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Financial firms lobby hard against stricter protections

WASHINGTON — The sting operation had the trappings of a Wall Street thriller, except that it was run by a team of Harvard and MIT economists. In an audacious experiment, the professors dispatched a squad of undercover operatives across Cambridge and Boston to pose as middle-class investors and ask retail brokers for investment advice.

The results were revealing. Just 21 out of 284 brokers contacted by the phony clients recommended investing in index funds, which mirror broader market performance and carry the smallest fees.

Nearly half the brokers, meanwhile, steered clients toward actively managed mutual funds. Those funds — which sometimes beat the market but most often don’t — carry higher fees that enrich brokers and fund managers but, critics say, stunt the growth of middle-class nest eggs.


“You get a worse deal,’’ said Antoinette Schoar, an MIT finance professor who helped lead the experiment, which received little attention when it was published in 2012.

The type of routine sales practices highlighted in the Massachusetts study, and a recent follow-up in New York involving 650 undercover visits, are driving an impassioned debate in Washington about whether small investors need stronger protections from an industry aggressively competing for a slice of their retirement savings. Advocates want strict rules forcing brokers to put their clients’ interests first.

The battle pits an array of consumer watchdog groups, AARP, and labor unions including the AFL-CIO against a slew of big, nationally known companies, with Fidelity Investments, which is headquartered in Boston, and MassMutual Financial Group, based in Springfield, prominent among them.

Investment firms have spent millions lobbying the administration and lawmakers, including $450,000 on a secretive effort in which the participants’ identities are kept under wraps. The industry says that excessive restrictions on brokers would make it economically unfeasible to offer financial advice at the lower end of the market. After winning delay after delay from regulators, they have fresh political developments to cheer.


Hostility to Wall Street regulations is expected to intensify in Congress with the Republican takeover of the Senate, posing a new test of President Obama’s resolve in his last two years in office.

Kentucky Senator Mitch McConnell, likely to rise to majority leader in January, said the Senate Banking Committee will seek to repeal elements of the Dodd-Frank Act, a 2010 financial industry reform law that he called “Obamacare for banks.’’

For all the lobbying over financial reform, the struggle over how to regulate retail brokers could have the biggest impact on mom-and-pop investors. Supporters of tougher standards say they want to reduce the influence of hidden payments and commissions that give brokers an incentive to steer clients to high-fee investments regardless of return.

“What the industry is fighting for is to continue to have undisclosed conflicts of interest that allow them to put their personal economic interest above the best interest of their clients,’’ said Dennis M. Kelleher, chief executive of Better Markets, a nonprofit advocacy group that supports regulations to change broker behavior.

The Department of Labor is expected early next year to formally propose a hotly contested rule that would require brokers offering retirement investment advice to put the interests of their clients ahead of their own. The Securities and Exchange Commission, after completing a study required under the Dodd-Frank law, is deciding whether to move ahead with a similar standard.


Both rules would expand what is known as a “fiduciary’’ standard governing investment advisers. Some advisers — called registered investment advisers, or certified financial planners — already adhere to a standard putting their clients’ interests first. Brokers are subject to a looser rule, which requires investments they recommend be “suitable’’ for a client.

Critics say the “suitability’’ standard leaves too much wiggle room for brokers to benefit themselves and their employers by promoting investments that are more costly for the investor.

The stakes are high for middle-class consumers, many of whom have been pushed out of traditional workplace pensions in the last three decades and now must make their own investment choices, navigating a landscape of 401(k) plans, individual retirement accounts, and annuities.

Americans had $5.4 trillion invested in IRAs alone at the end of 2012, according to the Investment Company Institute, a trade group.

Excessive fees and underperforming investments can, over time, shave tens of thousands of dollars or more off middle-class retirement account. But typical investors are often not sophisticated enough to spot the pitfalls, and they may fall victim to sales tactics disguised as earnest financial advice, say advocates for tighter rules.

“If they want to sell me a yellow Volkswagen, I want to know: Are they really selling me a yellow Volkswagen because it’s good for me, or if it’s because they are getting an extra commission because they are selling me a yellow Volkswagen,’’ said US Representative Michael Capuano, Democrat of Somerville, on the House Financial Services Committee.


