Hi everyone! Welcome back to Melissa Making Cents!

In my very humble opinion, one of the things that makes me a good financial planner is my love of education.  Especially financial literacy. Empowering clients to make healthy financial choices, whether through being a financial coach or a financial advisor representative, is a huge motivating factor for me. There is something so rewarding about seeing "Aha" moments!

As a CERTIFIED FINANCIAL PLANNER and financial advisor representative, I love working with people! I feel a strong sense of fulfillment from helping my clients reach their financial goals. But there are a few parts of my job that are a bit less glamorous. One of these is handling paperwork regarding rules and regulations for financial professionals. Usually, that’s all on me and my clients don’t have to concern themselves with this (somewhat tedious) part of financial planning. But if you’ve been working with me or another financial professional over the past few months, you may have received some new financial documents: Form CRS and Regulation BI.

A lot of my clients call to ask…why am I getting these and what do I need to do with them? Per new regulations released by the Securities and Exchange Commission (SEC), all of our clients must receive a copy of these forms. Today, I’m going to share some basics about these two important documents, including what they are, when they are required, and what you need to do when you receive them.

The new regulations were created to strengthen standards

Up until 2019 practically anyone could call themselves a generic "financial advisor" or "investment advisor", and to a certain extent it was correct because they were likely advising you on your finances. What investors were unaware of was that there were different standards in play depending on the type of "advisor".  A broker was not previously held to the same standards as a true registered investment advisor representatives.

A registered investment advisor representative (also known as an RIA Reps) are compensated by charging a management fee for assets under their management. They must register with the SEC or the state, hence the title "registered" advisor representative.  RIA Reps have always been held to the more strict standard, meaning that they must act in the best interest of the client, provide full disclosures of fees, and disclose any conflicts of interest.

Brokers are intermediaries that take orders from clients and execute them in the open market. Brokers may also offer financial advice (but are not registered advisors) and receive compensation through commissions on the trades they execute.  Brokers were not held to the same standard. They instead followed a "suitability rule" that meant they must select assets that were suitable for clients, with little regard to the amount of compensation they would receive in commission on the trades.

To even the playing field the Securities and Exchange Commission created Regulation BI to hold brokers to a higher standard and provide more transparency. Brokers are no longer allowed to call themselves advisors. 

The new standards also require:

• Disclosure of information about recommendations
• Exercise diligence, care and skill when making a recommendation
• Abide by policies that address conflicts of interest
• Complying fully with policies and procedures designed to fulfill the regulation

What is the difference between Best Interest and Suitability

As I mentioned above, investment advisor representatives have always had to follow stricter standards. Part of these standards was making sure that an investment was in a client's best interest. This means that the financial product is suitable for them but also provides a benefit or advantageous reason for making the investment.  Brokers were only required to make sure that an investment was suitable for the client.

Let's look at a non financial example.  We meet a person in a grocery store that appears to be a healthy weight. She is craving something sweet, and is trying to decide between purchasing a candy bar or an orange.  If we are following the suitability standards we could tell her to purchase the candy bar, because she appears to be healthy.  If we are truly looking out for her best interest, we would likely do a medical analysis to check glucose levels, do a nutritional analysis of each food, and finally a cost analysis of each product before making a recommendation.

The new financial standards the financial equivalent of helping clients decide between the candy bar or the orange.  From a suitability standpoint a certain stock, annuity or mutual fund might be suitable, but being suitable doesn't necessarily mean it's in the client's best interest... Even if that candy bar is a 100 grand bar! (Yum!!)

Where does Best Interest stop for Brokers and Investment Advisor Representatives

There are a still a few differences between a broker and RIA rep. The biggest difference has to do with where best interest stops for each financial professional. A registered investment advisor representative must always keep the client's best interest in mind. Their duty to their clients is to continually review assets held in a client's account, and recommend changes when an investment no longer meets the client's best interest. This is part of the ongoing management fees that you pay to the advisor in lieu of a commission. 

A broker must follow the best interest guidelines while making a financial recommendation to a client. Once the asset is purchased, the broker is no longer responsible for keeping tabs on the investment to make sure it is maintaining the client's best interest. Unfortunately if the investment goes south a few months later, it is up to the client to call the broker to talk about the investment. Because brokers receive commission on trades, many times it is a "one and done" investment.

Form CRS, or a Client Relationship Summary, educates clients about a financial firm’s services, fees, and legal history

The first of the forms you will receive (or have received) is called a client relationship summary, or Form CRS. The SEC requires both brokers and RIAs to provide relationship summaries. Both of these types of financial professionals provide recommendations to their clients about buying, selling, and holding investments such as stocks, bonds, and mutual funds. Form CRS is delivered to new customers when they open an account with a broker or investment adviser, or when a financial recommendation (such as buying a certain stock) is made for an existing customer. 

The purpose of the form is to educate clients about an investment adviser or broker-dealer’s services and background in order to help them make good financial decisions. Form CRS will list the firm’s registration information (whether it’s a broker, adviser, or both), the firm’s services, associated fees, potential conflicts of interest, and legal or disciplinary history. Form CRS will also include “conversation starters,” or a list of key questions for clients to ask their point of contact at the firm, in order to determine the best financial decisions for them.

As an example, you can see Form CRS for ISC Advisors here.

Regulation Best Interest Disclosure manages expectations that brokers are making recommendations that are meant to best serve their clients, not themselves.

The other new form is called the Regulation Best Interest Disclosure. It went into effect in summer of 2019, and the disclosure requirements became effective this summer (2020). Unlike Form CRS, which is required for both investment advisers and broker-dealers, Regulation BI only applies to broker-dealers. 

The purpose of this form is to ensure that broker-dealers only recommend financial products that are in their clients’ best interests. Regulation BI accomplishes this by disclosing any conflicts of interest and financial compensation the broker-dealer may receive from certain products’ transactions, fees, or other arrangements. This could include account transfer fees, transaction fees, processing fees, and more.

A retail investor would receive Regulation BI form:

• if they open a brokerage account with a broker based on the broker’s recommendation
• if they already have an account but receive a financial recommendation from the broker,
• or if the broker will receive some form of compensation as a result of a financial recommendation,
  • even if that retail customer does not have an account at the broker’s firm.

You can view an example of the ISC Advisors Regulation Best Interest Disclosure here.

When you receive these forms, read through them to get a full picture of your relationship with your financial professionals.

First things first; when you get these forms in the mail or in your inbox, read them carefully! Remember, these forms are designed to help you make the best financial decisions possible, especially when it comes to working with investment professionals. Form CRS in particular will include key questions to ask your financial professional, if you are seeking additional information. Regulation BI provides more information in regard to the financial incentives that a broker may receive as a result of their recommendations. 

If you’ve worked with several brokers or advisers, or you’re trying to find one that works best for you, you can compare these forms from several different firms. Taken together, Form CRS and Regulation BI are designed to foster greater trust and transparency between investors and the financial professionals they work with. If you have any questions about how these forms work, please call or email to schedule an appointment with me. 

Until next time...this is Melissa Making Cents!

Melissa Anne Cox CERTIFIED FINANCIAL PLANNER™ is also a College Planning and Student Loan Advisor in Dallas, Texas