Vanguard sued for [failing to charge market rates to and then paying taxes on services to its mutual funds]

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FrogPrince
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Re: Vanguard sued for charging too little

Post by FrogPrince » Mon Feb 23, 2015 5:57 pm

If you're interested in the legal arguments, see http://www.philly.com/philly/blogs/inq- ... Danon.html

It's interesting that Vanguard seems to be pinning their strategy on the ethics of Danon's (the whistleblower) behavior, charging that he violated the duties of confidentiality he owed originally as counsel to Vanguard. Danon is arguing that such duty does not apply if the Vanguard's actions are illegal (technically, whether the actions of Vanguard constituted a crime). It looks like it will come down to basically the judge deciding whether Vanguard broke the law.

won the lottery
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Re: Vanguard sued for charging too little

Post by won the lottery » Mon Feb 23, 2015 6:09 pm

But the big issue is with the IRS, not NY. Danon could lose NY on this issue (the attorney issue) but Vanguard could still have federal tax liability.

I am not fully buying the lawyer's implication (if this is what he implied) that there will be a quick resolution. Vanguard will almost certainly challenge the IRS' assessment. Appeals would take years, so I don't think there is any immediate worry. I wanted to look into how the SEC operates in cases like this, but haven't had the chance.

I do think that the fact that Vanguard did not tell the court that it is not under audit is significant. Not commenting to the press on litigation is standard (though with the lawyer throwing down the gauntlet, I'm not sure that's the best tactic) but why not provide highly favorable information to the court?

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Re: Vanguard sued for charging too little

Post by Tanelorn » Mon Feb 23, 2015 7:07 pm

So suppose everything alleged is true - the IRS and NY tax guys eventually decide on back taxes and interest and so forth. What does this mean for past, present, and future Vanguard fund and ETF shareholders? Would the tax liabities being discussed exceed the size of this "buffer fund" and then somehow get billed to fund shareholders? How would that work since the taxes due go back decades? Would all the funds take a one-time NAV hit, and how big might that be? If it's a fraction of a penny, that's not much, or could it be more significant?

Would they somehow try to claw back the tax liabilities of past shareholders who had redeemed their shares? If not, perhaps this risk could be avoided by buying a different low-cost index fund until the risk of these liabilities are resolved.

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Re: Vanguard sued for charging too little

Post by archbish99 » Mon Feb 23, 2015 10:30 pm

Just from the article, the alleged underpayment is $1 billion, and the reserve fund is $1.5 billion. Now, depending on the size of any penalties assessed, it might grow, but on the penalties I suspect Vanguard has a better argument that they've made their manner of operation public and have never received an indication from the IRS that their structure is a problem. I suspect the outcome would be payment of taxes out of the reserve, but then temporarily increased ERs to cover whatever the reserve fund was supposed to pay for. Earlier in the thread, it was pointed out that simply paying the income taxes themselves on an ongoing basis would only affect ERs by a few basis points at most.
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Re: Vanguard sued for charging too little

Post by in_reality » Tue Feb 24, 2015 2:32 am

archbish99 wrote:but on the penalties I suspect Vanguard has a better argument that they've made their manner of operation public and have never received an indication from the IRS that their structure is a problem.
I completely agree...

If it come to a penalty get Bogle on the stand...

Q. What were you try to do with Vanguard's structure?
A. Stop them from getting ripped off ...

Q. How much did you personally benefit from this tax scheme?
A. Compared to typical compensation in the industry not much really..

Q. Did anything Vanguard do really hurt anyone?
A. If you mean investors... Let me tell you how many people it helped...

If you need a character witness to explain what the intent of the structure is, why it got implimented the way it did, what the results to investors were, why they didn't think it was doing anything wrong and how unfair it would be to hold current account holders liable by imposing a large penalty for years of something in all honesty no-one really thought was wrong... I can't imagine a better character witness than Bogle to put on the stand.

So even if Vanguard were to lose the case, I can't image retroactive penalties for conduct that at the time was not clearly known to be wrong. Again, I am not saying Vanguard is in the wrong here as really I don't know. But if that turns out to be the case, I can't believe it would ever be seen as a deliberate attempt to avoid tax liabilities.

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Re: Vanguard sued for charging too little

Post by won the lottery » Tue Feb 24, 2015 4:22 am

This is a great thread; I agree with everything that is said. Unfortunately there are specific penalties for transfer pricing violations that apply irrespective of motive. There are 40% penalties based solely on IRS adjustments above a certain threshold, which would certainly be exceeded if Vanguard lost. However, the IRS could waive those, and likely would as part of negotiation before trial. On the other hand, if Vanguard fights liability in tax court the IRS would seek penalties as part of litigation and because the penalties are automatic based on the amount of the liability Vanguard would have to pay them.

