Earlier this year, the US Securities and Exchange Commission (SEC) issued a triad of rules and interpretive guidance that it hopes will bring order to a decades-long saga over regulation of the retail investment marketplace. Although many consumer interest groups expressed sharp disappointment that the rules did not go far enough, and one Commissioner dissented, these rules have a real chance to be long-lasting. This is in part because the new regime contains many elements long sought by investor advocates, and in part because major financial services industry groups, including SIFMA, perhaps fearing future piecemeal regulation by the states and Department of Labor (DOL), expressed strong support for the package overall.
The main battles over the final form of this regulation were whether the SEC would impose a “fiduciary” duty, so labelled, upon retail broker-dealers analogous to the existing fiduciary duty of registered investment advisers, and whether broker-dealers and investment advisers would be required to disclose, mitigate or eliminate financial conflicts of interest in their investment recommendations. At a high level, the Commission chose to create a new standard, called “best interest” to apply to recommendations made by broker-dealers, and to adopt compliance rules that take a disclose-and-mitigate approach to financial conflicts.
Although neither issue necessarily called for a wholly new disclosure form - - the Commission could have modified existing rules and public filing requirements - - and although the initial form proposal was widely criticized, the agency persisted. Disclosure forms are in the DNA of US securities laws. So, the third leg of the SEC’s new retail investment regulatory platform is Form CRS, a two- or four-page point-of-sale summary disclosure that the agency hopes will help educate retail investors about the nature and costs of services provided by investment advisers and broker-dealers.
Though framed as a purely procedural disclosure for investor benefit, Form CRS also substantively changes the rules regarding financial conflicts and the standard of conduct.
The SEC has long wanted to update retail fee disclosure rules, to adapt to vast changes in the retail investment landscape over the last forty years. The original securities laws governed an industry in which broker-dealers received transaction-based commissions, which could be put on a schedule; mutual fund advisers received management fees that could be disclosed in a prospectus; and investment advisers’ fees would be established by contract. Payments between financial services companies complicated this picture. Beginning with Rule 12b-1 in 1982, mutual funds were allowed to pay intermediaries ongoing asset-based fees for services intended to attract and retain assets; later, mutual funds’ investment advisers and other service providers began to offer a portion of their annual fees to intermediaries for sub-transfer agency and other customer services, a practice given the infelicitous name “revenue sharing.” These changes were part of a push for greater flexibility in mutual fund pricing, to allow for different mutual fund share classes as alternatives to the traditional, large front-end sales charge (or commission). At the same time, 401(k) plans discovered that mutual funds offered superior features to the existing generation of managed account options: daily pricing, daily trading, standardized performance, audited financial statements, and brand name advisers. This had the effect of importing the mutual fund intermediary compensation model into the retirement plan marketplace.
These developments were not without benefits for investors. Industry growth and market pressure, especially from institutional clients like 401(k) plans, have made no load or low load share classes more widely available and reduced asset-based fee levels over time, while the number and variety of investment options has exploded. The ongoing revenue model has also provided incentives for intermediaries to provide customer service, including services like asset allocation and retirement planning, that reduce the incentives to seeking transaction-based commissions.
This change in the structure of broker-dealer and investment adviser compensation was hardly a secret - - for example,12b-1 fees have always been disclosed in the mutual fund expense tables - - but securities regulators became concerned that investors may not understand the compensation or incentives of their account representatives or BD firms. In 2003, the industry self-regulatory organization NASD (now FINRA) proposed to require member broker-dealer firms to disclose: whether they received compensation from mutual funds beyond that described in the funds’ fee table; the names of the firms from which it receives such compensation; and any “differential cash compensation” programs under which representatives could be paid more for sales of certain investment products.  Months later, the SEC issued an even more elaborate rule proposal which would have required broker-dealers to provide point-of-sale and confirmation disclosure of, among other things, the sales charges, and the projected annual amounts of 12b-1 and revenue sharing to be generated by the customer’s purchase of mutual fund shares. These extremely complex proposals were not adopted, and the 2008 financial crisis brought other issues to the top of the SEC’s docket for several years.
In 2016, the Department of Labor entered the fray by proposing and adopting a comprehensive set of rules for investment service providers to ERISA-governed retirement plans, IRAs and other tax-advantaged retirement products. The Fifth Circuit Court of Appeals struck down these rules in 2018, finding that they went beyond the department’s statutory powers. The DOL, by then under the Trump administration, opted not to seek Supreme Court review. Though the DOL’s rules are defunct, the SEC clearly acted with these rules in mind, and reacted away from them in some important ways. The DOL approach was highly prescriptive: it had the effect of prohibiting an investment firm’s receipt of compensation from a retirement plan unless the firm entered into a customer agreement with specified terms, including that the firm committed to acting as a “fiduciary.” But the regulation went much further than labelling. It also expressly favored asset-based compensation arrangements, commonly used by investment advisers, over transaction-specific compensation more frequently used by broker-dealers; required extensive fee disclosure while providing that disclosure wouldn’t be sufficient to remedy conflicts of interest; required the establishment of internal compliance regimes governing conflicts; and even regulated the types of investments that could be sold to retirement accounts (e.g., generally prohibiting IPOs).
