported in the RAND 2018 report, as well as comments from roundtable participants and on Feedback Forms, indicated that prescribed terms such as “transaction-based fee,” “asset-based fee,” “discretionary account,” and “non-discretionary account” contributed to this difficulty.[271]

As discussed in Section II.A.1. above, we are sensitive to the potential inaccuracies and confusion that the prescribed wording can create. We also recognize that in some cases, providing instructions that require broker-dealers and investment advisers to describe similar services in different ways can create confusion. Accordingly, we have revised the instructions to allow firms to use more of their own wording. We also eliminated the separate instructions for brokerage account services and investment advisory account services, and instead are adopting one set of instructions that generally applies the same requirements to all firms.[272] To facilitate comparison of firms' relationships and services, however, we have retained the concept of specific sub-topics that each firm must cover in this section.[273]

Another change from the proposed instructions relates to a concern regarding how accounts were delineated. The proposed instructions would have applied based on whether or not broker-dealers and investment advisers offered brokerage accounts or investment advisory accounts to retail investors and would have included some prescribed language referencing accounts.[274] Insurance and variable annuity providers commented that this focus on accounts would not allow them to accurately describe insurance offerings and would be confusing, particularly to investors whose insurance or annuity products are held directly with an issuing insurance company.[275] We agree and have replaced references to accounts in this section with references to “services, accounts, or investments you make available to retail investors.” [276]

a. Description of Services

The final instructions have an overarching requirement to state that the firm offers brokerage services, investment advisory services, or both, to retail investors, and to summarize the principal services, accounts, or investments the firm makes available to retail investors.[277] A firm also must include any material limitations on those services.[278] The final instructions require firms to include certain Start Printed Page 33517information in their descriptions. Similar to the proposal, broker-dealers must state the particular types of principal brokerage services the firm offers to retail investors, including buying and selling securities, and whether or not they offer recommendations to retail investors (i.e., to distinguish execution-only services).[279] Investment advisers must state the particular types of principal advisory services they offer to retail investors, including, for example, financial planning and wrap fee programs.[280] The final instructions do not, however, require prescribed wording to describe the particular characteristics of these services, as did the proposed instructions.[281] Commenters argued that the proposed prescribed wording may not accurately describe the services of every broker-dealer or investment adviser.[282] As discussed in Section II.A.1 above, given that investors may be confused by information that does not directly relate to the firm's offerings, we are allowing firms to use their own wording to describe their own services. Therefore, unlike the proposal, the final instructions do not prescribe specific wording for firms to describe the particular characteristics of these services.[283]

Some commenters raised concerns about investor confusion if both broker-dealers and investment advisers discuss the advice they provide in the relationship summary. To mitigate that confusion, some commenters called for an explicit statement that broker-dealers are in sales relationships.[284] In response to these concerns, we added the explicit requirement that broker-dealers state that they buy and sell securities, in order to clarify their principal services.[285] We also have included a note in the final instructions that broker-dealers offering recommendations should consider the applicability of the Investment Advisers Act of 1940, consistent with SEC guidance.[286]

The final instructions require all firms to address the following topics in the description of their services: (i) Monitoring; (ii) investment authority; (iii) limited investment offerings; and (iv) account minimums and other requirements.[287] As discussed further below, the final instructions require firms to include much of the same substantive information as proposed, but rely less on prescribed wording and assumptions regarding typical brokerage and investment advisory accounts.[288] In response to comments, we added a new requirement for firms to disclose whether or not they have account minimums.[289] Commenters recommended that we include information about account minimums in the relationship summary.[290] In addition, a number of commenters submitting mock-ups included disclosures on account minimums in their forms.[291] We agree this information is important to investors when they are deciding on account types and services, particularly as they consider the amount of funds they are planning to invest and whether they may incur any fees or become ineligible for certain services if their accounts fall under certain dollar thresholds. We also removed requirements to discuss fees at the beginning of this section [292] and are consolidating these requirements with other related ones in the fees, costs, conflicts, and standard of conduct section, as discussed below.[293] We also are not adopting a proposed requirement to describe any regular communications with retail investors.[294] Neither the RAND 2018 report nor other surveys and studies suggested that this information was important to investors, as compared to fees. Mock-ups submitted by commenters also did not include this disclosure, underscoring the relative importance of other topics. Given the goal of limiting the length of the relationship summary so that investors remain engaged and are not overwhelmed by the information, we decided to prioritize requiring other information in the relationship summary.

Monitoring. The final instructions require both broker-dealers and investment advisers to explain whether or not they monitor retail investors' investments, including the frequency and any material limitations of that monitoring, and if so, whether or not the monitoring services are part of the firm's standard services.[295] In the proposal, different instructions concerning monitoring applied to broker-dealers and investment advisers. Broker-dealers would have stated whether they monitored the performance of retail investors' accounts, and if so, how frequently they performed such monitoring, whether it constituted additional services or was part of the broker-dealer's standard services, and whether a retail investor would pay more for it.[296] Investment advisers Start Printed Page 33518would have stated how frequently they monitor retail investors' accounts.[297]

One commenter objected to the requirement for broker-dealers to describe additional services, including monitoring, on the basis that the information would add little value.[298] On the other hand, several commenters suggested that understanding the degree to which firms monitor the performance of their investments can be important to investors.[299] One of these commenters noted that broker-dealers and investment advisers have different legal obligations to monitor accounts, and that differences would remain even under Regulation Best Interest.[300] Observations from surveys and studies indicated that investors are interested in or may benefit from clarification of monitoring services.[301] For example, an overwhelming majority of participants in the OIAD/RAND study believed that a financial professional required to act in an investor's best interest would monitor the investor's account on an on-going basis.[302] In qualitative interviews in the RAND 2018 report, participants seemed to distinguish brokerage and investment advisory accounts and assess which type of relationship was a better fit for different investors based on assumptions concerning monitoring.[303] Other surveys and studies also showed that participants varied in their understanding of monitoring and whether they should expect firms to monitor their account.[304]

We disagree with the comment that requiring broker-dealers to describe monitoring services would add little value. As we also state in the Regulation Best Interest Release, we believe that it is important for retail customers to understand (1) the types of monitoring services (if any) a particular broker-dealer provides, and (2) whether the broker-dealer will be monitoring the particular retail customer's account.[305] We also agree with commenters that monitoring is an important distinguishing feature of different investment services and believe that retail investors should have accurate expectations of the types of monitoring firms offer. We are therefore requiring firms to explain whether or not they monitor retail investors' investments, and if so, the frequency, material limitations, and whether or not monitoring is offered as part of the firm's standard services.[306]

The proposal provided different instructions for broker-dealers and investment advisers concerning monitoring, requiring broker-dealers to discuss monitoring of account performance only if they offered it, and requiring investment advisers to disclose how frequently they monitor retail investors' accounts, as monitoring is generally part of ongoing advisory services.[307] Even with the different wording for broker-dealers and investment advisers as proposed, some participants in investor studies still assumed that the level of monitoring was the same between broker-dealers and investment advisers.[308] As discussed above, we believe it is important for firms to describe more accurately and precisely the monitoring that they actually do for retail investors. Therefore, we are retaining, with slight modifications, the obligation to disclose monitoring services, applying the same instruction to both broker-dealers and investment advisers, and eliminating the prescribed wording. The final instructions pertain to monitoring services generally and are not limited to monitoring for account performance only; to the extent firms describe monitoring services, they must include the frequency and any material limitations on these services and whether or not they are offered as part of the firm's standard services. We believe that subjecting firms to the same requirements to describe their own monitoring services, including a specific statement that they do not provide monitoring, if that is the case, will better facilitate investor understanding of whether any monitoring is provided and if so, the scope and type of such service. This approach also may result in more comparable information so that retail investors can understand the key differences among monitoring services by different firms based on firm-specific descriptions.

Investment Authority. The final instructions require investment adviser firms that accept discretionary authority to describe those services and any material limitations on that authority. Broker-dealers may, but are not required, to state whether they accept limited discretionary authority. Both investment advisers that offer non-discretionary services and broker-dealers must explain that the retail investor makes the ultimate decision regarding the purchase or sale of investments.[309]

Commenters and results from the RAND 2018 qualitative interviews suggested modifications to the proposed investment authority disclosures in the relationship summary but generally supported including this topic.[310] In Start Printed Page 33519addition, various commenters submitting their own mock-ups included disclosures on investment authority in their relationship summaries.[311] One commenter also alluded to disputes that can arise when investors misunderstand the investment authority the financial professional exercises for different accounts.[312] One investor study indicated that only a few investors understood from the proposed sample dual-registrant relationship summary that non-discretionary advisory accounts offer investors the ability to approve recommendations.[313] Some RAND 2018 interview participants indicated that further definitions of “discretionary account” and “non-discretionary account” would be helpful.[314]

We continue to believe that it is important for investors to understand whether they or the firm or financial professional ultimately makes the investment decision in the relationship or service that they are considering. Accordingly, the final instructions generally require disclosure of the same substantive information on this topic as the proposed instructions, but in a less prescriptive way. As discussed in Section II.A.1, above, we believe that allowing firms to use their own wording to describe their discretionary and non-discretionary offerings and explaining what that means to retail investors in terms of who makes the ultimate investment decisions can lead to disclosures that are more meaningful and less confusing. We recognize that some investor feedback suggested that further definitions of “discretionary account” and “non-discretionary account” would be useful. While the final instructions do not require prescribed wording including these terms, as the proposed instructions would have required, the final instructions do require investment advisers that accept discretionary authority to use their own wording to explain similar information.[315]

The final instructions provide that investment advisers that accept discretionary authority will be required to describe these services and any material limitations on that authority.[316] Additionally, any such summary must include the specific circumstances that would trigger that discretionary authority and any material limitations.[317] Investment advisers may, for example, explain whether they seek the retail investor's approval before implementing or changing investment strategies or executing certain transactions. In comparison, the proposed instructions took a more prescriptive approach.[318] For example, the proposed instructions prescribed wording for investment advisers to include in their relationship summaries if they offer a discretionary account.[319] We believe that the more general final instruction provides investment advisers with the flexibility to describe their discretionary offerings more accurately.

For broker-dealers, the final instructions provide that they may, but are not required to, state whether they accept limited discretionary authority.[320] We have made this disclosure optional for broker-dealers because of our understanding that these services may not be a significant part of broker-dealers' services.[321] Accordingly, describing them here may detract from disclosure of other items that better characterize the firm's business and would be more helpful to investors. If limited discretion services are a significant part of a broker-dealer's business, for example, if limited discretion services constitute material facts relating to the scope and terms of the relationship with the retail customer that need to be disclosed under Regulation Best Interest, that broker-dealer may wish to include in its relationship summary a statement that it offers limited discretion services.

Finally, both broker-dealers and investment advisers that offer non-discretionary services must explain that the retail investor makes the ultimate decision regarding the purchase or sale of investments.[322] Under the proposed instructions, firms would have been required to explain whether they offer non-discretionary services and what that means, but using prescribed wording. Investment advisers would have been required to state that they give advice and the retail investor decides what investments to buy and sell.[323] Broker-dealers would have been required to state that the retail investor will make the ultimate investment decision regarding the investment strategy and the purchase or sale of investments, in addition to other prescribed wording to distinguish execution-only accounts from those in which the broker-dealer would offer recommendations.[324] The final Start Printed Page 33520instructions require firms to explain to retail investors that they make the ultimate investment decision in non-discretionary accounts, but do not include requirements to use prescribed wording or references to account types. This change is consistent with our general approach described above that such prescribed wording may be confusing or may not sufficiently cover the discretionary and non-discretionary services a firm may offer.[325]

Limited Investment Offerings. The final instructions require firms to explain whether or not they make available or offer advice only with respect to proprietary products, or a limited menu of products or types of investments. If so, they must also describe the limitations.[326] In comparison, the proposed instructions included prescribed wording for firms to include if they significantly limit the types of investments in any accounts.[327] Specifically, broker-dealers would have stated, “We offer a limited selection of investments. Other firms could offer a wider range of choices, some of which might have lower costs.” [328] Investment advisers would have stated, “Our investment advice will cover a limited selection of investments. Other firms could provide advice on a wider range of choices, some of which may have lower costs.” [329] The proposed instructions gave examples of what might constitute a significant limitation on the types of investments, specifically, offering only one type of asset (e.g., mutual funds, exchange-traded funds, or variable annuities); mutual funds or other investments sponsored or managed by the firm or an affiliate, i.e., proprietary products; or only a small number of investments.[330] If these limits applied only to certain accounts the proposed instructions would have required firms to identify those accounts.[331]

Comments were mixed on the proposed instruction concerning limited investment offerings. Several commenters acknowledged the importance of investors understanding limitations on investments.[332] Results of RAND 2018 qualitative interviews also indicated that investors would like to understand limits on investment offerings.[333] Some commenters expressed concerns that the proposed disclosure would not be of sufficient value to investors.[334] A number of commenters, whether or not they supported generally requiring firms to discuss limitations on investments, expressed concerns that the scope of “significantly limits” in the proposed instructions or “limited selection of investments” was not sufficiently clear.[335] Furthermore, a few commenters expressed concern that the prescribed wording (“Other firms could offer a wider range of choices, some of which might have lower costs.”) unduly prioritized cost over other investment product features or characteristics.[336]

We continue to believe that firms that limit product menus—such as offering only proprietary products or a specific asset class—should be required to describe those limitations in the relationship summary.[337] Other examples include limitations based on products that involve third-party arrangements, such as revenue sharing and mutual fund service fees. We agree with commenters who advocated for helping investors before entering into a relationship with a firm to understand whether a firm limits its product offerings, and to what extent.[338] In light of comments, we have determined, however, that the proposed prescribed wording may not allow all firms to describe limited investment offerings, if applicable, in a way that is accurate and helpful to investors, and are not requiring it in the final instructions.[339] Accordingly, we are revising the instructions to require firms to address whether or not they make available or offer advice only with respect to proprietary products or a limited menu of products or types of investments, and if so, to describe such limitations.[340] We believe that the final instructions address the same types of limitations on investments that the proposed instructions sought to address, but in a less prescriptive way, and allow firms to describe their investment offerings more accurately to reflect their scope of products and services.

Account Minimums and Other Requirements. The final instructions also include a requirement to explain whether or not the firm has any requirements for retail investors to open or maintain an account or establish a relationship, such as minimum account Start Printed Page 33521size or investment amount, which is a change from the proposal.[341] In response to our request for comments on such possible requirements, commenters recommended that we include this information in the relationship summary.[342] In addition, a number of commenters submitting mock-ups included disclosures on account minimums in their forms.[343]

We agree that this is important for retail investors to understand because many firms offer a number of services that are only available to investors with higher account balances.[344] Furthermore, fee schedules may be tiered based on account balances.[345] Investors benefit from being aware of and seeing a range of options in the same context, as discussed above. We believe investors can use information about different account requirements for both current and future decision-making purposes. Thus, the final instructions require firms to address whether or not they have any requirements for retail investors to open or maintain an account or establish a relationship, such as a minimum account size or investment amount.

b. Additional Information

In a change from the proposal we are requiring firms to provide specific references to more detailed information about their services that, at a minimum, include the same or equivalent information to that required by the Form ADV, Part 2A brochure (Items 4 and 7 of Part 2A or Item 4.A and 5 of Part 2A Appendix 1) and Regulation Best Interest, as applicable.[346] Broker-dealers that do not provide recommendations subject to Regulation Best Interest (e.g., execution-only broker-dealers) are not required to prepare more detailed information about their services, but to the extent they do, must include references to such information in their relationship summaries.[347] The final instructions require firms to use text features to make this additional information more noticeable and prominent in relation to other discussion text.[348]

As with other references to additional information, firms may include hyperlinks, mouse-over windows, or other means of facilitating access to this additional information and to any additional examples or explanations of such services.[349] This allows firms to summarize their services while making available more detailed and fulsome information for retail investors, in keeping with the design of the relationship summary as a short, succinct disclosure with links to additional information, as commenters and investors asked. We believe that requiring firms to make retail investors aware of the services they offer, at a high level, and where retail investors can obtain more detailed information through layered disclosure, will best engage retail investors and help them make more informed decisions when choosing from among firms, services, or accounts.

c. Conversation Starters

Firms will include in this section of the relationship summary three prescribed conversation starters for retail investors to ask their financial professional.[350] As discussed in Section II.A.4, these questions are taken from the Key Questions to Ask section in the proposed relationship summary, which a considerable majority of investors indicated were helpful.[351] Broker-dealers and investment advisers that are not dual registrants will include, respectively, “Given my financial situation, should I choose a brokerage service? Why or why not?” or “Given my financial situation, should I choose an investment advisory service? Why or why not?” [352] Dual registrants will include “Given my financial situation, should I choose an investment advisory service? Should I choose a brokerage service? Should I choose both types of services? Why or why not?” [353] These questions are largely the same as the first proposed Key Question but replace the terms “brokerage account” and “advisory account” with “brokerage service” and “investment advisory service,” respectively.[354] This revision addresses comments that the concept of “accounts” may not align with all firms' business models and may cause investor confusion.[355] In addition, some commenters stated that it was inappropriate for the Commission to require firms to describe products and services that they do not offer and about which they may have limited or no expertise.[356] Although the proposed instructions permitted firms to modify the first Key Question to reflect the type of accounts they offer to retail investors, we are replacing it with three formulations that are explicitly tailored to firm type in order to clarify that firms are obligated to discuss only the services that they offer. Finally, we have rephrased the questions as “Should I choose [a/an brokerage/advisory] service? Why or why not?” rather than “Why should I choose [a/an brokerage/advisory] service?” to avoid a presumption that the relevant service will always be an appropriate service for the retail investor. The questions are designed to prompt a conversation relevant to the specific retail investor's circumstances.

All firms also will include the questions “How will you choose investments to recommend to me?” and “What is your relevant experience, including your licenses, education and other qualifications? What do those qualifications mean?” [357] These questions are nearly identical to proposed Key Questions numbers six and nine except, again, for the removal of the account concept from proposed Key Question number six, and a minor revision to proposed Key Question number nine to encourage retail investors to ask a broader question regarding the financial professional's Start Printed Page 33522qualifications.[358] We believe that answers to these questions will be helpful to retail investors as they make their choices. In addition, a significant majority of participants from the RAND 2018 survey indicated that they would feel comfortable asking any of the Key Questions.[359] Although fewer participants indicated that they would feel “very comfortable” asking about the financial professional's experience and qualifications, compared with the other two questions,[360] we believe that including this question serves as a useful reminder both to investors who would feel comfortable and as encouragement to those who are hesitant that asking such a question is acceptable.

Requirements Removed from the Proposed Instructions. The final instructions do not include several specific requirements that were proposed in this item. First, the proposal would have required firms to describe their transaction-based fees and asset-based fees in this section, in addition to the more specific fee information required in a separate fee section.[361] We learned from an investor study submitted by commenters that dispersing information on the same topic throughout several sections of the relationship summary or separating that information with an unrelated topic could confuse investors.[362] This illustrated the importance of establishing sufficient context and increasing the salience of related information by ensuring that it is kept together in the relationship summary. We agree that fee information should be provided together, and have eliminated fee disclosures from the Relationship and Services section to locate it with other fee information in an effort to reduce investor confusion.

In addition, the final instructions do not require firms to describe regular communications with retail investors, including frequency and method, as proposed. Comments were mixed on the proposed instruction. One commenter expressed the view that proposed Form CRS suggested that firms should contact advisory clients by phone or email every quarter and disagreed with this implication. The commenter recommended that instead of mandating the form or frequency of contact with clients, the Commission should continue to give advisory clients flexibility to communicate how and when they want, as long as investment advisers are meeting their obligations under the Advisers Act.[363] Another commenter noted that misunderstandings concerning broker-dealers' duty or intention to monitor accounts can be avoided by proper communications, most importantly at the time the relationship is formed.[364] Mock-ups submitted by commenters generally did not refer to or describe communications between the firm or financial adviser and the investor.[365] The proposal was not designed to mandate the form or frequency of contact with clients. Nonetheless, given these mixed responses, our goal of keeping the relationship summary focused on a limited amount of information, and to allow more flexibility for firms to describe their services more accurately and meaningfully, firms will not be required to describe the frequency and method of their regular communications with retail investors. Firms may include this information, however, to help investors better understand the services provided.

3. Summary of Fees, Costs, Conflicts, and Standard of Conduct

In response to comments, feedback from investors at roundtables and on Feedback Forms, and observations reported by the RAND 2018 report and other surveys and studies, we are adopting changes to the relationship summary's required discussion of fees, costs, conflicts of interest, and standard of conduct. Commenters generally supported the Commission's goal of providing investors with reliable and straightforward information about the fees they pay, the standard of conduct applicable to financial professionals, and conflicts of interest relating to financial professional compensation.[366] Some suggested that the fee disclosure should be more prominent in the proposed relationship summary and located towards the front of the relationship summary and also suggested modifications to sections of the relationship summary addressing financial professional conflicts of interest and standards of conduct.[367]

Results of the RAND 2018 report and other surveys and studies showed that investors view information about fees and costs as one of the most important of the proposed sections of the relationship summary.[368] Investor Start Printed Page 33523feedback at roundtables and through Feedback Forms also showed the importance of fees and cost information to investors.[369] However, the RAND 2018 survey and other surveys and studies also indicated that the proposed relationship summary presentation of fee and cost information could be difficult for investors to understand.[370] The RAND 2018 survey and other surveys and studies also suggested that investors found sections in the proposed relationship summary covering the obligations of financial professionals and conflicts disclosure less informative,[371] and indicated that investors could have difficulty understanding and synthesizing information about the obligations of financial professionals and the impact of conflicts of interest.[372] As discussed more fully below, we considered all of this feedback, as well as comments received, in redesigning the disclosures related to the topics.

A new Item 3 will require the relationship summary to cover three areas: (i) Fees and costs; (ii) standard of conduct and conflicts of interest; and (iii) financial professional compensation and related conflicts of interest. Some of the key elements of these disclosures include:

  • Integrated sections covering fees, costs, conflicts of interest, and standard of conduct. We have modified the proposal by combining the fees and costs section and the sections discussing conflicts of interest and standard of conduct into one Item 3 that will require three consecutive sections. These sections will help illustrate the interconnectedness of fees, costs, conflicts, and standard of conduct, and will keep these related disclosures close in proximity to each other.
  • Distinct summaries of principal fees and costs other fees and costs, and other ways the firm makes money. We are also requiring separate sections discussing certain fees and costs, with one section discussing principal fees and costs, another section discussing other fees and costs related to the firm's services and investments, and another section discussing other ways the firm and its affiliates make money. We are not requiring firms to discuss all of the fees and costs together as proposed, to address comments and feedback that the section was complicated and overwhelming. We are also requiring a firm to include cross-references to more detailed information about the firm's fees.
  • A description of the standard of conduct with conflicts. We are placing the description of the standard of conduct under the same heading as a summary of conflicts in order to help retail investors better understand the relationship between the standard of conduct and conflicts.
  • Broadening the types of conflicts disclosure. We are requiring firms to disclose information on the topics that were required in the proposal—i.e., proprietary products, third-party payments (shelf space and revenue sharing arrangements), and principal trading. But we are requiring firms without these conflicts to disclose at least one material conflict. We are also requiring a firm to include cross-references to more detailed information about the firm's conflicts of interest.
  • Financial professional compensation. We are adding a separate section that will require a firm to highlight how its financial professionals are compensated and the conflicts of interest those payments create. This disclosure will distinguish firm-level from financial professional-level conflicts.

The proposal would have included one section summarizing fees and costs, one section summarizing conflicts of interest, and one section discussing the applicable standards of conduct. The principal fees were also discussed at the beginning of the services section, and for standalone investment advisers and broker-dealers, the section discussing fees and costs and the section discussing conflicts of interest were separated by a section discussing comparisons between investment advisers and broker-dealers. Commenters suggested locating fee and conflict disclosures more closely together, and several sample relationship summaries submitted by commenters placed the fees and conflicts sections in close proximity to each other.[373] As noted, we learned from an interview-based study submitted by a commenter that investors could have trouble connecting related information when those sections were not closely located.[374] Observations in the RAND 2018 qualitative interviews and comments submitted on Feedback Forms also suggested that investors' level of understanding varied significantly with regard to the relationship between the applicable standard of conduct and conflicts, and that investors might be more confused by this relationship when the relationship summary placed these sections far apart from one Start Printed Page 33524another.[375] We agree that it is important to illustrate the relationship between fees, conflicts, and standards of conduct. We are therefore combining in Item 3 of the final instructions the discussions on fees and costs with discussions of firms' conflicts of interest, and combining the standard of conduct discussion with the discussion of certain other conflicts of interest.

a. Description of Principal Fees and Costs and Other Fees

Similar to the proposal, firms will be required to summarize the principal fees and costs that retail investors incur with respect to their brokerage and investment advisory accounts, and the conflicts of interest they create.

As noted above, commenters generally supported the Commission's goal of providing investors with reliable and straightforward information about the fees they pay and suggested making this information more prominent and located towards the front of the relationship summary.[376] Similarly, observations in the RAND 2018 report, and other surveys and studies, and comments from investors at roundtables and in Feedback Forms, overwhelmingly supported including fee disclosure in the relationship summary and showed that investors believe that information about fees and costs is important to understanding their relationship with a financial professional.[377] The RAND 2018 survey reported, however, that survey participants were more likely to rate the proposed relationship summary section on fees and costs as “difficult” or “very difficult” to understand and would add more detail.[378] In the RAND 2018 qualitative interviews, participants generally understood that this section would provide information on the types of fees they could possibly pay, but also found the section overwhelming with the number of various types of fees and had some difficulty with language, including certain terms.[379] Some participants also did not appear to synthesize information about fees and conflicts of interest to be able to apply it.[380] Other surveys and studies, and comments provided on Feedback Forms, also indicate that investors both want additional information about fees and costs and found this information difficult to understand.[381] Several commenters also said that information on fees and costs was not straightforward and used too much technical jargon.[382] In addition, the IAC recommended that the Commission adopt a uniform, plain English document that covers basic information about fees and compensation, among other topics.[383] The Feedback Form commenters and observations reported in the RAND 2018 report and other surveys and studies reaffirms our view that it is critical for retail investors to better understand the fees and costs incurred with their investments and related conflicts of interest. This section has been revised to further our policy objective of helping investors better understand such fees, costs, and conflicts of interest.

Description of Principal Fees and Costs. First, using the heading “What fees will I pay?”,[384] firms will summarize their principal fees and costs that retail investors will incur for brokerage or investment advisory services, including how frequently such fees are assessed and the conflicts of interest they create.[385] Broker-dealers must describe their transaction-based fees [386] and investment advisers must describe their ongoing asset-based fees, fixed fees, wrap fee program fees, or other direct fee arrangements.[387] The fees described by investment advisers should align with the type of fee(s) disclosed in response to Form ADV Part 1A, Item 5.E, but they should be summarized in a way that provides retail investors a high-level overview.[388]

Although the proposal required firms to include information about their principal fees and costs, much of the wording was prescribed. For instance, the proposed instructions included prescribed wording to describe transaction-based fees and asset-based fees and the incentives that each of those fees create.[389] The proposed instructions also required firms to use technical terms and explain their definitions (e.g., “mark-up” or “mark-Start Printed Page 33525down,” “load,” and “custody”).[390] Additionally, firms providing advice about investing in wrap fee programs were required to include several more prescribed sentences.[391] Finally, dual registrants were required to state when a retail investor may prefer a brokerage or investment advisory service from a cost perspective,[392] and wrap fee program providers had to explain when a retail investor may prefer a wrap fee program.[393] Commenters argued that in many cases the prescribed wording was confusing and not accurate.[394] For example, several commenters indicated the proposed fee discussion was unnecessarily technical and suggested the relationship summary avoid the use of jargon (e.g., terms like “asset-based fee” and “load”) in this section.[395] Several roundtable participants also said that they did not understand these terms,[396] as did some participants in investor studies and surveys.[397] Other commenters noted that the wording in the proposal was too binary.[398] Another commenter argued that certain prescribed wording was obvious to retail investors and did not add value to the retail investor.[399]

In an effort to balance the goal of educating retail investors with the need to provide firms with enough flexibility to tailor the disclosure to their services and investments, we have decided to remove from the Instructions the prescribed wording we proposed about fees and costs.[400] Specifically we are replacing the prescribed wording with a requirement to describe the firm's principal fees and the conflicts of interest they create. We have also included examples in the instructions of statements that would describe certain principal fees. We have concluded, based on consideration of the comments and investor feedback, that the proposed requirements did not reflect the fees for all firms and, depending on firms' business models, could be confusing. Instead the relationship summary will focus on a high level summary of fees. Having considered comments, we believe this more flexible approach will better facilitate meaningful disclosure in the relationship summary, as well as conversations between the retail investor and his or her financial professional, and help the retail investor decide on the types of services that are right for him or her. Additionally, we believe that certain definitions and concepts explained in the proposed relationship summary can be better explained in other ways, such as through layered disclosure that explain technical terms as appropriate for the specific firm (e.g., “hovers”).[401] Further, requiring firms to draft their own descriptions will allow them to tailor the description to their particular business models, including the fees their prospective customers and clients will most commonly incur, which will make the discussion more accurate and relevant and further help facilitate retail investors' comprehension.

In addition, we are not including the proposed prescribed wording with respect to wrap fee programs.[402] Instead, investment advisers that offer these services to retail investors should include disclosure about the relevant fees and conflicts of interest, and explain the program. We are including instructions encouraging investment advisers with wrap fee programs to explain that asset-based fees associated with the wrap fee program will include most transaction costs and fees to a broker-dealer or bank that has custody of these assets, and therefore are higher than a typical asset-based advisory fee.[403]

We also removed the proposed disclosures about which type of service or account is better for a retail investor. Specifically, the proposal would have required firms to include prescribed wording about when a retail investor may prefer paying a transaction-based fee or an asset-based fee.[404] Although Start Printed Page 33526some commenters did not object to the proposed prescribed wording and some included it in their mock-ups,[405] several commenters raised concerns.[406] For example, one commenter argued that the required wording could be false and misleading, noting that the required statements do not take into account that transaction-based fees are not necessarily more affordable for buy-and-hold investors who do not trade often, many broker-dealers offer higher-cost investment products (e.g., variable annuities, non-traded REITs, and private placements), and many investment advisers recommend investments with lower operating expenses than those sold by brokers.[407] We have concluded that the proposed required wording did not capture all of the information that, in certain circumstances, would be necessary to help retail investors reasonably assess whether a particular service and its associated fees will be better for them. Instead, the relationship summary provides information about what the firm offers and encourages discussion with conversation starters. Such a discussion—facilitated by Form CRS—is more appropriate between the financial professional and the retail investor about the firm's specific offerings and associated fees and conflicts, and the retail investor's specific circumstances.

The proposal also required firms to state whether their fees vary and are negotiable and to describe the key factors that would help a reasonable retail investor understand the fee that he or she is likely to pay for services.[408] In the RAND 2018 qualitative interviews, some participants were confused by the statement about fees being negotiable and most mock-ups commenters submitted did not include this disclosure.[409] We did not include this requirement in the final instruction. It is important to instead focus the relationship summary on information about fees that retail investors identified as important to their assessment of firms. Given the comments and investor testing results showing that the fee section was technical and difficult to understand, we believe that the final instructions will help investors focus on the information the final instructions do require. We believe that removing information about negotiability should help achieve this objective.

In another modification from the proposal, we are requiring firms to discuss the conflicts of interest created by their principal fees and costs rather than prescribing specific wording about those conflicts. We are making this change in response to commenters, who pointed out that the conflicts of interest created by principal fees can vary in more ways than our prescribed wording contemplated.[410] Instead of prescribed wording, the final instructions include a requirement that firms explain the conflict of interest their principal fees create, as well as examples of how a firm may communicate certain conflicts of interest. These examples are the same conflicts the proposed instructions required. For instance, a broker-dealer could disclose its conflicts of interest related to transaction-based fees by stating that a retail investor would be charged more when there are more trades in his or her account and that the firm may therefore have an incentive to encourage a retail investor to trade often.[411] Investment advisers that charge an asset-based fee could disclose related conflicts of interest by stating that the more assets in a retail investor's advisory account, the more the retail investor will pay in fees, and the firm may therefore have an incentive to encourage the retail investor to increase the assets in his or her account.[412] Firms that offer variable annuity and variable life insurance products could disclose that they have a financial incentive to offer a contract that includes optional benefit features, which may entail additional fees on top of the base fee associated with the contract, that they may encourage contract owners to select investment options with relatively higher fees, or that they may offer the contract owner a new contract in place of the one that he or she already owns. Finally, we also have included a note in the final instructions that an investment adviser receiving compensation in connection with the purchase or sale of securities should consider the applicability of the broker-dealer registration requirements of the Exchange Act and any applicable state securities statutes.[413]

Description of Other Fees and Costs. Firms also will be required to describe other fees and costs related to their brokerage and investment advisory services and investments, in addition to the firm's principal fees and costs, that the retail investor will pay directly or indirectly. Firms must list examples of the categories of the most common fees and costs that their retail investors will pay directly or indirectly.[414] Those fees and costs may include, for example, custodian fees, account maintenance fees, fees related to mutual funds and variable annuities, and other transactional fees and product-level fees.[415] With regard to product-level fees, in particular, firms may wish to highlight certain fees such as distribution fees, platform fees, shareholder servicing fees and sub-transfer agency fees, in order to enhance the retail investor's understanding of these fees to the extent applicable to the customer's transactions, holdings, and accounts.

We recognize that the fees and costs that a firm determines to be the most common will vary and depend on particular products and services the firm offers and the fee arrangements associated with those products and services. Generally, in making this determination, firms should consider, for example, the amount of the fee (including whether the fee varies based on options the investor may select such as optional benefits and the investment options that a contract owner may select in the context of variable annuities and variable life insurance products), the likelihood that the fee will be applicable, whether the fee is ordinarily assessed on a significant number of the firm's clients, whether the fee is associated with a product or service that the firm frequently recommends or provides, whether the fee is contingent Start Printed Page 33527upon certain events the investor should be made aware of, the effect on returns, and the magnitude of the conflict of interest it may create. For example, an investment adviser should consider discussing commissions that are charged when an investment is bought or sold. A firm that commonly offers an investment that includes a surrender fee—for example, a variable annuity or variable life insurance contract is sold as a long-term investment that may entail relatively high surrender fees—should consider disclosing that a retail investor could be required to pay fees when certain investments are sold.

The proposal similarly required firms to state that retail investors will pay other fees in addition to the firm's principal fees. Like the final instructions, the proposal required disclosure of the other fees related to the services or account such as custodian fees, account maintenance fees, and account inactivity fees, and included these other fees in the same section discussing the firm's principal fees.[416] The proposal also required that all firms disclose that certain investments imposed additional fees, including fees that reduce the value of investments over time (e.g., mutual funds and variable annuities) and fees paid when an investment is sold (e.g., surrender charges for selling variable annuities).[417] Observations reported from RAND 2018 qualitative interviews and another study indicated that some investors could become overwhelmed with the number of various types of fees and many were surprised that so many different types of fees could apply in addition to a firm's principal fee.[418] At the same time, investors participating in surveys and studies and investors providing comments on Feedback Forms have indicated that more information would be helpful.[419] Industry commenters, commenters representing investors, and commenters on Feedback Forms, and roundtable participants supported some disclosure regarding product-level fees, though commenters differed in the level of suggested detail on such fees.[420] For instance, one commenter stated that the relationship summary should reveal all fees and commissions for all purchases.[421] Other commenters, however, believed that a link to the prospectus should sufficiently satisfy disclosure requirements regarding mutual fund fees and expenses.[422] Another urged the Commission to provide a list of examples of transaction-based fees.[423]

We agree that understanding these fees is important so that retail investors have the necessary information to evaluate between firms, firm types (i.e., investment adviser, brokerage, or dually registered), and firm services, accounts, and products so that they can select what is right for them. We continue to believe drawing retail investors' attention to these additional fees is important because they have an impact on investors' investment returns over time. Accordingly, we are requiring disclosure of these types of fees and listing examples of categories as proposed. The final instructions, however, make clear that firms can use their own wording, and only require examples of the most common fees and costs. As discussed below, firms will be required to include cross-references to more specific information, and will be permitted to use tools to help investors learn about these fees and costs in an interactive way without overwhelming retail investors with the additional information. We believe that this approach balances providing short, understandable disclosures about additional fees and costs with investors' interest in understanding more about fees and costs.

Additional Information. Finally, in a change from the proposal, firms will be required to state: “You will pay fees and costs whether you make or lose money on your investments. Fees and costs will reduce any amount of money you make on your investment over time. Please make sure you understand what fees and costs you are paying.” [424] The first sentence replaces a statement in the proposal that some investments impose additional fees that will reduce the value of the retail investor's investment over time. Given the importance of assisting investors to understand the impact of fees and costs, we are requiring prescribed wording in this instruction. The prescribed wording discloses to investors a key term under which a service will be offered, namely the fact that the service will not be free and that the cost of using the service will exist regardless of investment performance.[425]

Firms must also include specific cross-references to more detailed information about their fees and costs.[426] The cross-reference must, at a minimum, include the same information as, or contain information equivalent to that required by, the Form ADV Part 2A brochure (specifically Items 5.A., B., C., and D.) and Regulation Best Interest, as applicable.[427] If the firm is a broker-dealer that does not provide recommendations subject to Regulation Best Interest, to the extent it prepares more detailed information about its fees, it must include specific references to such information.[428] The final instructions require firms to use text features to make this additional information more noticeable and prominent in relation to other discussion text.[429] Firms may choose to Start Printed Page 33528provide a hyperlink, or other means of facilitating access, that leads directly to the relevant Regulation Best Interest disclosure or section of Form ADV, or they may choose to create an additional page that contains the same or equivalent information.[430] For example, a firm may decide to include information on a different website.