A fellow committee member, Representative Stephen Lynch, Democrat of South Boston, and both Massachusetts senators, Democrats Edward Markey and Elizabeth Warren, also support the initiatives.

Some of the disagreement has been fueled by the rise of low-cost index mutual funds, which were pioneered in the 1970s by the Vanguard Group, which is based in Pennsylvania and is Fidelity’s largest rival.

Overall, actively managed funds with their higher fees have fallen behind index funds in performance. More than 70 percent of actively managed mutual funds failed to deliver higher returns than the market in the last five years, reported SPIVA Financial Scorecard, part of McGraw Hill Financial.

Mutual fund companies point out that actively managed funds are still worth a bet because they offer at least a chance to beat the market, while index funds — by their very nature — do not.

As any viewer of a televised New England Patriots football game or professional golf tournament will attest, financial planning services and investment advice are widely marketed to Main Street investors. Fidelity, for instance, aired spots for its “Green Line’’ advisory services this month during the Patriots’ big win against the Denver Broncos.

These advertised services utilize brokers working under the “suitability’’ standard. Like most mutual fund companies, Fidelity offers both actively managed and index funds; it says customers buy shares in both types. In a statement, Fidelity said several of its managed funds have built up records of beating the market, and its array of managed offerings performs better than the national average.


Fidelity and others in the industry have offered qualified support for revised SEC fiduciary rules, but the agency has been studying the concept without action for years.

The Department of Labor regulations, focused on retirement investing, are generating more heated opposition. Industry executives and lobbyists point to a 2010 draft that was widely panned as overly strict, and then withdrawn. They contend the next version also is likely to be excessively restrictive, and have launched waves of preemptive political strikes.

Under terms of the 2010 proposal, “much of the financial education and guidance currently available to Americans would be significantly limited — even if the guidance is in their best interest,’’ said Ralph Derbyshire, a Fidelity senior vice president. “The result would be that many people, particularly middle- and lower-income workers, would be priced out of the market to get the help they need to plan and save for retirement.”

The argument is echoed in Congress, where Republicans and Democrats have bombarded the labor agency with letters.

About a dozen anonymous financial companies have banded together for a lobbying campaign that has sent studies and reports around Washington to support industry positions. Listed on public disclosure forms only as “Broker/Dealer Coordination Group,’’ the informal organization is managed by Kent Mason, a lobbyist with offices on Pennsylvania Avenue.

A 2007 law restricting such “stealth lobbying’’ organizations requires disclosure of individual members. However, the law also permits them to remain anonymous if each member spends less than $5,000 per quarter on lobbying activities.

Mason declined in an interview to name the companies in the group, which has spent $450,000 since 2011. MassMutual confirmed it is a member; Fidelity would not say.

“We are not going to confirm nor deny our participation,’’ Fidelity spokeswoman Eileen O’Connnor said, pointing out that the company routinely discloses its lobbying activities, “but we often work with like-minded firms on many regulatory issues that could impact our business or our customers.’’

The findings of several of the reports issued by the Broker/Dealer Coordination Group have been disputed. One is a survey, released with the US Hispanic Chamber of Commerce, warning that the Department of Labor rules would prompt large numbers of small businesses to drop 401k plans.

Consumer advocates contend the report was based on a loaded survey question. In the question, respondents were told retirement plan managers might be prohibited from giving employers investment guidance. False, say advocates.

“This is the Wall Street fog machine that spews out misrepresentations, disinformation, if not outright lies,’’ said Kelleher, with Better Markets.

Some question the industry’s aggressive mass marketing of personalized investment advice when a formula based on a family’s projected retirement dates and risk tolerance can easily produce a lineup of low-cost mutual fund options, said Schoar, the MIT professor.

But a finance professor at Boston College who studies investor behavior, Jonathan Reuter, said brokers play an important role when someone is leaving a job and needs to roll over a 401(k) plan into an IRA. In that scenario, even biased, self-interested advice is better than no advice at all, because a broker will at least encourage keeping the money in savings rather than, say, buying a new boat.

“It would be great if brokers just gave unbiased advice, but it also would be great if you went to Sears and they gave you unbiased advice on what washing machine to buy,’’ he said. “But that is not the world we live in.’’

Christopher Rowland can be reached at crowland@globe.com. Follow him on Twitter @GlobeRowland.