It’s important to note the limitations of the earlier proposals. The earlier NASD and SEC proposals would have pertained only to mutual funds, and not to other types of investment products or services. For example, the mutual fund disclosure would not have applied to advice about establishing a particular type of account, or rolling over a 401(k) plan to another plan or IRA. The DOL fiduciary rule would have applied to qualified retirement plans and IRAs, but not to retail investment services provided outside the context of these tax-favored plans.
After the rule’s compliance date (between May 1 and June 30, 2020), broker-dealer and investment adviser firms will be required to deliver Form CRS to retail investors essentially at the point of sale to a retail investor, that is, no later than: when the customer enters into an investment adviser contract; or when a broker-dealer makes a recommendation, places an order or opens an account. The main objective of Form CRS is to improve retail investors’ understanding of some difficult issues: the difference between the types of services offered by broker-dealers and investment advisers; the nature and amount of fees directly or indirectly paid by the customer in either model; and the potential conflicts resulting from the ways in which firms and representatives are compensated.
Though intended to address many of the same problems as the earlier proposals, Form CRS takes a much different approach to disclosure, in structure and appearance. With the aid of extensive focus-group testing, the agency pared down the initial CRS form to two pages (four for dually registered BD/IA firms). This was an effort to make the form more accessible to investors, not to lighten the industry’s burden. The page limits were reached by requiring the firms to prepare supplements: specified “conversation starter” questions (akin to FAQs), the answers to which are to be provided separately; and hyperlinks or cross-references to any more detailed financial or other information necessary to complete the disclosure. We will focus here on just two of the many issues raised by Form CRS.
- Compensation Disclosure
The SEC’s underlying premise is clear enough: how individuals or companies get paid influences - - perhaps guides - - their behavior. Disclosure of these incentives should in theory help customers evaluate the nature and quality of the firms’ advice, and may affect the way compensation is structured. It remains to be seen whether this approach will improve customer understanding, but it’s very clear that firms will face additional risks for incomplete or inaccurate disclosures.
On the customer side, the main challenge is that compensation is complicated. Mutual funds expense disclosures are standardized because the funds are obligated to treat each share of a given class equally. However, the range of what customers may pay under the investment adviser and, in particular, under the broker-dealer models, varies widely depending on the asset levels and the nature of the investments recommended. In addition, these fees are often negotiable, sometimes between firms that have extensive and complicated relationships. Larger firms offering a wide range of products or services will have limited ability to simplify, and may need to vary their representatives’ compensation depending on the ability, experience and the nature of the customer groups they serve. Form CRS addresses this problem by allowing for hyperlinking and cross-referencing to more detailed documents. This may force transparency, but also provides a relief valve for complexity. That is, firms could link to long, correct and very difficult schedules covering a multitude of contingencies. A fee schedule can be accurate without greatly improving customer understanding, like a cable plan or a car rental agreement, and it is an open question as to whether SEC staffers will view such complex or contingent disclosures as sufficient.
The Form CRS adopting release does nothing to discourage a defensive approach. While the Commission states that Form CRS itself is “not intended to create a private right of action,” it goes on to emphasize that “the antifraud standards under the federal securities laws apply to linked information, as with other securities law disclosures.” The effect, therefore, may be to elevate many broker-dealer fee disclosures that would otherwise reside in contracts, into filings that are subject to SEC examination and enforcement actions. This has been the clear trend in investment adviser enforcement, as shown by the staff’s 2018 initiative about disclosure of investment adviser conflicts of interest in their form ADVs. It is likely that the SEC examination and enforcement staff, not consumers, will be the most attentive readers of Form CRS.
- The Duty Question.
No doubt the most hotly contested issue during the rulemaking process was whether the SEC should or should not adopt a fiduciary duty standard, so labelled, for retail broker-dealer services. The SEC and court decisions have long considered an investment adviser’s role to be fiduciary in nature, although the SEC has taken the position that this duty has very specific elements not all of which are reflected in final court rulings. It was a great disappointment to consumer groups that the SEC instead called the broker-dealer’s duty one of acting in the “best interest” of the customer, and then declined to define this new term.