The proposed instructions did not include a specific cross-reference to additional fee disclosure, but the proposal required a cross-reference in the Additional Information section about where the retail investor could find information about the services offered, and we requested comment on whether to require firms to include a fee schedule.[431] In the RAND 2018 survey, a potential hyperlink to information on fees, however, generated the most interest among survey participants.[432] Some industry commenters suggested that the relationship summary should permit hyperlinks to fee schedules, arguing that additional information would be helpful for retail investors, but that including the fee schedule itself would be unwieldy.[433] Another commenter, however, suggested requiring a fee schedule that includes typical breakpoints and information on likely and/or maximum fees.[434]

Given the feedback from investors that fee information is important, we believe that requiring specific references to more detailed information about fees balances the goals of the relationship summary, to highlight information covering several topics, with investors' interest in understanding more about fees. This approach will give retail investors information about the types of fees at a higher level and then offer more details, permitting the relationship summary to cover other important topics as well.[435] Including a fee schedule in the relationship summary could make it more difficult to also cover the other topics while maintaining short, digestible disclosures. Instead, we are not including a fee schedule in the relationship summary but are requiring cross references to balance providing a shorter document with giving retail investors easy access to more detailed information.

Conversation Starter. We are also adopting a conversation starter that is designed to prompt a more personalized discussion regarding the fees and costs that will impact the particular retail investor's account. A firm must include the following question for the retail investor to ask his or her financial professional: “Help me understand how these fees and costs might affect my investments. If I give you $10,000 to invest, how much will go to fees and costs, and how much will be invested for me?” [436]

As discussed above, the proposal included the following “Key Question,” which was intended to serve as a conversation starter between the retail investor and the financial professional and to provide the investor an opportunity to receive a quantitative example of the impact of fees: “Do the math for me. How much would I expect to 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?” [437] The Proposing Release discussed the option of including an example of the impact of fees in the relationship summary, and requested comment on whether we should require an example showing how sample fees and charges apply to a hypothetical advisory account and a hypothetical brokerage account, as applicable.[438] We also requested comment on what assumptions firms should make in preparing such an example and how the information should be presented.[439]

Feedback from the RAND 2018 report, other surveys and studies, roundtables, and the Feedback Forms showed that retail investors want more information about fees and the impact of those fees on their investments.[440] At some of the roundtables, for example, participants discussed the utility of adding a hypothetical example in the relationship summary to illustrate fees.[441] Commenters on Feedback Forms also asked for more specific information about the impact of fees on their investments, such as example fee calculations or ranges of fees.[442] Commenters supported including a question highlighting fees a retail investor pays.[443] Commenters, including commenters representing investors and individual investors, also overwhelmingly supported requiring Start Printed Page 33529more information to help retail investors understand the fees and costs associated with their investments, particularly specific examples about how those fees could affect them.[444] Several commenters, however, objected to the inclusion of the key question addressed above because of the operational challenges present in answering such a question with respect to a particular retail investor.[445] Some argued that anticipated fees are unknown for broker-dealer customers, while others believed that it is too difficult for firms to build out systems for individualized fees.[446] Other commenters suggested eliminating this particular key question and instead requiring firms to include links to investor education materials prepared by the Commission.[447] Many commenters were concerned that this key question would impose new disclosure or recordkeeping requirements.[448]

Commenters that supported more fee disclosure had a range of suggestions as to how to include the additional information. For example, one commenter believed that if hypothetical or personal fee disclosures are included in the relationship summary, such disclosures should focus on helping investors understand the effect expenses have on an investment and should make clear that such an example is for educational purposes.[449] One individual advocated for more transparent fee information, suggesting the relationship summary provide individualized fees or a specific range of fees.[450] Another commenter noted that, in response to a previously commissioned report revealing participants' lack of knowledge about fees as well as their desire for a better understanding of fees, a general chart or graph that depicts the effects of fees on an account would be helpful for investors.[451] Another commenter included a sample mock relationship summary with a numerical example of how the fees might impact a hypothetical account.[452]

Given the importance of fees, we want to encourage retail investors and their financial professionals to have a conversation to further discuss the particular fees and costs that would apply to the retail investor, and the impact fees and costs could have on the retail investor's investment returns over time, in order to promote investor understanding. After consideration of the comments received, we are adopting a conversation starter that is designed to elicit a more personalized discussion regarding the fees and costs that will impact the particular retail investor's account, while mitigating the concerns regarding the proposed “Do the math for me” question posed.[453] We believe that this conversation starter will allow financial professionals to tailor the conversation to the particular retail investor even if the financial professional does not provide precise fee information for that individual during the conversation. For instance, if the financial professional intends to recommend mutual funds to the retail investor, he or she may choose to discuss firm- and product-level fees that may apply. The financial professional should be in a position to explain the fees and costs relevant to that particular retail investor if the investor chooses a certain type of account and certain investment, even if the financial professional provides examples and estimated ranges rather than a precise prediction of how much the investor will pay. In addition, the financial professional should explain how those fees and costs will work (for example, whether they are upfront charges, taken out of the initial investment amount, taken out over time, future charges, or charged in another manner) and how the fees and costs could impact the retail investor's investment returns over time. Firms may consider including calculators, charts, graphs, tables, or other graphics or text features to enhance an investor's understanding of these fees. Firms may also consider reviewing with their retail investors the impact of fees on the retail investor's account on a periodic basis.[454]

While we agree that examples are important to illustrate the potential impact of fees, we decline to require firms to provide a hypothetical example in the relationship summary.[455] Our intent with the proposed “Do the math for me” question was that it serve as a conversation starter and a prompt to encourage the retail investor to ask about the amount she would typically pay per year for the account, what would make the fees more or less, and what was included in those fees.[456] We believe that the conversation starter that is being adopted here is consistent with the proposal's intent to prompt retail investors to have a conversation with their financial professional about fees that may impact their investments and account while also addressing the concerns raised by commenters. We encourage firms to consider ways to provide more personalized disclosures to retail investors, and we will continue to consider whether to require more personalized fee disclosure, particularly as operational and technological costs fall.

b. Other Ways of Making Money, Standard of Conduct, and Conflicts of Interest

Firms will be required to include disclosure under a single heading describing their standard of conduct and a summary of certain firm-level conflicts, including the specific conflicts the proposal required.[457] The proposal required disclosure on both conflicts and the standard of conduct, but in separate sections. The final relationship summary requires discussion in one section of other firm-level revenues and conflicts of interest, Start Printed Page 33530and the applicable standard of conduct.[458]

We are placing these disclosures together, including the related conversation starter, because we believe they will more effectively allow retail investors to understand the standards of conduct for broker-dealers and investment advisers.[459] We are also modifying the requirements for the standard of conduct and conflict of interest disclosures, as discussed in more detail below.

We continue to believe it is important to highlight the presence of conflicts and their interconnectedness with how the firm makes money. We recognize that investment advisers, broker-dealers, and their financial professionals have conflicts that affect their retail investor clients and customers and believe it is important to underscore this for retail investors.[460] Similarly, we continue to believe that it is important to provide retail investors with disclosure regarding a broker-dealer or investment adviser's legal obligations regarding the required standard of conduct in a way that is understandable for retail investors.

Standard of Conduct. As proposed, we are adopting a requirement that firms describe their legal standard of conduct using prescribed wording (the “standard of conduct disclosure”).[461] In a change from the proposal, however, the final instructions modify both the content of the standard of conduct disclosure [462] and its placement in the relationship summary. As discussed in more detail below, the final instructions require broker-dealers, investment advisers, and dual registrants to include a brief statement of the applicable standard of conduct.[463] In addition, as discussed above, this disclosure is required to be included in the conflicts of interest section rather than a separate standard of conduct section.

Most commenters did not object to the proposal's requirement that broker-dealers and investment advisers provide disclosure regarding their standards of conduct or that such disclosure be standardized.[464] Results of the RAND 2018 report and other investor studies and surveys indicate that retail investors view this information as helpful.[465] Similarly, commenters on Feedback Forms indicated that this information was useful.[466] In addition, the IAC recommended that investors would benefit from receiving uniform, plain-English disclosure documents with topics, such as, to the extent the Commission does not adopt a uniform fiduciary standard, “what is your legal obligation to me?” [467] Certain commenters, however, suggested that the Commission discuss generally applicable information, including standards of conduct, in investor educational materials instead of requiring firms to do so in their relationship summaries.[468] A number of these commenters argued that this wording might unintentionally create an implied contractual relationship subject to a customer's private right of action.[469] The prescribed language describing the standard of conduct broker-dealers and investment advisers owe to their customers and clients is not intended to create a private right of action.

Many commenters, however, found that the specific wording we proposed [470] did not effectively address investor confusion concerning legal duties applicable to broker-dealers and investment advisers. Commenters indicated that the proposed wording in this section was confusing and did not clarify the applicable legal standards.[471] Some commenters argued that this section included legal jargon inaccessible to retail investors.[472] Others believed that retail investors are unlikely to understand the difference between “best interest” and “fiduciary,” with some suggesting that relationship summaries more clearly define the applicable legal standards or communicate the differences between “fiduciary” and “best interest.” [473] Investment advisers also expressed concern that retail investors may “wrongly” view “best interest” as a higher standard of conduct as compared to the fiduciary standard.[474]

Investor feedback through surveys and studies and in comments at roundtables and on Feedback Forms also showed some confusion. For example, some participants in investor studies and at one of the roundtables did not understand why conflicts of interest existed if broker-dealers and investment advisers were held to the standards of conduct described.[475] Investor studies and surveys showed Start Printed Page 33531that participants varied in their understanding of differing obligations for different account types, some viewing brokerage accounts and advisory accounts as subject to similar standards of conduct but others interpreting the section as conveying that the two account types are subject to different standards.[476] Observations reported by the RAND 2018 report, other surveys and studies and comments received on Feedback Forms demonstrated that many participants did not understand the meaning of the word “fiduciary” in particular.[477] Investor studies also further observed that, when presented with alternative mock-ups of a relationship summary designed to clarify this section, some investors still struggled with understanding the legal obligations of brokers and advisers.[478]

We proposed this section to address investor confusion concerning legal duties applicable to broker-dealers and investment advisers and, in combination with the key questions about the financial professional's legal obligations, to encourage a conversation between the retail investor and the financial professional about applicable standards of conduct.[479] The prescribed wording was intended to promote consistency in communicating these standards to retail investors.[480]

We continue to believe that it is appropriate for the final instructions to require broker-dealers and investment advisers to describe their standards of conduct to investors, because, as discussed above, we believe that it is important to promote retail investors' understanding of these obligations. We also agree with commenters that requiring these firms to include prescribed disclosure regarding these standards of conduct is important in achieving this goal.[481] While the final instructions generally do not require prescribed disclosure in other contexts,[482] we believe that investors should be provided with a consistent articulation of their firm's legal obligations regarding their standard of conduct and that the rationale for allowing firms flexibility to tailor their disclosure in other aspects of the relationship summary does not apply with respect to the standard of conduct. In this regard, some commenters stated that Form CRS should be an educational document, which would be a standardized document published and maintained by the Commission.[483] While the content of disclosure regarding a firm's standard of conduct should be uniform, this disclosure should appear in the relationship summary, which must be delivered to all retail investors, rather than a separate SEC-staff-created and maintained publication. In addition, prescribing language for this disclosure does not raise the same concerns that commenters raised about prescribed language generally. For example, we are permitting more flexibility in how firms describe their fees and services in response to comments that some of the prescribed wording, for example, was not necessarily applicable to their business and could make investors confused.[484]

By contrast, a legal standard of conduct, whether through an investment adviser's fiduciary duty, Regulation Best Interest, or both, will apply to all firms delivering the relationship summary that provide recommendations or investment advice, and prescribing language will avoid investor confusion when describing the applicable standard. Indeed, it may be confusing to investors comparing relationship summaries among prospective firms to see the same legal standard described differently among these firms. The required statements about the legal standard of conduct are disclosures of purely factual information about the terms under which the firms' services will be made available to investors.[485]

We have determined, however, that the proposed standard of conduct disclosure may not have appropriately addressed investor confusion. While the proposal was intended to provide retail investors with simple, easily understood disclosure, we agree with commenters and results from investor studies and surveys,[486] that the relationship summary could be revised in a manner that would be more beneficial to retail investors,[487] especially in light of the similarity between broker-dealers' and investment advisers' legal obligations to retail investors with respect to their standards of conduct when providing recommendations or advice under the rules and interpretations we are adopting concurrently.[488] In this regard, we have modified the standard of conduct disclosure to include it within the conflicts of interest section of the relationship summary and to contain simplified wording that is short, plain language, and user-friendly but still describes the key components of a broker-dealer's or investment adviser's standard of conduct when providing recommendations or advice.[489]

First, we are modifying the standard of conduct disclosure so that it is required to be provided under a modified heading [490] in the conflicts of Start Printed Page 33532interest section.[491] While broker-dealers' and investment advisers' legal obligations regarding their standard of conduct apply not just in the context of conflicts of interest,[492] we believe that requiring this disclosure to be included in the conflicts of interest section will provide a retail investor with a greater ability to discern how a particular legal obligation regarding a standard of conduct may affect him or her by describing the application of that obligation in the context of conflicts of interest, which was a primary concern for retail investors and commenters alike.[493] In addition, this placement is supported by observations reported in the RAND 2018 qualitative interviews and another study, which indicated that some participants struggled with how to reconcile the conflicts of interest section with the legal obligations section because they were discussed separately.[494]

Second, in the conversation starter relating to this section, we are requiring firms to include the following question: “How might your conflicts of interest affect me, and how will you address them?” [495] As discussed above, we believe that including questions for investors to ask their financial professionals is an important component of the relationship summary. This question also underscores for retail investors that investment advisers and broker-dealers have conflicts that may create incentives to put their interests ahead of the interests of their retail clients and customers.[496] As a corollary, it also underscores for retail investors how investment advisers and broker-dealers address these conflicts of interest in discharging their legal obligations regarding their standards of conduct to these investors. We believe that this requirement will improve a retail investor's understanding of the standard of conduct owed by his or her financial professional by helping the investor to better understand its application to him or her.

Unlike the proposal,[497] the final instructions do not require prescribed disclosure summarizing how a firm's standard of conduct would require it to address conflicts of interest. As discussed above, commenters found the proposal's standard of conduct disclosure confusing.[498] After considering comments and observations reported in surveys and studies, we recognize that the proposed disclosures were confusing, particularly the prescribed disclosure attempting to explain concepts of full and fair disclosure, mitigation, and informed consent.[499] Accordingly, we are removing this wording to shorten the disclosure and to provide more focus on the rest of the disclosure required in this section, as we believe this should improve investor comprehension. We believe that clearly disclosing to investors that firms have an obligation to act in the best interest of a client or customer and also simultaneously have conflicts of interest is more important than describing the particular aspects of firms' general duty to disclose, mitigate, or obtain informed consent to conflicts, as applicable. Instead of this disclosure, we are requiring a conversation starter to encourage firms to discuss with retail investors how their standards of conduct require them to address conflicts of interests. In addition, we believe that the discussion prompted by the conversation starter accompanied by examples of conflicts of interest [500] will provide retail investors with specific illustrations of how a firm's standard of conduct can apply, which could encourage investors to ask more detailed questions about how firms address their conflicts.

Finally, we have modified the standard of conduct disclosure for broker-dealers and investment advisers to reduce the amount of required disclosure,[501] to focus the disclosure on the standard of conduct that applies to the provision of recommendations and advice,[502] and to require that portions of the disclosure be presented in bold and italicized font.[503] We believe that streamlining the standard of conduct disclosure and tailoring the disclosure to the type of firm providing such disclosure will clarify for retail investors the applicable legal standard of conduct to which their particular firm is subject when providing recommendations or advice or when providing broker-dealer services without recommendations.

Most commenters found the proposal's standard of conduct disclosure confusing because it included legal or technical words. For example, some commenters, and results from investor studies and surveys, indicated that many did not understand the meaning of “fiduciary” or had never heard of the word.[504] Accordingly, the modified standard of conduct disclosure both eliminates technical words, such as “fiduciary,” and describes the standards of conduct of broker-dealers, investment advisers, or dual registrants using similar terminology in a plain-English manner. In particular, the final instructions use the term “best interest” to describe how broker-dealers, investment advisers, and dual registrants must act regarding their retail customers or clients when providing recommendations as a broker-dealer or acting as an investment adviser.[505] We believe that requiring firms—whether broker-dealers, investment advisers, or dual registrants—to use the term “best interest” to describe their applicable standard of conduct will clarify for retail investors their firm's legal obligation in this respect, regardless of whether that obligation arises from Regulation Best Interest or an investment adviser's fiduciary duty under the Investment Advisers Act.[506] The modified language, however, highlights a key difference in when a firm must exercise its obligation—specifically, when providing a recommendation (in the case of a broker-dealer),[507] or when acting as an Start Printed Page 33533investment adviser,[508] or either providing a recommendation or acting as an investment adviser (in the case of a dual registrant).[509] Portions of the modified standard of conduct disclosure also are required to be presented in bold and italicized font.[510] The final instructions are designed to provide retail investors with a clear understanding of when a firm's legal obligations regarding its standard of conduct is required to be discharged. In addition, with respect to broker-dealers, the modified standard of conduct disclosure, like the proposal,[511] distinguishes between broker-dealers that provide recommendations subject to Regulation Best Interest and broker-dealers that do not provide recommendations subject to Regulation Best Interest (e.g., execution-only brokers). The modified standard of conduct disclosure also requires that broker-dealers, investment advisers, and dual registrants to state that conflicts of interest will remain despite the existence of these legal obligations, and to provide examples of these conflicts.[512] This change is designed to address commenters' concerns that we clarify for retail investors the interaction between broker-dealers' or investment advisers' legal obligations regarding their standards of conduct and their conflicts of interest.

Examples of Ways the Firm Makes Money and Conflicts of Interest. Following the standard of conduct prescribed wording, a firm must summarize the following ways in which it and its affiliates make money from brokerage or investment advisory services and investments it provides to retail investors, to the extent they are applicable to the firm.[513] The specific wording is not prescribed, but firms must include specific information to describe each of the applicable conflicts.

  • Proprietary Products: Investments that are issued, sponsored, or managed by you or your affiliates;
  • Third-Party Payments: Compensation received from third parties when a firm recommends or sells certain investments;
  • Revenue Sharing: Investments where 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; and
  • Principal Trading: Investments the firm buys from a retail investor, and/or investments the firm sells to a retail investor, for or from the firm's own accounts, respectively.[514]

If none of those conflicts apply to the firm, it must summarize at least one of its material conflicts of interest that affect retail investors. Firms will be required to explain the incentives created by each of these examples.[515]

The proposal would have required a firm to discuss these same enumerated topics, to the extent they were relevant. If none of the four specified conflicts applied to a firm, the firm was not required to discuss any other conflicts that applied to its business. The proposal did not require a firm to summarize other ways its affiliates made money from the services and products the firm provides to retail investors.

We are adopting a heading that specifically asks how else the firm makes money in an effort to further highlight the firm's financial incentives and emphasize that they are intertwined with conflicts. In a departure from the proposal, the relationship summary will not include an introductory sentence explaining that the firm benefits from the services it provides to the retail investor because we believe that the new heading and required content of this item make this sentence unnecessary. We are also expanding the required conflicts disclosures to ensure that firms without any of the enumerated conflicts will still summarize at least one other material conflict of interest. Firms will include the four enumerated conflicts (if applicable) that were in the proposal, or otherwise at least one material conflict of interest, and a specific cross-reference to more detailed information about conflicts. Firms with none of the enumerated conflicts should carefully consider their operations in their entirety when selecting a material conflict to disclose to retail investors. While we think it is unlikely that a firm will not have any material conflicts to disclose, if this item is inapplicable, firms may omit or modify this disclosure.[516]

Commenters generally believed that at least some conflicts disclosure was important to include in the relationship summary, but many suggested changes to the approach, including fewer conflicts disclosures and increased use of layered disclosure.[517] Commenters generally supported requiring firms to disclose the types of conflicts of interest related to these financial incentives identified in the proposal, specifically disclosure regarding proprietary products,[518] compensation received Start Printed Page 33534from third parties,[519] revenue sharing,[520] and principal trading.[521]

Investor feedback, however, was mixed. Results from the RAND 2018 survey and another survey indicated that many survey participants did not find this section to be as informative as other sections,[522] and some participants in surveys and studies indicated that this section was “difficult” or “very difficult” to understand.[523] About 75% of Feedback Form commenters rated the conflicts of interest section as either “very useful” or “useful,” while narrative comments on the Feedback Forms suggested that the conflicts of interest disclosure could be clarified or otherwise improved.[524]

Several commenters suggested that we broaden the disclosures to require a firm to inform its retail investors of all of the conflicts related to its business.[525] Commenters also supported highlighting conflicts of interest stemming from affiliates,[526] and several commenters included disclosure about affiliates in their mock-ups.[527] One industry commenter expressed concern that including solely the proposed conflicts in isolation and on a standalone basis may lead investors to think these are the only meaningful conflicts.[528] Other commenters pointed out that if only the proposed conflicts were required to be included, then some firms would not include any conflicts disclosures because their conflicts do not fall within the requisite categories.[529] Furthermore, one commenter proposed to allow firms to affirmatively state that they did not have any of these conflicts without further disclosure of the firm's other conflicts of interest.[530]

We continue to believe that the conflicts we identified in the proposal should be highlighted to retail investors in the relationship summary. Accordingly, we are including in the final instructions a requirement that firms describe these four conflicts to the extent that any of these conflicts apply to them. Like other sections in the relationship summary, this section will provide firms with more flexibility in the way in which they describe their particular conflicts so that they can tailor the summary to more accurately reflect their specific business. While we are maintaining the proposal's approach of requiring firms to provide information about certain types of conflicts applicable to them, we are not requiring firms to state as many specific details with respect to such conflicts.[531] For example, the proposed instructions would have required firms to provide specific examples of advising on proprietary or affiliated investments or investments paying the firm a share of revenue, and we have removed such requirements from the final instructions. Instead, the relationship summary will focus on four specific ways a firm could make money from retail investors' investments to highlight that firms have conflicts of interest and encourage retail investors to ask and learn more about them.

Additionally, as some commenters pointed out, we agree that not mentioning any conflicts, or permitting the firm to affirmatively state that it has none of the enumerated conflicts, could lead retail investors to conclude that the particular firm does not have any material conflicts. Accordingly, the instructions require a firm that does not have any of the four required categories of conflicts to provide at least one example of the firm's conflicts of interest. Specially, the instructions require a firm to summarize at least one material conflict of interest that affects retail investors.[532] Firms are not expected to disclose every material conflict of interest, and should instead consider what would be most relevant for retail investors to know in deciding whether to select or retain the particular firm.

We determined to require an example of a conflict, rather than broadening the instruction to include all conflicts, as some commenters suggested. The language disclosing firms' standard of conduct and existence of conflicts includes wording to make explicit that the conflicts described in the relationship summary are examples. Firms will disclose at least one of their material conflicts of interest that impact their retail investors, and such a conflict is not limited expressly to financial conflicts. In addition, with respect to broker-dealers, this conflict disclosure (unlike the conflict disclosure obligation in Regulation Best Interest) [533] is not limited to conflicts associated with a recommendation.[534] To determine whether a conflict of interest should be disclosed, a firm could consider, for example, the benefit to the firm or its affiliate or the cost to the retail investor.

Start Printed Page 33535

We believe that an exhaustive list of conflicts in the relationship summary would not as effectively enhance investor understanding of conflicts. More details could inundate investors with information that makes it difficult for them to focus on the fact that conflicts exist and will impact them, and they may not focus on or may not realize the importance of the specific conflicts firms are required to summarize. We also agree with comments that disclosure of all conflicts would be too cumbersome [535] and lengthy for the relationship summary's intended purpose—that is, highlighting certain aspects of a firm and its services to help retail investors to make an informed choice and to find additional information about a topic. The approach we are adopting of requiring firms to provide examples will make retail investors aware that these types of conflicts exist, but will avoid providing a laundry list of conflicts. Taking into account all of these considerations, we believe that these examples of conflicts of interest should be highlighted for the investor. We recognize that this will be a high-level summary of conflicts and generally will not be a complete description. As discussed further below, we are requiring firms to include a link to additional information on their conflicts of interest.[536] This layered disclosure will facilitate investors' ability to review additional information on conflicts while balancing the high-level nature of the relationship summary.

Conversation Starter and Additional Information. To promote access to information about other firm conflicts, as well as to clarify for retail investors the application of their firms' standard of conduct as discussed above, firms will include a conversation starter prompting investors to ask about conflicts and a hyperlink to additional information. Specifically, firms must include the following question as a conversation starter: “How might your conflicts of interest affect me, and how will you address them?” [537]

The proposal included a longer key question asking about the most common conflicts of interest in the firm's advisory and brokerage accounts and how the firm will address those conflicts when providing services to the retail investor.[538] One commenter noted that this key question elicited the same information as provided elsewhere in the relationship summary.[539] We shortened the question to avoid this duplication. In addition, the firm's other conflicts will be disclosed as part of the summary of material conflicts or in the additional conflicts disclosure that firms will cross-reference. The new conversation starter is meant to complement these other disclosures and elicit more information about how specifically the firm's conflicts of interest could affect the retail investor.

Firms will also include specific cross-references to more detailed information about conflicts of interest that, at a minimum, includes the same or equivalent information to that required about a firm by the Form ADV, Part 2A brochure and/or Regulation Best Interest.[540] If a firm is a broker-dealer that does not provide recommendations subject to Regulation Best Interest, to the extent it prepares more detailed information about its conflicts, it must include specific references to such information.[541] Firms may include hyperlinks, mouse-over windows, or other means of facilitating access to this additional information and to any additional examples or explanations of such conflicts of interest.[542]

Over 60% of RAND 2018 survey respondents indicated that they would be “very likely” or “somewhat likely” to click on hyperlinks related to conflicts of interest.[543] While the proposal did not require firms to link to additional information with respect to their conflicts, several commenters suggested that the relationship summary include a link to all conflicts.[544] We believe that using layered disclosure through cross-references to a more detailed discussion of conflicts balances the Commission's objective of concise disclosure while providing interested investors with tools to easily access additional, useful information.

Many industry commenters also suggested that Regulation Best Interest's and Form CRS's conflicts disclosures be coordinated, and that any conflict disclosure obligations under Regulation Best Interest should be satisfied upon delivery of the relationship summary.[545] We recognize that broker-dealers may need to disclose additional conflicts or disclose additional conflicts at a point in time other than at the beginning of the relationship with an investor or other times the relationship summary is required to be delivered.[546] The relationship summary will provide a high-level summary for investors so that they can engage in a conversation with their financial professional about investment advisory or brokerage services, and so that the investors can choose the type of service that best meets their needs. Furthermore, as discussed above in Section II.A (Presentation and Format),[547] we believe it is essential to limit the length of the relationship summary and keep the disclosures focused, highlighting these topic areas while encouraging questions and providing access to additional information. As a result, we believe many firms may not be able to capture all of the necessary disclosures about their conflicts in this short summary disclosure.[548] The layered disclosure approach should strike a balance between alerting investors of these conflicts while keeping with the intended purpose of the relationship summary.

Finally, some commenters argued that the relationship summary should require firms to explain how conflicts will be mitigated or minimized, or that firms should be permitted to state that Start Printed Page 33536a particular firm has fewer conflicts than other firms.[549] While we agree that firms should have increased flexibility to describe conflicts, as discussed above, we are not permitting this additional disclosure. The purpose of this section is to highlight for investors that conflicts of interest exist.

c. Payments to Financial Professionals

Finally, in a change from the proposal, we are adding an additional section to Item 3 that requires a firm to include in its relationship summary the heading “How do your financial professionals make money?” [550] A firm will summarize how its financial professionals are compensated (including cash and non-cash compensation) and the conflicts of interest those payments create.[551] For example, the firm must, to the extent applicable, disclose whether financial professionals are compensated based on factors such as: The amount of client assets they service; the time and complexity required to meet a client's needs; the product sold (i.e., differential compensation); product sales commissions; or revenue the firm earns from the financial professional's advisory services or recommendations.[552]

In the Proposing Release, we asked if the relationship summary should include disclosure of compensation received by financial professionals and the related conflicts of interest such compensation might pose. Several commenters supported including disclosures related to the conflicts of interest that financial professionals' compensation arrangements create.[553] Several commenters suggested featuring financial professionals' compensation in the relationship summary, including in a separate section.[554] A number of commenters illustrated the importance of these disclosures by including sections discussing financial professionals' compensation in their mock-ups.[555] These disclosures generally included more detailed information about how broker-dealers and investment advisers earn money from various sources, in addition to what the retail investor may pay directly.

We have concluded that disclosure of conflicts of interest related to a financial professional's compensation is useful to highlight for retail investors in the relationship summary.[556] In particular, the commenters' mock-up disclosures highlighted the benefit of separately summarizing financial professionals' compensation to help retail investors identify and assess these conflicts of interest that may affect the services they receive.[557] We believe that requiring specific information on financial professional compensation and conflicts related to that compensation will provide improved clarity from the proposal and better help retail investors understand these conflicts and how they might impact a financial professional's motivation. We also believe it is useful to specifically highlight this conflict for retail investors, as it is a different type of payment and a different type of conflict than a conflict at the firm level. We further believe that by placing this discussion directly after the discussion on fees, costs and conflicts, it will mitigate potential investor confusion. This approach is also consistent with Regulation Best Interest, which treats compensation to financial professionals and the conflicts of interest that such compensation creates as material facts that must be disclosed.[558]

4. Disciplinary History

The relationship summary will include a separate section about whether a firm or its financial professionals have reportable disciplinary history and where investors can conduct further research on these events.[559] Inclusion of a separate disciplinary history section is a change from the proposed relationship summary, where this information was included in the Additional Information section.[560] Certain commenters suggested that we remove the requirement that firms disclose whether or not they have disciplinary history.[561] Similarly, some commenters suggested that any disciplinary information should simply direct retail investors to resources where they could review a firm's or a representative's disciplinary history, without any firm-specific information in the relationship summary.[562]

We have concluded, however, based on consideration of commenters and investor feedback received through surveys and studies, at roundtables and in Feedback Forms, to include the disciplinary history as a separate section of the relationship summary.[563] These comments emphasized the importance of disciplinary history information and advocated that it should be placed in a more prominent position than as part of the Additional Information section.[564] Commenters also generally supported firm-specific disclosure as to whether the firm has disciplinary history.[565] About 70% of commenters on Feedback Forms responded that they would seek Start Printed Page 33537out additional information about a firm's disciplinary history.[566] Similarly, more than 70% of investors surveyed in the RAND 2018 report reported that they were “very likely” or “somewhat likely” to look up the disciplinary history of a financial professional.[567]

However, results from investor studies and surveys and investor comments on Feedback Forms supported the concern that the Additional Information section may not provide enough salience. For example, in the RAND 2018 survey, the Additional Information section was most often selected as one of the two least useful sections of the proposed relationship summary.[568] On Feedback Forms, commenters rated the Additional Information section as “very useful” or “useful” less often than any other section of the relationship summary.[569] One investor study suggested a reason for these mixed results, finding that participants would skip the Additional Information section, in part because they did not understand that the websites in the section would allow them to review the disciplinary history of the investment adviser or broker-dealer that they were considering.[570] Comments on Feedback Forms similarly suggest that information about how to research a firm's disciplinary information should be presented more prominently and more simply in the relationship summary.[571] After taking comments into consideration, we believe that a separate disciplinary history section is appropriate, with a requirement that firms explicitly state whether or not they have legal or disciplinary history so that investors can find the information in the summary with ease.

The section will begin with the heading: “Do you or your financial professionals have legal or disciplinary history?” Firms will answer “yes” or “no,” depending upon whether they or one of their financial professionals have a triggering event enumerated in the instructions, as discussed below. The proposed relationship summary required a statement that the firm has legal and disciplinary events but did not require an affirmative statement that a firm or its financial professionals did not have disclosable events. We are requiring a “No” answer in the final instructions where applicable, given the importance of disciplinary history and to provide a complete answer to the question in the heading.

Regardless of whether firms report a “Yes” or “No” answer as to whether they or their financial professionals have legal or disciplinary history, the relationship summary will direct the retail investor to visit Investor.gov/CRS to research the firm and its financial professionals, as proposed.[572] This is responsive to RAND 2018 survey results, which indicated that 37% of investors did not know where to research disciplinary history.[573] Directing retail investors to the search tool is also consistent with the Commission's Office of Investor Education and Advocacy initiative to encourage retail investors to do background checks on financial professionals and is intended to increase awareness of available search tools.[574] In addition to disciplinary history, the search tools also can provide useful information regarding registration and licensing and financial professional employment history.

The triggering events for a statement that a firm does have legal or disciplinary history are the same as proposed.[575] Following the heading, firms will be required to state “Yes” in response to the heading questions if they currently disclose or are required to disclose (i) disciplinary information per Item 11 of Part 1A or Item 9 of Part 2A of Form ADV,[576] or (ii) legal or disciplinary history per Items 11A-K of Form BD (“Uniform Application for Start Printed Page 33538Broker-Dealer Registration”) [577] except to the extent such information is not released to BrokerCheck pursuant to FINRA Rule 8312.[578] Regarding their financial professionals, firms will determine whether they need to include an affirmative statement based on legal and disciplinary information on Form U4,[579] Form U5,[580] or Form U6.[581] In particular, firms will be required to state “Yes” if they have financial professionals for whom disciplinary history is reported per Items 14 A through M on Form U4, Items 7A or 7C through F on Form U5,[582] or Form U6 except to the extent such information is not released to BrokerCheck pursuant to FINRA Rule 8312.[583] Firms that do not have disclosable events for themselves or their financial professionals in connection with these provisions will state “No” in answer to the heading.[584]

As noted above, several commenters opposed the approach of requiring firms to indicate in their relationship summaries whether they or their financial professionals have disciplinary history, questioning the value of the disclosure to retail investors,[585] or citing to prejudicial or competitive concerns.[586] These firms recommended that the relationship summary include only a prompt for investors to research the disciplinary history of the firm or financial professional, directing them to Investor.gov/CRS.[587]

We recognize that the disciplinary history of firms and their financial professionals is already publicly available, as commenters have noted. From studies and investor feedback, however, we also understand that investors view disciplinary history as significant to their decision of whether or not to engage with a firm or a financial professional, but in many cases are unaware of the need for researching or the tools available to research whether disciplinary history exists.[588] Highlighting disciplinary history in this way provides information to retail investors before they enter into a relationship with a particular firm and financial professional and a “yes” response will alert retail investors that there is disciplinary history they may want to research, review, or discuss with their financial professional.[589] As there is no required waiting period between the delivery of the relationship summary to the retail investor and the time that the retail investor may enter into a relationship with or an order placed by a firm, highlighting the disciplinary information allows the retail investor time to consider any disciplinary history before moving forward or to monitor the relationship or financial professional more closely if the retail investor decides to move forward at that time. By basing this disclosure on information that is already reported elsewhere and also requiring the relationship summary to include details about where to find more information, we give retail investors the tools to learn more about firms and financial professionals.

We are not persuaded by commenters who believed that these disclosures are unduly prejudicial or would have sufficient competitive concerns and argued that we should not require this information. Firms or financial professionals would have the opportunity to provide more information about and encourage retail investors to ask follow-up questions regarding the nature, scope, or severity of any disciplinary history, so that retail investors have the information they need to decide on a relationship. In particular, financial professionals who themselves have no disciplinary history can make clear that a “Yes” disclosure in response to the heading question relates to the firm and other personnel (if applicable) and not to them. While we recognize that larger firms might be more likely to respond affirmatively to this question than smaller firms, we have determined to require this disclosure because we believe that, on balance, the potential benefit to the retail investor of seeing at a glance whether a firm or its financial professionals have disciplinary history (which may encourage the investor to conduct further research or monitor the relationship or financial professional more closely) justifies requiring the disclosures notwithstanding the concerns raised by commenters, Start Printed Page 33539particularly given the importance that commenters placed on disciplinary history.

A few commenters suggested revisions to the specific events that would trigger a disciplinary event disclosure in the proposed relationship summary.[590] We have considered these comments but have determined to adopt the triggers as proposed. As noted in the Proposing Release, those disclosable events are those that we believe may generally assist retail investors in evaluating the integrity of a firm and its financial professionals.[591] Additionally, these triggering events are already disclosed on existing systems for other regulatory purposes. As such, there will not be additional regulatory burdens for a determination of disciplinary history for the purposes of the relationship summary.

Different requirements between other aspects of Form ADV or Form BD and the relationship summary also could cause confusion and compliance uncertainty. One commenter suggested basing the relationship summary disciplinary disclosure around a standardized set of events that would trigger disclosures specific to the relationship summary.[592] This approach may have led to advisers or broker-dealers having publicly listed disclosure events on BrokerCheck or IAPD yet answering “No” to a question of whether they or their financial professionals have legal or disciplinary history. We believe that result could have been confusing or misleading to retail investors. By contrast, the approach we adopt allows for consistency across public information as to whether or not a firm or financial professional has a disciplinary event and leverages existing disclosure reporting systems. We believe that this consistency justifies not adopting a standardized set of events triggering disclosure on the relationship summary. Furthermore, the statement encouraging retail investors to visit Investor.gov/CRS for more information will help retail investors to more easily learn and compare additional details from the firms themselves and from their existing disclosures.[593]

Firms also will include the following conversation starter: “As a financial professional, do you have any disciplinary history? For what type of conduct?” [594] This conversation starter is intended to take the place of a similarly worded key question.[595] However, because this item's heading asks a similar question about disciplinary history with respect to the firm, we believe that the conversation starter would be most useful specifically with respect to the financial professional. This question will allow retail investors to assess that financial professional's disciplinary history as well as engage in further discussion about those events or any events applicable to the firm. In addition, this conversation starter is designed to encourage a discussion about any differences between the firm's disciplinary history and that financial professional's history, if applicable (e.g., if the financial professional has no disciplinary history while his or her firm has reportable discipline necessitating a “Yes” response to the heading question).