I can't agree more about Bogle; it seems inconceivable that he intended to illegally avoid taxes. On the other hand, according to the WB he informed Vanguard of the tax liability, it has been publicly aired since August and the IRS has been auditing for two years. Vanguard's failure to acknowledge its liability quickly (if it has clear liability) will not help with the IRS or the SEC.

But again, Vanguard will still be able to provide high value services and will still be more focused on client needs than most of its competitors. A current Vanguard vs. Fidelity thread includes tales of Fidelity acts that would never happen at Vanguard.

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Re: Vanguard sued for charging too little

Post by JamesSFO » Tue Feb 24, 2015 12:12 pm

Just to be clear there is NO IRS action, this is purely a state law, civil suit by a private party against Vanguard at this point.

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Re: Vanguard sued for charging too little

Post by FrogPrince » Tue Feb 24, 2015 12:46 pm

The IRS is reviewing, but yes it is independent of this lawsuit. However, should it be determined (IRS + judicial review I'm sure) that Vanguard owes back taxes plus potential penalties, Danon is likley to get a cut of it.
JamesSFO wrote:Just to be clear there is NO IRS action, this is purely a state law, civil suit by a private party against Vanguard at this point.

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Re: Vanguard sued for charging too little

Post by FrogPrince » Tue Feb 24, 2015 12:48 pm

Completely agree with you regarding Bogle's motivations, and I for one am happy he was pushing for the little guys like me.

However, the law is a parallel universe where most of our real world concerns are moot. If you cheat on taxes so you can pay your spouse's medical bills, you still will get nailed. Such is life.
in_reality wrote:
archbish99 wrote:but on the penalties I suspect Vanguard has a better argument that they've made their manner of operation public and have never received an indication from the IRS that their structure is a problem.
I completely agree...

If it come to a penalty get Bogle on the stand...

Q. What were you try to do with Vanguard's structure?
A. Stop them from getting ripped off ...

Q. How much did you personally benefit from this tax scheme?
A. Compared to typical compensation in the industry not much really..

Q. Did anything Vanguard do really hurt anyone?
A. If you mean investors... Let me tell you how many people it helped...

If you need a character witness to explain what the intent of the structure is, why it got implimented the way it did, what the results to investors were, why they didn't think it was doing anything wrong and how unfair it would be to hold current account holders liable by imposing a large penalty for years of something in all honesty no-one really thought was wrong... I can't imagine a better character witness than Bogle to put on the stand.

So even if Vanguard were to lose the case, I can't image retroactive penalties for conduct that at the time was not clearly known to be wrong. Again, I am not saying Vanguard is in the wrong here as really I don't know. But if that turns out to be the case, I can't believe it would ever be seen as a deliberate attempt to avoid tax liabilities.

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Re: Vanguard sued for charging too little

Post by talzara » Wed Feb 25, 2015 1:43 am

won the lottery wrote:This is very, very basic tax law. See quotes below in the links below, from Robert Willens, a very prominent tax lawyer, from articles about the case in The Financial Times and in Bloomberg BNA's Transfer Pricing Report, the most respected periodical on transfer pricing.

http://www.duffandphelps.com/SiteCollec ... %20BNA.pdf
The Bloomberg BNA report makes a very interesting point: Vanguard could have avoided this situation entirely if it had been organized as a Subchapter T cooperative, instead of a C corporation.

In other words, if Vanguard restructured as a Subchapter T cooperative, then any profits get refunded to the owners (the mutual funds), who can pass them through to us as dividends. Duff makes a big deal about how Vanguard cannot structure itself under Subchapter T, but the 1975 SEC order explicitly approved internalization of shared functions. It's just a matter of selecting the appropriate corporate form to achieve pass-through. The SEC has already approved the substance of what Vanguard is doing. Why would they insist that Vanguard be a C corporation?

The worst case scenario for Vanguard would seem to be a one-time tax penalty. 35% of $1.5 billion is $525 million, which is about 0.0175% of Vanguard's $3 trillion AUM. So Vanguard ETF expenses go up to iShares levels for one year, and then they go back down the next year under the new Subchapter T cooperative. New York seems to have very little to gain, even at treble damages. I can see why the New York attorney general declined to intervene.

P.S. It's ironic that Duff & Phelps is linking to the Bloomberg BNA report. The most clueless lawyer quoted in the article was Sherif Assef of Duff & Phelps! He claimed, among other things, that Vanguard was providing "a high-end service like managing assets," and that "common control or common ownership may not be immediately obvious."

Vanguard is, of course, not in the asset management business. They are in the fairly boring business of providing back-end services: marketing, recordkeeping, distribution, etc. The actively-managed funds do hire asset managers, but these are outside advisors unrelated to Vanguard. As for the second quote, Vanguard's corporate structure is plain as day. They boast about it in most of their marketing materials.