Form CRS and the adopting releases suggest that the Commission viewed this debate as purely semantic. Yes, investment advisers have a fiduciary duty, consisting of a duty of care and a duty of loyalty, each of which require that the investment adviser “must, at all times, serve the best interest of its client and not subordinate its client’s interest to its own.” This reframing allowed the Commission to drop the highfalutin term “fiduciary” from Form CRS altogether, and requires both investment advisers and broker-dealers to describe their duties as “best interest.” Indeed, the Commission was responding to comments that the term “fiduciary” was one reason that consumers found the initial Form CRS too confusing. Clarity and consistency were the Commission’s stated aims. “We believe that investors should be provided with a consistent articulation of their firm’s legal obligations regarding the standard of conduct.” Even so, the following passage must have come as a shock to parties on both sides of the pre-adoption debate:
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 BI or an investment adviser’s fiduciary duty under the IAA. 
The question remains whether, in attempting to make Form CRS easier to understand, the Commission has changed the substantive standards of care. Having expressly declined to define the term “best interest,” and expressly declined to apply the term “fiduciary” to broker-dealers, the Commission concluded that (a) “best interest” will help “clarify for retail investors their firm’s applicable standard of conduct” better than “fiduciary,” which has long judicial precedent; and (b) “best interest” is a synonym for fiduciary, at least on the investment adviser side. This leaves open several critical questions: (a) are the two standards also the same; (b) if they are the same, does “best interest” mean “fiduciary” as the courts have interpreted the term, or does “fiduciary” mean “best interest” as the SEC will develop the term through examination and enforcement; or (c) if they are different, does the Commission simply believe that they are not different enough that retail investors should be bothered to notice?
To be sure, the SEC explained how it believes these issues should be harmonized: the investment adviser version of “best interest” will generally apply continuously to the relationship, while the broker-dealer version only applies to recommended transactions. But this interpretation has other problems. It incorrectly assumes that broker-dealers never take on monitoring responsibilities and that investment advisers always do. More important, it continues to conflate the substance of the duty in each setting: stating (against the advocacy of consumer groups) that the “best interest” standard now applies to each constituent aspect of the investment adviser fiduciary duty, while implying (against the advocacy of broker-dealer industry commenters) that broker-dealers must meet the same standards as the fiduciaries when making transactional recommendations.
One thing is clear, however. By applying the undefined term “best interest” so broadly, the SEC has left itself a great deal of discretion in enforcement proceedings. We would hope that the agency makes a concerted effort to apply this standard in a consistent way, so that a clear and fair standard will become clear to investors and financial professionals, and their respective legal advisers.
 Regulation Best Interest: The Broker-Dealer Standard of Conduct, SEC Release No. 34-86031 (“Reg BI Adopting Release”); Form CRS Relationship Summary; Amendments to Form ADV, SEC Release Nos. 34-86032, IA-5247 (“Form CRS Adopting Release”); Commission Interpretation Regarding Standard of Conduct for Investment Advisers, SEC Release No. IA-5248 (“IA Conduct Release”).
 Securities Act § 5, 15 USC § 77e (prohibiting public offer or sale without delivery of a prospectus).
 NASD Notice to Members 03-54 (September 2003).
 Confirmation Requirements and Point of Sale Disclosure Requirements for Transactions in Certain Mutual Funds [etc.], SEC Release Nos. 33-8358; 34-49148; IC-26341(January 29, 2004).
 Chamber of Commerce of the United States v. U.S. Department of Labor, 885 F. 3d 360 (5th Cir., 2018).
 It is broken out into five sections: 1, Introduction; 2, Relationships and Services; 3, Fees, Costs, Conflicts and Standards of Conduct; 4, Disciplinary History; and 5, Additional Information.
 Form CRS Adopting Release, supra fn. 1, pp. 43, 58-59.
 In the Share Class Selection Disclosure Initiative, Press Release, February 12, 2018, the SEC Enforcement Division made a conditional settlement offer to investment advisers which had invested client funds in a 12b-1 fee paying share class when a lower cost share class was available, without explicit disclosure in the IA’s Form ADV. The release cited half a dozen previously settled enforcement matters as examples. The SEC reported that the program resulted in settlements with 79 investment advisers, which agreed to certain corrective conduct and agreed to return a total of over $125 million to customers. (SEC Press Release, March 11, 2019.)
 See Transamerica Mtg. Advisors, Inc. v. Lewis 444 US 11, 17 (1979) (limiting private remedy); SEC v. Capital Gains Research Bureau, Inc. 375 US 180, 194 (1963); see also, Commission Interpretation Regarding Standard of Conduct for Investment Advisers, supra fn.1 (duty to gather and update specific information in investor profile; duty of best execution).
 Reg BI Adopting Release, p. 35 and fn. 66.
 IA Conduct Release, pp. 7-8.
 Form CRS Adopting Release, supra fn. 1, pp. 25 (and fn. 48), 27 and 145-147.
 Id. p. 147.
 Id. at 153-4.
 Reg BI Adopting Release, supra, fn. 1, pp. 17-18.