5. Additional Information

At the end of the relationship summary, firms will state where the retail investor can find additional information about their brokerage or investment advisory services, as proposed.[596] This information should be disclosed prominently at the end of the relationship summary. However, unlike the proposed relationship summary, the adopted instructions do not prescribe the different references that a broker-dealer and investment adviser must include for such direction and do not require a heading for the section.[597] This approach is consistent with our intent to provide firms additional flexibility to provide information most useful to retail investors.[598] In addition, removing the prescribed wording from this section avoids potentially duplicative disclosure, as the Introduction now includes a statement that free and simple tools are available to research firms and financial professionals at Investor.gov/CRS. Investor.gov provides investors access to search for firms on BrokerCheck and IAPD, references to both of which would have been required in prescribed wording in the proposed relationship summary.[599] The flexibility is also responsive to observations reported in surveys and studies and comments from investors at roundtables and on the Feedback Forms indicating that investors found the proposed “Additional Information” section less helpful compared to other sections in the relationship summary.[600] Consistent with our layered disclosure approach, we encourage hyperlinks, QR codes, or other means of facilitating access for retail investors to obtain additional information.[601]

We also are not adopting the proposed requirement that firms include information on how retail investors should report complaints about their investments, investment accounts, or financial professionals in the relationship summary.[602] While some Start Printed Page 33540commenters supported including information on how retail investors could report complaints,[603] others disagreed with this approach[604] or suggested that it may not be information that is as critical at the beginning of a relationship.[605] Commenters submitting their own mock-ups of the relationship summary likewise took different approaches as to whether or not to include this information.[606]

We are requiring a conversation starter in this part of the relationship summary, which incorporates and adapts a key question from the proposal: “Who is my primary contact person? Is he or she a representative of an investment adviser or a broker-dealer? Who can I talk to if I have concerns about how this person is treating me?” [607] With required text features to highlight this conversation starter, as well as information from the Introduction to direct retail investors to Investor.gov/CRS, we believe that retail investors will be able to find information on who to contact and how to report a complaint to the firm at the appropriate time, and Investor.gov includes links to submit questions and complaints to the Commission. In light of the mixed feedback from commenters and the changes to the form designed to enhance flexibility and usability, we are not requiring firms to include more detailed information about submitting complaints, as proposed, to enable the disclosures in the relationship summary to focus on other information about the firm and its services.

We are also requiring firms to include a telephone number where retail investors can request up-to-date information and request a copy of the relationship summary.[608] This differs from the proposal, which required only those firms that do not have a public website to include a toll-free number that retail investors may call to request documents.[609] Some of the commenter mock-ups included a telephone number even though the firms maintained a public website.[610] A commenter who recommended including a contact telephone number in the relationship summary did not specify that it must be toll-free and we received a mock-up with a placeholder for a telephone number that was not specifically toll-free.[611]

After consideration of these comments and mock-ups, we determined that all firms should include a telephone number in the relationship summary. We continue to believe it is important for retail investors to have firm contact information in the event that they would like to request disclosures and there is no public website for that firm that the investor may easily access. In addition, we anticipate that requiring all firms to include a telephone number will more readily accommodate retail investors who prefer communicating with firms over the phone and will facilitate their requests for up-to-date information and a copy of the relationship summary. If firms do not already have a toll-free telephone number, they will not be required to obtain one to comply with the requirements of the relationship summary. Firms will have the flexibility to decide whether or not the telephone number they provide in their relationship summary will be toll-free.

6. Proposed Items Omitted in Final Instructions

The proposal included two sections that we are not adopting as separate sections in the relationship summary.[612] As discussed above, the relationship summary will not include a separate section for “Key Questions to Ask;” instead, the topics covered by the proposed key questions will be integrated throughout the relationship summary as headings to items or as “conversation starters.” [613]

The relationship summary will also not include the Comparisons section for investment advisers and broker-dealers, as proposed. Standalone broker-dealers would have been required to include the following information, using prescribed wording, about a generalized retail investment adviser: (i) The principal type of fees; (ii) services investment advisers generally provide; (iii) the applicable legal standard of conduct; and (iv) certain incentives based on an investment adviser's asset-based fee structure. For standalone investment advisers, this section would have required them to include parallel categories of information regarding broker-dealers.[614]

Many commenters opposed including discussions comparing investment advisers and broker-dealers. Some commenters stated that it was inappropriate for the Commission to require firms to describe products and services that they do not offer and about which they may have limited or no expertise.[615] Other commenters had concerns with the prescribed wording, which they said may increase investor confusion or be misleading with prescribed wording that would not reflect the likely relationship that an investor would have with a specific firm.[616] Some commenters believed that the wording in the comparison section Start Printed Page 33541favored broker-dealers over investment advisers.[617] Others indicated that the comparisons should allow for discussions regarding insurance products.[618] As an alternative, some commenters suggested that the Commission include the information intended for the proposed Comparison section on the Commission's website as educational material,[619] and that firms could link to the educational material from their relationship summaries.[620] Given such concerns and suggestions, a number of mock-ups did not include a comparison section.[621]

Comments on Feedback Forms indicated that this section was less useful than other sections of the relationship summary; fewer commenters rated this section as either “very useful” or “useful” compared to the other sections of the relationship summary.[622] Many narrative comments on Feedback Forms relating to this section (even from those who graded the section as “useful”) indicated that these commenters did not find this section informative and wanted more information to help them compare firms.[623] Feedback on this section from the RAND 2018 report and other surveys and studies was limited because the RAND 2018 report, and other surveys and studies, generally focused on the sample proposed dual registrant relationship summary. However, in a survey that focused on the standalone investment adviser relationship summary, most survey respondents indicated that this section was not useful in helping them to understand differences between firms.[624]

We have determined not to require a separate Comparisons section in the relationship summary for broker-dealers and investment advisers that are not dual registrants. In lieu of the separate section with prescribed wording, the final instructions include several requirements that will help facilitate comparisons among firms. First, each relationship summary will be required to provide answers to the same questions in a standard order.[625] Second, dual registrants will be required to provide either a combined relationship summary describing both brokerage and advisory services, presenting the information with equal prominence and in a manner that facilitates comparison of the two types of services or, alternatively, will be required to provide separate relationship summaries that clearly distinguish and facilitate comparison of the firm's brokerage and investment advisory services.[626] Similarly, a firm that has an affiliate providing brokerage or advisory services may choose to prepare a single relationship summary, or two separate relationship summaries, discussing the services provided by both firms, but only if the relationship summary or summaries are designed in a manner that facilitates comparison of the brokerage and investment advisory services.[627]

These changes enhance the relationship summary's usability and design and, we believe, will improve comparisons among firms by retail investors using the relationship summaries. The relationship summaries will have differentiated, firm-specific information in a comparable format as compared to the proposed approach of requiring prescribed and more generalized information. We believe this comparability and differentiation among firm relationship summaries will enhance usability for retail investors. In addition, removing the prescribed wording allows firms to describe their services and fees more accurately while simultaneously mitigating concerns commenters raised regarding potentially misleading or inappropriate prescribed wording. Investors seeking more general information about investment advisers and broker-dealers will know they can refer to educational materials that are available on the Commission's website, Investor.gov, and elsewhere for investor research and education, including Investor.gov/CRS, which the relationship summary's Introduction must reference.[628]

C. Filing, Delivery, and Updating Requirements

We are adopting the filing, delivery, and updating requirements with several modifications from the proposal. Firms will file copies of their relationship summaries with the Commission, will update the disclosures when the information becomes materially inaccurate, and will communicate any changes to retail investors who are existing clients or customers. The delivery requirements are designed to ensure a relationship summary is provided before or at the time a retail investor enters into a relationship with the firm and when changes are made to the services the firm provides.

We made several modifications to the proposed requirements in response to comments, in order to make it easier for retail investors to discern changes in updated relationship summaries, streamline the filing requirements, and provide greater clarity regarding several of the delivery requirements. As described further below, some of the key revisions include:

  • Broker-Dealer Initial Delivery Obligations. Broker-dealers will be required to deliver the relationship summary before or at the earliest of: (i) A recommendation of an account type, a securities transaction, or an investment strategy involving securities; (ii) placing an order for the retail investor; or (iii) the opening of a brokerage account for the retail investor, instead of before or at the time the retail investor first engages the broker-dealer's services, as proposed. We encourage delivery of the relationship summary to new or prospective clients or customers at the first possible opportunity, including the initial point of contact.
  • Other Delivery Obligations. Firms will deliver the relationship summary to existing retail investor clients and customers before or at the time firms open a new account that is different Start Printed Page 33542from the retail investor's existing account, as was proposed. In addition, firms will deliver the relationship summary when they recommend that the retail investor roll over assets from a retirement account, or when they recommend or provide a new service or investment outside of a formal account (e.g., variable annuities or a first-time purchase of a direct-sold mutual fund through a “check and application” process). In response to commenters' concerns, these changes are intended to replace the proposed instruction that firms deliver the relationship summary when making changes to an existing account that would “materially change the nature and scope” of the firm's relationship with the retail investor with more concrete delivery triggers.
  • Highlighting Changes. In a change from the proposal, we are adding a requirement that firms delivering updated relationship summaries to existing clients or customers also highlight the most recent changes by, for example, marking the revised text or including a summary of material changes. This additional disclosure must be filed as an exhibit to the unmarked amended relationship summary (but would not be counted toward the two-page or four-page limit, as applicable).
  • New Filing Requirements. As proposed, we are requiring that firms file the relationship summary using a text-searchable format. However, in response to comments received, we are also requiring that the filings contain machine-readable headings to enhance the ability to compare information submitted by different firms. Also in response to comments, which we solicited on this topic, we are changing the system that broker-dealers will use to file Form CRS from EDGAR, as proposed, to Web CRD®. Dual registrants will be required to file their relationship summaries using both IARD and Web CRD®.

Finally, we are revising the definition of retail investor to align more closely with the definition of “retail customer” in Regulation Best Interest. As discussed, below, we do not believe that this results in substantive changes in the definition as proposed.

1. Definition of Retail Investor

For purposes of Form CRS, “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.” [629] The proposal defined the term retail investor as “a prospective or existing client or customer who is a natural person (an individual), including trusts or other similar entities that represent natural persons, even if another person is a trustee or managing agent.” This definition was different from the definition of “retail customer” in proposed Regulation Best Interest [630] because the relationship summary was intended for an earlier stage of the relationship between an investor and a financial professional, and we thought it would be beneficial for all natural persons to receive information to facilitate their account choices.[631]

Many commenters recommended that we use a single definition for both “retail investor” and “retail customer” because consistent definitions would facilitate compliance and administrative efficiency.[632] Commenters were concerned that differences between the definitions could result in a requirement to deliver the relationship summary to broker-dealer customers who may not be “retail customers” for purposes of Regulation Best Interest.[633] Many commenters further recommended that the definitions of “retail investor” and “retail customer” should both be conformed to rules issued by FINRA, which use a net worth test to distinguish institutional and “retail” customers.[634] Commenters also asked us to clarify that the relationship summary need not be delivered to certain professionals retained to represent a natural person [635] and address whether participants in workplace retirement plans will be retail investors who should receive the relationship summary.[636]

In response to comments, the final instructions adopt a definition of retail investor that is consistent with the definition of retail customer in Regulation Best Interest, but differs to reflect differences between the relationship summary delivery requirement and the obligations of broker-dealers under Regulation Best Interest, including that the relationship summary is required whether or not there is a recommendation and covers any prospective and existing clients and customers (i.e., a person who “seeks to receive or receives services”) of investment advisers as well as broker-dealers.[637] Specifically, under Regulation Best Interest, retail customer will be defined as “a natural person, or the legal representative of such natural person, who: (A) 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 (B) uses the recommendation primarily for personal, family, or household purposes.” [638] Like the definition of retail customer in Regulation Best Interest, the definition of retail investor in the final instructions includes natural persons [639] who seek to receive or receive services “primarily for personal, family or household purposes” and the “legal representatives of such natural persons.” In addition, we provide an interpretation on who would be considered to be a “legal representative” for purposes of this definition.

The proposed definition of retail investor did not include the phrase “personal, family or household purposes.” No commenters addressed whether or not to include this phrase in the Form CRS definition of retail investor, other than commenting Start Printed Page 33543generally that they supported conforming both definitions. Commenters did comment and request clarification of this aspect of the definition of “retail customer” in Regulation Best Interest.[640]

We believe the final definition of retail investor remains consistent with our objective to provide all natural persons with information to facilitate their understanding of their choices among firms and types of accounts. Firms will be required to deliver the relationship summary to individuals seeking brokerage and investment advisory services in connection with any of the many different reasons that an individual may seek these services, including, for example, retirement, education and other personal, family or household saving and investing objectives. The final definition of retail investor will exclude natural persons seeking these services for commercial or business purposes, such as, for example, where an employee seeks services for an employer or an individual seeks services for a small business or on behalf of another non-natural person entity such as a charitable trust. However, firms must deliver the relationship summary to natural persons who might be seeking services for a mix of personal and commercial or other non-personal purposes, such as a sole proprietor or small business owner who may engage a firm or financial professional for multiple accounts and for personal as well as business purposes. Where firms do not know whether a natural person is seeking services for something other than personal, family, or household purposes at the beginning of a relationship, they may treat that natural person as a retail investor for purposes of delivery of the relationship summary.[641]

As in the proposal, the final retail investor definition will capture natural persons without any distinction based on net worth. While a number of commenters argued that firms should not be required to deliver a relationship summary to investors that meet certain asset or net worth thresholds,[642] others opposed narrowing the definition based on a net worth test or other test.[643] We continue to believe that the retail investor definition should not distinguish based on a net worth or other asset threshold test and that all individual investors would benefit from clear and succinct disclosure regarding key aspects of available brokerage and advisory relationships. As noted in the proposal, section 913 of the Dodd-Frank Act defines “retail customer” to include natural persons and legal representatives of natural persons without distinction based on assets or net worth.[644] Further, we believe that it also may be impractical to include a net worth or other test based on asset thresholds in the definition because it could be difficult for firms to determine a retail investor's net worth at the outset of the relationship when the relationship summary must be provided.

To conform definitions, the final definition of retail investor substitutes the language “the legal representative of such natural person” for language in the proposal referring to “a trust or other similar entity that represents natural persons, even if another person is a trustee or managing agent of the trust.” [645] We believe this is a clarification and not a substantive change from the proposal because it retains coverage of trusts and other similar legal entities that represent natural persons, and the proposal contemplated that certain legal representatives, e.g., a trustee or managing agent, would receive a relationship summary on behalf of a trust or other similar legal entity. Further, we clarify that we interpret a “legal representative” of a natural person to cover only non-professional legal representatives (e.g., a non-professional trustee that represents the assets of a natural person and similar representatives such as executors, conservators, and persons holding a power of attorney for a natural person).[646] In referring to non-professional legal representatives, we intend to capture persons who are acting on behalf of natural persons and are not regulated financial services professionals retained by natural persons to exercise independent professional judgment. This responds to those commenters who argued that it should not be necessary to provide a relationship summary to regulated professionals in the financial services industry, such as registered investment advisers and broker-dealers, corporate fiduciaries (e.g., banks, trust companies and similar financial institutions) and insurance companies, and the employees or other representatives of such advisers, broker-dealers, corporate fiduciaries and insurance companies.[647] Accordingly, non-professional legal representatives would not include such regulated financial services professionals. We agree with these commenters that delivery of the relationship summary to such regulated financial services professionals retained by natural persons to exercise independent judgment will not further our objective of facilitating retail investors' understanding of their account choices.[648] Importantly, however, this will not relieve firms or financial professionals retained to represent the assets of natural persons from their own obligations to deliver the relationship summary to clients or customers who are retail investors.

Commenters offered varying points of view about whether participants of workplace retirement plans should be treated as retail investors who receive the relationship summary. Some recommended that the definition of retail investor should include plan participants.[649] Others argued against Start Printed Page 33544delivering a relationship summary to plan participants, explaining that a relationship summary would confuse participants and would duplicate other required disclosures.[650] Several commenters suggested that only plan participants that choose to retain a firm or financial professional in connection with assets in his or her plan account should receive a relationship summary.[651] Commenters also asked us to clarify whether the definition of retail investor would include participants in plans not subject to ERISA, such as governmental or other non-ERISA workplace retirement plans meeting requirements under section 403(b) or 457 of the Internal Revenue Code of 1986, as amended (“Internal Revenue Code” or “Code”), and individual retirement accounts (“IRAs”) (including SEPs and SIMPLE IRAs).[652]

In response to comments, we are clarifying that the relationship summary applies when retail investors seek services for their retirement accounts as well as non-retirement accounts because retirement savings is a personal, household or family purpose. Accordingly, the definition of retail investor will include a natural person seeking to select and retain a firm to provide brokerage or advisory services for his or her own retirement account, including but not limited to IRAs and individual accounts in workplace retirement plans, such as 401(k) plans and other tax-favored retirement plans.[653] For example, firms will be required to deliver a relationship summary to plan participants seeking advice about whether to take a distribution from a 401(k) plan or other workplace retirement plan and how to invest that distribution. Similarly, a firm will be required to deliver a relationship summary to a plan participant seeking to retain the firm to provide brokerage or advisory services for the participant's individual account held in a 401(k) plan or other workplace retirement plan.[654]

However, participants in 401(k) plans and other workplace retirement plans will not be retail investors for purposes of the Form CRS delivery obligation when making certain ordinary plan elections that do not involve selecting or retaining a firm to provide brokerage or advisory services. We understand, for example, that participants in workplace retirement plans generally do not choose the firm that provides brokerage or advisory services in connection with certain ordinary plan elections, such as whether to enroll in the plan, make or increase plan contributions, or how to allocate contributions and plan account balances among a designated menu of plan investment options. We designed the relationship summary to assist investors in understanding their choices when they seek to engage a firm to provide brokerage and advisory services. Even if a financial professional or other firm representative assists a participant directly, e.g., at an enrollment meeting or through a call center interaction, the participant generally would not be making the type of account or firm choice contemplated by a relationship summary because the plan's sponsor or another representative designated by the terms of the plan (e.g., a trustee or other fiduciary or other responsible party) (a “plan representative”) already has selected the firm, has negotiated the terms of service, and remains responsible for supervising the firm.[655] We agree with commenters that delivering a relationship summary under these circumstances could be confusing to participants and duplicative of already required disclosures. Accordingly, plan participants should not be viewed as “seeking or receiving services” for purposes of the Form CRS definition of retail investor when they are merely electing among plan features offered by firms and financial professionals retained and supervised by a plan representative. This includes a participant's decision to invest his or her account balance through an in-plan self-directed brokerage account option or to select an in-plan managed account service option, where a plan representative retains and supervises the broker-dealer or investment advisory firm providing such services to the plan.

Finally, commenters asked us to address whether workplace retirement plans and their representatives (e.g., plan sponsors, trustees, and other fiduciaries) and service providers will be retail investors entitled to receive Form CRS. In the proposal, we excluded workplace retirement plans and their representatives from the definition of retail investor.[656] Most commenters agreed with this approach; some noting that workplace retirement plans and their representatives would not benefit from receiving a Form CRS.[657] Two Start Printed Page 33545commenters argued that workplace retirement plans and their representatives should receive Form CRS.[658]

We understand that plan representatives of workplace retirement plans typically are not seeking or receiving services primarily for personal, family or household purposes when they consider whether to engage a broker-dealer or investment adviser to provide services to a retirement plan established, maintained and operated by an employer to provide pension or retirement savings benefits to employees. Further, the relationship summary—designed to provide succinct information relevant to individual retail investors—is not designed to facilitate account and firm choices by the representatives of these workplace retirement plans. In this regard, we understand that plan representatives typically seek brokerage and advisory services bundled together with, or that will be complimentary with, other services supporting the plan's establishment, maintenance and operation, such as plan design, recordkeeping and other administrative services, and compliance services to meet applicable requirements under the Internal Revenue Code and ERISA (or applicable state law for non-ERISA governmental plans).[659]

Accordingly, the final definition of retail investor does not include most workplace retirement plans or their plan representatives seeking services for a plan established, maintained and operated by an employer to provide pension or retirement savings benefits to employees, because such plans and their representatives are not seeking services primarily for personal, family or household purposes. We note, however, that some plan representatives may participate under their employer's workplace plan, e.g., in the case of a workplace IRA or other workplace retirement plan is established and maintained by a sole proprietor or other self-employed individual that includes one or more employees in addition to the plan representative. If a plan representative who decides the services arrangements for a workplace retirement plan is a sole proprietor or other self-employed individual who will participate in the plan, the plan representative also would be a retail investor seeking services for personal, family or household purposes and must receive a copy of the firm's relationship summary.[660]

2. Filing Requirements

As proposed, all broker-dealers and investment advisers will file their relationship summaries with the Commission, and the relationship summaries will be accessible via the Commission's public website, Investor.gov,[661] in addition to each firm's website. There are several reasons we are requiring the relationship summaries to be filed with the Commission. First, the public will benefit by being able to access any firm's relationship summary by using one website, Investor.gov. This should make it easier to make comparisons across firms. Second, some firms may not maintain a website, and therefore their relationship summaries will not otherwise be accessible to the public. Third, by having firms file their relationship summaries with the Commission, Commission staff can more easily monitor the filings for compliance. Commenters generally supported requiring broker-dealers and investment advisers to file their relationship summaries with the Commission.[662]

We are requiring that the filing be in a text-searchable format, as proposed, and in addition, the final instructions will require that the filing be structured with machine-readable headings. Two commenters advocated that the relationship summary should be filed not only in a text-searchable, but also machine-readable, format,[663] in response to our solicitation for comment on filing formats. Both commenters stated that this would allow third parties to develop online comparison tools, making it easier for retail investors to compare firms with one another, including across key categories, such as fees.[664] We agree that requiring this formatting will enable investors and other data users, industry participants, and the Commission and Commission staff to better collect and analyze reported information and facilitate the development of tools to aggregate and compare the information. We are requiring that only the headings be machine-readable, given that firms will use their own wording in the narrative responses for each of the relationship summary items, and the responses will not be uniform. The machine-readable, structured headings could, for example, be implemented in PDF by creating a bookmark for each of the headings of the relationship summary that matches the text of the heading and that has the heading as its destination. We believe this promotes aggregation and comparison of responses to specific items across different relationship summaries but also limits the costs of preparing the relationship summary. This is consistent with the Commission's ongoing efforts to modernize our forms by taking advantage of technological advances both in the manner in which information is reported to the Commission and how it is provided to investors and other users.[665] These Start Printed Page 33546instructions are not intended to require firms to prepare a relationship summary in paper format. A firm that prepares and delivers a relationship summary only in an electronic format could, for example, file a rendering of the electronic disclosures with the Commission.

In a change from the proposal, broker-dealers will file through Web CRD® instead of EDGAR. Investment advisers will file their relationship summaries through IARD in the same manner as they currently file Form ADV Parts 1A and 2A, as proposed.[666] Whether dual registrants prepare a single relationship summary or two, they will file their relationship summaries using both IARD and Web CRD®.[667] We are requiring filing of the relationship summary through Web CRD® and IARD because they are currently used by and familiar to broker-dealers and investment advisers, respectively. This should minimize the systems changes firms would need to make, because they would not need to establish new systems in order to file their relationship summaries with the Commission. One commenter supported using EDGAR for analyzing and comparing fee information.[668] Several commenters, however, generally preferred Web CRD®, arguing that Web CRD® is more accessible for broker-dealers, which already make filings through Web CRD®, and that Web CRD® data provided on BrokerCheck is more familiar to retail investors.[669] In light of comments, we have determined that requiring broker-dealers to file their relationship summaries through Web CRD® should streamline broker-dealer filing requirements relative to requiring broker-dealers to file on EDGAR. Broker-dealers already use Web CRD® for filing their own registration records and those of their associated persons, and retail investors already can find broker-dealers' disciplinary history and other information on BrokerCheck. In addition, Investor.gov already has a prominent search tool on its main landing page that links to BrokerCheck and IAPD, which investors can use to search for information about firms and financial professionals. This minimizes the implementation changes needed to make relationship summaries easily accessible through Investor.gov because new search tools would not need to be created and existing search tools could be linked to the Investor.gov/CRS web page referenced in the relationship summary.

We also received comment that dual registrants should file only on one system, instead of on both EDGAR and IARD as proposed.[670] One commenter, however, implicitly supported the requirement that dual registrants file on two systems.[671] The final instructions require dual registrants to file their relationship summaries using both systems—Web CRD® and IARD.[672] This approach ensures a complete and consistent filing record for each firm and facilitates the Commission's data analysis, examinations, and other regulatory efforts. Firms offering brokerage or investment advisory services through affiliates will follow the same filing requirements as standalone firms.

For investment advisers, we are also adopting clarifications in the General Instructions to Form ADV that relate to the amending and filing of the relationship summary.[673] First, investment advisers may file an amended relationship summary as an other-than-annual amendment or by including the relationship summary as part of an annual updating amendment, within the 30 days in which they are required to file the amendment.[674] Second, the instructions provide that advisers may, but are not required to, submit amended versions of their relationship summary as part of their annual updating amendment and include additional technical references to implement this instruction.[675] Third, we added provisions to mirror the requirements of the General Instructions to Form CRS as to when amendments and exhibits showing changes to Part 3 must be made and filed.[676] We believe that investment advisers will benefit from these clarifications. Finally, we are adopting certain amendments to the General Instructions to Form ADV to add conforming technical changes and references to the Form ADV, Part 3.[677]

3. Delivery Requirements

a. Form of Delivery

The final instructions provide, as proposed, that firms will be able to deliver the relationship summary (including updates) within the framework of the Commission's existing guidance regarding electronic delivery.[678] This framework consists of Start Printed Page 33547the 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.[679] In the Proposing Release, we also provided proposed guidance that 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, and that this method of initial delivery for the relationship summary would be consistent with the Commission's electronic delivery guidance.[680] We have included this provision in the final instructions to provide additional clarity and certainty on what is permissible for initial delivery of the relationship summary.[681] This approach applies only to the initial delivery of the relationship summary to new or prospective clients or customers, and not to any other delivery obligation of any other required disclosure. With respect to existing clients or customers, as proposed, 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's electronic delivery guidance. The above delivery instructions are based on the assumption that retail investors are able to access and prefer to receive communications and disclosures through the same medium in which they request information from the firm or financial professional. If this assumption is not correct, retail investors can request a copy of the relationship summary in a format they prefer, as discussed below, and can establish their delivery preferences with the firm once they have entered into a relationship.

Numerous commenters expressed support for electronic delivery, including for modifications to the instructions to make electronic delivery a more accessible option for the relationship summary as well as other disclosures.[682] A number of commenters further advocated for the “notice plus access” model, in which posting the relationship summary to the firm's website, in combination with a notice to the retail investor that the relationship summary is available there, would constitute delivery.[683] Some of these commenters argued that this approach should suffice for delivery, even if the retail investor had not previously consented to electronic delivery in an affirmative way.[684] A few commenters cited to the Commission's recently adopted rule 30e-3 under the Investment Company Act [685] as a possible model for delivering the relationship summary.[686] Some of these commenters also advocated for a more comprehensive updating of the Commission's guidance concerning electronic delivery, not just for the relationship summary but for other disclosures as well.[687] Commenters advocating for more widespread use of electronic delivery cited to arguments including the potential cost savings and improved security of delivery to investors.[688]

On the other hand, some commenters expressed reservations about a notice plus access equals delivery approach and supported the Commission's proposed approach.[689] The RAND 2018 survey and another investor survey also showed mixed results relating to electronic delivery, with many participants indicating that they would prefer to receive the disclosures in paper.[690] Similarly, the IAC has stated that nearly half of investors (49%) still prefer to receive paper disclosures through the mail, compared with only 33% who prefer to receive disclosures electronically, either through email (27%) or by accessing them online (6%).[691] Additionally, we are aware, Start Printed Page 33548based on our filing data, that a number of firms do not host public websites and would not be able to make available an updated, electronic version of their relationship summary for their retail investors at all times.[692] Some commenters noted that some retail investors may lack readily available internet access.[693]

The relationship summary is designed to be delivered when a retail investor selects a firm or financial professional and which services to receive, including updated versions upon certain events when retail investors are again making decisions about whether to invest through an advisory account or a brokerage account. These selections affect all of the retail investor's subsequent investments under that relationship. In comparison, documents such as shareholder reports and prospectuses typically relate to investment decisions on single products; once the product is purchased, reporting is most commonly delivered at regular intervals, unlike the relationship summary. We are preserving an investor's ability to receive the relationship summary in paper, by maintaining the protections provided by the Commission's electronic delivery guidance.[694]

We recognize the benefits to retail investors of receiving the relationship summary as early as possible when considering a firm or financial professional and that electronic communication can facilitate earlier delivery, provided that retail investors can readily access the form of communication used. As noted above, we have adopted the instruction that delivery of the relationship summary to new or prospective clients or customers in a manner that is consistent with how that retail investor requested information about the firm or financial professional would be consistent with the Commission's electronic delivery guidance.[695] This approach applies only to the initial delivery of the relationship summary to new or prospective clients or customers, and not to any other delivery obligation of any other required disclosure. Moreover, to ensure that a relationship summary delivered electronically is noticeable for retail investors and not hidden among other disclosures, we are adopting a new instruction that a relationship summary delivered electronically must be presented prominently in the electronic medium and must be easily accessible for retail investors.[696] For example, a firm can use a direct link or provide the relationship summary in the body of an email or message.[697] We are also requiring firms to post the current version of the relationship summary prominently on their public website, if they have one, as proposed.[698]

We understand that, while many investors prefer receiving disclosures about investment advice in electronic format, many also value the option to receive them in paper.[699] We are adopting several additional requirements relating to relationship summaries in paper format. First, in a relationship summary that is delivered in paper format, firms may link to additional information by including URL addresses, QR codes, or other means of facilitating access to such information.[700] Second, if a relationship summary is delivered in paper format as part of a package of documents, the firm must ensure that the relationship summary is the first among any documents that are delivered at that time, substantially as proposed.[701] All firms will be required to make a copy of the relationship summary available upon request without charge.[702] However, we are not requiring that firms make the relationship summary available in paper format. We understand that some firms' business models—for example, those of advisers providing automated investment advisory services and broker-dealers that provide services only online—are based on delivering substantially all disclosures and conducting substantially all correspondence with clients and customers electronically. We do not intend to change these practices and believe that retail investors that prefer paper communications will have the opportunity to establish relationships with firms that accommodate paper delivery.

b. Initial Delivery

The final instructions require an investment adviser registered with the SEC to deliver a relationship summary to each retail investor before or at the time the firm enters into an investment advisory contract, even if the agreement is oral, as proposed.[703] The timing for standalone investment advisers to deliver the relationship summary to new or prospective retail clients generally tracks the initial delivery requirement for Form ADV Part 2A.[704] As described further below, we are changing the instruction for broker-dealers to require delivery before or at earliest of one of three triggers.[705] In Start Printed Page 33549comparison, under the proposal, broker-dealers would have delivered the relationship summary before or at the time the retail investor first engages their services.[706] Under the final rules, dual registrants, and affiliated broker-dealers and investment advisers that jointly offer their services to retail investors, must deliver at the earlier of the initial delivery triggers for an investment adviser or a broker-dealer, including a recommendation of account type.[707] This applies whether the dual registrant or affiliated firms prepare one single relationship summary describing both brokerage and investment advisory services, or two separate relationship summaries describing each type of service.

Some commenters supported keeping the initial delivery requirements as proposed.[708] Other commenters expressed concern that under the proposal, the relationship summary would be delivered only after the investor has already made a decision about which firm to engage and which type of account to open, and recommended variations on the proposed initial delivery requirements, including mandating even earlier delivery.[709] The variations include, for example, delivery at the point of first contact or inquiry between the retail investor and firm, whenever possible; [710] at the earlier of when a customer contacts the firm or enters into an advisory agreement or engagement of services; [711] and upon the first interaction with a prospective retail investor.[712] For dual registrants, one commenter recommended requiring delivery no later than the point at which a recommendation is made regarding which type of account to open.[713] One commenter asserted that the Commission should not permit delivery “at” the time of service but rather should always require delivery “before” the provision of service.[714] The IAC recommended providing “a uniform, plain English disclosure document . . . to customers and potential customers of broker-dealers and investment advisers at the start of the engagement, and periodically thereafter.” [715]

A few commenters supported requiring a period of time between delivery of the relationship summary and the beginning of the relationship.[716] One commenter suggested allowing time for retail investors to review the relationship summary, subsequent to delivery when the firm first interacts with a retail investor.[717] A number of investors at Commission-held roundtables also supported a waiting period.[718] Other commenters, however, opposed a mandated delay between delivery of the relationship summary and engaging in services.[719]

Various commenters explained logistical and recordkeeping issues if firms were required to deliver the relationship summary at first contact or prior to engaging a firm's services.[720] For example, one commenter stated that it would not be feasible to obtain an investor's affirmative consent to electronic delivery before the investor decides to engage the firm.[721] Tracking whether or not prospective customers had consented to electronic delivery of the relationship summary would be difficult because prospective customers who do not open accounts would not have account numbers or other unique identifiers for the firm's recordkeeping purposes.[722] Other commenters argued that keeping records of when a relationship summary was given to a prospective retail investor would be unnecessarily burdensome for firms and would likely provide de minimis benefits.[723] Still other commenters discussed the difficulty of defining when a customer first engages the firm's services, the terminology used in the proposal.[724]

We encourage investment advisers and broker-dealers to deliver the relationship summary far enough in advance of a prospective retail investor's final decision to engage the firm to allow for meaningful discussion between the financial professional and retail investor, including by using the conversation starters, so that the retail investor has time to understand the relationship summary and to weigh available options. We believe that prospective clients or customers would benefit from receiving the relationship summary as early as possible when deciding whether to engage the services of a firm or financial professional. In response to comments on initial delivery, including those relating specifically to broker-dealers, we are modifying the broker-dealer initial delivery requirements, as discussed below. However, we are declining to mandate a delivery requirement based on first contact or inquiry, or to impose a waiting period. First, “first contact or inquiry” may include circumstances that are not limited to the seeking of investment services, such as business Start Printed Page 33550interactions for other purposes or social interactions, and therefore could create compliance uncertainty. Second, we believe the availability of each firm's relationship summary through Investor.gov and on its own website, if the firm has one, helps to address the concern that investors will not have the opportunity to review and compare relationship summaries before entering into an investment advisory contract or receiving services from a broker-dealer.[725] Third, some investors may not want to wait to begin services,[726] and those who do can always take as much time as needed to review the relationship summary and wait to sign an advisory agreement or begin receiving brokerage services at a later time. Fourth, firms will be permitted to deliver the relationship summary well before they enter into an advisory agreement or provide brokerage services, and as noted, we encourage firms to deliver the relationship summary early in the process. Finally, dual registrants, and affiliated broker-dealers and investment advisers that jointly offer their services to retail investors, must deliver their relationship summaries at the earlier of the delivery triggers for broker-dealers or investment advisers. To the extent the initial delivery requirements for a broker-dealer are earlier than the delivery requirements would be for an investment adviser, the earlier requirements will apply to an investment adviser that is a dual registrant or that offers services jointly with a broker-dealer affiliate. We believe this will provide a significant benefit to retail investors, given the substantial percentage of regulatory assets under management (“RAUM”) managed by dual registrants and investment advisers with broker-dealer affiliates, relative to the total RAUM managed by investment advisers overall.[727]

To facilitate earlier delivery, as discussed above, the final instructions allow firms to deliver the relationship summary to a new or prospective client or customer in a manner that is consistent with how the retail investor requested information about the firm or financial professional, clarifying that this approach would be consistent with the SEC's electronic delivery guidance.[728] We believe this approach alleviates concerns expressed by commenters that obtaining the consent of prospective clients or customers to receive electronic delivery and maintaining records of that consent would be challenging.[729] While we recognize recordkeeping burdens relating to the delivery of the relationship summary to prospective clients—for example, we are not imposing a delivery requirement upon first contact or inquiry by a retail investor, as discussed above—we disagree that they are insurmountable and would outweigh the benefits to retail investors. As discussed further in Section II.E. below, investment advisers and broker-dealers have experience with similar recordkeeping requirements.[730] Moreover, we believe there is considerable benefit to retail investors in receiving the relationship summary before deciding to engage a firm, to allow time for questions and discussion with the financial professional, to understand the relationship summary, and to weigh available options.

Commenters suggested modifications to the proposed initial delivery requirements specifically for broker-dealers. Several commenters requested that we require broker-dealers to deliver the relationship summary at the point of first contact, inquiry, or interaction with a retail investor.[731] A number of commenters also raised questions about the meaning of “engaging the services” of a broker-dealer, noting that it was unclear when that may ultimately occur and that it is a new and undefined concept in the context of a customer relationship with a broker-dealer.[732] Other commenters suggested that we exclude or exempt certain types of broker-dealers that provide limited services to retail investors from the requirement to deliver the relationship summary or from the requirements of Form CRS more generally.[733]

In response to these concerns, we are modifying the initial delivery requirements for broker-dealers. Instead of “at the time the retail investor first engages a broker-dealer's services,” broker-dealers will be required to deliver the relationship summary to each retail investor before or at the earliest of: (i) A recommendation of an account type, a securities transaction, or an investment strategy involving securities; (ii) placing an order for the retail investor; or (iii) the opening of a brokerage account for the retail investor.[734] We believe that these more concrete initial delivery triggers for broker-dealers avoid the uncertainty of when a retail investor first engages a broker-dealer's services and include scenarios that encompass earlier delivery, in response to commenters' concerns.

