The Securities and Exchange Commission (SEC) is hoping that a new, mandatory disclosure form, called a Customer Relationship Summary (CRS), will help retail investors better understand the difference between the standards that broker-dealers (BD) and a Registered Investment Advisors (RIA) are held to when offering services to their clients. 

However, according to a new survey — commissioned by AARP, the Consumer Federation of America (CFA) and the Financial Planning Coalition (FPC)—  the SEC’s proposed mandatory disclosure form fails to clarify that distinction.

Confusion Prompts Proposed Disclosures

The introduction of the CRS form is part of a larger effort by the SEC to help investors understand changes to conduct standards as a result of their proposed rule: Regulation Best Interest. Form CRS is a central component of Regulation Best Interest, and is intended to help investors make informed decisions between different types of accounts and different types of service providers.

Prior to the introduction of Regulation Best Interest, broker-dealers and other non-registered professionals (who are typically commission-based sellers) were held to a lower “suitability” standard when recommending transactions. 

Financial planners who are licensed by the SEC, and designated as Registered Investment Advisors (RIAs), have always been held to the fiduciary standard (and are typically fee-based providers). The fiduciary standard is a more stringent requirement for professional conduct than what is required by both the current "suitability" standard and the proposed "best interest" standard. If this regulation is finalized, the suitability standard for broker-dealers will be replaced by the revised "best interest" standard. 

The suitability standard, the best interest standard and the fiduciary standard all dictate conduct requirements for financial advisors who are recommending investments or services to their clients.

The fiduciary standard is considered the "highest" standard and sets a legal requirement for advisors to put their clients' interests above their own. The suitability standard requires that advisors recommend "suitable" services for their clients' interests, but does not address conflicts of interest that may arise when two similar products may be suitable for the investor, but the lower-cost option that does not yield as high of a commission rate for the broker.

According to the results of the testing, the CRS form makes it clear to investors that conflicts of interest may exist when a broker's recommendations adhere to the best interest standard, but does not communicate the potential impact of conflicts of interests on the recommendations they receive. In a letter that the groups sent to SEC Chair Jay Clayton and members of the Commission, they stated, "Few [investors] made a connection between the conflicts described and the possibility that they could result in recommendations that were not in their best interests."

Research Tests Usability of CRS

The independent research, conducted by Kleimann Communication Group in July, was intended to test the usability of the CRS form. The survey took the form of 90- minute, one-on-one interviews with 16 investors from three different locations in the U.S. during the month of July. The results suggest that retail investors – even after looking over the CRS form – have trouble understanding the differences between the legal standards that broker-dealers and RIAs are subject to, the kind of relationship they can expect from their service provider, or the different fee structures (fee-based or commission-based) they employ. 

One of the goals of the CRS is to make sure that consumers understand the difference between the new best interest requirement and the fiduciary standard. Based on the research report that Kleimann published, participants didn’t understand how those two requirements differed. In addition, most respondents couldn’t sufficiently define the term “fiduciary” when asked. That led some to the opinion that, because brokerage firms were associated with the term “best interests,” they represented a higher level of responsibility to the client.

CRS Does Not Accomplish Intended Goal

The study aimed to achieve an in-depth look at whether the CRS succeeded in its goal of reducing investor confusion and enabling informed choices. Researchers gave each participant a sample version of the form provided by the SEC, and each participant took part in a focus group-type discussion and a structured questionnaire. 

Already, there has been criticism by some firms that investors, even if offered a disclosure, won’t read them thoroughly in a real-world setting. But even with significant time to examine the document, the study’s participants didn’t arrive at a demonstrably better understanding of the broker-client relationship.

While interview subjects understood the difference between transaction-based fees and asset-based fees, for example, many had trouble figuring out which model would cost them more. And several participants believed all financial professionals would provide the same level of account monitoring, despite that component not being a required part of the services of a broker-dealer.

Call for Revisions

Investopedia reached out to the SEC, AARP and Consumer Federation of America for comments. The SEC respectfully declined to comment. Barbara Roper, CFA’s director of investor protection, responded saying: "The SEC has proposed to maintain separate standards of conduct for broker-dealers and investment advisers based, at least in part, on the notion that the proposed Customer Relationship Summary would enable investors to make an informed choice between the two types of accounts. Our research confirmed that the disclosures, as proposed by the SEC, will not solve the problem of investor confusion and may even mislead investors on issues essential to an informed choice of providers. At the very least, the Commission should commit to conducting a rigorous process of testing and revision to improve the disclosures before moving forward with its regulatory proposal."

Cristina Martin Firvida, vice president, financial security and consumer affairs at AARP, also commented to Investopedia. "The SEC and Chair Jay Clayton have stated that it is their priority to improve the experience of retail investors. We’ve seen and heard what the chair has said and we take it very seriously. We believe that the SEC wants to make good on their commitment to improving the retail investor’s experience. Whatever the final version of the disclosure is, we believe that it will look different than the proposed version, and that the new version can be improved."

While the formal comment period for the rule ended Aug. 7, the three sponsoring organizations notified the SEC that they would be conducting a usability study and would provide the regulator with results upon its completion. In a joint statement, the groups said they expect the report to be included in the public record. 

The Bottom Line

It's clear that there’s a need for greater understanding about how broker-dealers and registered advisors operate. But whether the current format of the CRS helps retail investors understand the differences is a big question mark. The independent survey seems to demonstrate the limited ability of a disclosure form to communicate a complex issue to the average investor in a way they can easily understand.