[Certain] State Securities Commissioners Overstepping Legal Authority in Mandating Form CRS

Many state securities commissioners are starting to require the preparation, filing, and delivery of Form CRS for investment advisers in their jurisdictions. State securities authorities must be prepared to provide their legal authority for requiring Form CRS or make it clear that compliance with their desires are optional. It is a detriment to the industry, its lawyers, and compliance professionals if they do not. In addition, if they don’t have the authority, they will likely be found to be engaged in rule-making without following state administrative law.

For example, the Securities Division of the Rhode Island Department of Business Regulation released Securities Bulletin Number 2020-2 (the “Bulletin”) to state-registered investment advisers in early June of 2020. Notably, that bulletin is not yet publicly available on its website as of June 10, 2020. As an aside–how can the industry possibly know what is required of them if the Division won’t post the Bulletin?

The Division’s position is that Rhode Island registered investment advisers must file Form CRS before June 30, 2020. This is clearly in violation of the Rhode Island Administrative Procedures Act, and therefore, is unconstitutional.

The Bulletin states that “entities registering or registered as investment advisers [pursuant to 230-RICR-50-05-2.7-B of the Post-Licensing Requirements in the Rules and Regulations of the Rhode Island Securities Department and the Administrator of the Department of Securities (the “Rules”)], must file the Form CRS Relationship Summary as a part of the Form ADV filing requirement.”

230-RICR-50-05-2.7-B of the Post-Licensing Requirements in the Rules states that “Every investment adviser, whether or not subject to the Investment Advisers Act of 1940, shall make and keep current the records required by that Act and rules thereunder.” The title of this section is “Required Records”. While this rule requires an investment adviser to make and keep records required by the Investment Advisers Act of 1940, that applicable rule (Rule 204-2 under the Investment Advisers Act of 1940) does not require state-registered investment advisers to make and keep copies of Form CRS. It certainly does not require the delivery of Form CRS to state-registered investment adviser’s clients.

Rule 204-2(a)(14)(i) requires investment advisers registered with the SEC to “make and keep true, accurate and current…A copy of each brochure, brochure supplement and Form CRS, and each amendment or revision to the brochure, brochure supplement and Form CRS, that satisfies the requirements of Part 2 or Part 3 of Form ADV, as applicable; any summary of material changes that satisfies the requirements of Part 2 of Form ADV but is not contained in the brochure; and a record of the dates that each brochure, brochure supplement and Form CRS, each amendment or revision thereto, and each summary of material changes not contained in a brochure given to any client or to any prospective client who subsequently becomes a client.”

The General Instructions to Form CRS make it clear that Part 3 of Form ADV is only required to be prepared and delivered for investmetn advisers registered under section 203 of the Investment Advisers Act of 1940 and broker-dealers registered under section 15 of the Securities Exchange Act of 1934. Anyone else would not need to satisfy the requriemetns of Part 3 of Form ADV.

It is clear that the Division does not have the legal authority to mandate the preparation, submission, and delivery of Form CRS. The Bulletin goes on to state: “although the Rules do not explicitly require the delivery of the Form CRS to clients, as a fiduciary, an investment adviser is obligated to ensure that clients understand the capacity in which it is functioning. Since this is the whole purpose of the form, delivering the Form CRS to clients will now be a best practice for Rhode Island registered investment advisers. Such delivery would particularly be true for dually registered firms and their representatives.”

So which is it? Is it a requirement or is it a best practice? If it is a best practice, does the Division acknowledge that it has no authority to penalize non-compliant investment advisers?

Also, I am not sure I understand the argument that investment advisers must provide a Form CRS as a fiduciary so that clients understand the capacity in which they are functioning. Investment advisers already provide extensive disclosure to clients in Form ADV Part 2A about their capacity in which they are acting. If a representative is also registered with a broker-dealer, the client will receive a copy of the broker-dealer’s Form CRS, which will highlight the broker-dealer’s capacity and services. That representative will need to also comply with Regulation Best Interest.

Ultimately, each state’s laws and regulations must be reviewed to determine whether they have the authority to require Form CRS.

Leave a Reply