By Anne Sherry, J.D.
Witnesses at the SEC Investor Advisory Committee meeting suggested that much more work needs to be done to craft a relationship summary for broker-dealer and investment adviser clients that complements Regulation Best Interest without overwhelming retail investors. The SEC is seeking comment on the Form CRS proposal, including three sample forms: one for broker-dealers, another for investment advisers, and a third for dual registrants. Even at just four pages, these forms may be too confusing, the witnesses posited, and one committee member even doubted whether it is possible to create a simple, paper document that addresses complex issues.
Testimony identifies areas for improvement. Dale Brown, President and CEO of Financial Services Institute, advocated for a two-tier disclosure system. The first tier would be a document given to investors at the point of sale and would include only the most salient information such as an explanation of the broker’s or adviser’s duty of care, the services to be provided, nature of the engagement, nature and scope of compensation, and conflicts of interest. Brown posited that there could be a safe harbor for firms that use a model form, similar to the model privacy form under Gramm-Leach-Bliley. The second tier of disclosure would include more detail and would be searchable, with a hard copy provided to investors upon request.
David Certner of AARP agreed with the idea that the information should be kept nontechnical and as short as possible. One weakness is that the current standard does not define key concepts such as a “fiduciary standard” or “best interest standard,” or the nuances between the two, he said. Retail investors already expect financial professionals to act in their best interest and are unaware that there are differing legal standards. Certner commended the SEC’s effort to restrict the use of the term “adviser,” but said that industry advertising will ultimately determine whether the spirit of this restriction is achieved. Marketing may eventually use other terms that cause the same confusion.
Susan Kleimann, the founder and President of Kleimann Communication Group, broke down for the committee how humans actually approach disclosures by skimming, asking questions, relating the information to themselves, and finding the story. The three sample disclosures are all “cursed by knowledge,” she said, meaning that the drafters assumed that the end user would share their level of knowledge. But the inclusion of a list of questions at the end of each sample form hints at a solution to the problem. Kleimann urged the committee to reimagine a disclosure organized around those questions to offer the same information in a format that readers are inclined to respond to.
Finally, Joe Carberry of Charles Schwab offered four core critiques of the proposal. First, it tries to do too much: dual registrants like Schwab would have to fit 40 items into 4 pages. Second, the form includes extraneous information that can confuse retail investors. Third, it may be duplicative by including information that the investor already has access to. Finally, it is not a layered approach, which would allow for further information based on a customer’s interests and concerns. Schwab developed a single-page prototype for consideration; Carberry suggested that such a form could stand out so starkly against other financial disclosures that customers could be more inclined to read it.
Testing a disclosure format. Committee member Jennifer Marietta-Westberg, Senior Economist at Cornerstone Research, asked the witnesses how the SEC should test disclosures for effectiveness. Kleimann said that one very effective but also very rarely conducted test is to go out in the field after the disclosure is in place and determine whether people are actually using it. Certner cautioned that warnings can have unintended consequences by indicating to people that a product has been evaluated and tested. The product must be okay because it is still on the market.
Putting disclosure in a larger context. Damon Silvers of AFL-CIO took a more holistic view of the problem. The committee and Commission cannot undertake this project without understanding the relationship between the disclosure regime and the quasi-fiduciary regime. Disclosure can inform investors about the different models for fees and what duties are required under each model, but it cannot provide most investors with sufficient information to be able to police conflicts of interest, he said. And the issues are intertwined with the distinction between a fiduciary standard and a best interest standard. Disclosure regimes in this context have always had an element of paternalism due to the imbalance of information, time, and focus between the investment manager and the client. To task the client, who specifically seeks out the professional because of that imbalance, with policing misconduct is nonsensical, he concluded.
Is a simple paper document achievable? Barbara Roper of the Investor Protection Consumer Federation of America also stressed the complexity of the issues. Roper doubted whether it was possible to develop a simple disclosure document covering complex issues. There is no sentence in the forms, she said, that an investor can be assumed to understand—not even something as fundamental as “This is a brokerage account.” When it comes to the nuances of a best interest standard compared to fiduciary standard, even people who have spent their entire careers in the industry sometimes have trouble understanding the difference. Roper believes every sentence in the disclosure needs to be layered and it is unlikely that this will work outside of an electronic context. In the retail market, however, 40 to 50 percent of investors prefer paper disclosures.
Commissioner Peirce observed the apparent preference for plain, simple disclosure, but said that one of the pushbacks when developing Form CRS was that not everything should be simplified and that there should be an effort to get investors comfortable with complex terms. Kleimann agreed that this goal is critical and said that “plain and simple” does not mean technically inaccurate. Certner added that different people want different levels of information, so the disclosure should offer a skimmable summary along with more detail, preferably on paper, for those who want to go further. Finally, Carberry said that the disclosure regime can assume intelligence on the part of investors. It is not a question of their ability, but their willingness, he said.