As noted, the proposal would have required broker-dealers to deliver the relationship summary before or at the time the retail investor first engages the firm's services. This proposed requirement was 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”. The proposed rule would not have required delivery to a retail investor to whom a broker-dealer makes a recommendation, if that retail investor did not open or have an account with Start Printed Page 33551the broker-dealer, or that recommendation did not lead to a transaction with that broker-dealer.[735] If the recommendation led to a transaction with the broker-dealer who made the recommendation, the retail investor would have been considered to be “engaging the services” of that broker-dealer at the time the customer places the order or an account is opened, whichever occurred first. Instead, in response to comments advocating for earlier delivery, the final requirement expands on the proposed initial delivery requirement and potentially pushes it earlier, to require delivery (even where a brokerage account has not been established) before or at the time a broker-dealer recommends an account type, a securities transaction, or an investment strategy involving securities without regard to whether the retail investor acts on the recommendation. We believe that revising the delivery requirement in this way will give retail investors the opportunity to consider the information included in the relationship summary earlier in the process of determining whether to establish a brokerage relationship with the broker-dealer, as well as in evaluating the recommendation.

Compared to the proposal, the final requirement also pushes earlier the time at which broker-dealers must deliver the relationship summary in instances in which the retail investor does not open an account but still engages in a securities transaction such as the “check and application” example described above. Under these circumstances, broker-dealers must deliver the relationship summary before or at the time an order is placed for the retail investor, instead of before or at the time the transaction is effected, as proposed. This delivery obligation would be triggered to the extent this type of transaction were unsolicited, because, as described above, if a recommendation preceded this type of transaction, delivery would have been triggered before or at the time of the recommendation.

To the extent the broker-dealer had not already made a recommendation of an account type, a securities transaction or an investment strategy involving securities, or placed an order for the retail investor, delivery would be triggered before or at the time the retail investor opens a brokerage account with the broker-dealer. As revised, we believe that the initial delivery triggers for broker-dealers avoid the uncertainty of the proposed initial delivery standard and include scenarios that encompass earlier delivery, in response to commenters' concerns.

In response to the comments requesting exemptions or exclusions from the relationship summary obligations generally and the delivery obligations for certain broker-dealers that engage in limited activities, we are clarifying that we do not intend for the Form CRS requirements to apply to certain types of relationships between a broker-dealer and a retail investor. Pursuant to Exchange Act Rule 17a-14, the scope of the Form CRS requirement applies “to every broker or dealer registered with the Commission pursuant to section 15 of the Act that offers services to a retail investor” (emphasis added). Solely for purposes of Form CRS, we are describing here the types of relationships between a broker-dealer and a retail customer that we would not consider to be “offer[s] [of] services to a retail investor”.

Specifically, clearing and carrying broker-dealers that are solely providing services to third party or affiliated introducing broker-dealers would not be considered to be offering services to a retail investor for purposes of Exchange Act Rule 17a-14, and would not be subject to the Form CRS requirements when acting in such capacity. As described above, the relationship summary is designed to make it easier for retail investors to get the facts they need when deciding among investment firms or financial professionals and the accounts and services available to them. When a retail investor is establishing or has a relationship with an introducing broker-dealer, we believe that the retail investor would benefit most from focusing on that broker-dealer's services, fees, standard of conduct, conflicts of interest and disciplinary history. In these circumstances, we believe that receiving an additional relationship summary from a clearing or carrying broker-dealer could create confusion and detract from the goals of this disclosure.

Additionally, we would not consider a broker-dealer that is serving solely as a principal underwriter to a mutual fund or variable annuity or variable life insurance contract issuer to be offering services to a retail investor for purposes of Exchange Act Rule 17a-14, when acting in such capacity. As with clearing and carrying broker-dealers, broker-dealers serving solely as principal underwriters do not typically establish the kind of relationship with retail investors that Form CRS has been designed to address. To the extent such broker-dealers interact with a retail customer in a different capacity (beyond serving as a principal underwriter to the mutual fund or variable contract that the retail investor owns), we believe the nature of their relationship could become one where delivery of the Relationship Summary would be useful. Accordingly, Form CRS's obligations would apply in those instances.[736]

We are adopting as proposed the approach to delivery for dual registrants, whereby they must deliver the relationship summary to a new or prospective retail investor at the earlier of the delivery triggers applicable to investment advisers and broker-dealers.[737] One commenter argued that a dual registrant should be required to deliver the relationship summary at the earlier of providing an investment recommendation or the time a retail investor opens an account with the firm.[738] We believe that the broker-dealer initial delivery requirements, as adopted, accommodate this comment. Another commenter asserted that dual registrants should be required to deliver the relationship summary no later than when a recommendation is made as to the type of account to open.[739] We believe that the final initial delivery requirements accommodate this comment also. Broker-dealers will be required to deliver the relationship summary before or at the earliest of (i) a recommendation of an account type, a securities transaction, or an investment strategy involving securities, (ii) placing an order for the retail investor, or (iii) the opening of a brokerage account for the retail investor.[740] Investment advisers will be required to deliver the relationship summary before or at the time of entering into an investment advisory contract with the retail investor.[741] Dual registrants will be required to deliver the relationship summary when recommending an account type to the retail investor if it is the earliest occurrence among the initial delivery triggers for broker-dealers and investment advisers, which we believe will typically precede the opening of a brokerage account or Start Printed Page 33552entering into an investment advisory contract.[742]

c. Additional Delivery Requirements to Existing Clients and Customers

We are adopting requirements for firms to re-deliver the relationship summary to existing clients and customers under certain circumstances, with some modifications from the proposal. We continue to believe that these investors will benefit from being reminded of the information contained in the relationship summary, including about the different services and fees that the firm offers, when they are again making decisions about whether to invest through an advisory account or a brokerage account. Specifically, after an initial delivery of the relationship summary to existing clients and customers who are retail investors, firms will be required to deliver the most recent version of the relationship summary to a retail investor if they (i) open a new account that is different from the retail investor's existing account(s); (ii) recommend that the retail investor roll over assets from a retirement account into a new or existing account or investment; or (iii) recommend or provide 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, for example, the first time purchase of a direct-sold mutual fund or insurance product that is a security through a “check and application” process, i.e., not held directly within an account.

In comparison, as proposed, the instructions would have required a firm to deliver a relationship summary to existing clients or customers when: (i) A new account is opened that is different from the retail investor's existing account, or (ii) changes are made to the existing account that would materially change the nature and scope of the relationship. The proposed instructions provided that whether a change was material for these purposes would depend on the specific facts and circumstances and gave as examples transfers from an investment advisory account to a brokerage account, transfers from a brokerage account to an investment advisory account, and moves of assets from one type of account to another in a transaction not in the normal, customary or already agreed course of dealing.

In the RAND 2018 survey, 50% of respondents reported that they would like to receive an updated relationship summary “whenever there is a material change in the Relationship Summary, such as a change in fees or commission structure,” about 30% would prefer to receive the relationship summary periodically and almost 40% preferred to receive the summary on request.[743] One commenter supported the additional delivery requirements to existing clients and customers as proposed, agreeing that investors are again making decisions about relationships and account types under these circumstances and would benefit from the information the relationship summary provides.[744] Another commenter recognized the value of delivering the relationship summary to existing clients and customers but recommended specific limitations to the requirements.[745] One commenter supported once a year or periodic updates and continued availability of a current version on a firm's website,[746] while another commenter opposed any requirement to provide periodic updates.[747] Several commenters argued that some or all of the additional delivery requirements are not necessary, given the prior initial delivery and online availability of relationship summaries.[748] A few commenters argued that the additional delivery requirements could confuse investors because of either an apparent duplication or difference from delivery requirements of existing disclosures.[749] One commenter also stated that the proposed additional delivery requirements could overwhelm investors in a counterproductive way.[750] Furthermore, commenters requested additional guidance or examples for what would “materially change” the relationship.[751]

In addition, some commenters expressed concerns about administrative and operational burdens relating to the proposed additional delivery requirements.[752] For example, one commenter asserted that firms would be required to build entirely new operational and supervisory processes to identify asset movements divorced from any account opening process that could trigger an additional delivery requirement.[753] This commenter also argued that the review that would be required prior to effecting potentially triggering asset movements could cause delays that are detrimental to the retail Start Printed Page 33553investor.[754] Similarly, another commenter explained that most of the proposed additional delivery triggers would be relatively easy to identify and address through existing processes, such as new account openings and when a brokerage account is converted to an investment advisory account and vice versa.[755] Other potential delivery triggers, however, such as investments of inheritances or proceeds of a property sale, or a significant migration from savings to investment, would present operational challenges and compliance costs.[756] These commenters recommended limiting additional delivery requirements to circumstances in which a brokerage account is converted to an investment advisory account and vice versa.[757]

We disagree that delivery of the relationship summary to existing clients and customers is unnecessary if the investor has already received one. As noted above, when investors are again making decisions about whether to choose an investment advisory or brokerage account, we believe they will benefit from being reminded that different options are available and where they can get more information to inform their choice. We are not requiring that the relationship summary be delivered at periodic intervals or at every transaction; thus we disagree with comments that the additional delivery obligations will not provide commensurate benefit to investors, or will confuse or overwhelm investors. We are therefore adopting additional delivery requirements that apply to a firm's existing clients and customers, with some modifications from those proposed.

First, as proposed (and supported by two commenters as noted above), we are adopting the requirement that a firm deliver the relationship summary when opening any new account that is different from the retail investor's existing account(s).[758] Second, in response to comments we are replacing the proposed standard of “materially change the nature and scope of the relationship” with two, more specific and easily identifiable, triggers that we believe would not implicate the same operational or supervisory burdens described by commenters to meet the proposed requirement.[759] Instead, firms will be required to deliver a relationship summary to existing clients and customers when recommending that the retail investor roll over assets from a retirement account, or recommending or providing 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, for example, the first-time purchase of a direct-sold mutual fund or insurance product (e.g., variable annuities) that is a security through a “check and application” process, i.e., not held directly within an account.[760] While these requirements will still impose operational and supervisory burdens, we believe they are more easily identified and monitored, such that firms will not need to create new systems or processes to the extent that commenters said would be necessary to comply with the proposed “material change” standard. These more specific triggers are intended to provide investor protection under these circumstances in a more cost-effective manner, while still addressing the objectives that the “material changes” language sought to address, that is, to ensure that a firm does not switch existing customers or clients into accounts or services without explaining or giving them the opportunity to consider other available options.[761] Also, as proposed, we are adopting the instruction that firms must deliver the relationship summary to a retail investor within 30 days upon the retail investor's request.[762] While some commenters requested changes to the proposed delivery requirements, they nonetheless supported requiring delivery upon request.[763]

Finally, delivery of the relationship summary will not necessarily satisfy any other disclosure obligations the firm has under the federal securities laws or other laws or regulations, as proposed. The relationship summary requirement will be in addition to, and not in lieu of, other disclosure and reporting requirements or other obligations for broker-dealers and investment advisers.[764] One commenter suggested that we require that the relationship summary include a prominent statement that it does not replace, but rather should be read in conjunction with, Form ADV or Form BD.[765] This commenter also suggested that the relationship summary should include a hyperlink to the appropriate Form ADV or Form BD, as applicable.[766] We believe that the required links in the Additional Information section, discussed in Section II.B.5. above, addresses these comments.

Some commenters argued that investment advisers should not be required to deliver a relationship summary to retail clients because they already deliver a Form ADV Part 2A brochure.[767] We disagree. By requiring both investment advisers and broker-dealers to deliver a relationship summary that discusses at a high level both types of services and their differences in a comparable format, the relationship summary would help all retail investors compare not only among investment advisory services, but also between investment advisory and brokerage services. We do not believe that existing disclosures provide this level of transparency and comparability across investment advisers, broker-dealers, and dual registrants. Form CRS is a summary disclosure designed to provide a high-level overview of services, fees, costs, conflicts of interest, standard of conduct, and disciplinary history, to retail investors in order to help them decide whether to engage a particular firm or financial professional, including deciding whether to seek investment advisory or brokerage services. Form ADV Part 2A, in contrast, requires more detailed disclosures specific to advisory services. 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 will not be required to prepare or file a relationship summary, as proposed.[768]

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4. Updating Requirements

We are adopting substantially as proposed a requirement for firms to update the relationship summary within 30 days whenever the relationship summary becomes materially inaccurate.[769] Firms also must post the latest version on their website (if they have one), and electronically file the relationship summary with the Commission.[770] Although some commenters expressed different views on the requirement to communicate updated information to retail investors, as discussed below, most commenters did not object to the proposed requirements to update the relationship summary within 30 days of a material change and the associated posting and filing obligations.[771] On the other hand, one commenter advocated that firms be allowed 60 days to update the relationship summary to address operational issues, but did not describe the specific operational challenges.[772] Based on our experience with other similar filings, we believe the proposed approach is consistent with the current requirements for investment advisers to update the Form ADV Part 2A brochure,[773] and with broker-dealers' current obligations, including to update Form BD if its information is or becomes inaccurate for any reason.[774] We continue to believe that allowing 30 days for firms to make updates provides sufficient time for firms to make the necessary revisions. Therefore, we are adopting these requirements as proposed.

The proposed instructions also would have required firms, without charge to the retail investor, to communicate updated information by delivering the amended relationship summary or by communicating the information another way.[775] As noted above, commenters expressed different views regarding this approach. Some commenters advocated for posting the relationship summary on a firm's website in order to meet the communication requirement.[776] On the other hand, one commenter advocated for requiring firms to deliver updated relationship summaries whenever a change is made, rather than permitting firms to communicate the information in another way.[777] We are adopting slightly revised final instructions to eliminate the proposed wording “another way” in order to clarify that a firm may communicate the information through another disclosure, and that disclosure must be delivered to the retail investor.[778] In other words, merely providing notice of or access to another disclosure or the relationship summary would not satisfy this final instruction. 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 that also contained the updated information, this would support a reasonable belief that the information had been communicated to the retail investor, and the investment adviser will not be required to deliver an updated relationship summary to that retail investor. This requirement provides firms the flexibility to disclose changes to the relationship summary without requiring them to incur additional delivery costs.

In another modification from the proposal, the rules as adopted will allow firms to communicate the information in an amended relationship summary to retail investors who are existing clients or customers within 60 days after the updates are required to be made, instead of 30 days as proposed.[779] Two commenters advocated that allowing 60 days for the communication would increase the likelihood that firms could deliver an updated relationship summary along with other disclosures that firms commonly deliver on a quarterly basis, rather than in a separate delivery.[780] Delivery with other disclosures is consistent with the instructions regarding the way in which relationship summary updates may be communicated. We are clarifying this, as noted above, and adopting the requirement that firms must communicate updates to the relationship summary within 60 days after the updates are required to be made.

In a further change from the proposal, firms must highlight the changes in an amended relationship summary by, for example, marking the revised text or including a summary of material changes and attaching the changes as an exhibit to the unmarked amended relationship summary.[781] The unmarked amended relationship summary and exhibit must be filed with the Commission.[782] We believe that including this exhibit is important in assisting retail investors to assess changes that may impact their accounts or their relationships with their firm or financial professional. A retail investor will be able to find the latest version of the relationship summary through Investor.gov and on the firm's website, if it has one, and firms will be required to deliver a relationship summary within 30 days upon the retail investor's request, as proposed.[783]

As discussed in the proposal, for purposes of the requirement to communicate updates to the Start Printed Page 33555relationship summary, 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, a broker-dealer will 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 continue to believe this approach will facilitate broker-dealers building upon their current compliance infrastructure in identifying existing customers [784] and will enhance investor protections to retail investors engaging the financial services of broker-dealers.

D. Transition Provisions

To provide adequate notice and opportunity to comply with the adopted relationship summary filing requirements, firms that are registered, or investment advisers who have an application for registration pending, with the Commission prior to June 30, 2020 will have a period of time beginning on May 1, 2020 until June 30, 2020 to file their initial relationship summaries with the Commission.[785] On and after June 30, 2020, newly registered broker-dealers will be required to file their relationship summary with the Commission by the date on which their registration with the Commission becomes effective, and the Commission will 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.[786] The adopted transition period is longer than we proposed. The proposal would have required broker-dealers to comply with their relationship summary obligations beginning six months after the effective date of the new rules and rule amendments.[787] Similarly, in the proposal, investment advisers or dual registrants would have been required to comply with the new filing requirements as part of the firm's next annual updating amendment to Form ADV that would have been required after six months after the rule's effective date.[788] The extended time to comply with the relationship summary requirements reflects our consideration of comments we received from firms and the modifications to the proposed requirements of the relationship summary.

In the proposal, we asked for comment on the proposed implementation requirements and whether the six-month period was enough time for newly registered broker-dealers and investment advisers to prepare an initial relationship summary.[789] A number of commenters requested a longer implementation period, ranging from 12 to 24 months from the effective date.[790] One commenter suggested a phased-in approach, such that requirements may be effected at different points in time.[791] Commenters cited a number of reasons for a longer implementation period, including the time needed to hire additional staff and create and deploy new disclosures, procedures, training, and technology,[792] as well as to have the opportunity to apply innovative technology and designs.[793]

We are mindful of the time needed to create the relationship summary, as well as to update a firm's policies, procedures, and systems in order to provide these new disclosures. We are, however, lengthening the time that firms will have to comply relative to the proposal after considering commenters' suggestions for a longer implementation period. We expect that approximately twelve months will be adequate for firms to conduct the requisite operational changes to their systems and to establish internal processes to satisfy their relationship summary obligations.

Some commenters expressed the view that the proposed one-time, initial delivery to existing clients and customers is not necessary.[794] One survey reported, on the other hand, that over 90% of survey respondents with an existing financial professional relationship stated that they knew more about their relationship with the adviser after reading the proposed relationship summary.[795] We believe the information contained in the relationship summary could improve existing investors' ability to monitor and make more informed decisions related to their existing relationships with firms during their duration, including whether to terminate a relationship. For example, as discussed above in Section II.A., retail investors that may learn of account types whose minimum requirements they did not meet when they first opened their existing account, through a one-time, initial delivery to existing clients and customers. Upon seeing this range of options, existing clients and customers could seek to take advantage of cost savings or additional services offered through these other account types. We believe that existing clients and customers would benefit from this one-time delivery of the relationship summary and therefore are adopting the requirement as proposed. Firms will be required to deliver their relationship summary to new and prospective clients and customers who are retail investors as of the date by which they are first required to electronically file their relationship summary with the Commission.[796] In addition, as proposed, firms will be required, as part of the transition, to Start Printed Page 33556deliver their relationship summaries to all 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.[797]

E. Recordkeeping Amendments

We are adopting amendments to the recordkeeping and record retention requirements under Advisers Act rule 204-2 and Exchange Act rules 17a-3 and 17a-4, as proposed. These rules set forth requirements for firms to make, maintain, and preserve specified books and records. Pursuant to paragraph (a)(14)(i) of Advisers Act Rule 204-2 as amended, investment advisers will be required to make and preserve a record of the dates that each relationship summary was given to any client or prospective client who subsequently becomes a client.[798] New paragraph (a)(24) of Exchange Act Rule 17a-3 as adopted will require broker-dealers to create a record of the date on which each relationship summary was provided to each retail investor, including any relationship summary provided before such retail investor opens an account.[799] In addition, paragraph (a)(14)(i) of Advisers Act rule 204-2, as amended, will require investment advisers to retain copies of each relationship summary and each amendment or revision thereto while paragraph (e)(10) of Exchange Act rule 17a-4, as amended, will require broker-dealers to maintain and preserve a copy of each version of the relationship summary as well as the records required to be made pursuant to new paragraph (a)(24) of Exchange Act rule 17a-3 as adopted by the Commission.[800] The amended rules set forth the manner in which and the period of time for which these record must be retained.[801] These records will facilitate the Commission's ability to inspect for and enforce compliance with the relationship summary requirements.

We received no comments on the proposed manner and time period for records preservation or the requirement to maintain a copy of each version of the relationship summary and each amendment or revision to the relationship summary.[802] We are adopting these requirements as proposed. Some commenters expressed concern with the potential costs and feasibility of complying with the proposed recordkeeping requirements for broker-dealers.[803] Several commenters argued that keeping records of when a relationship summary was given to a prospective retail investor would be unnecessarily burdensome for firms and would likely provide de minimis benefits.[804] Some investment adviser and broker-dealer commenters stated that most firms' recordkeeping systems and procedures are not designed to maintain records relating to prospective clients and that conforming such systems and procedures to the proposed rule requirements would be burdensome and costly and would not result in an offsetting benefit.[805] Others noted they may have to retain records for an indefinite length of time because their interactions with prospective clients about engaging services often span weeks, months or years and may include numerous phone calls, meetings or other forms of contact.[806]

As an alternative, commenters suggested that firms only be required to maintain a record of the most recent date they delivered the relationship summary to a prospective client that becomes an actual client preceding the opening of an account.[807] Commenters suggested only requiring a record that the relationship summary was delivered at account opening or when a retail investor becomes an investment advisory client.[808]

Based on our experience with similar recordkeeping requirements for the Form ADV Part 2A brochure, requiring firms to create and maintain records of the dates they provide or give a relationship summary to an existing, new, or potential retail investor will facilitate examiners' ability to inspect and examine for compliance with the relationship summary delivery and content requirements. Specifically, the dates will help examiners to identify the relationship summary disclosures that retail investors may have relied on to decide whether to engage a firm's services. Absent having these dates to examine, we believe that it would be exceedingly difficult for examiners to evaluate firms' compliance with the relationship summary delivery and content requirement. These records also may assist firms in monitoring their compliance with the relationship summary delivery requirements.

Recordkeeping obligations for the relationship summary may be less burdensome if firms' recordkeeping and compliance systems are already capable of creating and maintaining records related to communications with prospective clients. For example, investment advisers are required to keep similar records for the delivery of the Form ADV Part 2A brochure [809] and broker-dealers, especially those registered with FINRA, are subject to comparable recordkeeping requirements with respect to communications and correspondence with prospective retail investors.[810]

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Several firms also requested clarification and expressed concern regarding the potential recordkeeping implications related to the “Key Questions to Ask” provision of the proposal.[811] Some commenters stated that requiring firms to make and maintain records of their answers to the “Key Questions to Ask” and of supplemental information cross-referenced in or linked from the relationship summary would result in substantial and unnecessary burdens and/or might stifle potentially beneficial discussions between firms, clients and/or prospective clients.[812] Commenters requested clarification that “Key Questions to Ask” are intended to promote dialog between firms and clients rather than creating any sort of recordkeeping requirement, which commenters believed could lead to less robust discussions between firms and clients.[813]

As discussed above, the “Key Questions to Ask” section of the relationship summary has been eliminated, but firms will be required to include “conversation starters” in their relationship summary.[814] We are not establishing new or separate recordkeeping obligations related to the conversation starters or the answers provided by firms in response to the conversation starters. We are also not adding separate or new recordkeeping obligations related to the use of layered disclosure in the relationship summary. Current recordkeeping rules for investment advisers and broker-dealers already impose recordkeeping and retention requirements related to a firm's disclosures and other communications with retail investors, which will include responses to conversation starters or information cross-referenced in the relationships summary.[815] Responses to conversation starters or hyperlinked material may trigger recordkeeping requirements under other federal securities statutes and rules or the rules of self-regulatory organizations of which firms are members or registrants.[816] Further, firms may wish to develop scripts for their financial professionals in responding to conversation starters to ensure the quality and consistency of responses and then preserve the scripts for compliance purposes.

III. Disclosures About a Firm's Regulatory Status and a Financial Professional's Association

In connection with Form CRS, we recognized that 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.[817] This concern was particularly acute where such communications 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.[818] To mitigate these concerns, we proposed additional rules as part of the Proposing Release. One of our proposed rules required disclosure of a firm's regulatory status and a financial professional's association with a firm. Specifically, we proposed rules under the Exchange Act and the Advisers Act that would have required a broker-dealer and an investment adviser 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.[819] The proposed Exchange Act rule also would have required 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.[820] Similarly, the proposed Advisers Act rule would have required 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.[821] As we discussed in the Proposing Release, we believed that requiring a firm to disclose whether it is a broker-dealer or an investment adviser in print or electronic retail investor communications would assist retail investors in determining which type of firm is more appropriate for their specific investment needs.[822] For similar reasons, we noted 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.[823]

Several commenters expressed general support for the proposed Affirmative Disclosures.[824] Some of these commenters believed that the rules could be beneficial in helping investors to understand the legal distinctions between broker-dealers and investment advisers.[825] Another commenter in support of the Affirmative Disclosures stated that investors would benefit more if they were also provided with readily accessible regulatory and disciplinary histories of the financial professional.[826] However, one commenter noted that while “the required disclosure could have some modest benefit, . . . it is important not to overstate [its] likely value.” [827]

Several commenters also opposed the Affirmative Disclosures.[828] Some commenters believed that the proposed rules were duplicative, noting that Start Printed Page 33558Regulation Best Interest, Form CRS, and/or other required disclosure obligations (e.g., Form ADV, FINRA Rule 2210) would inform retail investors of the capacity of a firm and its financial professionals, obviating the need for the additional rules.[829] Some of these commenters stated that Form CRS alone or in combination with FINRA Rule 2210(d)(3) (providing specific requirements for disclosure of the broker-dealer's name in retail communications and correspondence) would provide retail investors with a firm's capacity and its name, making the Affirmative Disclosures duplicative.[830]

Several commenters also opposed the Affirmative Disclosures because they believed the costs to implement and comply with the proposed rules did not justify the benefits.[831] In particular, these commenters noted a range of cost-related impacts, such as replacing new and existing business cards [832] and amending numerous electronic and print marketing materials.[833] Several commenters also noted the difficultly in implementing and supervising specific types of communication including business cards, oral communications, and voice overlay and on-screen text in televised or video presentations.[834]

After considering the comments received and the obligations we are adopting under Regulation Best Interest and Form CRS, we have concluded that the capacity disclosure requirement in Regulation Best Interest and Form CRS are sufficient to achieve the objectives of the proposed Affirmative Disclosures. These rules enhance retail investor awareness of the firm and professional type that they are engaging or seeking to engage and would therefore assist a retail investor in choosing the type that best suits his or her financial goals.

As discussed in the Regulation Best Interest Release, as part of its disclosure obligations, a broker-dealer and its associated natural persons must disclose when they are acting as a broker-dealer when making a recommendation. This type of disclosure is designed to improve awareness among retail customers such that a retail customer can more readily identify and understand their relationship.[835] This capacity disclosure requires a broker-dealer and its financial professionals to disclose that the firm or the financial professional is acting as a broker-dealer, as a material fact relating to the scope and terms of the relationship subject to its disclosure obligation.[836] As noted in the Regulation Best Interest Release, a broker-dealer and its financial professionals must disclose the required information prior to or at the time of a recommendation but Regulation Best Interest does not mandate the form, specific time, or method of delivering disclosures pursuant to its disclosure obligation.[837] In fulfilling this obligation, a broker-dealer that is not a dual registrant generally will be able to satisfy the requirement to disclose the broker-dealer's capacity by delivering the Relationship Summary to the retail customer. For broker-dealers who are dually registered, and for associated persons who are either dually licensed or are not dually licensed and only offer broker-dealer services through a firm that is dually registered, the information contained in the Relationship Summary will not be sufficient to disclose their capacity in making a recommendation.[838] As discussed in the Regulation Best Interest Release, although some commenters expressed concerns about potential investor confusion caused by “additional” disclosure regarding a dual registrant's capacity, the disclosure obligations of Regulation Best Interest will not duplicate or confuse, but instead will provide clarifying detail on capacity to supplement the information contained in the Relationship Summary.[839]

Additionally, as discussed above, Form CRS includes a requirement for firms to state their name and whether they are “registered with the Securities and Exchange Commission as a broker-dealer, investment adviser, or both.” [840] Form CRS is required to be delivered before or at the time the financial professional enters into an investment advisory relationship or, for a broker-dealer, before or at the earliest of a certain recommendation, the execution of a securities transaction, or the opening of a brokerage account.[841] Additionally, Form CRS will need to be prominently posted on the firm's public website, if it maintains one, in a location and format that is easily accessible to retail investors [842] and must be provided to retail investors 60 days after a material change is made.[843] These requirements highlight for an investor's attention, and promote access to, the capacity information at times that we believe are crucial to a retail investor when seeking to make a choice of financial firms.

We recognize that the proposed Affirmative Disclosures would have included capacity requirements on more communications than what is required by Form CRS and capacity disclosure requirement in Regulation Best Interest. Specifically, under the Affirmative Disclosures, all forms of communications used by broker-dealers, investment advisers and their financial professionals, such as business cards, letterheads, social media profiles, and signature blocks would have included these required capacity disclosures. However, several commenters questioned whether the benefit provided by covering more communications justified the costs of implementing the requirements.[844] Start Printed Page 33559While commenters did not provide quantitative data that would demonstrate the cost impact on firms, certain commenters did describe the scope of the impact along with the operational challenges in implementing the rule.[845] One commenter stated that “the costs of such requirement would be significant” as firms would need to reprint all business cards to include this disclosure and make changes to firm technology and electronic communications to make the disclosure.[846] Additionally, another commenter stated that adding a voice overlay and on-screen text for video presentations would be difficult to implement, costly, and challenging to supervise.[847]

After considering the comments received and the obligations we are adopting under Regulation Best Interest and Form CRS, we have concluded that the policy concerns underlying the Affirmative Disclosures are addressed by the rulemaking package we are adopting, particularly the disclosure obligations in Regulation Best Interest and Form CRS, as discussed above.[848] We therefore believe that the costs of the Affirmative Disclosures do not justify any incremental benefit of requiring registration status on all communications and as a result, we are not adopting the Affirmative Disclosures.

IV. Economic Analysis

A. Introduction

The Commission is sensitive to the economic effects, including the benefits and costs and the effects on efficiency, competition, and capital formation that will result from the new rules and amendments to existing 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.[849] 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.[850] 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.[851]

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, to also consider whether the action will promote efficiency, competition, and capital formation, in addition to the protection of investors.[852] 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 not feasible due to lack of relevant data, or the difficulty of predicting how market participants would act under the conditions of the proposed rules. For example, to the extent that the relationship summary will increase retail investors' understanding of the services provided to them, investors are likely to respond differently to the increased understanding. Such responses could be transferring to a different financial firm or professional, hiring a financial professional for the first time, not taking any action, deciding to invest on their own without advice, or entirely abandoning the brokerage or investment advisory market while moving their assets to other products or markets (e.g., bank deposits or insurance products). Given the number and complexity of assumptions that would be required to be able to estimate how the relationship summary will affect investors' understanding and their decision-making, the Commission is not able to estimate the propensity of investors to respond in one way or another.

In the economic analysis that follows, we first examine the current regulatory and economic landscape to form a baseline for our analysis. The economic effects of the adopted changes are discussed below.

B. Baseline

This section discusses, as it relates to this rulemaking, 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.

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1. Providers of Financial Services [853]

a. Broker-Dealers

This rule will affect registrants in the market for broker-dealer services, including dual registrants [854] and broker-dealers offering services to retail investors that are affiliated with an investment adviser.[855] The market for broker-dealer services encompasses a small set of large and medium sized broker-dealers and thousands of smaller broker-dealers competing for niche or regional segments of the market.[856] The market for broker-dealer services includes many different markets for a variety of services, including, but not limited to, managing orders for customers and routing them to various trading venues; providing advice to customers that is in connection with and reasonably related to their primary business of effecting securities transactions; holding retail customers' funds and securities; handling clearance and settlement of trades; intermediating between retail customers and carrying/clearing brokers; dealing in corporate debt and equities, government bonds, and municipal bonds, among others; privately placing securities; and effecting transactions in mutual funds that involve transferring funds directly to the issuer. Some broker-dealers may specialize in just one narrowly defined service, while others may provide a wide variety of services.

As of December 2018, there were approximately 3,764 registered broker-dealers with over 140 million customer accounts. In total, these broker-dealers have over $4.3 trillion in total assets, which are total broker-dealer assets as reported on Form X-17a-5.[857] More than two-thirds of all brokerage assets and close to one-third of all customer accounts are held by the 17 largest broker-dealers, as shown in Table 1, Panel A.[858] Of the broker-dealers registered with the Commission as of December 2018, 359 broker-dealers are dually registered as investment advisers.[859] These firms hold over 90 million (63%) customer accounts. Approximately 539 broker-dealers (14%) report at least one type of non-securities business, including insurance, retirement planning, mergers and acquisitions, and real estate, among others.[860] Approximately 73.5% of registered broker-dealers report retail customer activity.[861]

Panel B of Table 1 is limited to the broker-dealers that report some retail investor activity. As of December 2018, there are approximately 2,766 broker-dealers that served retail investors, with over $3.8 trillion in total assets (89% of total broker-dealer assets) and almost 139 million (97%) customer accounts.[862] Of those broker-dealers serving retail investors, 318 are dually registered as investment advisers.[863]

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Table 1—Panel A: Registered Broker-Dealers as of December 2018

[Cumulative broker-dealer total assets and customer accounts]

Size of broker-dealer (total assets)Total number of broker-dealersNumber of dually registered broker-dealersCumulative total assets (billion)Cumulative number of customer accounts 864
>$50 billion1710$2,87940,550,200
$1 billion to $50 billion114221,36396,037,591
$500 million to $1 billion35723397,814
$100 million to $500 million10519231,603,818
$10 million to $100 million490101174,277,432
$1 million to $10 million1,0211303.6460,748
<$1 million1,982700.55,675
Total 8658663,7643594,309143,333,278

Table 1—Panel B: Registered Retail Broker-Dealers as of December 2018

[Cumulative broker-dealer total assets and customer accounts]

Size of broker-dealer (total assets)Total number of retail-facing broker-dealersNumber of dually registered retail-facing broker-dealersCumulative total assets (billion)Cumulative number of customer accounts
>$50 billion168$2,80640,545,792
$1 billion to $50 billion751899091,991,118
$500 million to $1 billion21513365,632
$100 million to $500 million8416181,603,818
$10 million to $100 million37891143,762,620
$1 million to $10 million7831202.8450,132
<$1 million1,409600.45,672
Total BDs 8672,7663183,844138,724,784

Table [868] 2 reports information on brokerage commissions,[869] fees, and selling concessions from the fourth quarter of 2018 for all broker-dealers, including dually-registered firms.[870] We observe significant variation in sources of revenues for broker-dealers, with large broker-dealers, on average, generating substantially higher levels of commission and fee revenues than smaller broker-dealers. On average, broker-dealers, including those that are dually registered as investment advisers, earn about $5.1 million per quarter in revenue from commissions and nearly four times that amount in fees, although the Commission notes that fees encompass a variety of fees.[871] 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 toward commissions for broker-dealers with less than $10 million in assets and is weighted more heavily toward fees for broker-dealers with assets in excess of $10 million. For example, for the 114 Start Printed Page 33562broker-dealers with assets between $1 billion and $50 billion, average revenues from commissions are approximately $45 million, while average revenues from fees are approximately $225 million.[872]

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 42% of total revenues earned by these firms.

Table 2, Panel B below provides aggregate revenues by revenue type (commissions, fees, or selling concessions from sales of IC shares) for broker-dealers delineated by whether the broker-dealer is also a dually-registered firm. Broker-dealers dually registered as investment advisers have a significantly larger fraction of their revenues from fees other than commissions or selling concessions, whereas commissions are approximately 42% of the revenues of broker-dealers that are not dually registered.

Table 2—Panel A: Average Broker-Dealer Revenues From Revenue Generating Activities

Size of broker-dealer in total assetsNumber of broker-dealersCommissionsFees 873 874Sales of IC shares
>$50 billion17$170,336,258$414,300,268$23,386,192
$1 billion-$50 billion11445,203,225225,063,25753,671,602
500 million-1 billion358,768,54730,141,2705,481,248
100 million-500 million10512,801,88933,726,33616,610,013
10 million-100 million4903,428,8438,950,8929,092,971
1 million-10 million1,021996,1301,037,825652,905
<1 million1,982197,907269,45985,219
Average of All Broker-Dealers3,7645,092,80821,948,5514,368,823

Table 2—Panel B: Aggregate Total Revenues From Revenue Generating Activities for Broker-Dealers Based on Dually-Registered Status

Broker-dealer typeNumber of broker-dealersCommissions (billion)Fees 875 (billion)Sales of IC shares (billion)
Dually Registered as IAs359$4.52$17.54$2.63
Broker-Dealers3,4054.163.252.57
All3,7648.6820.795.20

As shown in Table 3, based on responses to Form BD, broker-dealers most commonly provided business lines include private placements of securities (62.7% of broker-dealers); retail sales of mutual funds (55.4%); acting as a broker or dealer retailing corporate equity securities over the counter (52.0%); acting as a broker or dealer retailing corporate debt securities (47.2%); acting as a broker or dealer selling variable contracts, such as life insurance or annuities (41.0%); acting as a broker of municipal debt/bonds or U.S. government securities (39.8% and 37.4%, respectively); acting as an underwriter or selling group participant of corporate securities (31.2%); and investment advisory services (26.4%); among others.[876]

Table 3—Lines of Business at Retail Broker-Dealers as of December 2018

Line of businessNumber of broker- dealers (total)Percent of broker- dealers (total)
Private Placements of Securities1,73562.7
Mutual Fund Retailer1,53355.4
Broker or Dealer Retailing:
Corporate Equity Securities OTC1,43852.0
Corporate Debt Securities1,30647.2
Start Printed Page 33563
Variable Contracts1,13240.9
Municipal Debt/Bonds—Broker1,10139.8
U.S. Government Securities Broker1,03537.4
Put and Call Broker or Dealer or Options Writer99335.9
Underwriter or Selling Group Participant—Corporate Securities86231.2
Non-Exchange Member Arranging for Transactions in Listed Securities by Exchange Member78528.4
Investment Advisory Services73026.4
Broker or Dealer Selling Tax Shelters or Limited Partnerships—Primary Market61922.4
Trading Securities for Own Account61422.2
Municipal Debt/Bonds—Dealer47517.2
U.S. Government Securities—Dealer33912.3
Solicitor of Time Deposits in a Financial Institution30811.1
Underwriter—Mutual Funds2378.6
Broker or Dealer Selling Interests in Mortgages or Other Receivables2167.8
Broker or Dealer Selling Oil and Gas Interests2077.5
Broker or Dealer Making Inter-Dealer Markets in Corporate Securities OTC2077.5
Broker or Dealer Involved in Networking, Kiosk, or Similar Arrangements (Banks, Savings Banks, Credit Unions)1977.1
Internet and Online Trading Accounts1926.9
Exchange Member Engaged in Exchange Commission Business Other than Floor Activities1716.2
Broker or Dealer Selling Tax Shelters or Limited Partnerships—Secondary Market1645.9
Commodities1625.9
Executing Broker1073.9
Day Trading Accounts893.2
Broker or Dealer Involved in Networking, Kiosk, or Similar Arrangements (Insurance Company or Agency)883.2
Real Estate Syndicator943.4
Broker or Dealer Selling Securities of Non-Profit Organizations7126
Exchange Member Engaged in Floor Activities612.2
Broker or Dealer Selling Securities of Only One Issuer or Associate Issuers431.6
Prime Broker210.8
Crowdfunding FINRA Rule 4518(a)210.8
Clearing Broker in a Prime Broker140.5
Funding Portal80.3
Crowdfunding FINRA Rule 4518(b)50.2
Number of Retail-Facing Broker-Dealers2,766

(1) Disclosures for Broker-Dealers

As discussed above, broker-dealers register with and report information, including about their business, affiliates, and disciplinary history, to the Commission, Self-Regulatory Organizations (“SROs”), and other jurisdictions through Form BD.[877] 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.[878] 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.[879] 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.[880] In addition, firms report similar information and additional information to FINRA pursuant to FINRA Rule 4530.[881]

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.[882] 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.[883]

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Broker-dealers are subject to other disclosure obligations 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.[884] Disclosure has also been a feature of other regulatory efforts related to financial services, including certain FINRA rules.[885]

b. Investment Advisers

As discussed above, SEC-registered investment advisers that offer services to retail investors will be subject to the final rule. In addition, although not required to comply with the final rule, state-registered investment advisers will also be affected, because the final rule will impact the competitive landscape in the market for the provision of financial advice.[886] This section first discusses SEC-registered investment advisers, followed by a discussion of state-registered investment advisers.