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Re: Vanguard sued for charging too little

Post by in_reality » Wed Feb 25, 2015 5:28 am

FrogPrince wrote:Completely agree with you regarding Bogle's motivations, and I for one am happy he was pushing for the little guys like me.

However, the law is a parallel universe where most of our real world concerns are moot. If you cheat on taxes so you can pay your spouse's medical bills, you still will get nailed. Such is life.
What I am suggesting is that Vanguard's structure is atypical and that is was not intended to be a tax dodge. I mean would raising ERs a few basis points materially change the company or the industry? Does not paying taxes somehow enrich the executives?

If in fact Vanguard is in violation of transfer pricing somehow, it is a fact that is truly not clear enough for the IRS whose job it is to know to really understand.

So if I were to provide expensive medical treatment for my wife, and dutifully deduct it from my taxes, and then find out that the treatment is now proven to just be a placebo effect (likely due to the high cost and expectation) and so it won't be considered a medical treatment anymore, have I really cheated on my taxes? Well my intent was not to cheat and if that large deduction which was never approved nor disapproved by the IRS but was taken by me as it was considered to be an effective medical treatment is retroactively disallowed ...

Yeah I get your point, but what motivation is there for Vanguard to knowingly cheat on taxes to shave off a few basis points from ERs?

Maybe they aren't paying what they should in taxes, and note the "maybe" because I don't know for sure, but truly "who knew"? Not the IRS I think. Not Bogle I think. Not the SEC I think. And not their competitors. Nobody knew and what they were doing was in plain sight?

The atypical structure is not to cheat on taxes. Cheating on taxes, if that is really what is happening, is a result of not knowing how an atypical structure fits into the incredibly complex tax code. That I think should be properly taken into consideration. Obviously I am not a lawyer and happily live in the real world where things make sense.

Anyway, my understanding of implementing new financial products is that typically there are policy discussions with relevant regulators and other officials to discern how edge cases or grey areas which aren't dealt with under existing legislation would be handled. Maybe taxation never came up, and maybe it was Vanguard's responsibility to know but I can't believe they'd knowingly go ahead with an illegal plan (because the tax involved would not materially change their chances for success -- the ER differential is overwhelming to the industry average already).

It's simply beyond credulous to believe Vanguard was knowingly structured in such a way as to violate tax law. Someone would have raised concerns on the organizational risk. I bet no-one can find any record of that anywhere (even in the documents Danon stole).

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Re: Vanguard sued for charging too little

Post by won the lottery » Wed Feb 25, 2015 10:42 am

A number of comments to the last two posts. Readers should know that tax lawyers are quite interested in this case; lawyers at my firm have discussed the case extensively and a top law firm has described it as one of the top cases of interest for 2015.

Vanguard could not be a Subchapter T corp (a cooperative) for many reasons; one of the articles on the case discussed this and I looked into it myself to confirm that its discussion was correct.

First, the funds are mutual funds and must meet a number of tax law requirements to maintain this status. One of these tests imposes strict limits on "active income," which means business income as opposed to dividends, interest, etc. Vanguard's income is active income and if it were a cooperative the "patronage dividends" it would pay to the funds would be active income and endanger their qualification as mutual funds.

There are a number of other reasons Vanguard could not be a Subchapter T corporation; Vanguard's operations don't meet, and couldn't meet, the cooperative qualification tests.

Most important, income earned by cooperatives is subject to tax, either at the level of the cooperative or at the level of the patrons (the owners) and Section 482/arms-length pricing rules apply just as they do to C corporations. So Vanguard would still not be able to provide at-cost services.

I understand the thinking behind the comment that Vanguard is not providing high end services, but as a tax law manner that is wrong. Investment management is a sophisticated multifaceted business in a highly regulated industry. And control would not be obvious to the IRS at all. Control ordinarily exists when there is 50% or greater ownership.

The SEC order approves the structure only for securities law purposes. The order is very short and says nothing about tax. I agree with the other writers that it is very unlikely that Bogle intended to illegally avoid tax. However, he's very smart and may have intended to avoid tax thinking doing so was legal. It is possible that no one ever looked at it until the whistleblower did. At that point Vanguard should have reconsidered and it is not apparent that they did.

The one idea which I really think readers should understand is that the fact that it benefits investors is not an argument and in no way justifies the structure. Corporate tax avoidance always benefits shareholders. If a US corporation illegally avoids tax by parking money in illegal overseas bank accounts and not reporting the income and then pays higher dividends to its US shareholders does anyone on this forum think that would be ok? I understand that people (justifiably) love Vanguard, but it could pay tax as legally required and still be the best bargain in town. I'm not saying that it is not doing that, the jury is still out. I'm just saying that people should stop claiming that the benefit to investors is an argument against complying with the law.

