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Fatal Flaws in the SEC’s Best Interest Disclosure?

By Rita Raagas De Ramos June 21, 2018

A key component of the SEC’s proposed Regulation Best Interest package is a disclosure form that’s intended to clear up any confusion investors may have about their relationship with their financial professionals, exactly what kind of standard of service they can expect from them and how these professionals are getting paid.

The problem, according to industry and consumer groups alike, is that this disclosure form has the potential to further confuse investors or mislead them into thinking their money is 100% safe with their financial professional.

This disclosure form – the Customer Relationship Summary – is supposed to clearly state to clients if they are dealing with a broker-dealer or an advisor.

The CRS form – set at a maximum of four pages in length – requires an explanation of the principal types of services offered; the legal standards of conduct that apply to the investment advisor or the broker-dealer (whichever relationship applies); the fees a client might pay; and certain conflicts of interest that may exist.

Clarifying the role of the financial professionals investors deal with is high on SEC Chairman Jay Clayton's list of priorities when it comes to the proposed Regulation Best Interest package. He has said repeatedly that he’s looking out for the welfare of investors, especially the smaller, less-sophisticated ones. He’s also said he believes in giving investors the choice between a transaction-oriented broker-dealer and a portfolio management-oriented advisor.

“We're concerned the relationship summary will further confuse investors, or worse, provide them with a false sense of security.”
David Certner

Part of the proposed best interest rule is the prohibition of the use of the title advisor/adviser by broker-dealers, unless they are dually registered.

The SEC has prepared three mock-ups of the CRS form, which would be used depending on whether the financial professional is a broker-dealer, an advisor, or an individual who is dually registered as a broker-dealer and advisor.

At a meeting of the SEC’s Investor Advisory Council last week, industry and consumer groups critiqued the CRS form and urged the commission to share the results of how informative and user-friendly it is for investors participating in the ongoing testing being conducted.

Based on their own review of the mock-ups, industry and consumer groups present at the meeting are already calling on the SEC to improve the form so that it can serve its purpose of eliminating investor confusion and become more visually appealing for investors to read.

The “AARP is concerned that the relationship summary will further confuse investors, or worse, provide them with a false sense of security,” David Certner, legislative counsel and director of legislative policy for government affairs for the group, said at the meeting. AARP advocates for the rights and protection of the aging population in the U.S. As it stands, the CRS form is “too long, technical, and therefore too onerous for the average investor and household to process,” Certner said.

Technical terms, such as “fiduciary” and “asset-based fee,” shouldn’t be used unless they are clearly defined, he added.

“It is imperative that the relationship summary provides information in a manner that is clear, understandable, and not overwhelming in order to facilitate the retail investor’s ability to make informed decisions about their investments,” Certner said. “They should understand their choices and what they are selecting – especially when their hard-earned savings are on the line.”

Certner said the CRS form should be limited to one page to “avoid information overload.”

“We can assume intelligence of our clients. What we’re really talking about here is their willingness” to sift through disclosure documents.
Joe Carberry
Charles Schwab

That’s a suggestion supported by Charles Schwab, which created a one-page protype of the CRS form for the SEC’s consideration, Joe Carberry, the firm’s senior vice president of corporate communications, said at the meeting.

Carberry said the need to simplify the document isn’t just to address the common notion that many investors aren’t sophisticated or smart enough to make their own informed choices.

“We can assume intelligence of our clients,” Carberry said. “What we’re really talking about here is their willingness” to sift through disclosure documents.

Carberry said consumers are connected to an average of 3.6 devices. Adults spend more than six hours per day on digital media, more than half that time through their devices, he said. And Facebook mobile users scroll through an average of 300 feet of content per day.

That kind of digital connectivity “has significant implications” on just how much time and effort consumers will want to devote to disclosures, according to Carberry. Thus, when it comes to disclosures, “less is more,” he said.

Carberry said the CRS form should be focused on conveying the relevant information, which must be clear, visually engaging, and take into consideration the consumer’s “mobile-first” mentality.

At the meeting, Susan Kleimann, founder and president of Kleimann Communication Group, said she’s bothered that the CRS form contains a set of 10 questions on the last page that investors are encouraged to ask their financial professionals -- yet the CRS form is not organized around those questions. Her firm analyzes communication products – such as documents and websites as well as disclosures for federal agencies – and offers perspectives on how consumers will respond to them.

Kleimann said most humans have an attention span of nine seconds and would get turned off by a document that seems hard to read.

The CRS form should be plain but meaningful, building on context and with thoughtful design, Kleimann said. “Design is critically important,” she said.

Barbara Roper

Barbara Roper, director of investor protection at the Consumer Federation of America, said she isn’t convinced it’s possible to condense the information on the CRS form to just one page because of all the information that’s required.

“Every single sentence in this document, we cannot be sure investors understand,” Roper said, referring to the mock-up CRS forms created by the SEC. “I’m not convinced” all the information can be contained “without layering more information,” she added.

By layering, Roper meant that some terms may need to be explained and links may be needed to do so, leading her to wonder if the CRS form should be in electronic-only format.

For Dale Brown, president and CEO of the Financial Services Institute, more disclosure does not necessarily result in better disclosure. It all boils down to simplicity, a pleasing design and more white space, he said.

Brown said the FSI has long advocated for a two-tiered disclosure – one for the initial point of sale, specific to the investment recommendation, and another for detailed information that can be accessed through a firm’s website. That way, an investor can gain immediate access to the information that’s “most critical” at the point of sale and get more information later, he said.