As of December 2018, there are approximately 13,300 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.[887]

Of all SEC-registered investment advisers, 359 identify themselves as dually registered broker-dealers.[888] Further, 2,421 investment advisers (18%) report an affiliate that is a broker-dealer, including 1,878 investment advisers (14%) that report an SEC-registered broker-dealer affiliate.[889] As shown in Panel A of Table 4 below, in aggregate, investment advisers have over $84 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, the total number of accounts for investment advisers is only 29% of the number of customer accounts for broker-dealers.

Based on staff analysis of Form ADV data as of December 2018, approximately 62% of registered investment advisers (8,235) have some portion of their business dedicated to retail investors, including both high net worth and non-high net worth individual clients,[890] as shown in Panel B of Table 4.[891] In total, these firms have approximately $41.4 trillion of assets under management.[892] Approximately 8,200 registered investment advisers (61%) serve over 32 million non-high net worth individual clients and have approximately $4.8 trillion in assets under management, while approximately 8,000 registered investment advisers (60%) serve approximately 4.8 million high net worth individual clients with $6.15 trillion in assets under management.[893]

Table 4—Panel A: Registered Investment Advisers (RIAs) as of December 2018

[Cumulative RIA Assets Under Management (AUM) and Accounts]

Size of investment adviser (AUM)Number of RIAsNumber of dually registered RIAsCumulative AUM (billion)Cumulative number of accounts
>$50 billion27015$59,26420,655,756
$1 billion to $50 billion3,45312122,74913,304,154
$500 million to $1 billion1,635471,1511,413,099
$100 million to $500 million5,9271191,3975,135,070
$10 million to $100 million1,0702459310,031
$1 million to $10 million16230.869,664
<$1 million782300.0213,976
Total13,29935984,62141,081,750
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Table 4—Panel B: Retail Registered Investment Advisers (RIAs) as of December 2018

[Cumulative RIA Assets Under Management (AUM) and accounts]

Size of investment adviser (AUM)Number of RIAsNumber of dually registered RIAsCumulative AUM (billion)Cumulative number of accounts
>$50 billion11914$30,29120,592,326
$1 billion to $50 billion1,6141119,57013,224,188
$500 million to $1 billion1,007447001,392,842
$100 million to $500 million4,5481131,0265,287,584
$10 million to $100 million7062340308,285
$1 million to $10 million10230.569,534
<$1 million169100.0213,946
Total RIAs 8948,23531841,43440,887,325

In addition to SEC-registered investment advisers, other investment advisers are registered with state regulators.[895] As of December 2018, there are 17,268 state-registered investment advisers,[896] of which 125 are also registered with the Commission. Of the state-registered investment advisers, 204 are dually registered as broker-dealers, while approximately 4.6% (786) report a broker-dealer affiliate. In aggregate, state-registered investment advisers have approximately $334 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 63% for Commission-registered investment advisers.

Approximately 81% of state-registered investment advisers (13,927) have some portion of their business dedicated to retail investors,[897] and in aggregate, these firms have approximately $324 billion in AUM.[898] Approximately 13,910 (81%) state-registered advisers serve 14 million non-high net worth retail clients and have approximately $137 billion in AUM, while 11,497 (67%) state-registered advisers serve approximately 170,000 high net worth retail clients with approximately $169 billion in AUM.[899]

Table 5 details the compensation structures employed by approximately 13,000 SEC-registered investment advisers. Approximately 96% 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, in addition to fee-based compensation, including fixed fees, hourly charges, and performance based fees. Less than 4% of investment advisers charge commissions [900] to their investors.

Table 5—Registered Investment Advisers Compensation by Type

Compensation typeYesNo
A Percentage of Assets Under Management12,678614
Hourly Charges3,9149,378
Subscription Fees (For a Newsletter or Periodical)12213,170
Fixed Fees (Other Than Subscription Fees)5,8007,492
Commissions45412,838
Performance-Based Fees4,9388,354
Other1,89911,393

As discussed above, many investment advisers participate in wrap fee programs. As of December 31, 2018, more than 8.5% of the SEC-registered investment advisers sponsor a wrap fee program and more than 13.1% act as a portfolio manager for one or more wrap Start Printed Page 33566fee programs.[901] 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.

(1) Disclosures for Investment Advisers

As discussed more fully in the Fiduciary Release, investment advisers have a duty to provide full and fair disclosure of all material facts about the advisory relationship to their clients as well as to obtain informed consent from their clients.[902] SEC- and state-registered investment advisers are also subject to express disclosure requirements in Form ADV. 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.[903] Part 1 of Form ADV provides information to regulators about the registrants' ownership, investors, and business, and it is made available to clients, prospective clients, and the public. 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,[904] 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.[905] The Part 2A brochure is the primary client-facing disclosure document,[906] however, Parts 1 and 2A are both made publicly available by the Commission through IAPD,[907] and advisers are generally required to deliver Part 2A and Part 2B to their clients.

c. 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 SEC-registered investment advisers between 2005 and 2018. Over the last 14 years, the number of broker-dealers has declined from over 6,000 in 2005 to less than 4,000 in 2018, while the number of investment advisers has increased from approximately 9,000 in 2005 to over 13,000 in 2018. 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 retail investors regarding how to receive or pay for such advice, the nature of the advice, and the attendant conflicts of interest.

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An increase in the number of investment advisers and a decrease 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,[908] 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. 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 that provide a steady source of revenue rather than accounts that charge commissions and are dependent on transactions.[909] Broker-dealers have indicated that the following factors have contributed to this migration: Provision of revenue stability or increase in profitability,[910] perceived lower regulatory burden, and provisions of more services to retail customers.[911]

Further, there has been a substantial increase in the number of retail clients of 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-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.

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d. 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 SRO (“registered representatives”).[912] 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.[913]

We estimate the number of registered representatives and registered IARs, including dually registered financial professionals, (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.[914] We only consider employees at firms who have retail-facing business, as defined previously.[915] We observe in Table 6 that approximately 60% of registered financial professionals are employed by dually registered entities. The percentage varies by the size of the firm. For example, in firms with total assets between $1 billion and $50 billion, 67% of all registered financial professionals are employed by dually registered firms. Focusing on dually registered firms only, approximately 62.7% of total licensed representatives at these firms are dually registered financial professionals, approximately 36.9% are only registered representatives; and less than one percent are only registered investment adviser representatives.

Table 6—Total Registered Representatives at Broker-Dealers, Investment Advisers, and Dually Registered Firms With Retail Investors

Size of firm (total assets for standalone BDs and dually registered firms; AUM for standalone IAs)Total number of reps.% of reps. in dually registered firms% of reps. in standalone BD w/an IA affiliate% of reps. in standalone BD w/o an IA affiliate% of reps. in standalone IA w/a BD affiliate% reps. in standalone IA w/o a BD affiliate
>$50 billion84,4617370191
$1 billion to $50 billion170,25667110157
$500 million to $1 billion29,8747151716
$100 million to $500 million66,92451270418
$10 million to $100 million106,1785542111
$1 million to $10 million33,79035541100
<$1 million12,5228523631
Total Licensed Representatives 916504,0056023296

In Table 7 below, we estimate the number of employees who are registered representatives, registered investment adviser representatives, or both (“dually registered representatives”).[917] Similar to Table 6, 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.[918]

In Table 7, approximately 25% of registered employees at registered broker-dealers or investment advisers are dually registered representatives. However, this proportion varies significantly across size categories. For example, for firms with total assets between $1 billion and $50 billion,[919] approximately 35% of all registered employees are both registered representatives and investment adviser Start Printed Page 33571representatives. In contrast, for firms with total assets below $1 million, 13% of all employees are dually registered representatives.

Table 7—Employees at Retail Facing Firms Who Are Registered Representatives, Investment Adviser Representatives, or Both

Size of firm (total assets for standalone BDs and dually registered firms; AUM for standalone IAs)Total number of employeesPercentage of dually registered representativesPercentage of registered representatives onlyPercentages of IARs only
>$50 billion218,53919161
$1 billion to $50 billion328,84235124
$500 million to $1 billion43,211184010
$100 million to $500 million119,21423249
$10 million to $100 million176,55920391
$1 million to $10 million56,23017391
<$1 million18,33413463
Total Employees at Retail Facing Firms 920960,92925234

Approximately 87% 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,[921] 87.6% of registered investment adviser representatives were dually registered as registered representatives as of mid-October 2010.[922] In contrast, approximately 52% of registered representatives were dually registered as investment adviser representatives at the end of 2018.[923]

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 [924] and U5 [925] for their representatives. SROs, regulators and jurisdictions report disclosure events on Form U6.[926] FINRA's BrokerCheck system and IAPD discloses to the public certain information on registered representatives and investment adviser representatives, respectively, such as principal place of business, business activities, owners, and criminal prosecutions, regulatory actions, and civil actions in connection with any investment-related activity.

e. 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. The OIAD/RAND survey estimates that approximately 73% of adults live in a household that invests.[927] The survey indicates that non-investors are more likely to be female, to have lower family income and educational attainment, and to be younger than investors.[928] Approximately 35% of households that do invest do so through accounts such as broker-dealer or advisory accounts.[929]

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. According to the Investment Company Institute (“ICI”), as of December 2016, nearly $24.2 trillion is invested in retirement accounts, of which $7.5 trillion is in IRAs.[930] 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).[931] With respect to IRA accounts, one commenter, the ICI, documents that 43 million U.S. households own either traditional or Roth IRAs and that approximately 70% are held with financial professionals, with the remainder being direct market.[932] Start Printed Page 33572Further, ICI finds that approximately 64% of households have aggregate IRA (traditional and Roth) balances of less than $100,000, and approximately 36% of investors have balances below $25,000. As noted in one study, the growth of assets in traditional IRAs comes from rollovers from workplace retirement plans; for example, 58% of traditional IRAs consist of rollover assets, and contributions due to rollovers exceeded $460 billion in 2015 (the most recently available data).[933]

While the number of retail investors obtaining services from investment advisers and the aggregate value of associated assets under management has increased, the OIAD/RAND study also suggests that the general willingness of investors to use planning or to take financial advice regarding strategies, products, or accounts is relatively fixed over time.[934] With respect to the account assets associated with retail investors, the OIAD/RAND survey also estimates that approximately 10% of investors who have broker-dealer or advisory accounts hold more than $500,000 in assets, while approximately 47% hold $50,000 in assets or less. Altogether, many investors who have brokerage or advisory accounts trade infrequently, with approximately 31% reporting no annual transactions and an additional approximately 30% reporting three or fewer transactions per year.[935]

With respect to particular products, commenters have provided us with additional information about ownership of mutual funds and IRA account statistics. For example, ICI stated that 56 million U.S. households and nearly 100 million individual investors own mutual funds, of which 80% are held through 401(k) and other workplace retirement plans, while 63% of investors hold mutual funds outside of those plans.[936] Of those investors that own mutual funds outside of workplace retirement plans, approximately 50% rely on financial professionals, while nearly one-third purchase direct-sold funds either directly from the fund company or through a discount broker.[937]

Table 8 below provides an overview of account ownership segmented by account type (e.g., IRA, brokerage, or both) and investor income category based on the SCF.[938]

Table 8—Ownership by Account Type in the U.S. by Income Group

[As reported by the 2016 SCF]

Income category% Brokerage only% IRA only% Both brokerage and IRA
Bottom 25%1.27.62.4
25%-50%3.214.5.4
50%-75%4.121.411.4
75%-90%7.533.416.5
Top 10%12.024.743.9
Average4.418.311.6

With respect to the nature of the accounts held by investors and whether they are managed by financial professionals, the OIAD/RAND survey finds that 36% of its sample of participants report that they currently use a financial professional and approximately 33% receive some kind of recommendation service.[939] Of the subset of those investors who report holding a brokerage, advisory, or similar account, approximately 33% self-direct their own account, 25% have their account managed by a financial professional, and 10% have their account advised by a professional.[940] For those investors who take financial advice, the OIAD/RAND study suggests that they may differ in characteristics from other investors. Investors who take financial advice are generally older, retired, and have a higher income than other investors, but also may have lower educational attainment (e.g., high school or less) than other investors.[941]

Similarly, 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.[942] Panel A of Table 8 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) use advice services of broker-dealers for savings and investment decisions, while 49% (7.8 million households) take advice from a “financial planner.” Approximately 36% (7.2 million households) seek advice from other sources such as bankers, accountants, and lawyers. Almost 25% (5.0 million households) do not use advice from the above sources.

Panel B of Table 9 below presents the breakdown of advice received for Start Printed Page 33573households who have an IRA. 15% (5.7 million households) rely on advice services of their broker-dealers and 48% (18.3 million households) obtain advice from financial planners. Approximately 41% (15.5 million households) seek advice from bankers, accountants, or lawyers, while the 25% (9.5 million households) use no advice or seek advice from other sources.

Table 9—Panel A: Sources of Advice for Households Who Have a Brokerage Account in the U.S. by Income Group 943

Income category% Taking advice from brokers% Taking advice from financial planners% Taking advice from lawyers, bankers, or accountants% Taking no advice or from other sources
Bottom 25%20.5553.8935.6424.30
25%-50%22.9838.0343.9232.36
50%-75%20.7552.0031.4223.61
75%-90%22.5648.9432.2528.10
Top 10%25.2950.5338.4721.06
Average23.0249.0235.9924.94

Table 9—Panel B: Sources of Advice for Households Who Have an IRA in the U.S. by Income Group 944

Income category% Taking advice from brokers% Taking advice from financial planners% Taking advice from bankers, accountants, or lawyers% Taking no advice or from other sources
Bottom 25%12.1438.3043.6931.85
25%-50%9.7943.8240.6732.74
50%-75%14.9345.2041.2325.23
75%-90%14.6852.1441.6524.26
Top 10%21.4055.4040.0318.56
Average15.2548.4541.1725.28

The OIAD/RAND survey notes that for survey participants who reported working with a specific individual for investment advice, 70% work with a dually registered firm, 5.4% with a broker-dealer, and 5.1% with an investment adviser.[945]

2. Investor Perceptions About the Marketplace for Financial Services and Disclosures

Our proposal discussed a number of studies providing information on investors' perceptions of the market for financial services and advice, including those conducted by Siegel & Gale [946] in 2005, RAND [947] in 2008 and CFA in 2010.[948] Commenters to the proposal provided their own studies or survey evidence conducted by third party research firms, which we have discussed throughout the release.[949] In addition, the Commission's Office of the Investor Advocate collaborated with RAND to prepare the OIAD/RAND study,[950] which included focus groups and a survey about the retail market for investor advice. The Commission's Office of the Investor Advocate also engaged RAND to conduct investor testing of the proposed relationship summary using the dual registrant sample in the proposal. The report, RAND 2018,[951] discusses both larger sample survey results and smaller sample in-depth interview results. Finally, the proposal solicited public feedback from individual investors on a feedback form issued with the Proposing Release.[952] Responses and data from these sources inform our understanding of how investors approach the marketplace for financial services and how investors respond to disclosures about financial services generally.

a. 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.[953] For instance, the RAND 2008 study reported that 46% of survey respondents indicated that they located a financial professional from personal referral, although this percentage varied Start Printed Page 33574depending on the type of service provided (e.g., only 35% of survey participants used personal referrals for brokerage services). After personal referrals, RAND 2008 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 2008 study separately inquired about locating a financial firm,[954] in which respondents reported selecting a 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%).

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.[955] In the 917 Financial Literacy Study,[956] 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.

The OIAD/RAND focus group study notes that among the factors that group participants report for not working with a financial professional was participants being unsure how they would go about working with a professional.[957]

b. Investor Confusion

As discussed in the Proposing Release and by commenters to the proposal, many sources indicate that retail investors do not understand or find confusing the distinctions between broker-dealers and investment advisers, particularly in terms of services provided and applicable standards of conduct.[958]

Studies such as those conducted by Siegel & Gale [959] in 2005, RAND [960] in 2008, and CFA in 2010,[961] discussed in the Proposing Release, support findings that retail investors are confused about the roles and titles of financial professionals. The OIAD/RAND study assessed survey and focus group participants' understanding of the types of financial services and financial professionals they used.[962] Specifically, the authors of the OIAD/RAND study asked survey participants who were investors to identify which type of financial professional they worked with (investment adviser, broker-dealer, or dually-registered firm). The authors compared the types of financial professionals reported by the survey participants with the actual status of those financial professionals as verified on the IAPD database, and found that the verified types of financial professionals in many cases did not match the types of financial professionals that were reported by the survey participants.[963] For example, when financial professionals were verified to be dually registered, only 34% were reported by survey participants to be dually registered (and 56% were reported to be only investment advisers). In addition to the survey, the OIAD/RAND authors also asked a small focus group of participants that used financial professionals to identify which type of professional they were using, which was then verified by IAPD. Only one of the twelve participants was able to identify the correct type of financial professional unambiguously (although it was not clear if clients of verified dually-registered firms were only utilizing one type of that professional's services). The study authors concluded that this showed low awareness of the classification of investment advisers and broker-dealers.

Further, the OIAD/RAND survey asked all survey recipients whether they could identify the type of financial professional that would typically exhibit certain business practices (such as executing transactions or being paid by commission), and concluded that at least a significant minority of participants could not do so for any of the typical practices. Between 13% and 21% of survey participants incorrectly answered “none of the above” for each of the business practices offered by the survey, although those practices were aligned with either investment advisers or broker-dealers in the marketplace. Moreover, only 36% of participants were able to identify that investment advisers were typically paid by a percentage of assets, whereas 43% of participants thought that practice was typical of broker-dealers. Twenty-six percent of participants incorrectly indicated that investment advisers execute transactions for clients.[964] In Start Printed Page 33575all, the study authors concluded that the survey participants' knowledge of the marketplace for financial professionals appeared to be incomplete.

The OIAD/RAND study authors draw further conclusions from their focus group study, where after being offered explanations of the differences between investment advisers and broker-dealers, some focus group participants continued not to be able to understand the distinctions between the two types of professionals. For the OIAD/RAND study authors, the focus group exercise underscored the difficulty of the topic for some investors.

Investors are also confused about financial professionals' standards of conduct and legal obligations. As discussed in the Proposing Release, the Siegel & Gale and RAND 2008 studies found that focus group participants generally did not understand legal terms, such as “fiduciary” or “best interest.” [965] In addition, the RAND 2008 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.[966]

Similarly, many survey respondents in the OIAD/RAND study had difficulty understanding the basic relational aspects of financial advice and the responsibility for taking risk in any form.[967] Thirty percent of survey respondents believed that financial professionals would get paid only if an investor made money on an investment, and another quarter of respondents indicated that they did not know if financial professionals would get paid only if an investor made money on an investment.[968] A majority of survey respondents expected that a financial professional acting in the client's best interest would monitor the account, help the client choose the lowest cost products, disclose payments they receive, and avoid taking higher compensation for selling one product over another when a similar but less costly product is available.[969] OIAD/RAND focus group discussions about the distinctions between investment advisers and broker-dealers also suggested that some focus group participants were not able to distinguish investment advisers from broker-dealers. The study's authors concluded that comments of those focus group participants also suggest that some individuals might value having a clear distinction between professionals who do act in the client's best interest and professionals who do not act in the client's best interest.[970] Similarly, in RAND 2018 and in interview-based studies submitted by a group of commenters that test the proposed sample dual-registrant relationship summary, it was observed that investors could have difficulty understanding distinctions between the standard of conduct applicable to broker-dealers and investment advisers.[971]

With respect to investor perceptions of financial advisers' fees and potential conflicts of interest, the OIAD/RAND study revealed that “some participants seemed unconcerned with conflicts or took it as a good sign if their professional had not disclosed a conflict to them . . . In all three groups that had experience using a financial professional . . . participants reported that their professional had not disclosed any conflicts.” [972] The OIAD/RAND study also found that almost a half of the investors who received investment advice in the study believed that their investment professional receives commissions. About a third believed the provider received payments from product companies (e.g., mutual funds); another 20% of participants believed the provider received a bonus. Altogether, more than half of the participants believed the provider received some sort of compensation whether through commission, bonus or product payment.[973] The study concluded that “awareness of the nature of provider payments could help investors to recognize conflicts of interest . . .” and thus it could potentially improve investors' decision making. Potential investor recognition of the importance of the conflicts of interest is reflected in that 51% of the OIAD/RAND study respondents said that it was important or extremely important that the financial professional receive all compensation from the customer, and only 15% reported that it was not important at all.[974]

With respect to investor trust, one commenter discussed the results of an online survey it had initiated that found that 96% of survey respondents mostly or completely trusted their financial professional.[975] The vast majority of survey respondents (97%) also believed that their financial professional always or mostly has their investors' best interest in mind.[976]

3. Investor Responses to Disclosures About Financial Professionals and Firms

a. Retail Investors and Financial Disclosures Generally

Commenters provided conclusions based on studies of potential limitations to the efficacy of financial disclosures, as discussed below.[977] With respect to the particular areas of disclosure that retail investors find helpful, commenters provided us with information about the usefulness of such disclosures to retail investors from surveys or assessments. We generally note that the RAND 2018 survey and other surveys that were provided by commenters gathered participants' subjective views and were not designed to objectively assess whether any sample disclosures improved participant comprehension.[978] However, the RAND 2018 qualitative interviews included some general questions to participants about comprehension and helpfulness of the sample proposed relationship summary, which provided some insight into participants' understanding of concepts introduced, as did another survey and two interview-based studies with respect to sample relationship summaries.[979] Further, the RAND 2018 report and surveys and studies submitted by commenters reported that their participants subjectively thought that they were informed from the sample disclosures that they were provided. The RAND 2018 study authors found that nearly 90% of respondents stated that the sample proposed relationship summary that they reviewed would help them make informed decisions about investment accounts and services.[980] Likewise, the RAND 2018 study authors also observed that interview participants demonstrated that they learned new information from the proposed relationship summary that they were provided. However, there was variation in understanding among participants and the interviews also revealed areas of Start Printed Page 33576confusion.[981] Similarly, the Woelfel survey authors noted that after survey respondents were given time to read a sample proposed dual registrant relationship summary, the majority, regardless of their current investments or relationship with an investment adviser or broker-dealer, believed that they knew a “little more” about investment advisers and broker-dealers.[982]

Several commenters suggest that generally not all investors fully read or are able to digest information from disclosures about financial professionals. One commenter reports that almost half of its survey participants said they selectively skim the disclosures and eight percent said they rarely or do not ever read them.[983] Along similar lines, commenters pointed to observations that investors may be overconfident in their ability to read and understand disclosures and that investors are unable to understand disclosures relating to compensation arrangements and conflicts of interest.[984] Similarly, the RAND 2008 study highlighted that participants' confusion about titles, services, legal obligations, and compensation persisted even after a fact sheet on broker-dealers and investment advisers was provided to participants.[985]

With respect to what type of disclosures from firms or financial professionals retail investors find helpful, commenters provided two surveys of retail investors' general views of disclosures about financial professionals in response to the Proposing Release.[986] One commenter reported results from an online survey that provides support for the idea that retail investors value at least some disclosures from financial professionals. From the a survey of 801 individuals, a majority of the survey participants (62%) said they would be interested in reading a hypothetical standardized document provided to all new clients that explained the relationship between a financial professional and clients and thought that such a document would “boost transparency and help build stronger relationships between me and my financial professional” (72%).[987] Separately, with respect to what aspects of financial disclosures retail investors might find most helpful, Koski Research conducted an investor survey on behalf of another commenter and reported that the “majority of retail investors want communications that are relevant to them (91%), short and to the point (85%), and visually appealing (79%).” [988] The survey also reported that the top four things retail investors wanted communicated were the costs for advice, description of advice services, the obligations of the firm and its representatives, and the conflicts of interest.[989] Additionally, approximately 70% of the participants in the 917 Financial Literacy Study indicated that they would read disclosures on conflicts of interest if made available.[990]

b. Investor Perceptions About Specific Disclosures Concerning Financial Professionals

(1) Conflicts of Interest

As discussed in the Proposing Release, previous studies have found that investors consider conflicts of interest to be an important factor in disclosures from firms and financial professionals.[991] For example, in the 917 Financial Literacy Study, 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.[992] 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 own 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.

Among those participants in the 917 Financial Literacy Study who indicated that they would read disclosures on conflicts of interest if made available, 48% would request additional information from their adviser, 41% would increase the monitoring of their adviser, and 33% would propose to limit their exposure of specific conflicts. The majority of participants (70%) also wanted to see specific examples of conflicts and how those related to the investment advice provided.

(2) Fees

With respect to disclosures about fees, the Proposing Release also discussed the 917 Financial Literacy Study as well as the FINRA Investor Study [993] regarding the importance that investors place on disclosures about fees and compensation of financial professionals, and how those disclosures should be presented.[994] Similar to the findings regarding conflicts of interest, the 917 Financial Literacy Study found that a majority participants indicated that disclosure of the fees and compensation of investment advisers was an essential element to any disclosure.[995]

(3) Disciplinary History

As discussed in the Proposing Release, survey evidence in the 917 Financial Literacy Study indicate 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.[996] Despite this, most Start Printed Page 33577investors do not actively seek disciplinary information for their advisers and broker-dealers. For example, a FINRA survey in 2009, 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.[997] The FINRA Investor Study 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.[998]

C. Broad Economic Considerations

We are adopting a requirement for broker-dealers and investment advisers and firms that are dually registered to deliver a relationship summary to retail investors because, as discussed in the baseline,[999] many retail investors can be confused about their choices in the market for brokerage and investment advisory services. To that end, the relationship summary is meant to assist retail investors with both the process of deciding whether to engage or remain with a particular firm or financial professional and whether to establish or maintain an investment advisory or brokerage relationship. Specifically, low financial literacy, lack of knowledge about the market for financial advice, and lack of information about important aspects of the relationship between particular firms and their customers or clients,[1000] may harm retail investors by deterring them from seeking brokerage or investment advisory services even if they could potentially benefit from it,[1001] or by increasing the risk of a mismatch between the investors' preferences and expectations and the actual brokerage or advisory services they receive from a firm or professional.[1002] To ameliorate this potential harm, the relationship summary is intended to reduce investor confusion and search costs in the process of (i) deciding whether to engage a particular firm or financial professional, (ii) whether to establish an investment advisory or brokerage relationship, and (iii) whether to terminate or switch the relationship or specific service provided. The relationship summary is expected to provide significant benefit to retail investors by focusing their attention on salient features of their potential relationship with a particular broker-dealer or investment adviser and highlighting the most important elements of this relationship in a single, succinct, and easy-to-understand document. The relationship summary also allows for comparability among broker-dealers and investment advisers by requiring disclosures on the same topics under standardized headings in a prescribed order to retail investors.[1003] As we discuss above in Section I, we do not believe that existing disclosures provide this level of transparency and comparability across investment advisers, broker-dealers, and dual registrants.

Below, we discuss in more detail the nature of the potential harm faced by retail investors from confusion about the market for brokerage and investment advisory services. We also discuss considerations involved in creating disclosures for retail investors that may reduce the potential for investor harm by increasing their knowledge about the market for brokerage and investment advisory services and facilitating their search for a firm or financial professional.[1004]

Academic studies have documented a multitude of potential benefits that accrue to retail investors as a result of seeking investment advice, including, but not limited to: Higher household savings rates, setting long-term goals and calculating retirement needs, more efficient portfolio diversification and asset allocation, increased confidence and peace of mind, facilitation of small investor participation, improvement in financial situations, and improved tax efficiency.[1005] Further, financial Start Printed Page 33578professionals may also explain to retail investors the informational asymmetries between product providers and their customers. Retail investors might not be able to disentangle such information asymmetries on their own. Studies also find that low financial literacy is negatively associated with the propensity to seek financial advice.[1006] These findings collectively suggest that retail investors of low level financial literacy might be harmed because they might be less likely to seek financial advice in spite of the potential benefit from it.

For a retail investor who decides to enter a relationship with a financial services provider, a low level of knowledge about the market for financial services might reduce the investor's ability to accurately identify whether any given firm or financial professional offers a type of relationship that matches his or her preferences and expectations. This, in turn, increases the risk that the firm or financial professional is a poor match for the retail investor when compared to an alternative financial services provider. A relationship that represents a poor match between an investor and a firm or financial professional can leave an investor worse-off, relative to a better match, or no match at all, because the relationship could result in a cost of services that is higher than the investor expects or a level or type of service that is different than the investor expects, such as episodic recommendations versus continuing advice.

A retail investor might search across a set of financial service providers to find a financial professional that best meets his or her needs.[1007] For an investor who is able to acquire information from the financial service providers the investor chooses to evaluate, the more extensive a search the investor engages in, the more likely the investor will locate a good match. However, conducting such a search is costly and requires time, effort, and access to resources. Investors likely balance the benefits of evaluating each additional provider against the incremental cost of doing so, ending their search when the expected marginal cost of the search is greater than the expected marginal benefit from the search.[1008] Moreover, some investors may experience higher-level of uncertainty about the benefits or costs of a search. For example, investors who are less knowledgeable about the general differences between different types of financial professionals, the services these professionals provide, and the factors they should consider in their choice, may not fully appreciate the benefits of searching for a provider that best meets their needs. To the extent such investors perceive a search as burdensome because they underestimate the benefits of searching, they might refrain from conducting a search or conduct a less extensive search to learn about potential alternatives, thereby increasing their risk of entering a relationship with a firm or financial professional that is a poor match with their expectations and preferences or not engaging in a relationship even if one might be beneficial.[1009]

General trust (in the sense of confidence) in financial markets can help alleviate certain behavioral biases and encourage participation in, for example, the stock market.[1010] Trust at an interpersonal level may be less beneficial in certain circumstances. Research suggests that lower financial literacy among investors is positively associated with higher personal trust in their financial professionals.[1011] However, to the extent retail investors substitute trust for knowledge in their relationship with a financial professional, overreliance on trust may induce some investors to maintain a mismatched relationship longer than they otherwise would if they had higher financial literacy and a better understanding of the costs and benefits of the financial advice they receive from the professional, as well as awareness of alternative services or providers.[1012] That is, particularly for less-knowledgeable investors, a high level of trust in a particular financial professional or firm may exacerbate the potential harm of a mismatched relationship. Similarly, some retail investors that select a firm or financial professional based on referrals from friends and family may do so solely on the basis of a high level of trust in these referring parties.[1013] This can exacerbate the potential harm of a mismatched relationship in particular for less sophisticated investors and/or for investors who relied on referrals from less financially sophisticated parties.[1014]

Further, investors may endure a mismatched relationship for a longer period of time than they would absent switching costs, including the cost of a new search and any transaction costs involved in moving assets from one firm to another. These costs lower a retail investor's incentive to look for a new firm or financial professional even if the Start Printed Page 33579current relationship turns out to be a poor match. Both overreliance on trust and the presence of switching costs increase the ex-ante value of avoiding a mismatched relationship in the first place.

Retail investors could increase their knowledge about the market for brokerage and investment advisory services, and thereby engage in a more efficient search, by accessing information and disclosures currently provided directly by firms or available in a number of existing regulatory forms and platforms. Current sources of information include, among others, Form ADV (and IAPD) and BrokerCheck.[1015] However, because existing disclosures are made on multiple and sometimes lengthy forms, and are obtained in different ways, it can be difficult for investors to grasp the most important features of the financial services from reading these materials.[1016] 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, which makes direct comparisons between broker-dealers and investment advisers more difficult.

Voluntary disclosures and educational efforts made by financial services providers such as broker-dealers and investment advisers can potentially inform investors about the specific relationships they can have with providers and the types of services providers offer, but also about the overall market for financial advice and the different types of service providers and relationships available in the market. And such voluntary disclosure could, in principle, facilitate investor search. However, financial services providers may lack incentives to voluntarily disclose salient information or make the effort needed to educate investors about the various alternatives available to them because it is costly to do so. In addition to the costs of producing disclosures and training employees to deliver disclosures, providers may also perceive a risk that competitors would take advantage of disclosed information. Furthermore, disclosures that are not tailored to the provider and have more general educational value to retail investors have the features of a public good. If providers rely on their competitors to educate potential clients generally about the market for financial advice, there is an inefficiently low level of general educational material available to investors. Underprovision might occur even if such disclosures, were they to be provided, would increase the overall efficiency of the market for financial advice and thus benefit financial services providers as a group in the long run, for example, by sufficiently reducing confusion among the general investing public that more investors are willing to search for a financial services provider.

Additionally, some broker-dealers and investment advisers may even privately gain from a lack of knowledge among retail investors to the extent they profit from attracting and retaining customers and clients who would be a better match with another provider.[1017] For example, a customer of a broker-dealer who has a preference for active investing may actually be better off being a client of an investment adviser and paying a fixed percentage of assets per year as a fee for the advice instead of broker commissions each time she receives a recommendation that results in a transaction. However, this investor is likely a profitable customer for the broker-dealer. Similarly, a client of an investment adviser who prefers buy-and-hold investments in a few index funds could potentially be better off in a relationship with a broker-dealer, by only paying a few one-time sales charges and commissions instead of a recurring percentage fee on the assets, which is likely more profitable to the investment adviser. In both of these cases, the firm has little incentive to provide the investor with information about available advice relationships that could persuade the investor to seek advice elsewhere or to switch to a different business line.

In the presence of the frictions described above, requiring firms and financial professionals to furnish a short summary disclosure like Form CRS can benefit retail investors by reducing information asymmetry between investors and firms and financial professionals and turning investor attention to more salient aspects of a firm and its services. In addition, as discussed above, no current required disclosure allows for comparability among broker-dealers and investment advisers by requiring disclosures on the same topics under standardized headings in a prescribed order to retail investors. A reduction in information asymmetry and improved comparability may reduce search costs for investors and increase their understanding about differences in offered relationships across firms and financial professionals, thereby reducing the risk of investors' hiring a provider that is a poor match for their needs. However, for the relationship summary to be effective for retail investors it must be understandable. Studies have found that the format and structure of disclosure may improve (or decrease) investor understanding of the disclosures being made.[1018] We discuss these studies below.

Some commenters questioned the general efficacy of disclosure in the context of investment advice to retail investors.[1019] We do not share this view. As we discussed above, we believe a short summary disclosure like Form CRS can provide benefits to retail investors. However, as we also discussed in the Proposing Release,[1020] we recognize that there may be limits to the efficacy of disclosure in some Start Printed Page 33580circumstances. For example, the documented low level of financial sophistication of many retail investors can make it harder for them to process the implications of disclosure.[1021] Another limitation of the efficacy of disclosure documented in research is that investors may have various behavioral biases, such as anchoring [1022] and over-confidence,[1023] which could affect how the disclosed information is interpreted.[1024] This could in turn lead investors to misinterpret, under-weight, or over-weight the implications of disclosures. Limited attention problems can also impede investors' ability to effectively process the implications of some disclosures.[1025]

In addition, academic studies find that sometimes certain disclosures may result in unintended consequences. In particular, existing research has found that conflict of interest disclosures can increase the likelihood that the disclosing party would act on the conflict of interest.[1026] 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 (including to the customer's detriment), or it can be caused by “strategic exaggeration,” aimed at compensating the disclosing party for the anticipated loss of profit due to the disclosure. Experimental evidence also suggests that disclosure could turn some clients or customers into “reluctant altruists.” [1027] 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.[1028] The above literature indicates that conflicts of interest disclosures may interact with psychological biases to produce unintended effects that undermine the intended benefits of the disclosures. 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.[1029]

Academic research has identified a set of characteristics that may increase the effectiveness of a disclosure document to consumers. These characteristics, discussed below, frame our analysis of the economic impacts of the proposed rule.[1030]

Studies have found that the structure or format of disclosure may improve (or decrease) investor understanding of the disclosures being made.[1031] Every disclosure document not only presents new information to retail investors but also provides a particular structure or format for this information that affects investors' evaluation of the disclosure.[1032] 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 history relative to firms with no disciplinary history. If, instead, disciplinary history information were provided at the end of the relationship summary, the effect of the information could be moderated because it would no longer frame the other information provided to investors. Because of such framing effects, it is important that the structure of a disclosure document supports the intended purpose of the disclosure.

