Securities Law News

INSIGHT: Covid-19 Shows Why SEC Should Use E-Delivery for Form CRS

June 9, 2020, 8:00 AM

Broker-dealers are feverishly racing to meet the June 30 effective date for Form CRS and Regulation Best Interest (Reg BI), the most important regulation imposed on them in over 85 years.

Form CRS will require delivery of a relationship summary to retail customers, describing the broker-dealer’s customer relationships, services, fees, and conflicts of interest. Reg BI requires (among other obligations) delivery to retail customers of a disclosure statement about the conflicts of interest and other features associated with a recommended securities transaction or investment strategy.

Retail customers thus will know about circumstances that could lead the broker-dealer or its representative to overcharge the customer or sell her the wrong investment.

The Securities and Exchange Commission has helped to ensure that customers read the relationship summary. For example, it is limited to two pages and must be written with a reasonable paper size, font size, and margins, in plain English with design features making it easy to read. The SEC encouraged the use of graphs and charts and an online relationship summary must have hyperlinks to information to which it refers. The SEC established similar expectations for Reg BI disclosure.

The relationship summary thus will be concise, informative and appealing—for a legally-required disclosure statement. The SEC is to be commended for creating a document that customers might read. Unfortunately the relationship summary must be delivered in a way that will discourage some customers from reading it.

Paper Delivery Is Default

As a general matter the SEC permits electronic delivery of disclosure, including the relationship summary, only if the customer affirmatively consents. Any customer who does not request electronic delivery will receive disclosure in paper form, typically through the postal service. Paper delivery is the default method of delivery.

According to a 2018 U.S. Census survey, about 30% of U.S. households do not have broadband internet access. These households probably read disclosure statements, if at all, in paper form. A dial-up connection or the absence of home internet service would make online reading of the relationship summary cumbersome at best. The SEC must continue to protect the right of these customers to receive the relationship summary in paper form.

The question is whether paper delivery should be the SEC’s default position. At least 70% of U.S. households have broadband internet service. Most senior citizens, often accused of a Luddite distaste for technology, subscribe to internet services. The Social Security Administration requires benefit recipients to obtain their statements online, and AARP members may only request a membership card online. These organizations recognize that senior citizens, like other investors, commonly communicate through the internet.

The 70% of American households who pay for broadband internet service use it to receive information of interest. Electronic delivery makes their life easier. They can read a document on screen and search for key words, or they can download it to peruse more deliberately.

If the Reg BI disclosure is also delivered electronically then the customer can better see how it is layered with the relationship summary. Electronic delivery makes for more convenient reading of the relationship summary and Reg BI disclosure, and increases the chance that the customer will not ignore them.

More Fluid Process and Fewer Obstacles

Electronic delivery better protects customers in at least two situations.

First, some rules require disclosure that is timed to be meaningful in relation to the transaction. Reg BI requires disclosure of certain information before or at the time of a recommendation, for example. Electronic delivery offers a more fluid process, in which the firm or representative delivers the disclosure, discusses the disclosure and the proposed recommendation with the customer, answers the customer’s questions, allows the customer to decide whether to execute the transaction, and can create a contemporaneous record of these steps. Paper delivery disrupts this course and is less conducive to such meaningful disclosure.

Second, the pandemic has demonstrated that paper delivery is inimical to the business continuity of broker-dealers. The pandemic has complicated preparation and delivery of a paper relationship summary for many firms. A broker-dealer’s printing company might be closed and postal services might not operate on schedule. The broker-dealers’ front-line regulator, FINRA, recently reported similar obstacles. When it had to issue letters required by a FINRA rule, its staff was forced to manually print them in their offices and post them for delivery.

Customers have a right to continuous access to their account information and to on-time delivery of the relationship summary and other disclosure. When print shops are closed, postal services are not fully operational, and workers are working remotely, paper delivery will not ensure that all customers receive the information to which they are entitled.

SEC Should Continue Its Trailblazing

Historically speaking, the SEC has been a pioneer among federal agencies in permitting electronically delivered disclosure. The SEC issued its first major pronouncement on this issue in 1995, the early days of the internet. Yet the agency has not modernized its guidelines since 2000—seven years before Steve Jobs unveiled the iPhone.

The time has come for the SEC to modernize its rules governing electronic delivery of disclosure. Customers should receive disclosure in the form in which they will read it. Those who prefer paper delivery should continue to receive it in that form, and the 70% of Americans who receive important information on the internet should be able to receive it electronically. Since far more customers fall into the latter category, the SEC should make electronic delivery the default method of transmitting the relationship summary and other disclosure.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Thomas M. Selman is the founder of Scopus Financial Group, providing regulatory guidance to broker-dealers. Until January 2020, Selman served as FINRA’s executive vice president for regulatory policy and its legal compliance officer.

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