Registered Investments Advisors (RIAs) are required to complete several filings with the Securities and Exchange Commission (SEC). One of them, Form ADV Part 1, is a series of short answer, numerical, and bullet point questions. Its intent is to be a standardized way that you can compare two financial firms to one another. While this sounds promising, the data is too inconsistent to be reliably useful as advisors interpret and answer the questions differently.
Regardless, investors can look up their prospective financial advisors using the official website investor.gov. There, you can search for a firm or individual and quickly find the link for their SEC filing. Our filing is here: Marotta Wealth Management.
Because the ADV Part 1 compliance filing is in a machine readable format and hidden behind a clunky user interface, several websites have been created to strive to display this information in a more user friendly format.
One such website is investor.com. Investor.com is owned by Reink Media Group. They scrape the conflicts of interest and disciplinary history sections of the ADV Part 1 and then report that information back, after filtering it through their “Trust Algorithm .”
According to their article on the topic , investor.com makes money two ways: “clearly labeled advertising” and “financial service providers in affiliate relationships.” One of those affiliate relationships is disclosed in the footer as “Certified accolades including ‘investor.com Star Rating Badge’ are only available to firms participating in investor.com’s paid subscription-based program.”
A prospective client recently sent us our investor.com profile here: Marotta Wealth Management and asked us to comment. Investor.com gave us a five-star trust rating and noted one “conflict alert.”
The alert is:
Trades Recommended Securities
SEC ADV Part 1 | Item 8.A.2
What does this mean and why is it important?
Firm or a related person trades securities for themselves that they also recommend to their clients.
While this can be seen as “eating your own cooking,” there are conflicts that may arise. For example, front-running is when a financial professional buys or sell securities ahead of their client. Financial professionals should disclose all positions they hold (or have sold short) that they will also be recommending to their clients.
Questions to ask
Which securities does your firm trade for itself that it will also be recommending to me?
Trading recommended securities could be an alert whether it is answered “yes” or “no.” It might be a problem if an advisor recommends one course of action for his clients while following a different course of action for themselves. A chef who doesn’t eat their own cooking might be a bad thing. Why are the investments advisors recommend for you not also the right investments for themselves?
On the other hand, trading securities for clients that you also trade for yourself can be problematic. For example, an advisor could purchase the securities in his or her own account first, and then purchase that same security in hundreds of client accounts in order to run the price up. Then, they could sell their copy of the security in their own account for a profit. This illegal practice is called “front-running .”
Front-running is much easier to accomplish when the stock is a thinly traded individual stock (rather than an exchange-traded fund). Front-running would be much harder when the purchase is an index fund comprised of many different individuals stocks all moving independently from one another. Since we mostly invest in common exchange-traded funds, these investments have average daily volumes that are typically significantly larger than our average daily trading. This would make any attempts at front-running very difficult.
As we discuss in our ADV Part 2 Item 11. Code of Ethics, Participation or Interest in Client Transactions, and Personal Trading (2023 Version Pages 8-9, emphasis added here):
The Advisers Act imposes a fiduciary duty on investment advisers. As fiduciaries, we have a duty of utmost good faith to act solely in the best interests of each of our clients. Our fiduciary duty compels all employees to act with the utmost integrity in all of our dealings. This fiduciary duty is the core principle underlying our Code of Ethics and Personal Trading Policy, and it represents the expected basis of all of our dealings with our clients.
We have adopted a Code of Ethics that sets forth the high ethical standards of business conduct we require of our employees. Character is as important as competence in the financial services profession, and we strive to be outstanding in both. We have structured the firm to avoid many potential conflicts of interest. The most obvious conflict of interest we have avoided is commission-based compensation. We operate on a fee-only basis.
We place the interests of clients ahead of the firm’s or any employee’s own investment interests. Employees are expected to conduct their personal securities transactions in accordance with the firm’s Personal Trading Policy and strive to avoid any actual or perceived conflict of interest with the interests of clients.
Our Code of Ethics includes provisions forbidding the use of nonpublic securities information (insider trading) and requires compliance with all applicable federal and state securities laws. We have an obligation to adhere not only to the specific provisions of the Code of Ethics but to the general principles guiding that code.
We suggest the same investments to you that we may hold in our own accounts, and we purchase securities in our own accounts that we may also recommend to you. Most of our recommended securities have a sufficient daily volume such that our trading activities should not significantly move a security’s price. Our Personal Trading Policy provides advisor guidelines to avoid any appearance of front-running or trying to benefit from the timing of personal trades.
Here at Marotta Wealth Management, we generally trade in client accounts twice each quarter, once as a major rebalance and a second time as a minor rebalance. Trades are specific to that client and done whenever the workflow for that client comes due. We are mostly trading exchange-traded funds with sufficient daily volume of trades compared to the volume that our trades represent. Each month, as Chief Compliance Officer, David John Marotta looks over that month’s trades, reviewing trades for trade errors, securities not on our Investment Committee’s buy list, trades made at the discretion of our clients, or trades made in a staff or staff-related account to monitor activity. Additionally, staff are required to submit all the trades they make in accounts not under our management (like an HSA) to our Chief Compliance Officer for review every six months. No review is required for mutual funds as they do not trade during the day and always receive pricing at 4pm.
Other firms may need additional rules to safeguard their clients from advisor misconduct.
Some firms employ analysts who are responsible for rating a particular set of companies. Because many financial advisors may use these ratings to recommend stocks to their clients, these analysts are banned from investing in the companies that they rate.
Some companies may make large trades for all of their clients at once. They may be required to make large block trades which all receive the same price rather than individual trades in client accounts. Their professionals may be allowed to participate in these block trades since every participant receives the same price.
Finally, some professionals may recommend specific stocks in the media which they also own. Because these recommendations reflect an honest review of the stock, they are not considered front-running. They may also be accompanied by a disclosure that they are held by the professional as well as a delay in trading that stock for three days on either side of the recommendation. These are usually seen as sufficient disclosures and allow time to avoid the appearance of front-running.
You can see from this commentary how “Trades Recommended Securities” is a more complicated topic than it originally appears.
Websites such as investor.com are useful, but not as useful as you might hope.
The prospective client who shared this with us was able to use investor.com to find some of the potential conflicts of interest inherent with their current advisor, picking up on the fact that their current advisor was also a broker-dealer. Alas, investor.com failed to list any of the 17 disclosures for the owners of the same advisory firm simply because those disclosures were related to the broker-dealer side of their filing rather than the advisory firm side of their filing.
Use investor.com if it helps you. However, in the end, National Association of Personal Financial Advisors (NAPFA.org) is still the only search we have found which will allow you to receive recommendations limited to fee-only financial planners who have received their CFP® certification and offer comprehensive financial planning services. To find a NAPFA advisor near you, read our article “How To Find A NAPFA-Registered Advisor In Your Area.”
Photo by Toa Heftiba on Unsplash. Image has been cropped.