Because individuals can exhibit limited ability to absorb and understand the implications of the disclosed information, for example due to limited attention or low level of sophistication,[1033] more targeted and simpler disclosures may be more effective in communicating information to investors than more complex disclosures. Academic studies suggest that costs, such as increased investor confusion or reduced understanding of the key elements of the disclosure, are likely to increase as disclosure documents become longer, more convoluted, or more reliant on narrative text.[1034] Consistent with such findings, other empirical evidence suggests that disclosure simplification may benefit consumers of disclosed information.[1035] In general, academic research appears to support the notion that shorter and more focused disclosures could be more effective at increasing investors understanding than longer, more complex disclosures.

Start Printed Page 33581

Another characteristic of effective disclosures documented in academic research is disclosure salience.[1036] Salience detection is a key feature of 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.[1037] Within the context of disclosures, information disclosed to promote greater salience, such as information presented in bold text, or at the top a page, would be more effective in attracting attention than less saliently disclosed information, such as information presented in a footnote. Limited attention among individuals also increases the importance of focusing on salient disclosure signals. Some research finds that more visible disclosure signals are associated with stronger stakeholder response to these signals.[1038] Moreover, research suggests that increasing signal salience is particularly helpful in reducing limited attention of consumers with lower education levels and financial literacy.[1039] There is also empirical evidence that visualization improves individual perception of information.[1040] 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).[1041] Overall these findings suggest that problems such as limited attention may be alleviated if key information in Form CRS is emphasized, is reported closer to the beginning of the document, and is visualized in some manner. This is also consistent with the recommendation of several commenters.[1042] However, it is also important to note that given a choice, registrants may opt to emphasize elements of the disclosure that are most beneficial to themselves rather than investors, while deemphasizing elements of the disclosure that are least beneficial to them. As discussed further in the economic analysis below and discussions above, the final instructions of the relationship summary include requirements that are designed to mitigate this risk. For example, the final instructions require standardized headers in a prescribed order, certain other prescribed language (including for the required conversation starters), page limits, and certain text features, which mitigate providers' incentives to behave opportunistically.

There is also a trade-off between allowing more disclosure flexibility and ensuring disclosure comparability (e.g., through standardization).[1043] Greater disclosure flexibility potentially allows the disclosure to reflect more relevant information, as disclosure providers can tailor the information to firms' own specific circumstances.[1044] Although disclosure flexibility allows for disclosure of more decision-relevant information, it also allows registrants to emphasize information that is most beneficial to themselves rather than investors, while deemphasizing information that is least beneficial to the registrants. Economic incentives to present one's services in better light may drive investment advisers and broker-dealers to deemphasize information that may be relevant to retail investors.[1045] Moreover, although standardization makes it harder to tailor disclosed information to a firm's specific circumstances, it also comes with some benefits. For example, people are generally able to make more coherent and rational decisions when they have comparative information that allows them to assess relevant trade-offs.[1046] The final rules are intended to strike a balance between the relative benefits and costs of disclosure standardization versus disclosure flexibility; for example, by requiring standardized headings and a prescribed order of topics but allowing some flexibility in the firm's own wording and the order of presentation within each topic.

D. Economic Effects of the Relationship Summary

1. Retail Investors

a. Overall Anticipated Economic Effects of Form CRS

Overall, we expect that these final rules requiring firms to deliver a relationship summary will benefit retail investors in several ways, including by reducing information asymmetry between investors and firms (and their financial professionals), reducing search costs and facilitating easier comparisons between and among brokerage and investment advisory firms, and increasing understanding of, and confidence in, the market for financial services more generally.

First, in the specific context of a retail investor considering a firm or financial professional, the relationship summary will reduce the information asymmetry between the investor and the firm or professional by increasing transparency to that investor about a firm's services, fees, conflicts of interest, standard of conduct, and disciplinary history.[1047] Some—though not all—of this information is currently available in the marketplace. The relationship summary, however, will require all firms to provide information on these topics in one summary disclosure, which will be available on firms' websites, if they have one, at BrokerCheck and IAPD, and through Investor.gov. Current disclosure requirements do not provide this level of transparency and comparability for both broker-dealers and investment Start Printed Page 33582advisers. In addition, through the use of layered disclosure, the relationship summary will facilitate investors' access to additional, more detailed, information. The relationship summary is also the first narrative disclosure for broker-dealers' retail customers that will be filed with the Commission and widely available to the public. We believe providing this overview of information in one place will enhance the accessibility of this information for the retail investor reviewing it relative to the baseline. Moreover, some information, such as the payments to financial professionals, is not currently required to be publicly disclosed, making that information available for the first time. The relationship summary may also benefit investors by helping them separate “hard” information about services and fees from marketing communications. To the extent the relationship summary will be effective at informing retail investors,[1048] it should improve their ability to assess whether a relationship offered by a particular firm is a good match with their preferences and expectations. Moreover, a reduction in information asymmetry may also help retail investors increase the value from any given relationship they enter with a firm or financial professional by potentially increasing their ability to monitor the relationship and to make more informed decisions related to the relationship during its duration, including whether to terminate the relationship.

Second, Form CRS will provide benefits to those retail investors that want to compare more than one provider or service, including those that want to compare brokerage and advisory services, relative to the baseline. Form CRS is distinct from other required disclosures as it is a standardized disclosure to retail investors that is broadly uniform between investment advisers and broker-dealers, or that requires dual registrants to describe both brokerage and advisory services. In facilitating this comparability, the relationship summary may promote competition between financial service providers along dimensions such as fees, costs, and conflicts, in ways that improve retail investor welfare. The comparative benefits discussed above could increase further should third-party data aggregators enter the market and use the information disclosed in relationship summaries to provide consolidated data on firms, as search and processing costs could be reduced even further for retail investors.[1049]

Third, we also believe that requiring all broker-dealers and investment advisers that serve retail investors to provide a relationship summary, along with the other initiatives we are adopting, will increase understanding of, and confidence in, the market for financial advice more generally. Specifically, because of confusion about the market for brokerage and advisory services or a general lack of confidence in the market, some retail investors are potentially discouraged from seeking a relationship with a financial provider and do not participate in the market for financial services.[1050] The relationship summary may help spread awareness and understanding about the market for financial services by increasing transparency about the services, fees, conflicts and standard of conduct of financial professionals; reducing confusion among investors generally; and increasing the general level of confidence. This general increase in understanding and confidence should, in turn, make it more likely that investors participate in the market for financial services when participation is likely to benefit them.

Some commenters suggested the general benefits to investors of the proposed relationship summary would be limited.[1051] More specifically, several commenters were concerned that retail investors may be subject to information overload from reading the relationship summary, reducing the potential benefits to investors because of the cognitive costs of digesting the information.[1052] We acknowledge that there are limits to investor cognition with respect to lengthy and detailed disclosures,[1053] however the relationship summary is shorter and more concise than disclosures currently available to investors, which should reduce the likelihood of information overload. Moreover, we have modified the relationship summary from the proposal to further streamline and shorten it, and minimize the use of legal or technical jargon, thereby further reducing the potential that the relationship summary poses a cognitive burden for retail investors that undermines the overall benefit of the disclosure.

We also recognize that the relationship summary, as with other required disclosures, has costs.[1054] For example, as discussed above, there is a risk that disclosure of conflicts of interest can actually increase costs to investors by, for example, providing a perceived “moral license” to financial professionals to act on disclosed conflicts and encourage them to provide more conflicted advice at the expense of investors.[1055] In addition, some commenters expressed a belief that the disclosures in the proposed relationship summary, particularly due to the prescribed wording, may increase investor confusion [1056] or may “create misimpressions, and may even constitute outright misstatements, inaccuracies, or misrepresentations” in certain contexts.[1057] In consideration of these comments, the final requirements for Form CRS permit firms, within the parameters of the instructions, largely to describe their services, investment offerings, fees, and conflicts of interest using their own wording. The final requirements also incorporate many other changes in response to commenters' concerns and suggestions and insights from investor surveys and roundtables, which are intended to increase the benefits and reduce the costs to investors relative to the proposed disclosure. Additionally, as with required disclosures generally, we recognize that the relationship summary alone likely would not fully alleviate investor confusion or risk of mismatched relationships in the marketplace.

Moreover, firms may attempt to pass through some of the direct compliance costs we discuss further below to retail investors, for example, by charging higher commissions, asset-based management fees, or other fees. However, we believe such pass through of costs is likely to be limited because we expect these direct expenses to be Start Printed Page 33583relatively small in the context of the overall size of the brokerage and investment advisory industries.[1058] Additionally, to the extent the relationship summary may promote competition between financial service providers, as discussed above, any increase in competition both among and between broker-dealers and investment advisers could reduce the pricing power of firms, and thereby reduce the ability to pass through the compliance costs associated with the relationship summary.

The magnitude of the anticipated economic effects discussed above will depend on a number of factors, including the extent to which the relationship summary will increase investors' understanding about their potential or current relationships with firms and financial professionals, and in what ways such an increase in understanding would affect their behavior. Given the number and complexity of assumptions that would be required to be able to estimate how the relationship summary will affect investors' understanding and their decision-making, and the lack of data on relevant characteristics of individual firms and their prospective and existing retail investors, the Commission is not able to meaningfully quantify the magnitude of these anticipated economic effects.

We discuss the benefits and costs to retail investors of certain elements of the relationship summary requirements below, including requirements regarding length and presentation, standardization, content (including layered content), delivery, and filing. As part of these discussions, we also discuss certain changes from the proposal and how we anticipate those changes affect the benefits and costs of the final relationship summary relative to the proposed requirements.

b. Presentation and Format

The presentation and format of the relationship summary are designed to facilitate retail investors' processing of the provided information to help them compare information about firms' relationships and services, fees and costs, specified conflicts of interest and standards of conduct, and disciplinary history, among other things. The relationship summary is also designed to promote effective communication between firms and their retail investors. Several features of the relationship summary should reduce some of the limitations discussed above that may undermine the efficacy of disclosures, such as cognitive limitations and disclosure overload, as discussed further below.

The magnitude of the anticipated benefits and costs to retail investors discussed below will depend on a number of factors, including the extent to which the presentation and formatting requirements for the relationship summaries will help increase investors' understanding about the content of the relationship summaries, and in what ways such an increase in understanding would affect their behavior.

(1) Length and Amount of Information

Unlike many other required disclosures by financial firms, the relationship summary has a page limit. We believe that limiting the disclosure length and prescribing certain elements of the relationship summary's content could benefit investors relative to the baseline by forcing firms to provide concise and clear investor-relevant information, thereby reducing information overload and increasing the likelihood that investors will focus their attention on the relationship summary. The optimal length of the relationship summary for investors may vary from investor to investor based on individual limits to attention and ability to process a lengthier document, though investor and commenter feedback indicated many investors preferred a relationship summary no longer than, and in some cases shorter than, what was proposed.[1059] We have also reduced the page limit for standalone broker-dealers' and standalone investment advisers' relationship summaries from four to two, thereby potentially increasing the benefits of a shorter document relative to the proposal.

However, we recognize that there are potential costs to requiring a page limit.[1060] For example, as pointed out by commenters, a prescribed page limit may make it more difficult for some firms to effectively describe the nature or range of the relationships and may prompt them to exclude details that investors might find important.[1061] To the extent the provided disclosure becomes too abbreviated it may confuse investors rather than inform them about the relationship, which could increase search costs and increase the risk of a mismatched relationship relative to the baseline. The relationship summary includes several elements to mitigate the potential costs of providing less comprehensive information by utilizing layered disclosure, which includes encouraging, and in some cases requiring, hyperlinks to additional information and other textual features, such as hovers, to provide descriptions or definitions of terms.[1062] The relationship summary also includes conversation starters that are designed to elicit more substantial conversations on certain topics. Such conversations could further mitigate the costs of less comprehensive information by encouraging the providers to elaborate on topics that investor may find confusing.

Finally, we believe that allowing only the required and permitted information will promote standardization of the information presented to retail investors, minimize information overload, and allow retail investors to focus on information that we believe is particularly helpful in deciding among firms. However, we acknowledge that the potential cost of this level of standardization is that firms will not be able to include other information that might also be helpful to investors.

(2) Organization of Information and Text Features

As discussed above, academic research has documented how individual perceptions of information can change depending on the framing of the information.[1063] The relationship summary's requirement to use standardized questions as headings should help retail investors frame the information that follows the question by establishing sufficient context and increasing salience of the information presented.[1064]

The final instructions include an instruction encouraging the use of Start Printed Page 33584electronic and graphical features in the relationship summary.[1065] Additionally, the relationship summary requires the use of text features for certain information, such as the conversation starters, which should increase the salience of this particular information and increase the likelihood that investors will review it. Based on academic research on disclosure readability,[1066] we believe the use of text features, whether voluntary or required, will facilitate retail investors' absorption of the provided information. Additionally, certain electronic features, such as embedded hyperlinks and hovers, should facilitate retail investors' access to additional information if they are interested, thereby reducing their costs in locating the information.

We recognize that because we are encouraging, but not requiring, firms to use graphical and electronic features, some firms might not use text features beyond what is required, potentially reducing their use and the attendant benefits. We believe, however, that providing some flexibility in design to firms may provide a benefit to retail investors, because firms competing for retail investors likely have incentives to use graphical and electronic features to enhance the retail investor's experience. Moreover, flexibility also allows firms to continuously improve their use of graphical and electronic features as they learn over time what features are the most effective. We recognize, however, that one potential cost of allowing this flexibility is that firms may also have incentives to use certain text features to increase the salience of the portions of the disclosed information that they prefer to highlight, rather than the information that may be the most useful to investors to highlight.

The final instructions do not include certain presentation requirements that we had proposed. For example, we proposed requiring that dual registrants present their information in a single relationship summary, using a two-column format. The final instructions permit dual registrants (or affiliated broker-dealers and investment advisers) to prepare either a single relationship summary describing both brokerage and investment advisory services, or two separate relationship summaries describing each service.[1067] Additionally, we are requiring such firms to use standardized headings in a prescribed order, and to design their relationship summary in a manner that facilitates comparison, but the final instructions do not specifically require a two-column format. We believe this modification could increase the benefits relative to the proposal to investors of the relationship summary by permitting firms to choose design elements that might facilitate comparison more effectively than a two column format. We recognize, however, that absent a specific design requirement, some firms might present this information in a manner that is less effective at facilitating investors' understanding than the proposed two-column format. We believe, however, that the potential benefits of allowing firms with differing business models to determine the design methods most effective at facilitating comparability justifies the change from a single, prescribed design element. Additionally, the final rule does not adopt the proposed restrictions on paper size, font size, or margin width, and instead requires them to be “reasonable.” We believe that these modifications from the proposal will incentivize firms to design relationship summaries that most effectively and accurately communicate their disclosed information to the benefit of investors, as well as encourage firms to make interactive, electronic disclosures available.

c. Standardization

(1) Standard Question-and-Answer Format and Standard Order of Information

The final rules require that firms present information under standardized headings and respond to all the items in the final instructions in a prescribed order.[1068] We expect that requiring the same set of headings in a prescribed order for each relationship summary will facilitate retail investors' ability to compare relationship summaries across firms. In addition, the prescribed wording of the headings reduces the risk that firms would use the headings to “frame” each topic in ways that would be less useful for retail investors' understanding of the disclosed information. As discussed above, academic research has documented how individuals' perceptions of information can change depending on the framing of the context of the information.[1069]

We expect retail investors to benefit from this standardization to the extent they review relationship summaries from more than one firm, as the standardized headings in the prescribed order will allow them to compare firms' responses.[1070] Additionally, the requirement that firms structure the headings in machine-readable format could reduce the cost of third party data aggregators to analyze relationship summaries across many firms and display comparisons of responses, ultimately reducing search costs for investors.[1071]

Because firms will be given very limited flexibility in terms of language for headings and the order of the sections,[1072] some firms may find it more difficult to effectively present the information specific to their business and circumstances they believe should be made salient to retail investors. To the extent that the headings and the specified order do not specifically promote such information for a particular firm, and this information is relevant to investment decisions, investors may potentially find the relationship summary less useful in evaluating the specific firm. To mitigate this potential cost and provide some flexibility to firms, the final rules allow firms to discuss the required sub-topics within each item in an order that firms believe best promotes accurate and readable descriptions of their business.[1073] The final rules also allow firms to omit or modify a disclosure or conversation starter that is inapplicable to their business or specific required wording that is inaccurate. The benefit of such flexibility is that it allows firms to increase saliency of and direct investor attention to the more relevant Start Printed Page 33585disclosures. We believe the mix of requiring standardized headings and a prescribed order of topics but allowing some flexibility in the order of presentation within each topic strikes an appropriate balance in the inevitable trade-off, discussed further below, between the relative benefits and costs of disclosure standardization versus disclosure flexibility.

The magnitude of the anticipated benefits and costs to retail investors discussed above will depend on a number of factors, including the extent to which the standardized headings and prescribed order of information will help increase investors' understanding about the content of the relationship summaries, and in what ways such an increase in understanding would affect their behavior.

(2) Prescribed Wording

The final instructions include a mixture of limited prescribed wording that firms must include and requirements for firms to draft their own descriptions that comply with instructions about topics they must address.[1074] As with any disclosure document, there are inevitable trade-offs between prescribing specific wording for firms to use (when applicable) and providing discretion to firms to use their own wording. We describe those trade-offs, as they relate to the final instructions, below.

The proposed instructions would have required prescribed wording in several items of the relationship summary, including fees and costs and a comparison section for standalone broker-dealers and investment advisers. We explained in the Proposing Release that prescribed wording for these items could benefit investors through standardization and by improving comparability across relationship summaries, while at the same time could impose costs on investors if prescribed wording does not accurately represent a firm's services.[1075] We are adopting final instructions that largely eliminate prescribed wording for most of these items and instead permit firms, within the parameters of the instructions, to respond to the relationship summary items using their own wording.[1076] We continue to prescribe wording for headings, conversation starters, and the standard of conduct, as well as a factual disclosure concerning the impact of fees and costs on investments over time.[1077] However, firms may omit or modify required disclosures or conversation starters that are inapplicable to their business or specific wording required by the final instructions that is inaccurate.[1078] Based on feedback from commenters and observations reported by investor studies and surveys, this change will increase the benefits of the relationship summary to investors relative to the proposal. Specifically, several commenters suggested that some of the prescribed wording would not only reduce the accuracy of the information provided by firms but could also confuse investors about a firm's offerings, and we have made changes in light of those comments. We believe the final rules strike an appropriate balance between comparability between firms and the accuracy and relevance of information contained in relationship summaries, increasing potential benefits to investors relative to the proposal.

We nevertheless recognize reductions in benefits relative to the proposal stemming from this approach. It decreases the degree of standardization of the information which could impact comparability across relationship summaries, as suggested by some academic research.[1079] However, to the extent some of the prescribed language in the proposed rules would be considered “boilerplate” by investors or would not be applicable to a particular firm's services or business, the reduction of such prescribed wording in the final rules is not likely to come at a cost to investors (and in fact is likely to benefit investors). The risk of lower standardization and comparability also is mitigated because, while not prescribing specific wording, the final instructions require prescribed topics that all firms must include in each item. For example, in their description of services, all firms must address monitoring, investment authority, limited investment offerings, and account minimums.[1080] Moreover, increased flexibility for firms to describe their services and offerings relative to the proposal could impose costs on retail investors if it increases the potential ability of some firms to provide information in a less useful or clear way in their own words than when required to use prescribed wording.[1081]

One section proposed for standalone broker-dealers and investment advisers, which we referred to as the Comparisons section, had entirely prescribed wording.[1082] We are not adopting this proposed section. Additionally, we removed prescribed wording from the proposed introduction, which would have noted that brokerage and advisory services were distinct.[1083] On one hand, omission of the Comparisons section potentially could reduce the risk of information overload for investors. On the other hand, omitting this section might reduce benefits relative to the proposal by reducing the salience of potentially valuable comparative information available to retail investors at the point of forming a relationship, particularly if a retail investor does not review relationship summaries of multiple firms. We have taken specific measures to maintain some of the benefits we had intended to achieve in the proposed Comparisons section by using other methods to enable retail investors to continue to view comparative information and access more general educational information. For example, all firms must provide at the beginning of the document a link to Investor.gov/CRS, which offers educational information about investment advisers, broker-dealers, financial professionals and other information about investing in securities. In addition, dual registrants and affiliated firms that offer their brokerage and investment advisory services together are required to provide information about both types of services with equal prominence and in a manner that clearly distinguishes and facilitates comparison. This instruction applies regardless if they prepare a single relationship summary or two separate relationship summaries describing each type of service. If dual registrants prepare two separate relationship summaries, they must cross-reference or link to the other and deliver both with equal prominence and at the same time. Affiliates offering brokerage and investment advisory services together have similar presentation and delivery requirements.

The magnitude of the anticipated benefits and costs to retail investors discussed above will depend on a number of factors, including the extent Start Printed Page 33586to which the specific requirements regarding wording will help increase investors understanding about the content of the relationship summaries, and in what ways such an increase in understanding would affect their behavior.

d. Content

The final instructions require firms to include specific items in the relationship summary. Below we discuss the anticipated benefits and costs to retail investors from these items.[1084] The magnitude of these anticipated benefits and costs to retail investors will depend on a number of factors, including the extent to which the specific items of disclosure will help increase investors understanding about their potential or current relationships with firms and financial professionals, and in what ways such an increase in understanding would affect their behavior.

(1) Relationship and Services

The relationship summary requires an overview of the services that the firm provides to retail investors.[1085] The topics that the firm must discuss include principal brokerage and advisory services, monitoring, investment authority, limited investment offerings, as proposed, and, new to the adopting release, account minimums and other requirements. The services firms provide to retail investors vary widely. These differences exist not only between broker-dealers and investment advisers, but also within different types of broker-dealers and investment advisers. We believe that this section will increase the transparency, saliency, and comparability of information about the types of services, accounts, and investments provided by firms, which should likewise improve matching between firms and retail investors.

We have made some changes from the proposal intended to increase the potential matching benefit. In particular, instead of using prescribed wording, firms will describe their services using their own wording. Firms must also describe account minimums, which could improve matching with the provider and may reduce investor search costs, especially for investors that fall short of required minimums so that retail investors can be aware of potential limitations on their initial or continued eligibility for services.[1086] Because all firms must describe particular topics, we believe investors can also use this information to compare firm services if they review multiple relationship summaries. We believe the approach of firms using their own wording to describe their services will increase the benefit to investors relative to the proposal by allowing firms to provide descriptions that are a better match for their particular services. This approach also avoids the cost of firms being required to make inaccurate or confusing disclosures given their specific business models, as raised by commenters.[1087] This potential increase in benefit, however, comes with attendant potential increases in costs to the extent that firms do not present the most relevant aspects of their services or their descriptions are unclear, as discussed in the considerations regarding prescribed wording above. On balance, we believe that allowing for a description that is accurate and better matched to a firm's services likely would be more beneficial and less confusing to investors.

(2) Fees and Costs, Standard of Conduct, and Conflicts of Interest

The relationship summary requires several prescribed questions and required responses about fees, conflicts of interest, and the standard of conduct.[1088] Some of this information will be required to be provided to investors for the first time, such as an articulation of the standard of conduct. Other information, while currently available in various sources, will be presented centrally in the relationship summary, with links to more detailed, layered information about fees and conflicts. Additionally, providing retail investors with context for the more detailed information could potentially pique their interest and lead retail investors to seek more information about fees and conflicts through the required links. We believe both the information not previously required and the consolidated summary of information already available elsewhere will benefit investors by increasing salience, transparency, and comparability, and reducing information asymmetry compared to the baseline. More specifically, including these disclosures prominently, in one place, in a digestible manner, at or before the start of a retail investor's relationship with a firm or financial professional could facilitate meaningful disclosure in the relationship summary, as well as conversations between the retail investor and his or her financial professional, and help the retail investor decide on the types of services that are right for him or her. In addition, to the extent that the specified conflicts of interest disclosures could draw retail investors' attention to conflicts, they may improve retail investors' ability to select and monitor firms and financial professionals.

The fees, costs, and conflicts disclosure also potentially has costs for investors. In particular, and as discussed above,[1089] the perception that an investor has been warned (via the disclosure) of a firm's and financial professional's potential bias may lead some financial professionals to believe that they are less obligated to provide unbiased advice. Further, the standard of conduct and conflict disclosures could make firms and financial professionals appear more trustworthy and as a result reduce the incentives for retail investors to examine additional information more carefully. Conversely, a potential cost for investors of such disclosures is that some investors may mistakenly leave the market for financial services or choose to not engage with a financial professional because they infer from the discussion of conflicts of interest and fees that a financial professional could provide bad advice or recommend products that will reduce their financial well-being. However, the placement of the prescribed standard of conduct disclosure immediately preceding the conflicts disclosure may alleviate the risk that investors will overreact to the conflicts of interest disclosure in this manner, because the standard of conducts disclosure clarifies that the firm or financial professional must act in the investor's best interest.

We received significant comments about the potential efficacy of the proposed disclosures related to fees and costs, conflicts, and the standard of conduct, and the ultimate benefit of such disclosures to investors. Likewise, feedback from investors through surveys and studies and in Feedback Forms revealed confusion about the proposed standard of conduct section in Start Printed Page 33587particular.[1090] Results reported in investor surveys and studies also showed that the proposed conflicts section was rated one of the least useful sections, which may suggest that some investors did not understand the role of conflicts based on the disclosure as presented by the sample proposed dual registrant relationship summary.[1091] We have made several changes from the proposed relationship summary designed to increase the clarity and salience of the disclosures, thereby increasing the potential benefit and reducing the potential costs discussed above relative both to the baseline and the proposal. We also believe the changes will reduce the risk that investors will not read the section or will misinterpret it, increasing the effectiveness of these disclosures and therefore the potential benefit.

First, by integrating the section covering fees, costs, conflicts of interests, standard of conduct, and how representatives are paid,[1092] we believe retail investors may be more primed to process implications of these disclosures in a more integrated fashion due to their proximity. In particular, providing these disclosures in the same section could increase the salience of this information for investors,[1093] both relative to the proposal and the baseline, and may potentially improve investor cognitive processing of how conflicts of interest can have an impact on the services and advice provided and costs paid by investors.

Second, with respect to fees, the relationship summary requires firms to discuss under separate question headers (i) the principal fee and the incentive that it creates and (ii) other fees and costs that the investor will pay. We are requiring firms to summarize, in their own words, the principal fees and costs that retail investors will incur, including how frequently they are assessed and the conflicts of interest that they create. We think investors will be better able to process the implications of the principal fee disclosure through this requirement. Additionally, requiring firms to describe other fees and costs investors will pay, distinct from the principal fee, will clarify for investors that they pay not only a principal fee for advice, but also additional fees and costs. This may potentially prompt investors to use the required link to learn more information, ask follow-up questions, or monitor for such fees and costs.

Third, the instructions require that the standard of conduct disclosure be placed under the same header as the summary of firm-level conflicts. The expected benefit of placing these conflicts of interest and standard of conduct disclosures together is to improve investor processing of the implications of conflicts of interest disclosure and legal obligations underlying the particular standard of conduct (i.e., best interest for broker-dealers and fiduciary duty for investment advisers) as well as to prevent investor misinterpretation of these disclosures. We continue to prescribe wording for the standard of conduct, which we believe will have greater benefits than giving firms flexibility to describe the standard of conduct. Unlike other areas where we are allowing firms to use their own words, the standard of conduct, whether a fiduciary duty for an investment adviser or Regulation Best Interest for a broker-dealer, applies during the course of the adviser's relationship or where a broker-dealer makes recommendations. We also changed from the proposal the specific wording in an effort to simplify the disclosure relating to the standard of conduct and thereby increase understanding by investors. We believe reducing the length and the complexity of the prescribed wording for the standard of conduct will increase the salience and comprehension of the required standard of conduct disclosure, because a more readable and shorter disclosure is less likely to be ignored by investors due to information overload and limited attention.

While retail investors may benefit from understanding the standard of conduct that firms and financial professionals are subject to when providing investment advice or recommendations, discussing the standard of conduct in connection with conflicts of interest may benefit investors by making it clear that the standard of conduct does not mean that advice is conflict-free.

Regarding the conflicts disclosure itself, we have added a new requirement that if none of the enumerated conflicts required to be disclosed by the instructions is applicable to a firm, the firm must select at least one of its material conflicts to describe. This was designed to eliminate the potential that firms would not have to disclose any conflicts, which would have been costly to investors if it caused them to believe that the firm had no conflicts. The relationship summary does not require disclosure of all conflicts but does require firms to include a link to additional information about their conflicts. We believe this will benefit investors relative to the baseline by providing sufficient information about certain conflicts to increase their understanding of incentives generally and potentially inducing them to review the linked information, which also minimizes the potential for information overload.

Finally, in addition to requiring firm-level conflicts, the relationship summary includes a separate question and required response about how financial professionals are compensated and the conflicts of interest those payments create. This disclosure will distinguish firm-level from financial professional-level conflicts, which we believe will benefit retail investors by helping them better understand the role of conflicts and how these conflicts might impact a financial professional's motivation when providing investment advice.

Despite the changes to presentation of fees, costs, conflicts, and standard of conduct relative to the proposal to increase clarity, we recognize the complexity of these issues. Accordingly, we recognize benefits to investors could be limited by investors' potential lack of ability to comprehend the disclosure.[1094] In the extreme, standards of conduct disclosure may also have a reverse effect of unduly enhancing investor trust in providers because investors may misperceive providers as holding themselves to a standard higher than legally required, and making investors discount the severity of the disclosed conflicts.[1095] Because firms have some flexibility to decide what additional fees and costs to describe and, in the case of a firm with none of the enumerated conflicts, which conflict to use as an example, benefits could be reduced to the extent that they choose examples that are not informative to the retail investor. Additionally, there could be a cost to investors to the extent they believe the enumerated fees and conflicts in the relationship summary are the only fees and conflicts the firm has, although we believe that the required wording that explains the Start Printed Page 33588summarized conflicts are examples, as well as the required links to more information about fees and conflicts, mitigate the risk of this misperception.

In addition, referencing academic research on the potential negative effects of conflicts of interest disclosure, several commenters expressed concerns that the proposed required disclosure of conflicts of interest in the relationship summary could lead to a “moral license” for financial professionals to provide even more biased advice and thus take unfair advantage of investors, or lead investors to fail to discount biased advice, trust their providers even more or make them feel pressured to remain in a potentially disadvantageous relationship, i.e., the panhandler effect.[1096] Despite the changes we have made from the proposal to the required conflicts of interest disclosure in the final instructions, we acknowledge that there is still some risk for such negative unintended consequences.

(3) Disciplinary History

As proposed, the relationship summary will contain a section where firms must state in binary fashion whether or not they have disciplinary history, as well as include a reference to Investor.gov/CRS, where investors can conduct further search for additional information on those events.[1097] We have made a change to increase the salience of this information relative to the proposal by making a separate Disciplinary History section, including its own question and required response, rather than—as proposed—including it with other content in an Additional Information section, which should increase any benefits or costs relative to the proposal.

The primary benefit of the disciplinary history disclosure relative to the baseline is that investors will be alerted to a potential need to search and review their provider's disciplinary information and will have a mechanism to find more information about any disciplinary history. Although this information already exists publicly, clearly linking to Investor.gov/CRS for further information about disciplinary history at the time investors are selecting a firm or financial professional will help retail investors know where to find additional information about those events, which should reduce search costs and is an improvement relative to the baseline.[1098] The conversation starters also will provide investors with a cue to the importance of understanding the disciplinary history and could trigger more information gathering and ultimately more effective cognitive processing of this disclosure. As a result, an investor may choose to not engage a firm or financial professional if the disciplinary history is considered to be too problematic, or, if an investor chooses to proceed with a provider that has some concerning disciplinary history, awareness of those events could provide incentives to the investor to monitor his or her account more carefully than if she were not aware.

The potential cost is that investors may overreact to the “yes” or “no” response reported in the Disciplinary History section. Investors may attribute the disciplinary history of one or few financial professionals at a firm to the entire firm, and thus choose not to select a provider that could be a good match for them (for example, a larger firm with more employees and thus a greater likelihood of disclosable events) [1099] or avoid hiring a financial professional altogether. Retail investors may also misinterpret a higher baseline rate of disciplinary history for broker-dealers than for investment advisers, given that the scope of events that trigger a disclosure event is arguably broader for broker-dealers than for investment advisers.[1100] As a result, retail investors may avoid choosing a broker-dealer, even when such a relationship would be a better match for the investors. Relatedly, investors may over-rely on lack of disclosure of disciplinary history as evidence of more ethical conduct; however, lack of such disclosures may be due to unrelated factors such as a comparatively short history of a particular firm or fewer employees (and thus less likelihood of having employees with disclosable events). However, the risk of some investors misinterpreting, or over-relying on, the disciplinary history should be mitigated to the extent firms or financial professionals provide more information about and encourage retail investors to ask follow-up questions regarding the nature, scope, or severity of any disciplinary history. On balance, we believe the benefits to investors from including the disclosure on disciplinary history, as discussed above, justify any potential negative effects.[1101]

(4) Additional Information

The relationship summary will conclude with a section where registrants will let investors know where investors can find additional information about their services and request a copy of the relationship summary, which should benefit investors relative to the baseline by providing this general resource, in addition to the links or references provided throughout the document.[1102] In a change from the proposal, the Additional Information section eliminates the proposed requirement to provide information on how investors should report complaints about their investments, accounts, or financial professionals. Instead, we are requiring a conversation starter on whom investors should contact about their concerns. The benefit of this approach is that it improves readability of the form by reducing prescribed wording and potentially facilitates a conversation between investors and their financial professionals; the cost of this approach is that some investors will not have access to direct instructions on how to report their complaints. Finally, investors with limited or no access to internet (e.g., due to costs of internet access or due to a disability) will also benefit from a requirement that firms provide a number through which retail investors can request up-to-date information or a copy of the relationship summary.

(5) Conversation Starters

Disclosures currently required by investment advisers and broker-dealers generally do not have suggested questions for investors to ask their financial professional. The relationship summary will require firms to incorporate suggested follow-up questions for the investor to ask, which the instructions refer to as “conversation starters.” [1103]

Conversation starters should benefit investors relative to the baseline by improving the potential to match investors with providers that provide services more suitable to the investors' Start Printed Page 33589preferences and needs. We believe that this is accomplished through enabling the investor to be more engaged, potentially assisting the investor with comprehension of relevant disclosures, and assisting the investor in receiving more personalized information than the firm-level disclosure documents, such as Form ADV or documents issued by broker-dealers. That is, to the extent that these conversation starters promote more transparency and better communication between investors and financial professionals, retail investors are more likely to understand the information and select the right firm or financial professional to meet their preferences and expectations. In addition, to the extent the conversation starters help increase investors' engagement in a selected relationship it may also increase their monitoring of their relationship and more critically evaluate any advice or recommendations they receive. However, a closer personal engagement between retail investors and financial professionals may cause some investors to feel social pressure to act on the advice or recommendations of the professional due to a panhandler effect,[1104] which may attenuate some of the benefits of the conversation starters.

A potential cost associated with the conversation starters is that the particular required questions may anchor the attention of retail investors to those prescribed questions and reduce the likelihood that they would explore other potential questions that could be important to them based on their individualized circumstances. In response, we have reframed the proposed questions, which were at the end of the proposed relationship summary as “Key Questions,” and instead have integrated them within the relevant information item throughout the relationship summary to reduce the risk that investors only focus on this set of questions in their discussions.[1105] Moreover, many of the conversation starter questions are broad and open-ended, which could further mitigate the risk of investors' anchoring on the content of these questions at the expense of the other disclosures in the relationship summary.

As pointed out by one commenter, unless the “Key Questions” in the relationship summary are provided to investors in advance, some retail investors may entirely ignore these questions.[1106] As discussed above, the final rules incorporate the questions as “conversation starters” directly in the different sections of the relationship summary, which should increase their salience and reduce the risk of them being ignored by investors compared to the proposal. In addition, because the relationship summaries will be available to investors online on firms' websites or through Investor.gov/CRS, the relationship summaries may be downloaded and accessed by some investors prior to meeting a financial professional, which would give such investors the opportunity to review the conversation starters before meeting a financial professional.

e. Filing, Delivery, and Updating Requirements

(1) Filing Requirements

The final instructions require firms to file their relationship summaries with the Commission (using IARD, Web CRD®, or both, as applicable), and make their relationship summaries available on their websites. In addition to firms' websites, firms' most recent relationship summaries will be accessible to the public through IAPD and BrokerCheck, public interfaces of IARD and Web CRD®, respectively. Investors also will be able to use the Commission's website Investor.gov, which has a search tool on its main landing page and at Investor.gov/CRS that links to BrokerCheck and IAPD. If investors prefer, they may request copies of firms' relationship summaries by calling the numbers that firms must include in their relationship summaries. We expect that making firms' relationship summaries accessible in these ways should reduce investor search costs in connection with selecting investment firms or financial professionals. We also believe that retail investors could benefit from their ability to access the relationship summaries independently through the companies' websites, BrokerCheck, IAPD, or Investor.gov prior to any contact with a financial professional. Such access could increase retail investors' understanding about differences between firms and financial professionals even before approaching a particular firm or financial professional, which could reduce search costs for investors early on in the search process and further reduce the risk of a mismatched relationship. The online availability of the relationship summaries will also enable investors who are currently not participating in the market to become better informed about the market for financial advice and the particular relationships provided without the need to incur the cost of actively contacting a firm or financial professional, which may ultimately encourage them to seek out a relationship with a provider.

In addition, the online availability of the relationship summaries in central locations and the machine-readable headers of the summaries will allow third-party data aggregators to more easily collect relationship summaries and facilitate the development of comparison tools for the investing public. To the extent such tools and metrics are developed, it could facilitate investors' searches by helping them narrow the set of available financial service providers to those that are most likely to provide a good match. However, the benefits to investors from the development of such tools will be mitigated by any fees charged by third-party aggregators for access to the tools.

