Take-Away: The Securities and Exchange Commission (SEC) recently released proposed rules that require both investment advisers and broker-dealers to provide a Customer Relationship Summary  (the Summary) to explain the nature of the relationship, the services to be provided, standards of conduct, conflicts of interest and fees and costs associated with the provided services. This proposed rule is not to be confused with the Department of Labor’s proposed Fiduciary Rule that was recently successfully challenged in federal court by the U.S. Chamber of Commerce. The SEC rule  would prohibit some broker-dealers from using the term adviser when they describe their role to their retail customer.

Background: This proposed rule would be issued under the Investment Advisers Act of 1940, and the Securities Exchange Act of 1934. It would require a registered investment adviser and a registered broker-dealer to provide a customer relationship summary (the Summary) to retail investors. The scope of that Summary would inform customers as to the nature of the relationship, the services to be offered, the fees and costs of those services, conflicts of interest, and the standard of conduct of the adviser, including any currently reportable legal or disciplinary events. The proposed rule reflected by the Summary would be required to be provided at the beginning of the relationship and it would have to be updated whenever a material event occurs. The Summary would be limited to 4 pages and would be subject to the ‘plain language’ content requirement.

Summary: Some key elements of the scope of the required Summary are addressed below:

Comments: Comments to the proposed rule are currently being elicited by the SEC through August 7.

Adviser vs Broker-Dealer vs Dual Registrant: The Summary’s content would vary depending upon whether the financial professional is either a (i) financial adviser; or (ii) a broker-dealer; or (iii) a dual registrant with the SEC. Mandatory bold type disclosures would be required to identify the role of the financial adviser. Example: We are an investment adviser and provide advisory accounts and services rather than brokerage accounts and services.

Introductory Alert: The Summary would include an introductory bold type alert to the retail customer: There are different ways you can get help with your investments. You should carefully consider which types of accounts and services are right for you.

Fees: The professional adviser will be required to provide in the Summary information that pertains to the type of fees received by the adviser, including a clarification as to how fees apply to investment advisory accounts as distinguished from brokerage accounts. The Summary will be required to state whether fees vary by investor and whether fees are negotiable. The Summary must describe the transactional nature of the brokerage fee. Example:  The fee you pay is based on the specific transaction and not the value of your account. If it is a dual registrant, then the Summary must contain language which notes that the investor may be better off based on whether the investor will, or will not, trade on a regular basis.

Frequency of Advice: The Summary will specify if the investment advice will be offered on a regular basis, and if so, how often.

Choices: The Summary must address the nature of the investment advisory services, e.g. discretionary or non-discretionary. In addition, if there exists a limited variety of investment choices, the Summary must note that other firms might offer a wider range of options. If investment options are limited, the Summary must contain language that identifies those limitations.

Brokers: Broker-dealers will have to explain the principal brokerage services, as well as the nature of the transaction-based commission. In this regard, the Summary must also expressly address whether recommendations are offered, and with whom the ultimate investment decision lies. If additional services are to be provided by the broker, e.g. a retail investment strategy, then the additional fees, if any, for those services must be separately identified.

Fiduciary Standards: The Summary will have to specify incentives that broker-dealers may have to place their own interests ahead of those of the investor. The Summary must contain the following language: We are held to a fiduciary standard that covers out entire investment advisory relationship with you. Our interests can conflict with your interests. We must eliminate these conflicts or tell you about them in a way you can understand, so that you can decide whether or not to agree to them. We must act in your best interest and not place our interests ahead of yours when we recommend an investment or an investment strategy involving securities. [Execution-only brokers are not required to include these statements in the Summary that they use.]

Monitoring: Generally there must be included in the Summary some description of the frequency of the monitoring of an investor’s account. Consistent with the required statements with regard to fiduciary standards, the Summary must also specify that the adviser is required to monitor the investor’s portfolio, unless ongoing investment advice is not to be provided.

Conflicts of Interest: The Summary will have to contain required language, depending on the role of the professional, that addresses conflicts of interest. Example:  for a broker-dealer: We benefit from our recommendations to you.

‘Adviser’ and ‘Advisor:’ The proposed Rule limits the use of the terms adviser and They are limited to registered investment advisers who deal with retail investors. A dually registered firm can use these terms when it deals with retail investors,  except that such terms can only be used by an associated natural person of a dually registered firm where that person is actually supervised by a registered investment adviser.

Conclusion: Who knows if the SEC’s Customer Relationship Summary will ever make its way into required use, or if it will meet the same fate of the Department of Labor’s proposed Fiduciary Rule. We can only watch and wait and see what happens after the Comment period ends in early August.