On October 8, 2020, the U.S. Securities and Exchange Commission released updated guidance to help clarify questions that have surfaced regarding information on firm and employee disciplinary history that must be disclosed on the client relationship summary (Form CRS).
Less than two months after Form CRS took effect, The Wall Street Journal reported that hundreds of financial advisory firms had skipped over Item 4 in the form which asks, “Do you or your financial professionals have legal or disciplinary history?”
It’s a question the SEC says demands one or two simple responses, depending on the situation, and they involve the words ‘yes’ and ‘no.’ But not providing a response of any kind and leaving Item 4 entirely blank is not acceptable.
Findings of The Journal’s investigation published in August identified approximately 2,300 individual employees with disciplinary history disclosures that their firms failed to reflect on Form CRS. About 70% of those had customer complaints. Roughly 300 had disclosures of regulatory actions against them. A similar number had criminal histories, and about as many had left previous employers amid claims of misconduct. 
A Conversation Starter
Form CRS, a critically important component of the SEC’s new Regulation Best Interest, is designed to help retail investors make an informed decision regarding whether to establish a relationship with a particular advisory firm or financial professional. It’s a two-page document (four-pages in the case of dual registrants) meant to provide a succinct summary of the business and generate questions for retail investors to ask their investment adviser or broker-dealer.
“One of the general instructions to Form CRS does allow for the omission or modification of disclosures or conversation starters if they’re not applicable to a firm’s business,” said Adam Stutz, a Compliance Consultant whose specialized experience includes analyzing, monitoring, and responding to foreign and domestic filing requirements. “But it does not allow for the omission of whether a firm or any of its employees has any disciplinary history.”
As Simple as ‘Yes’ and/or ‘No’
Stutz said it is important that firms understand that they have to provide a ‘yes’ or ‘no’ response to Item 4; however, the SEC has clarified that a firm can provide a two-part answer to the question.
“If a firm does not have any disciplinary history, but an employee of the firm does, then they can give a two-part answer,” Stutz said. “You can answer ‘no’ for a firm and ‘yes’ for financial professionals. Or you can answer ‘yes’ for the firm and ‘no’ for your financial professionals.”
“The reason that the response to the question needs to be written so simply is because it’s intended to act as a conversation starter. It’s supposed to prompt the prospective client or investor to ask questions of their investment professionals such as, ‘Why does the firm have this or what are the reasons?’ And then the financial professional can provide more information with respect to that disciplinary or legal issue.”
The SEC’s FAQs on Form CRS say that even if a firm provides a two-part answer, it cannot include descriptive information on the form as to why the firm or the individual had disciplinary action. The yes-or-no response is the most important component of Item 4 and should simplify the process of completing the form.
How to Provide Additional Information Regarding Disciplinary or Legal History on Form CRS
“The Form CRS does not preclude firms or financial professionals from providing separate copies of additional regulatory disclosures,” Stutz said. “Firms or financial professionals can give potential clients or copies of Form ADV Part 2B brochure supplements or a print-out of the IAPD or BrokerCheck “Disclosures” section for their particular firm or financial professional. But you can’t put that additional information into the Form CRS.”
Retail investors can visit Investor.gov/CRS for a free and simple search tool to research financial professionals.
“Firms should review your Form CRS to make sure you’re following the instructions,” Stutz said. “The SEC has been conducting focused examinations to make certain firms and financial professionals are completing Form CRS correctly.”
This topic is likely to remain one of the SEC’s top priorities. With that in mind, consider reaching out to our many experienced CCLS professionals who can help. Contact us at 619.278.0020 or Info@corecls.com.