(2) Delivery and Updating Requirements

Firms will deliver a relationship summary to each new or prospective retail investor based on the initial delivery triggers specific to investment advisers, broker-dealers, and dual registrants.[1107] Firms also must deliver the relationship summary to existing clients and customers who are retail investors in certain circumstances.[1108] For these existing clients and customers, the final rules require that firms deliver the relationship summary (including updates) in a manner consistent with the Commission's electronic delivery guidance and the firm's existing arrangement with that client or customer.[1109]

Because retail investors may face substantial switching costs when they move from one financial professional to another, the benefits associated with finding a good match may be particularly significant. Accordingly, investors' benefits should increase in accordance with their ability to understand and compare relationship summaries, which may take time. We recognize that, as some commenters noted, if a financial professional delivers the relationship summary at the time of service, retail investors may not have sufficient time to thoroughly evaluate the financial professional or may have already made a preliminary decision to engage the particular financial professional by the time they receive the relationship summary. As discussed above, however, there are Start Printed Page 33590compliance uncertainties and other costs associated with requiring a relationship summary be delivered at first contact or requiring a waiting period, as suggested by some commenters.[1110] First contact between an investor and a financial professional may include circumstances that are not limited to the seeking of investment advice, such as business interactions for other purposes or social interactions. In addition, as noted by commenters, a waiting period may prevent investors from meeting certain deadlines.[1111] As we discuss above, the availability of relationship summaries online may mitigate the concern that retail investors will not have enough time to review them, to the extent that it provides retail investors an opportunity to compare firms before contacting them to obtain services.

We expect that the rules regarding form of delivery—electronic or paper—generally will be beneficial for retail investors relative to the baseline by enabling a form of delivery that is a good match for the particular retail investor. For retail investors who prefer electronic delivery, electronic forms of delivery should facilitate both the engagement with and the processing of the disclosed information, particularly the required and optional hyperlinks and other features. For the investors who prefer paper documents, paper delivery should result in greater likelihood of the investor paying attention to the relationship summary disclosures. We believe that maintaining the mode of delivery consistent with the way information was requested for new customers and consistent with existing arrangements for existing customers will help to further ensure that the investors will not miss and will process the information contained in the relationship summaries. Customers requesting the relationship summary in paper format may be less likely to access the additional information available through the electronic means of access discussed above, which could result in their inability to process potentially important additional information.

We also believe that existing clients and customers of broker-dealers and investment advisers that are retail investors will benefit from the requirement that firms deliver the relationship summary again if they: (i) Open a new account that is different from the retail investor's existing account(s); (ii) recommend that the retail investor roll over assets from a retirement account into a new or existing account or investment; or (iii) recommend or provide 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, for example, the first time purchase of a direct-sold mutual fund or insurance product that is a security through a “check and application” process, i.e., not held directly within an account.

This requirement should have the benefit of increasing retail investors' attention to disclosures provided in the relationship summary and the implications of new services or account options at the time of that decision. Additionally, the instructions require firms to update their relationship summaries to existing retail clients or customers if the existing relationship summary becomes materially inaccurate, which would include information that is materially outdated or materially incomplete. Firms must communicate the changes by delivering the amended relationship summary or by communicating the information through another disclosure that is delivered to the retail investor. Firms delivering the amended relationship summary must highlight the most recent changes by, for example, marking the revised text or including a summary of material changes and attaching the changes as an exhibit to the unmarked amended relationship summary. Investors should benefit from receiving updated relationship summaries under these circumstances because this information is relevant to the decision of whether to enter into new services or continue existing services, based upon whether the new or existing services match or continue to match their preferences and expectations. The requirement to attach revised text or a summary of material changes to the amended relationship summary should benefit retail investors by helping them to process the new information quickly. However, we recognize that to the extent that retail investors with established financial professional relationships tend to remain in such relationships, it may attenuate the benefits of receiving the relationship summary again.

2. Broker-Dealers and Investment Advisers (Registrants)

a. Benefits to Registrants

Beyond benefits to retail investors, we also expect broker-dealers and investment advisers potentially to benefit from the relationship summary. Some retail investors, who could benefit from obtaining advice and other services from financial professionals, currently may choose to stay out of the market for financial services because they do not understand what type of firm or financial professional they require. The relationship summary may provide a clear and concise document that may draw new investors to the market. If the relationship summary draws new retail investors to the market for financial services, both broker-dealers and investment advisers may gain new customers and clients, respectively. An increase in new retail investors could enhance revenues for firms and financial professionals, although firms and financial professionals could also bear additional costs, which are discussed below.

Moreover, the relationship summary could provide additional benefits to firms and financial professionals by improving the efficiency of the search process in the market for financial advice. For example, retail investors will be able to access and obtain relationship summaries for any number of firms online, including both broker-dealers and investment advisers. To the extent investors use this feature at the start of their search for a firm, they are more likely to opt to approach only firms that ex ante meet their preferences and expectations. Thus, broker-dealers and investment advisers may be less likely to expend time and effort meeting and discussing their business model and services with prospective customers and clients, who are seeking a different kind of relationship and that would ultimately not engage in a relationship with the firm or financial professional. Instead, firms and financial professionals can devote their efforts to acquiring customers and clients that are more likely to contract for their services. In addition, to the extent the relationship summary leads to fewer retail investors entering or remaining in a mismatched relationship that does not meet their expectations, it may benefit firms by reducing costly customer complaints and arbitrations.

While some commenters suggested that brokers have incentives to provide ineffective disclosures,[1112] academic studies show that sellers can benefit from better disclosure of product quality information to the buyers, and competitive sellers thus have incentives to disclose better information.[1113] While Start Printed Page 33591some disclosure documents may contain topics of material that investors may not understand or prioritize, the relationship summary has been designed to focus on issues already identified by retail investors to be of first-order importance with respect to their relationship with their financial professional,[1114] such as fees and costs, conflicts of interest, and disciplinary history of firms and financial professionals, among other items.[1115] Further, the relationship summary is intended to be clear, concise, and readable, while permitting firms the flexibility to provide information pertinent to their business model and services offered. Finally, firms may benefit from providing more clear and understandable disclosures to the extent it will facilitate a more efficient matching process with prospective investors. Firms could also bear potential legal liability [1116] and reputational costs as a result of providing potentially less transparent disclosures. For these reasons we believe registrants will generally have incentives to use the discretion permitted in the final instructions to design a relationship summary that is effective at informing retail investors about the nature of their business and offerings.

The magnitude of the anticipated benefits discussed above will depend on a number of factors, including the extent to which investors' will change their behavior as a result of receiving the relationship summary and how firms and financial professionals will react to such a change. Given the number and complexity of assumptions that would be required to be able to estimate how the relationship summary will affect investors' understanding and their decision-making, and the lack of data on relevant characteristics of individual firms and their prospective and existing retail investors, the Commission is not able to meaningfully quantify the magnitude of these anticipated benefits.

b. Costs to Registrants

The final rule will also impose costs on affected broker-dealers and investment advisers, including: costs associated with preparation, filing, delivery, and firm-wide implementation of the relationship summary; costs of the associated recordkeeping rules; and as well as training, monitoring, and supervision for compliance. We expect that these costs may differ across firms depending on their type (broker-dealer or investment adviser), size, and complexity of business. We discuss these costs in more detail below. The Commission has, where possible, quantified the costs expected to result from the final rules in the analysis below. However, we are unable to quantify some of the potential costs discussed below, because of the number and complexity of assumptions that would be required to be able to estimate how the relationship summary will affect investors' understanding and choice of financial services provider and the lack of data on relevant characteristics of individual firms and their prospective and existing retail investors.

(1) Preparation, Implementation, and Content

Registrants will incur costs in connection with preparing and implementing the relationship summary. With respect to aggregate compliance costs, as discussed in more detail below, some commenters suggest these costs could be high.[1117] One commenter provided a survey of financial professionals that indicate that 79% of survey participants agree that implementation costs may be higher at first but will likely lessen over time, and 40% of firms in the same survey anticipate moderate or substantial time to implement the requirements of Form CRS (and Regulation Best Interest).[1118]

Broker-dealers currently are not required to prepare a consolidated disclosure document for their customers similar to the Form ADV, Part 2A brochure and may incur comparatively greater costs in preparing the relationship summary than investment advisers, given that investment advisers can draw on their experience with preparing and distributing Form ADV Part 2A. The Commission believes that costs of preparation would also fall differently 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.

The relationship summary requires the use of standardized headings in a prescribed order, while permitting some flexibility in other aspects of the relationship summary's wording and design within the parameters of the instructions. There is a trade-off in terms of preparation costs to registrants between requirements that prescribe specific wording and formats for disclosures and requirements that do not provide any prescribed language and format. For example, we would expect that the more extensively the relationship summary would rely on prescribed format and wording, the lower the preparation costs for providers, because there would be less need for them to devote resources to construct their own format and wording. On the other hand, the more extensively the relationship summary would rely on prescribed format and wording, the more likely it would turn into a “one-size-fits-all” document with largely boilerplate language, and firms would lose the benefit of being able to more precisely and accurately describe their own business and offerings to investors. We believe the final instructions strike an appropriate balance in this trade-off, with some higher-level prescribed format and language, such as the standardized language and order of headings, while firms generally will be able to (and have to) choose their own wording and organization of the required information under each heading.

The final instructions provide for more flexibility than the proposed instructions. We acknowledge that this change could increase certain compliance costs relative to the proposal, as firms will have to develop more of their own wording and organization of the information that is required to be included. However, the flexibility permitted by the final instructions is mainly in terms of the wording while the topics and sub-topics of information that are required to be discussed are largely proscribed. This narrows the field of subjects that firms could choose to discuss and potentially mitigates the cost increase from additional flexibility. Moreover, we believe that the expected benefits of this additional flexibility justify this cost increase. In particular, we expect this change from the proposal to benefit firms by allowing them to more Start Printed Page 33592accurately describe their services and offerings to retail investors.[1119] We also expect the additional flexibility to benefit both firms and retail investors to the extent it results in disclosures that are more engaging and useful to investors and mitigates the possibility of a mismatch. In addition, several commenters requested greater flexibility to provide accurate descriptions of their business models and services, noting the potential for liability for prescribed disclosures in the proposal that might not be accurate for a particular registrant's business.[1120] Some topics, however, will require firms to use prescribed wording, such as the headings, conversation starters, statement of their legal standard of conduct, and two statements related to fees and costs, for the reasons generally discussed in Section II.A.1.[1121]

In a change from the proposed instructions, the final instructions encourage rather than require dual registrants and affiliates to prepare one single relationship summary, but also allow them to instead prepare two separate relationship summaries.[1122] In addition, if firms prepare one combined relationship summary, the final instructions required them to employ design elements of their own choosing to promote comparability, rather than the two-column format, as prescribed in the proposed instructions. This increased flexibility in presentation relative to the proposal can benefit dual registrants and affiliates because it allows them to design disclosures more suitable to their business models. For example, a firm which generally is marketing both sides of its business to retail investors may find it less costly and/or more beneficial to provide a combined summary. However, dual registrants for which either the brokerage or investment advisory side of their business is not generally marketed to most customers or clients may find it more beneficial to provide two separate relationship summaries. If a firm chooses to prepare two distinct relationship summaries, it may incur an extra cost of preparing the second summary, but we expect firms will only elect to prepare two separate summaries if they believe the benefits of separate summaries justify such additional preparation costs.

Beyond the more general costs discussed above from the prescribed formatting and wording requirements, some specific requirements may be costly for certain firms. For example, because the relationship summary requires information to be organized by standardized headings in a prescribed order, some firms may find it difficult to effectively present the most salient information specific to their business and services. As such, certain firms may incur costs associated with trying to fit their business model and other relevant information into the standardized headings. This is mitigated by the fact they have flexibility to present the required sub-topics of information in the order of their choosing within each subtopic and by firms' ability to omit irrelevant information. Firms and financial professionals also may bear costs in providing additional information to potential or existing investors to clarify any information that is salient to their business but does not fit into the standardized headings of the relationship summary. These costs are mitigated by firms' ability to supplement their relationship summaries with cross-references or hyperlinks to additional information.

The page limit for the relationship summary also has potential costs, particularly for firms with complex business models, even under the increased flexibility provided by the final instructions, because they would have to distill the complexity of their business into the same space as less complex firms. The use of layered disclosure, through mediums such as hyperlinks, will permit firms to provide more detailed information that may ameliorate this cost to some extent, while still adhering to the formatting requirements of the relationship summary.

Firms will also incur costs associated with the production and verification of information in the relationship summary. Although some of the information that will be summarized in the relationship summary is contained in other disclosures that firms already provide, firms will bear the cost of editing this information for the relationship summary and cross-referencing or hyperlinking to additional information. For example, to the extent that some firms do not already have in place a concise description of how fees, costs, conflicts, and standards of conduct are potentially connected, that also will allow for meeting the relationship summary's space constraints, firms will have to expend time and effort to develop an accurate, clear, and concise description of these items, written in plain English, for insertion into the relationship summary, and cross-referencing or hyperlinking to additional information about these items. These costs may be larger for broker-dealers than for investment advisers, who can directly draw on the disclosures of fees, costs, and conflicts they have to provide to retail investors in Part 2 of Form ADV. Also, to the extent the costs of developing this section have a fixed component, the relative burden of developing this section may be higher for smaller firms. On the other hand, smaller firms are likely to have fewer types of fees, costs, and conflicts to report compared to larger firms, potentially making it less burdensome for them to summarize the required information.

In addition, the relationship summary requires “conversation starters” as part of each section, and the conversation starters must be highlighted through text features to improve their prominence relative to other discussion text. Firms will incur costs associated with the conversation starters, particularly with respect to preparation and training on how financial professionals provide accurate and complete responses to the “conversation starters” when asked. We do not have access to data and information that would allow us to estimate these costs to firms, but we expect them to be comparatively greater for firms with more complex business, a wider range of offered services and products, because training and supervision costs for such firms could be more extensive. For firms that provide automated investment advisory or brokerage services, those firms will incur burdens to prepare answers to each conversation starter question and make those available on the firm's website (while providing in the relationship summary a means of facilitating access, e.g., by providing a hyperlink, to that section or page).[1123]

We also anticipate that firms will bear some costs in the production of the electronic format as well as other graphical elements, such as charts and tables, which may make important information more salient to investors. Smaller firms may disproportionately incur costs associated with electronic and graphical formatting, particularly if they do not have an existing web presence or currently produce brochures or other disclosures that make use of graphical formatting. However, because the final instructions encourage, but do Start Printed Page 33593not require electronic formatting and graphical, text, and online features, firms would only bear these costs if they expected these features to provide benefits that justify these costs.

Finally, there could also be some indirect costs to firms from some of the required content in the relationship summary. In particular, 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, firms that affirm they have one or more reportable disciplinary events may face a loss in competitiveness compared to firms that have no event to report. This can in particular be costly for firms that have few or less serious disciplinary events that may be overlooked by investors that do not research the nature of the disciplinary history in more detail.[1124] We also recognize larger firms might be more likely to incur such competitive costs, because larger firms are more likely to have at least one reportable disciplinary event than smaller firms. Similarly, holding size constant, older firms, by virtue of having a longer business history, are more likely to have one or more reportable events than younger firms. Although we acknowledge the potential for firms to incur competitive costs from having to affirm they have reportable disciplinary history, those costs are justified by the potential benefits to investors from this disclosure, as discussed above.

(2) Filing, Delivery, and Updating Requirements

As proposed, the final instructions require firms to file their relationship summaries with the Commission and make them available on firms' publicly available websites, if they have one. The relationship summary must be filed in a text-searchable format with machine-readable headings. Further, the final instructions will require investment advisers to file their relationship summaries using IARD, as proposed; however, the final instructions—in a change from the proposal—will require broker-dealers to file through Web CRD® instead of EDGAR. This should reduce overall burdens relative to the proposal as broker-dealers already have extensive experience filing on Web CRD®, which is more accessible for broker-dealers. As proposed, dual registrants will be required to file on two systems. Instead of filing on EDGAR and IARD, as proposed, dual registrants will be required to file using both Web CRD® and IARD. We recognize that requiring dual registrants to file using both Web CRD® and IARD may be more costly than filing through just one system; however, we believe that any such cost is justified to ensure a complete and consistent filing record for each firm and to facilitate the Commission's data analysis, examinations, and other regulatory efforts.

As discussed above, the firms that deliver relationship summaries electronically must do so within the framework of the existing Commission guidance regarding electronic delivery.[1125] With respect to initial delivery of the relationship summary to new or prospective investors, firm are required to deliver the relationship summary in a manner consistent with how the retail investor requested information, consistent with the Commission's electronic delivery guidance.[1126] Flexibility in the method of delivery, consistent with Commission guidance, could promote efficiency by allowing firms to communicate with retail investors in the same medium by which they typically communicate other information.[1127] Regardless of the method of delivery (e.g., paper or electronic delivery), firms will incur costs associated with delivering the relationship summary to retail investors.

Moreover, requiring firms to make a copy of the relationship summary available upon request without charge will require firms to incur costs. For example, firms that provide a paper version of the relationship summary to retail customers that request it will incur printing and mailing costs when such requests are made. Further, firms may incur additional costs associated with systems for tracking customer delivery preferences.

Firms will also incur costs for updating and filing the relationship summary within 30 days of whenever any information becomes materially inaccurate.[1128] 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, the ability to disclose material changes by delivering another required disclosure containing the updated information should mitigate the cost of the requirement to communicate updated information in the relationship summary to investors. Firms could also incur costs to keep records of when the initial or updated relationship summary was delivered; however, we believe that firms will be able to leverage their current compliance infrastructures in maintaining such information.

The Commission anticipates that the costs associated with delivery for an average broker-dealer or average dual registrant will be higher than the costs for the average investment adviser. As Table 1 and Table 3 in Section IV.A.1 indicate, broker-dealers maintain a larger number of accounts than investment advisers; 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 investors.[1129] Similarly, given that the average dual registrant has more customer accounts than the average investment adviser, and that the preparation of relationship summaries and any updates for dual registrants may require more effort than for standalone broker-dealers or investment advisers, the compliance costs could be larger for those firms.

Firms will be required to deliver the relationship summary to retail investors. The final instructions have adopted a definition of retail investor that is similar to the definition of retail customer in Regulation Best Interest, but differs to reflect the differences between the relationship summary delivery requirement and the obligations of broker-dealers under Regulation Best Interest, including that the retail investor definition covers prospective as well as existing clients and customers and natural persons who seek services from investment advisers as well as broker-dealers. This definition of retail investor relative to the proposal may reduce uncertainty for broker-dealers and investment advisers about which customers should obtain relationship summaries. We do not believe this changes the scope of retail investors that will benefit collectively from the final rules.Start Printed Page 33594

(3) Recordkeeping Amendments

As adopted and discussed above, firms will be required to make and preserve records of each version of their relationship summary and each amendment filed with the Commission. Firms will also be required to make and preserve a record of the dates that each relationship summary was given to any client, customer, or prospective client or customer who subsequently becomes a client or customer and such records will be maintained in the same manner, and for the same period of time, as other books and records under the applicable recordkeeping rules. As previously discussed, commenters stated that they believe the requirement to maintain records of the dates that the relationship summary was given to prospective clients or customers may impose significant and unnecessary costs and burdens.[1130] Commenters stated that firms do not have compliance and recordkeeping systems in place that could, without substantial and costly modification, maintain records of related to prospective clients or customers who might not become actual clients or customers of the firms for weeks, months or years after firms begin communicating with such individuals. As an alternative, commenters suggested that firms only be required to maintain a record of the most recent date they delivered the relationship summary to a prospective client that becomes an actual client preceding the opening of an account. Commenters suggested only requiring a record that the relationship summary was delivered at account opening or when a retail investor becomes an investment advisory client.

The inclusion of the recordkeeping requirements in the amended rules will impose costs on firms in the form of revised recordkeeping policies and procedures and possible modifications to their recordkeeping systems. The record requirements, however, may be less burdensome if their recordkeeping and compliance systems are already capable of creating and maintaining records related to communications with prospective clients. For example, investment advisers are required to keep similar records for the delivery of the Form ADV Part 2 brochure and broker-dealers are subject to comparable recordkeeping requirements with respect to communications and correspondence with prospective retail investors.[1131] Further, these recordkeeping requirements may benefit firms by assisting them in monitoring their compliance with the relationship summary delivery requirements. Finally, these records will facilitate the Commission's ability to inspect for and enforce compliance with the relationship summary requirements.

(4) Estimates of Certain Compliance Costs

Although we are unable to quantify all costs discussed above, we quantify certain direct compliance costs based on the estimates developed for the purpose of the Paperwork Reduction Act analysis in Section V. These costs, which we discuss below, are estimated separately for investment advisers and broker-dealers that are required to prepare and file a relationship summary. We note that all aggregate cost estimates for either category of firms include the 318 dually registered firms.[1132] In addition, the costs estimates are calculated for the average investment adviser or average broker- dealer. We recognize that the actual compliance costs burdens for some firms will exceed our estimates and the burden for others will be less because firms vary in the size and complexity of their business models.

First, we quantify certain one-time costs associated with the initial preparation and filing of the relationship summary. The cost burden for an average investment adviser to initially prepare and file the proposed Form CRS for the first time is estimated to range between approximately $5,460 and $9,165, depending on the extent to which external help is used.[1133] The estimated aggregate non-amortized combined internal and external costs for all current investment advisers of initially preparing and filing the relationship summary will be approximately $65.3 million.[1134] In addition, based on IARD system data, the Commission estimates that each year approximately 656 newly investment advisers will be required to prepare and file the relationship summary with us.[1135] The aggregate non-amortized initial preparation and filing costs of the relationship summary for these new investment advisers is estimated to be approximately $5.2 million.[1136] Similarly, for broker-dealers, the cost to an average broker-dealer for preparing Form CRS for the first time is estimated to range between approximately $10,920 and $14,625.[1137] We estimate the aggregate non-amortized aggregate combined internal and external costs to all current broker-dealers of initially preparing and filing the relationship summary will be approximately $38.8 million.[1138] We do not expect any new broker-dealer firms based on the secular decline in broker-dealer firms we have seen in recent years.[1139]

Firms will also incur one-time costs of the initial delivery of relationship summaries to their existing retail investors. We expect the non-amortized initial delivery costs to be Start Printed Page 33595approximately $4,941 for the average investment adviser.[1140] In total, we estimate that the aggregate non-amortized initial delivery costs to existing retail investors will be approximately $40.7 million for all current investment advisers,[1141] and $3.2 million for newly registered investment advisers.[1142] For the average broker dealer, we expect costs for the initial delivery to existing retail investors to be approximately $45,801.[1143] The aggregate non-amortized initial delivery cost for all current broker-dealers is estimated to be approximately $126.7 million.[1144]

Moreover, firms are required to post a current version of their relationship summary prominently on their public website (if they have one). We estimate that the initial posting will cost approximately $93 per firm (whether an investment adviser or a broker-dealer).[1145] In aggregate we expect the initial cost of posting the relationship summary to firms' websites to be approximately $686,437 for existing investment advisers,[1146] $54,682 for newly registered investment advisers,[1147] and $257,238 for broker-dealers.[1148]

In addition to the estimates of one-time costs discussed above, for the purposes of the Paperwork Reduction Act analysis, we have also developed estimates of certain expected ongoing compliance costs of the final rules. For example, firms will incur costs each year due to the requirement to re-deliver the relationship summary to existing retail investors in certain situations. We estimate that the annual average cost to re-deliver the relationship summary will be approximately $992 for an average investment adviser and in aggregate approximately $8.8 million annually for all investment advisers.[1149] For broker-dealers, we estimate that the annual average cost to re-deliver the relationship summary will be approximately $9,222 for the average firm, and in aggregate approximately $25.5 million annually for all broker-dealers.[1150] Firms will also be required to deliver relationship summaries to new and prospective retail investors. Based on the Commission's projections of future client and customer account growth, we estimate that the annual costs to current firms of delivery to new and prospective retail investors would be between approximately $223 for an average investment adviser and $5,072 for an average broker-dealer, or approximately $1.8 million annually in aggregate for investment advisers and approximately $14.0 million annually in aggregate for broker-dealers.[1151] The difference in cost estimates between investment advisers and broker-dealers is mainly due to the fact that investment advisers serving retail investors generally have fewer clients than broker-dealers serving retail investors have customer accounts, but also because we project a lower growth rate for retail clients for investment advisers (4.5%) [1152] than for retail customer accounts for broker-dealers (11.0%).[1153] In addition, firms will also incur costs associated with making paper copies of the relationship summary available upon request. We estimate that such annual costs would be approximately $31 for the average firm (whether investment adviser or broker-dealer), and the aggregate annual costs for investment advisers and broker-dealers combined would be approximately $338,272.[1154]

In Section V, for the purposes of the Paperwork Reduction Act analysis, we also estimate the quantifiable expected ongoing costs associated with updating the relationship summary. These costs would be associated with preparing updated relationship summaries when information becomes materially inaccurate, re-posting updated relationship summaries to a public website, and communicating changes to the relationship summary through re-delivery to existing retail investors. We estimate that the annual costs for firms to update and file amended relationship summaries will be approximately $467 for the average investment adviser, or approximately $3.8 million in aggregate for all investment advisers.[1155] For investment advisers with a public website, we estimate the average annual costs of re-posting amended relationship summaries to be approximately $53.32 per adviser, or $402,207 in aggregate for all investment advisers with public websites.[1156] Finally, we expect investment advisers will incur quantifiable costs of communicating changes to amended relationship summaries, if they choose to do so by delivery. We estimate the average annual costs of communicating changes to amended relationship summaries by delivery will be $8,450 per adviser that to choose to do so, and in aggregate approximately $34.8 million for all investment advisers that we expect to choose delivery to communicate updated information.[1157] For broker-dealers, we estimate the annual costs to update, file, and post amended relationship summaries will be approximately $608 for the average firm and approximately $1.7 million in aggregate for all broker-dealers.[1158] We estimate annual delivery costs will be approximately $ 91,602 for the average broker-dealer that will choose delivery to communicate updated information, and in aggregate approximately $126.7 million annually for all broker-dealers that we expect to choose delivery.[1159]

Finally, for the purposes of the Paperwork Reduction Act analysis, we also developed estimates of certain compliance costs associated with the recordkeeping requirements in the final rules. We estimate that the annual costs to firms related to these recordkeeping requirements will be $12.67 for an average investment adviser and approximately $104,354 in aggregate for all investment advisers.[1160] For broker-Start Printed Page 33596dealers, we estimate annual recordkeeping and record retention costs to be approximately $39 for an average broker-dealer, and $107,017 in aggregate for all broker-dealers.[1161]

3. Impact on Efficiency, Competition, and Capital Formation

In addition to the specific benefits and costs discussed in the previous section, we expect that the relationship summary could produce a number of broader long-term effects on the market for financial advice. Below, we elaborate on these potential effects, in particular as they pertain to their impact on efficiency, competition, and capital formation.

a. Efficiency

The final rule requiring broker-dealers, investment advisers, and dually registered firms to produce a relationship summary could result in increased informational or allocative efficiency for retail investors by reducing the risk of matching with a firm or financial professional that is different from the investor's expectations and preferences. As discussed above, the risk of mismatch potentially imposes costs on investors, financial professionals, and firms. Investors may inadvertently, in the absence of information provided by the relationship summary, select the wrong type of financial professional or account, leading to increased costs (direct and indirect) and potentially suboptimal outcomes as it pertains to meeting the investor's financial goals. For firms and financial professionals, cultivating relationships with potential investors requires resources in terms of time and effort. If an investor and financial professional or firm is mismatched, then both sides of the relationship can incur costs. For example, the financial professional may devote time and resources to develop a relationship with a retail investor that is comparatively costly to maintain because of a mismatch between the investor's expectations and the services offered by the professional,[1162] and the investor incurs costs associated with obtaining services that do not fit his or her needs. As such, the relationship summary may reduce the costs associated with mismatch for investors, firms, and financial professionals and increase the efficiency of the market for financial advice. We expect these efficiency gains particularly in the initial matching between investors and firms and financial professionals. For some retail investors, receipt of the relationship summary from their existing firm or financial professional could highlight that they are mismatched in their current relationship. Those investors may benefit from terminating the mismatched relationship and looking for a more appropriate match, but such gains are likely to only be realized to the extent investors anticipate the long-term benefits from a better match will be greater that the short-run switching and search costs. Moreover, these efficiency benefits may be attenuated to the extent that investors tend to stay in relationships with financial professionals once investors are committed to the relationship, even if the relationship is mismatched.

Informational efficiencies could also be enhanced with the relationship summary because key information is focused on information that has been previously identified as important to retail investors, salient and consistently disclosed across broker-dealers and investment advisers. The relationship summary will provide concise, user-friendly information which will allow retail investors to better understand the relationship that they will have with their financial professionals and will allow them to seek services commensurate with their expectations. In addition, to the extent the information asymmetry between investors and financial professionals is reduced, investors may make more informed investment decisions, or become more able to critically evaluate any investment advice they receive. Further, the use of layered disclosure and conversation starters will allow retail investors to access additional information that may be relevant to them when selecting their firm or financial professional, further reducing the risk of mismatch.

The firm-specific nature of the relationship summary required by the final rules about a particular firm will enhance retail investors' information set about each firm, providing them with a more concise and simple document, which should alleviate potential investor confusion about the key elements of the relationship that the investor could expect to have with that firm.

However, such improved efficiency could be lower than that expected under the proposal because, unlike the proposed relationship summary, the adopted relationship summary will include less prescribed language and greater flexibility. For example, the relationship summary will not include a comparison between general broker-dealer and investment adviser standards and services.[1163] The elimination of this proposed requirement will likely reduce (relative to the proposal) the usefulness to retail investors from obtaining this general information from a single source (e.g., any firm's relationship summary) and instead will require effort from investors in the form of search costs to provide an adequate comparison across firms within a given type of firm (e.g., investment advisers). Moreover, for investors that may not know which type of firm is likely to best meet their preferences and expectations with respect to financial services, a less general relationship summary requires that investors that expend search costs also select the correct types of firms in order to make such a comparison. This may be difficult for some retail investors, and could increase the costs of search and the risk of mismatch. Also, allowing dual registrants the flexibility to prepare two separate relationship summaries rather than one combined document may result in some efficiency loss in terms of less direct comparability. Nonetheless, we believe that investors having access to specific and tailored information about the firms, as provided in the final rules, is more important for reducing investors search costs and risk of mismatch, thereby justifying the potential efficiency losses (relative to the proposal) discussed above.

Beyond informational efficiencies that could arise, the relationship summary also may lead to more efficient investor allocation of assets within their portfolios relative to the baseline. Some retail investors that previously avoided the market for financial services because they did not understand the material characteristics of either broker-dealers or investment advisers may be more Start Printed Page 33597likely to hire a financial professional if the costs associated with the acquisition of this information are reduced relative to the baseline. The relationship summary is a simple, concise document providing investors information about key elements of the investor-provider relationship that could incent some investors to seek the services of a financial professional. As such, for some investors that previously abstained from hiring a financial professional, portfolio efficiency could be improved, for example, through increased portfolio diversification.[1164] Furthermore, because of being provided the relationship summary, some current investors may realize that other services provided by their financial professional could be more appropriate for them. For example, an advisory client of a dual registrant may learn more about the broker-dealer services offered by the firm and realize that those services better match his or her preferences and make a switch, which may ultimately improve portfolio efficiency for the client.

However, as noted in Regulation Best Interest, certain studies suggest that for some financial professionals, the improvements to portfolio efficiency could be limited if the financial professionals are subject to the same behavioral biases, such as limited attention or anchoring, as retail investors in their portfolio allocation decisions.[1165] Further, to the extent the relationship summary makes the conflicts of interest of financial professionals more salient to retail investors relative to the baseline, there is a risk that some professionals would feel they have a “moral license” to act on their conflicts,[1166] which could harm the efficiency of retail investors' portfolio allocations. Despite such potential negative effects related to conflicts of interest disclosure, we believe that, on balance, retail investors will benefit from the inclusion of this disclosure in the relationship summary. In particular, the conflicts of interest disclosure should enhance investors' ability to evaluate which relationship is best for them and also help them more critically evaluate the recommendations or investment advice they receive, which should ultimately improve the efficiency of their portfolio allocations.

In addition, and in a modification from the Proposing Release, the headings on the relationship summary will be machine readable, which will facilitate third-party data aggregators', as well as the Commission's, analysis and comparison of certain elements of the relationship summary across firms to the benefit of retail investors. Comparability will lead to greater informational efficiency because retail investors will be better able to choose the right type of firm or financial professional and the right type of account and services, thereby increasing the likelihood that they choose what best meets their needs and reduces the likelihood of mismatch. Providers may likewise benefit from higher information acquisition efficiency because firms may be more likely to initially attract retail investors who prefer their services, thereby potentially reducing customer acquisition costs, such as time and effort spent on initial engagement with prospective customers who ultimately do not contract for their services.

b. Competition

Beyond increased efficiency for retail investors, the relationship summary may also increase competition among broker-dealers and investment advisers. Provision of the relationship summary by firms could enhance the competitiveness of broker-dealers and investment advisers by allowing retail investors to better evaluate and compare firms and financial professionals through increased transparency, and more generally increase retail investors' understanding of the market for brokerage and investment advisory services. In particular, increased transparency may allow investors to better assess the types of services available and the types of fees and costs associated with such services. Moreover, and as discussed above, the relationship summary may facilitate comparisons across firms and lead to reduced search costs for retail investors, allowing investors to match their preferences and expectations for certain financial services, possibly at lower costs relative to the baseline, and may increase competitiveness between firms to lower prices for some services. We believe the changes made to the relationship summary in the final rules have potentially strengthened such competitive effects, for example, by using less prescribed general language and instead requiring disclosure of firm-specific information about services, fees, costs, and conflicts, and by making the headings machine readable, which may encourage the development of search tools by third party providers. An increase in competition may apply only between like firms (i.e., broker-dealers only or investment advisers only) or may have intra-industry effects across broker-dealers and investment advisers.

As discussed above, increased competition both among and between broker-dealers and investment advisers could reduce the pricing power of firms, benefitting investors through lower fees. Lower fees could draw more retail investors that are not currently seeking investment advice to the market, although some retail investors may be willing to pay higher prices for other reasons, including enhanced services and firm reputation. Combined with improved informational efficiency, increased competition for retail investors resulting from information provided by the relationship summary may drive prices at the margin to competitive levels across all types of firms, depending on how price sensitive retail investors are. Alternatively, and similar to what we have today, a separating equilibrium may result where investors' demand for particular services is relatively price insensitive and they cannot be persuaded to move to a different level of service simply because of lower prices (e.g., investors seeking ongoing advice may be more likely to pay higher prices for advisory services provided by investment advisers, even though a potentially lower cost option could be available through broker-dealers).

Further, lower costs of information acquisition and processing due to the content, format, and structure of the relationship summary may lead to more people entering the market for brokerage and investment advisory services and may increase overall retail investor participation. Such an increase in the number of retail investors in the market for financial services could raise demand for brokerage and investments advisory services and mitigate the potential increase in competition discussed above. However, increased levels of retail investor participation could also encourage new broker-dealer and investment adviser entrants to meet the needs of the new pool of investors, and may increase competition for investor capital through lower fees and costs.

How the competitive landscape will shift as a result of the relationship summary is difficult to determine and the effect on aggregate level of competition among and between broker-dealers and investment advisers could be limited. For example, the relationship summary may not necessarily increase the number of new broker-dealer or investment adviser Start Printed Page 33598entrants to the market, but could lead to shifts of investors between broker-dealers and investment advisers to the extent that some currently engaged retail investors are mismatched, and that search and switching costs associated with correcting the mismatch do not justify the costs associated with the potential mismatch. Moreover, the incidence of mismatched relationships with retail investors could be likely for both broker-dealers and investment advisers, so competition could be relatively unaffected in the aggregate; therefore, any mismatch corrected as a result of the relationship summary may not result in a significant net loss of investors for either broker-dealers or investment advisers. In addition, to the extent currently mismatched investors are customers of dual registrants, any switch in account type (brokerage or investment advisory), as a result of the relationship summary, may take place within a dual registrant rather than between different firms, further attenuating any competitive impact.

By reporting legal or disciplinary history, the relationship summary may provide benefits to retail investors by prompting them to seek out additional information (e.g., from Investor.gov or BrokerCheck) on their current or prospective firms and financial professionals and take that information into account when considering whom to engage for financial services. Competition between firms may be enhanced if firms and financial professionals with better disciplinary records drive out those with worse records. We note, however, that legal and disciplinary history reported in the relationship summary may bias firms towards hiring financial professionals with fewer years of experience (i.e., fewer opportunities for customer complaints) and against hiring experienced financial professional with some (minor) complaints. Further, investors may also bias their choice of firm or financial professional in the same manner. One commenter stated that reporting of legal and disciplinary history “imposes an inappropriate competitive imbalance and inaccurate picture concerning the relative number of disciplinary actions in sales organizations with large number of financial professionals.” [1167] The expected economic impact of disciplinary reporting on competition across large and small firms, however, is generally unclear because small firms may suffer disproportional reputational penalties from more salient disciplinary history disclosure. In general, reportable disciplinary history is less common for smaller firms than for larger firms.[1168] Thus, small firms may appear to have better disciplinary history reputation than large firms solely because of their size of operations, rather than their actual legal and regulatory compliance or the professional ethics or integrity of their employees. At the same time, investors may over-react to generally more frequent disciplinary history disclosure by larger firms and forego potentially well-matched relationship with the larger firms as a result.

Disclosing reportable legal and disciplinary history in the relationship summary may confer a small competitive advantage for investment advisers over broker-dealers because broker-dealers are more likely to have to report that they have a disciplinary history due to broader broker-dealer disclosure obligations. Reporting from Form BD with respect to broker-dealer disclosures of disciplinary actions taken by any regulatory agency or SRO show than 308 (86%) out of 318 retail-facing dual-registered broker-dealers disclosed a disciplinary action. In contrast, 1,330 (54%) out of 2,448 retail-facing standalone broker-dealers disclosed a disciplinary action. For investment advisers, Form ADV requires disclosure of any disciplinary actions taken in the past 10 years, and 284 (79%) of 318 retail-facing dual-registered investment advisers disclosed a disciplinary action. However, for standalone investment advisers, only 1,176 (15%) of 7,917 retail-facing investment advisers disclosed a disciplinary action.[1169] As broker-dealers have relatively more reportable legal and disciplinary history than investment advisers, retail investors may engage investment advisers with greater frequency than broker-dealers as a result of the disciplinary history reporting on the relationship summary, potentially creating a competitive advantage for some investment advisers.

Although the 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 rule changes such as investment advisers not registered with the SEC (e.g., state registered investment advisers), bank trust departments, insurance companies, 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, this could attract new retail investors to the broker-dealer and investment adviser markets from firms in other markets. At the same time, it is possible that, as a result of conflicts of interest and the existence of disciplinary history being saliently disclosed in the relationship summary, some investors may be deterred from seeking services of registered investment advisers or broker-dealers and instead seek the services provided by a state registered advisor or another professional not regulated by the Commission, or forego seeking financial services altogether.

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 types of fees and costs of investment advisory and brokerage services more prominent. Such a switch could be within the market for investment advisory and brokerage services, or to a financial services provider outside this market (such as a bank or insurance company). The information disclosed in the relationship summary may also lead some investors to realize a relationship with any financial services provider may not be in their best interest, and therefore withdraw altogether from the market. The exact extent and direction of substitution among different types of providers' 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, and the extent to which investors will digest and use the provided information in firms' relationship summaries.Start Printed Page 33599

To the extent the relationship summary increases competition between broker-dealers and investment advisers, and between these firms and other financial services providers, it may result in development of new products and services, and general innovation by the industry at large. Competition among firms could provide incentives for firms to seek alternative ways to attract retail investors and generate profits. In the process, firms could develop new and better ways of providing services to retail investors, for example, by utilizing information technology to deliver information to retail investors at lower costs. In this way, innovation could improve retail investors' welfare as well as the profitability of financial service providers.

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 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.[1170] 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. To the extent the relationship summary increases the transparency and salience of such selling concessions and related conflicts of interest, investors may start to avoid investing in products that provide selling concessions, encouraging broker-dealers to avoid such arrangements. To compensate for the potential loss of concession-based revenue, dually registered firms could try to switch customers from their brokerage account to their advisory accounts. As noted above, however, if the relationship summary also increases the competitiveness in the broker-dealer and investment adviser markets, the increased competitiveness would create some general downward price pressure in the market which may spillover to selling concessions.

c. Capital Formation

As discussed above, the relationship summary may improve retail investors' understanding about, and confidence in, the market for brokerage and investment advisory services, which may increase participation in this market by investors that previously avoided it. Such additional entry by new investors could increase the level of total capital across markets and increase the demand for new investment products and securities, which could precipitate capital formation in aggregate across the economy. Depending on the magnitude of these effects, the increased availability of funds could result in lower cost of capital for companies, which could facilitate economic growth.

However, to the extent the disclosure of certain information such as conflicts of interest or disciplinary history decreases some retail investors' level of confidence in market for brokerage and investment advisory services, or the information provided makes some investors believe that they do not benefit from a relationship with a firm or financial professional, such investors could exit this market, which could attenuate any effects on capital formation. In addition, to the extent that the market for financial services is already saturated, there may only be a redistribution between broker-dealers, investment advisers, and other financial service providers (such as state-registered investment advisers, banks, and insurance companies) as a result of retail investors becoming more informed, and any effects on capital formation would be attenuated.

4. Alternatives to the Relationship Summary

To reduce retail investor search costs and costs of potential mismatch between retail investors and professionals in brokerage and investment advisory services, we considered various alternative approaches to the relationship summary, including whether to adopt additional disclosure requirements. We have previously learned through public comments, investor testing, and a staff financial literacy study that industry commenters and survey participants generally supported a short disclosure document to retail investors that would address firms' nature and scope of services, fees, and material conflicts of interest.[1171] Accordingly, we proposed rules and rule amendments to require firms to provide retail investors with disclosures designed for those purposes. In our proposal, we solicited comment on alternatives to various elements of the relationship summary. As discussed in Section I above, we also conducted extensive public outreach, including investor roundtables, specific solicitation of investor comments through the Feedback Forms, and investor testing.[1172] We considered the suggestions and recommendations received through these processes as alternative approaches in our rulemaking, many of which we discussed in greater detail in Sections I and II above. In determining the required scope and level of detail of information in the relationship summary, we balanced the need for robust disclosures with the risk of investor information overload and failure to properly process these disclosures, a recurring theme in both comment letters and investor feedback received through surveys and studies, roundtables and on Feedback Forms.

a. Amending Existing Disclosures

The relationship summary will be a new, separate disclosure, in addition to other disclosures that firms already must provide.[1173] As noted in Section I above, some commenters argued that the relationship summary is duplicative of other disclosures, for example in Form ADV or in Form BD, and is thus unnecessary.[1174] The Commission considered amending Part 2A of Form ADV to require a brief summary at the beginning of the brochure in addition to the existing narrative elements, or changing certain existing Part 2A requirements to reduce or eliminate redundancy with parts of the relationship summary. Similarly, the Commission considered whether to amend and require delivery to retail investors of a revised Form BD to include the same information as in the relationship summary, and make that information publicly available.[1175]

After careful consideration and for the reasons discussed in Section I above, we believe that a separate summary disclosure will be more effective to help retail investors to choose from among firms and investment services than modifying existing disclosures.[1176] We believe that a short, standalone relationship summary that facilitates comparisons across different providers Start Printed Page 33600and types of services is necessary to highlight information that is relevant to a retail investor before or at the time she is deciding to select a firm, financial professional, account type, or services. To that end, the short and succinct relationship summary includes topics that retail investors indicated would be important to them in selecting a provider. Specifically, because the relationship summary is a shorter document and designed to be more of an overview than the existing investor-facing disclosures, such as Form ADV, and is specifically targeted to help retail investors obtain certain information before deciding to enter into a relationship with a financial professional, retail investors facing that decision can process its information content more efficiently. The relationship summary facilitates layered disclosures and highlights where investors can access more detailed information, including existing documents that investors receive, which could facilitate review of those documents, such as Form ADV Part 2. The relationship summary also promotes the investor receiving more detailed information about the provider and its services, as necessary, through conversation starters. Furthermore, when compared to other disclosures that financial professionals may make on, for example, Form ADV and Form BD, the relationship summary seeks to enhance comparability across both adviser and broker-dealer provider types for retail investors.

Thus, despite some content duplication with other existing disclosure requirements and firms having to bear the cost of creating additional disclosures, we believe that retail investors will benefit from having information relevant to deciding on a firm, financial professional, and/or accounts and services in one place in a more succinct, salient and standardized fashion. Overall, we believe that the relationship summary will enable better-informed decision-making, reduce risk of mismatch, and reduced search costs by retail investors.

b. Form and Format of the Relationship Summary

Under the final instructions, firms will be required to describe, largely in their own wording, different topics related to their offerings in a question-and-answer format. In comparison, we proposed instructions providing for standardized, declarative headings for each section of the relationship summary and a mix of prescribed and firm-specific language within each section. As discussed in Section I above, nearly all commenters and investors providing feedback at roundtables and on Feedback Forms suggested modifications to the sample relationship summary and proposed instructions, and numerous commenters submitted alternative sample relationship summaries.[1177]

Delivery of SEC-authored form. Commenters suggested that the SEC author a standard industry-wide disclosure to deliver to retail investors, which could then be supplemented by firm-specific documents.[1178] For example, one commenter suggested using as a potential framework the Buyers Guides developed by the National Association of Insurance Commissioners that insurance companies must deliver under certain circumstances.[1179] Commenters supporting an SEC-authored educational layer believed that the SEC was better placed than firms to discuss areas viewed to be educational in nature, such as comparisons, standard of conduct, and key questions to ask.

We have incorporated an element of these commenters' suggestion by removing the comparisons section, which many commenters viewed as educational, and adding a link at the beginning of the relationship summary to Investor.gov/CRS where investors can obtain educational materials. However, we believe that investors are better served by keeping certain disclosures that may be viewed as more educational in nature, such as the standard of conduct and some of the “conversation starters” (replacing the “Key Questions to Ask”), in the relationship summary. We believe investors are more likely to understand how such content will affect them when presented in the context of the particular firm.

Level of Flexibility in the Disclosure

As discussed in more detail above, we considered the appropriate level of prescribed wording and topics in the disclosure. Several commenters suggested that, as an alternative to the prescriptive wording in the proposed relationship summary, we provide firms with more flexibility to craft their responses to items, with or without an SEC standardized disclosure to accompany the relationship summary or available on Investor.gov. We considered the relative merits of prescribed wording and formatting versus allowing firms to use their own, as well as a mix of prescribed requirements and discretionary choices. We considered this for different topics and sub-topics in the relationship summary, as well as for the relationship summary overall. In some instances, we determined that prescribed wording would provide targeted benefits that discretionary wording could not, for example, through the use of standardized headings and a prescribed order of topics in order to maintain the benefits of comparability and utility for retail investors.[1180] For the reasons discussed in Section II, above, we also determined to prescribe wording for conversation starters, the standard of conduct, and a factual statement regarding the effect of fees over time. In the event that prescribed wording is inapplicable to a firm's business or inaccurate, the firm may omit or modify that wording. We believe that this approach will allow firms greater flexibility to tailor their relationship summary disclosures to reflect their offerings more closely and accurately. However, greater flexibility in terms of wording could also allow firms to present disclosures in a more advantageous manner to them, rather than in a manner that would maximize the benefits to investors from the disclosures. Nonetheless, we believe retail investors will benefit under this adopted approach by receiving disclosures that may be more understandable, and also more informative about a particular firms' offerings that they are considering.

c. Summary of Fees, Costs, Conflicts, and Standard of Conduct

In response to comments and investor feedback through surveys and studies, roundtable and the Feedback Forms, we are adopting changes from the proposal to the relationship summary's required discussion of fees, costs, conflicts of interest, and standard of conduct, as described above.[1181]

In connection with fee disclosure, the Commission considered many alternative approaches relating to the scope and types of fees firms must include in their relationship summaries, as well as the presentation of the fee disclosure.[1182] As discussed in Section II.A.4 above, commenters' views varied on the scope and types of fees that should be disclosed and their level of Start Printed Page 33601detail.[1183] In addition to what we had proposed and what we have adopted, the Commission considered other alternatives, such as whether to require firms to list all fees that retail investors may incur, to allow firms the flexibility to determine what fees to highlight, and variations or combinations of these approaches. The final approach is designed to balance the need to provide a comprehensive view of what fees retail investors will pay with the need to produce relevant, succinct and understandable disclosures. The final instructions do not require firms to disclose every single fee and instead permit firms to highlight examples of the categories of the most common fees that their retail investors will pay directly or indirectly.[1184] We believe this approach benefits retail investors because they will be able to compare fee information that is more closely tailored to firms' particular business practices, but also reflective of common fees that retail investors are likely to incur.

The Commission also considered alternative ways in which firms should present their fees, such as whether to require firms to link to or include a fee schedule directly in the relationship summary,[1185] or to require firms to include a hypothetical fee example.[1186] Under the final instructions, firms must summarize their principal fees and costs and other fees and also include specific cross-references to more detailed information about their fees available in other sources.[1187] The Proposing Release discussed the option of including an example of the impact of fees in the relationship summary.[1188] While some commenters supported the inclusion of various forms of additional examples of fees calculations,[1189] after careful consideration of the comment file and investor feedback received through studies and surveys, roundtables and Feedback Forms, we are declining to include a hypothetical fee example in the relationship summary. We do so in light of commenters who suggested that such an example could be operationally difficult to implement, and that it could be perceived as confusing.[1190] Specifically, we believe the assumptions required to make a fee example relevant for investors vary for individual investors to the extent that a standardized example risks increasing investor confusion.

Instead, to help stimulate this discussion, a firm must include in the relationship summary the following conversation starter: “Help me understand how these fees and costs might affect my investments. If I give you $10,000 to invest, how much will go to fees and costs, and how much will be invested for me?” [1191] As discussed above,[1192] this represents a different wording from the corresponding “Do the Math for Me” Key Question in the proposal, but we expect it to similarly encourage the retail investor to ask about the amount they would typically pay per year for the account and what is included in those fees, while being easier and less costly to answer for firms at the outset of the relationship.

d. Filing and Delivery

In connection with filing and delivery, Commission considered alternatives relating to filing formats, filing systems, and timeframes for firms' initial relationship summary and subsequent updates. As discussed in Section II.C. above, firms will file copies of their relationship summaries with the Commission. The proposed instructions provided that firms must file their relationship summaries in a text-searchable format but did not specify one. We solicited comment on whether the relationship summary should be filed as a text-searchable PDF, similar to how Form ADV is currently filed, or other enumerated formats. We also asked about what type of format would facilitate greater comparability across forms. Two commenters advocated that the relationship summary should be filed not only in a text-searchable, but also machine-readable format, in order to facilitate development of data aggregation tools allowing for comparability of forms across providers.[1193] The Commission believes that although a PDF submission format would not be the most ideal for comparing or aggregating data across relationship summary filings, it would likely be the easiest and least costly. A fillable form allowing the firm to enter text, similar to Form ADV Part 1, also would not be costly, but would not easily accept formatted tables or other graphical information. The final instructions, as with the proposed instructions, do not specify a particular format, but the current filing systems default firms to PDF format. In a change from the proposal, we are requiring firms to implement machine-readable headings for their filings. We agree with the commenters that suggested this change that this approach facilitates some degree of data aggregation, while imposing limited costs on registrants.

Furthermore, we requested comments on alternative filing systems for the relationship summary. In response to comment and upon further consideration, as discussed in Section II.C.2 above,[1194] we are requiring broker-dealers to file their relationship summaries through Web CRD®, instead of EDGAR, as proposed.

As discussed in Section II.C.3.a above, we also considered whether to allow more permissive use of electronic delivery. As proposed, we are affirming that the relationship summary must be delivered in accordance with the Commission's electronic delivery guidance. We are adopting an additional instruction, however, that a firm may 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, and that this method of initial delivery for the relationship summary would be consistent with the Commission's electronic delivery guidance.[1195] Commenters suggested different approaches to electronic delivery, such as the “notice plus access” model, and a more comprehensive updating of the Commission's electronic delivery guidance, which we considered as alternative approaches in this rulemaking. While we recognize the Start Printed Page 33602potential cost savings to firms of allowing greater use of electronic delivery, we place great importance on how investors prefer to receive information. Some commenters said that investors prefer to receive electronic disclosures because they are delivered faster and can be in more engaging formats, including video and audio. On the other hand, investor surveys and investor testing show that some investors still prefer to receive paper disclosures, including in a hybrid approach of electronic disclosure with the option for paper.[1196] As discussed in greater detail in Section II.C.3.a, the adopted approach of encouraging electronic presentations that are engaging to retail investors, while preserving the option for paper, within the framework of the Commission's electronic delivery guidance and in accordance with retail investors' preferences, is appropriate for the relationship summary.

e. Transition Provisions

As discussed above, we are adopting an initial date of June 30, 2020 for all firms that are registered, or investment advisers who have an application for registration pending with, the Commission prior to June 30, 2020, to file their initial relationship summaries with the Commission. We considered tiered compliance dates for firms of different sizes. We believe that the compliance dates, as adopted, balance the time and resources needed by different firms, as well as the assets under management and the number of firms that would be covered within the different compliance periods.

V. Paperwork Reduction Act Analysis

The amendments that we are adopting here contain “collection of information” requirements within the meaning of the Paperwork Reduction Act of 1995 (“PRA”).[1197] In the Proposing Release, we solicited comment on the proposed collection of information requirements. We also submitted the proposed collection 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 collections of information we are amending 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 we are adopting [1198] relate to (i) “Rule 204-5 under the Investment Advisers Act of 1940” (OMB control number 3235-0767); and (ii) “Form CRS and rule 17a-14 under the Exchange Act” (OMB control number 3235-0766). We are also amending 17 CFR 200.800 to display the control number assigned to information collection requirements for “Form CRS and rule 17a-14 under the Exchange Act” by OMB pursuant to the PRA. 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 OMB number.

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 2A is the client brochure. 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 adopting amendments to Form ADV to add a new Part 3, requiring registered investment advisers that offer services to retail investors to prepare and file with the Commission, post to the adviser's website (if it has one), and deliver to retail investors a relationship summary, as discussed in greater detail in Section II above. Advisers will deliver the relationship summary to both existing clients and new or prospective clients who are 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 relationships and services the firm offers to retail investors, fees and costs that the retail investor will pay, specific conflicts of interest and standards of conduct, legal or disciplinary history, and how to obtain additional information about the firm. The amendment requiring investment advisers to deliver the relationship summary is contained in a new collection of information under new rule 204-5 under the Advisers Act, for which estimates are discussed below. We did not propose amendments to Part 1 or 2 of Form ADV.[1199]

As discussed in Sections I and II of this release, we received comments that addressed whether the relationship summary is duplicative of other disclosures and necessary for investment advisers, and whether we could further minimize the burden of the proposed collections of information. One commenter specifically addressed the accuracy of our burden estimates for the proposed collection of information, suggesting that our estimates were too low because compliance professionals estimated it would take 80-500 hours to Start Printed Page 33603prepare, deliver, and file the relationship summary, depending on the firm's size and business model.[1200] Another commenter said the current Form ADV requirements are a burden to smaller firms and that the currently approved burdens of 23.77 hours and $6,051 are too low.[1201] Others commented more broadly that certain costs to prepare and file the relationship summary would be higher than we estimated in the proposal.[1202] We have considered these comments and are increasing our PRA burden estimates from 5 hours to 20 hours for investment advisers to prepare and file the relationship summary. We also modified several substantive requirements to mitigate some of these estimated increased costs relative to the proposal.

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 exempt reporting advisers.[1203] Based on the IARD system data as of December 31, 2018, approximately 13,299 investment advisers were registered with the Commission, and 4,280 exempt reporting advisers file reports with the Commission.

As discussed above, we are adopting amendments to Form ADV that will add a new Part 3, requiring certain registered investment advisers to prepare and file a short and accessible relationship summary for retail investors. Based on IARD system data as of December 31, 2018, the Commission estimates that 8,235 investment advisers have some portion of their business dedicated to retail investors, including either individual high net worth clients or individual non-high net worth clients,[1204] which is higher relative to the estimate in the Proposing Release.[1205]

This will leave 5,064 registered investment advisers that do not provide advice to retail investors [1206] and 4,280 exempt reporting advisers that will 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.[1207] We also note that these figures include the burdens for 318 registered broker-dealers that are dually registered as investment advisers as of December 31, 2018.[1208] We did not receive comments related to the methodology used for estimating the number of investment advisers that will be subject to Form ADV Part 3 requirements. We are maintaining the methodology we used in the Proposing Release and are updating our estimates to reflect the increased number of investment advisers and exempt reporting advisers since the last burden estimate.

2. Changes in Average Burden Estimates and New Burden Estimates

Based on the prior revision of Form ADV,[1209] 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,[1210] with a monetized total of $92,404,369, or $6,051 per adviser.[1211] 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.[1212] The amendments will increase the current burden estimate due in part to the 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 did not propose amendments to Part 1 or Part 2 of Form ADV.

The amendments to Form ADV to add Part 3 will increase the information collection burden for registered investment advisers with retail investors. As discussed above in Sections I and II of this release, registered investment advisers providing services to retail investors will be required to prepare and file a relationship summary with the Commission electronically through IARD in the same manner as they currently file Form ADV Parts 1 and 2. We are also requiring that all relationship summaries be filed in a text-searchable format with machine-readable headings. These investment advisers also will be required to amend and file an updated relationship summary within 30 days whenever any information becomes materially inaccurate.

As noted above, not all investment advisers will 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 will remain the same, in particular, 29.22 hours per registered investment adviser without relationship summary obligations. Similarly, because exempt reporting advisers also will not have relationship Start Printed Page 33604summary obligations, the annual hour burden for exempt reporting advisers to meet their Form ADV obligations will remain the same, at 3.60 hours per exempt reporting adviser. However, although we did not propose amendments to Form ADV Part 1 and Part 2, and the per adviser information collection burden will 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 will increase due to an increase in the number of registered investment advisers and exempt reporting advisers since the last information collection burden estimate. We discuss below the increase in burden for Form ADV overall attributable to the adopted amendments, i.e., new Form ADV Part 3: Form CRS, and the increase due to the updated number of respondents that will not be subject to the adopted amendments.

a. Initial Preparation and Filing of Relationship Summary

As discussed above in Section II, investment advisers will be required to prepare and file a relationship summary summarizing specific aspects of their investment advisory services that they offer to retail investors. Much of the required information overlaps with that required by Form ADV Part 2A 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 2A brochure on IARD, and we have considered this factor in determining our estimate of the additional burden to prepare and file the relationship summary.

In the Proposing Release, we estimated that the initial first year burden for preparing and filing the relationship summary, for investment advisers that provide advice to retail investors, would be 5 hours per registered adviser.[1213] Some commenters said that these estimated burdens were too low,[1214] and one argued that the current burden estimates for Form ADV are too low.[1215] One commenter specifically argued that preparing, delivering, and filing the relationship summary would take from 80 to 500 hours, based on input from compliance professionals, and noted there would be additional costs that are hard to quantify, including human resources and information technology programming.[1216] Commenters also said more broadly that the relationship summary would be burdensome for investment advisers [1217] and would result in additional compliance burdens including training.[1218]

We are revising our estimate of the time that it would take each adviser to prepare and file the relationship summary in the first year from 5 hours in the proposal to 20 hours in light of these comments and the changes we are making to the proposed relationship summary.[1219] For example, as discussed in the Proposing Release, we estimated that it would take firms a shorter amount of time to prepare the relationship summary than to prepare more narrative disclosures due to the standardized nature and prescribed language of the relationship summary. As discussed above, the final instructions require less prescribed wording relative to the proposal and require firms to draft their own summaries for most of the sections. In addition and in a change from the proposal, we are now requiring that all relationship summaries be filed with machine-readable headings, as well as in a text-searchable format as proposed. We acknowledge that these changes will increase cost burdens because advisers will have to develop their own wording and design, as well as implement machine-readable headings, to comply with these requirements.

The relationship summary will also require more layered disclosures relative to the proposal and will encourage the use of electronic formatting and graphical, text, online features to facilitate access to other disclosures that provide additional detail. Although much of the information that will be summarized in the relationship summary is contained in other disclosures that firms already provide, firms will bear the cost of preparing a new relationship summary and cross-referencing or hyperlinking to additional information. The higher estimated burden estimate also reflects our acknowledgement that it will take firms longer to draft certain disclosures than we estimated in the Proposing Release, such as answers to “conversation starters” that advisers providing automated investment advisory without a particular individual with whom a retail investor can discuss these questions must include on their website. We believe these factors and the other changes we made to the proposal will increase the burden to prepare a relationship summary relative to the proposal.

We are estimating the same hourly burden for investment advisers and investment advisers that are dually registered as broker-dealers because we are counting dually registered firms in the burden calculation for Form ADV and the Exchange Act rule that requires the relationship summary for broker-dealers.[1220] We recognize that the burden for some advisers will exceed our estimate, and the burden for others will be less due to the nature of their business, but we do not believe that the range could be as high as some commenters suggested.[1221] After consideration of comments and changes we made to the requirements relative to the proposal and in light of the current approved burden for Part 2 of Form ADV, which requires more disclosures than the relationship summary, we are increasing the estimated burden relative to the proposal to 20 hours in the first year.[1222] We therefore estimate that the Start Printed Page 33605total burden of preparing and filing the relationship summary will be 164,700 hours.[1223]

As with the Commission's prior Paperwork Reduction Act estimates for Form ADV, we believe that most of the paperwork burden will be incurred in advisers' initial preparation and filing of the relationship summary, and that over time this burden will decrease substantially because the paperwork burden will be limited to updating information.[1224] The estimated initial burden associated with preparing and filing the relationship summary will be amortized over the estimated period that advisers will use the relationship summary, i.e., over a three-year period.[1225] The annual hour burden of preparing and filing the relationship summary will therefore be 54,900.[1226] In addition, based on IARD system data, the Commission estimates that 1,227 new investment advisers will file Form ADV with us annually; of these, 656 will be required to prepare and file the relationship summary.[1227] Therefore, the aggregate initial burden for newly registered advisers to prepare and file the relationship summary will be 13,120 [1228] and, amortized over three years, 4,373 on an annual basis.[1229] In sum, the annual hour burden for existing and newly registered investment advisers to prepare and file a relationship summary will be 59,273 hours,[1230] or approximately 6.67 hours per adviser,[1231] for an annual monetized cost of $16,181,529, or $1,965 per adviser.[1232]

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.[1233] We do not anticipate that the amendments to add a new Part 3 will affect the per adviser cost burden for those existing requirements but 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. We do not anticipate external costs to investment advisers in the form of website set-up, maintenance, or licensing fees because they will 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.

In the Proposing Release, we estimated that an external service provider would spend 3 hours helping an adviser prepare an initial relationship summary. While we received no specific comments on our estimate regarding external costs in the Proposing release, one commenter suggested that there would be additional implementation costs such as legal advice, but that these costs are difficult to quantify.[1234] Another argued that that the current burden estimates for Form ADV did not take into consideration the time spent on learning about the complexities of what is needed to comply with similar requirements.[1235] Based on the concerns expressed by these commenters and the changes we are making to the relationship summary, we are increasing the estimate relative to the proposal from 3 to 5 hours. 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, particularly given our experience with the burdens for Form ADV.[1236]

Although advisers that will 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 strict page limits will make it unlikely that the amount of time, and thus cost, required for outside legal and compliance review will vary substantially among those advisers who elect to obtain outside assistance.

Most of the information required in the relationship summary is readily available to investment advisers from Form ADV Part 2A, and the narrative descriptions are concise, brief, and at a summary level. As a result, we continue to anticipate, as discussed in the proposal, that only 25% of investment advisers will seek the help of outside legal services and 50% of investment advisers will seek the help of compliance consulting services in connection with the initial preparation of the relationship summary.[1237] We estimate that the initial per existing adviser cost for legal services related to Start Printed Page 33606the preparation of the relationship summary will be $2,485.[1238] We estimate that the initial per existing adviser cost for compliance consulting services related to the preparation of the relationship summary will be $3,705.[1239] Thus, the incremental external cost burden for existing investment advisers is estimated to be $20,371,331, or $6,790,444 annually when amortized over a three-year period.[1240] In addition, we estimate that 1,227 new advisers will register with us annually, 656 of which will be required to prepare a relationship summary. For these 656 new advisers, we estimate that they will require $1,622,780 in external costs to prepare the relationship summary, or $540,927 amortized over three years.[1241] In summary, the annual external legal and compliance consulting cost for existing and new advisers relating to obligations to prepare the relationship summary is estimated to total $7,331,370, or $825 per adviser.[1242]

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. In the Proposing Release, we estimated that the relationship summary would increase the annual burden associated with Form ADV by 0.5 hours [1243] due to amendments to the relationship summary, for those advisers required to prepare and file a relationship summary. We did not receive comments regarding hour burdens associated with preparing and filing amendments to the relationship summary. As discussed in section II.C.4 above, in a change from the proposal, we are adding a requirement that firms preparing updated relationship summaries to existing clients also highlight the most recent changes by, for example, marking the revised text or including a summary of material changes.[1244] To account for this change, we are increasing the annual burden to 1 hour per year to amend and file a relationship summary.[1245]

We do not expect amendments to be frequent, but based on the historical frequency of amendments made on Form ADV Parts 1 and 2, we estimate that on average, each adviser preparing a relationship summary will likely amend and file the disclosure an average of 1.71 times per year.[1246] We therefore estimate that for making and filing amendments to their relationship summaries, advisers will incur an estimated total paperwork burden of 14,082 hours per year,[1247] or approximately 1.58 hours per adviser,[1248] for an annual monetized cost of $3,844,386, or $467 per adviser.[1249]

Although advisers will be required to amend the relationship summary within 30 days whenever any information becomes materially inaccurate, we expect that amendments will require relatively minimal wording changes, given the relationship summary's page limitation and summary nature. We believe that investment advisers will be more knowledgeable about the information to include in the amended relationship summaries than outside legal or compliance consultants and will be able to make these revisions in-house. Therefore, we do not estimate that investment advisers will need to incur ongoing external costs for the preparation and review of relationship summary amendments.

d. Incremental Increase to Form ADV Hourly and External Cost Burdens Attributable to Form ADV Part 3 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 73,355 hours,[1250] or 8.25 hours per adviser,[1251] and a monetized cost of $20,025,915, or $2,252 per adviser.[1252] The incremental external legal and compliance cost is estimated to be $7,331,370.[1253]

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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 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. One commenter said that the current Form ADV requirements are a burden to smaller firms and that the currently approved burdens for Form ADV Parts 1 and 2 are too low.[1254] We disagree. We recognize that the burden for some advisers will exceed our estimate and the burden for others will be less due to the nature of their business, but we continue to believe that on average our estimates are appropriate for purposes of the PRA analysis. For example, the current burden estimates for Form ADV Parts 1 and 2 range from 15 hours for smaller advisers to 1989 hours for larger advisers.[1255]

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 amendments to Form ADV, equals 37.47 hours per adviser, with 8.25 hours attributable to the adopted amendments.[1256] On an aggregate basis, this totals 333,146 hours for existing and newly registered advisers, with a monetized value of $90,978,858.[1257]

As noted above, we estimate 5,064 of existing registered advisers will not have retail investors; therefore, they will not be obligated to prepare and file relationship summaries, so their annual per adviser hour burden will remain unchanged.[1258] 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 will be 164,655,[1259] with a monetized value of $44,950,816.[1260] 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, will be 16,996 hours,[1261] for a monetized cost of $4,639,908, or $983 per exempt reporting adviser.[1262]

In summary, factoring in the amendments to Form ADV to add Part 3, the revised annual aggregate burden for Form ADV for all registered advisers and exempt reporting advisers will be 514,797,[1263] for a monetized cost of $140,569,582.[1264] This results in an annual blended average per adviser burden for Form ADV of 29.28 hours [1265] and $7,996 per adviser.[1266] This is an increase of 151,715 hours,[1267] or $48,165,213 [1268] in the monetized value of the hour burden, from the currently approved annual aggregate burden estimates, increases which are attributable primarily to the larger registered investment adviser and exempt reporting adviser population since the most recent approval, adjustments for inflation, and the amendments to Form ADV to add Part 3.

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.[1269] 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.[1270] We do Start Printed Page 33608not 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 aggregate cost of obtaining the fair value of private fund assets is likely to 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, 2018, 4,806 registered advisers advise private funds. We therefore estimate that approximately 288 registered advisers may incur costs of $37,625 each on an annual basis, for an aggregate annual total cost of $10,836,000.[1271]

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 relationship summary, we estimate the annual aggregate external cost burden of the Form ADV information collection will be $21,767,370, or $1,637 per registered adviser.[1272] This represents an $8,083,870 increase from the current external costs estimate for the information collection.[1273]

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.

The amendments to rule 204-2 will require registered advisers to retain copies of each relationship summary. Investment advisers will 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. These records will 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 for the Form ADV Part 2A brochure under the Advisers Act rule 204-2(a)(14)(i), to allow regulators to access the relationship summary during an examination.[1274]

As discussed above in Section II.E several commenters suggested that our estimated burdens for the relationship summary recordkeeping obligations were too low.[1275] Some commenters argued that keeping records of when a relationship summary was given to prospective retail clients would be unnecessarily burdensome or not feasible, and was not adequately considered in the Commission's burden estimates.[1276] One of these commenters said that it would be difficult for firms to integrate pre-relationship delivery dates into their operational systems and procedures, and that there is no way to track when a disclosure is accessed on a website.[1277]

Based on our experience with similar requirements for Form ADV Part 2A brochures, we disagree with commenters that retaining records of when a relationship summary was given to prospective retail clients would be significantly more burdensome for investment advisers than our proposed estimate of 0.2 hours. While we recognize that this recordkeeping requirement will impose some additional burden on investment advisers that must prepare and deliver relationship summaries, advisers are already required to keep similar records for the delivery of the Form ADV Part 2A brochures and the currently approved burden for that requirement is 1.5 hours. Accordingly, based on our experience, advisers already maintain this information with respect to their brochures and should be able to update their systems to also include the relationship summary. We also do not expect that investment advisers will incur additional external costs to make and keep these records because we believe that advisers will create and retain them in a manner similar to their current recordkeeping practices for the Form ADV Part 2A brochure.

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 will facilitate the Commission's ability to inspect for and enforce compliance with firms' obligations with respect to the relationship summary. The information generally is kept confidential.[1278]

The likely respondents to this collection of information are all of the approximately 13,299 advisers currently registered with the Commission. We estimate that based on updated IARD data as of December 31, 2018, 8,235 existing advisers will be subject to the amended provisions of rule 204-2 to preserve the relationship summary as a result of the adopted amendments.

1. Changes in Burden Estimates and New Burden Estimates

The currently approved annual aggregate burden for rule 204-2 is 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 Start Printed Page 33609adviser.[1279] We estimate that the requirements to make and keep copies of each relationship summary under the amendments to rule 204-2 will result in an increase in the collection of information burden estimate by 0.2 hours [1280] for each of the estimated 8,235 registered advisers with relationship summary obligations, resulting in a total of 183.2 hours per adviser. This will yield an annual estimated aggregate burden of 1,508,652 hours under amended rule 204-2 for all registered advisers with relationship summary obligations,[1281] for a monetized cost of $95,588,191, or $11,607 per adviser.[1282] In addition, the 5,064 advisers not subject to the amendments will continue to be subject to an unchanged burden of 183 hours under rule 204-2, or a total aggregate annual hour burden of 926,712,[1283] for a monetized cost of $58,716,472, or $11,595 per adviser.[1284] The increase in the collection of information burden estimate by 0.2 hours as a result of the amendments to rule 204-2 will therefore result in an annual monetized cost of $12 per adviser.[1285] In summary, taking into account the estimated annual burden of registered advisers that will 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 amendments, is estimated to be 2,435,364 total hours,[1286] for a monetized cost of $154,304,663.[1287]

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.[1288] The revised annual aggregate hourly burden for rule 204-2 will be 2,435,364 [1289] hours, represented by a monetized cost of $154,304,664,[1290] based on an estimate of 8,235 registered advisers with the relationship summary obligation and 5,064 registered advisers without, as noted above. This represents an increase of 235,573 [1291] annual aggregate hours in the hour burden and an annual increase of $23,988,552 from the currently approved total aggregate monetized cost for rule 204-2.[1292] These increases are attributable to a larger registered investment adviser population since the most recent approval and adjustments for inflation, as well as the rule 204-2 amendments relating to the relationship summary as discussed in this release.

C. Rule 204-5 under the Advisers Act

New rule 204-5 will require an investment adviser to deliver an electronic or paper version of the relationship summary to each retail investor before or at the time the adviser enters into an investment advisory contract with the retail investor. The adviser also will make a one-time initial delivery of the relationship summary to all existing clients within a specified time period after the effective date of the rule. Also with respect to existing clients, the adviser will deliver the most recent relationship summary before or at the time of (i) opening any new account that is different from the retail investor's existing account(s); (ii) recommending that the retail investor roll over assets from a retirement account into a new or existing account or investment; or (iii) recommending or providing 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 the existing account.[1293] The adviser will be required to post a current version of its relationship summary prominently on its public website (if it has one), and will be required to communicate any changes in an amended relationship summary to retail investors who are existing clients within 60 days, instead of 30 days as proposed, after the amendments are required to be made and without charge.[1294] The investment adviser also must deliver a current relationship summary to each retail investor within 30 days upon request. In a change from the proposal, an adviser must make a copy of the relationship summary available upon request without charge, and where a relationship summary is delivered in paper format, the adviser may link to additional information by including URL addresses, QR codes, or other means of facilitating access to such information.[1295] The adviser must also include a telephone number where retail investors can request up-to-date information and a copy of the relationship summary.[1296]

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As discussed further below, we received comments that our estimated burdens for delivery of the relationship summary were too low. Some of these comments focused on the administrative and operational burdens related to monitoring for changes that would “materially change” the nature and scope of the relationship and thereby require delivery to existing clients and customers.[1297] One commenter also argued that imposing different delivery requirements for the Form ADV, Part 2 brochure and the relationship summary would create substantial administrative burdens specifically for investment advisers.[1298] Other comments focused on the recordkeeping burdens related to the requirement to deliver the relationship summary to a new or prospective retail investor.[1299] As discussed further below, we made changes to the proposal to require more specific triggers for initial delivery and additional delivery to existing customers in order to replace the requirements in response to comments. We discuss below the specific separate delivery requirements and modifications.

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 will 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 will use the information to determine eligibility for registration with us and to manage our regulatory and examination programs. This collection of information will be found at 17 CFR 275.204-5 and will be mandatory. Responses will not be kept confidential.

1. Respondents: Investment Advisers

The likely respondents to this information collection will be the approximately 8,235 investment advisers registered with the Commission that will be required to deliver a relationship summary per new rule 204-5. We also note that these figures include the 318 registered broker-dealers that are dually registered as investment advisers.[1300]

2. Initial and Annual Burdens

a. Posting of the Relationship Summary to Website

Under new rule 204-5, advisers will be required to post a current version of their relationship summary prominently on their public website (if they have one). In the Proposing Release, we estimated that each adviser will incur 0.5 hours to prepare the posted relationship summary, such as to ensure proper electronic formatting and to post the disclosure to the adviser's website, if the adviser has one.[1301] Although we did not receive any comments regarding burdens associated with posting of the relationship summary to a public website, we are increasing our estimate of the time from 0.5 to 1.5 hours based on the staff's experience.[1302] We do not anticipate that investment advisers will incur additional external costs to post the relationship summary to the adviser's website because advisers without a public website will not be required to establish or maintain one, and advisers with a public website have already incurred external costs to create and maintain their websites. Additionally, external costs for the preparation of the relationship summary are already included for the c