Finally, I don't understand why anyone would think that New York has little to gain. If the WB is correct Vanguard avoided tens of millions of dollars of NY tax. NY may have declined to pursue the case because it knows the IRS is pursuing it. NY, like most states imposes tax based on federal income, so if the IRS adjusts Vanguard's income NY will get tax without having to do anything. The law permits the IRS to share taxpayer information with states so NY may know more than anyone other than the IRS. (Ironic that the WB may be pursuing NY because he doesn't know what the IRS is doing.)

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Re: Vanguard sued for charging too little

Post by won the lottery » Wed Feb 25, 2015 2:18 pm

I should add that I think there is a good chance the WB loses on the motion to dismiss because of the attorney confidentiality issue. This is not my area but there is strong case law in a related area (the Federal False Claims Act) that bars an attorney from being a false claims act litigant against a former client in most circumstances. This is a NY False Claims Act suit and the facts are very different, but he could easily lose. I suspect he thought that NY would take the case in which case the bar would not apply, or would be much less strict.

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Re: Vanguard sued for charging too little

Post by talzara » Wed Feb 25, 2015 10:03 pm

won the lottery wrote:First, the funds are mutual funds and must meet a number of tax law requirements to maintain this status. One of these tests imposes strict limits on "active income," which means business income as opposed to dividends, interest, etc. Vanguard's income is active income and if it were a cooperative the "patronage dividends" it would pay to the funds would be active income and endanger their qualification as mutual funds.
Not even close.

26 U.S.C. § 851 (b)(2) states that 90% of a mutual fund's gross income must come from investment activity. There is not a single fund at Vanguard that would fail the 90% test if Vanguard were to organize itself as a Subchapter T cooperative that pays out its profits as a patronage rebate. The expenses are simply too low.

For example, Total Stock Market has a 1.9% dividend yield and a 0.17% expense ratio for the Investor shares. If Vanguard is required to make a 10% profit on that 0.17% in an arms-length transaction, then 99.1% of the Investor shares' gross income would come from investment activity.
won the lottery wrote: There are a number of other reasons Vanguard could not be a Subchapter T corporation; Vanguard's operations don't meet, and couldn't meet, the cooperative qualification tests.

Most important, income earned by cooperatives is subject to tax, either at the level of the cooperative or at the level of the patrons (the owners) and Section 482/arms-length pricing rules apply just as they do to C corporations. So Vanguard would still not be able to provide at-cost services.
Since your first example doesn't work, you will understand that I can't take your word for those "other reasons." Perhaps you could list them. Vanguard funds own shares in Vanguard, which does business only with Vanguard funds. How is this not a cooperative?

The point of a cooperative is to avoid adding another layer of double-taxation. The fact that the cooperative earns a profit is irrelevant from an economic perspective, since it gets passed through to the owner. For a mutual fund, which is itself a pass-through entity, the income would get distributed to the shareholders, who then get taxed on it.
won the lottery wrote: Finally, I don't understand why anyone would think that New York has little to gain. If the WB is correct Vanguard avoided tens of millions of dollars of NY tax. NY may have declined to pursue the case because it knows the IRS is pursuing it. NY, like most states imposes tax based on federal income, so if the IRS adjusts Vanguard's income NY will get tax without having to do anything. The law permits the IRS to share taxpayer information with states so NY may know more than anyone other than the IRS. (Ironic that the WB may be pursuing NY because he doesn't know what the IRS is doing.)
If Vanguard is forced to raise its expense ratio, then this could lead to a general industrywide slackening of price competition. If New York pension funds end up paying higher expenses on all their index funds, it is quite possible that this will cancel out much or even all of the taxes that New York could stand to collect from Vanguard. Even worse, New York is on the hook for any future actuarial shortfall in the pension fund, but the whistleblower gets his cut of taxes without the risk of being clawed back to pay into the pension fund. Besides, most of the money would go to the federal government, and most of the rest would go to Pennsylvania.

You work at a law firm. It is not surprising that you're taking a narrow legalistic viewpoint of this. On the other hand, the attorney general of New York would like to be the next governor of New York. You can see why he might want to steer clear of this case.

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Re: Vanguard sued for charging too little

Post by littlebird » Wed Feb 25, 2015 10:19 pm

FrogPrince wrote:However, the law is a parallel universe where most of our real world concerns are moot. If you cheat on taxes so you can pay your spouse's medical bills, you still will get nailed. Such is life.
.
So if the law were a part of our universe instead of being a "parallel" one as you claim, what would the result be if you cheated on your taxes "to pay your spouse's medical bills"? :confused

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Re: Vanguard sued for charging too little

Post by won the lottery » Thu Feb 26, 2015 3:43 am

I appreciate the skepticism, talzara, of course you shouldn't take my word for it but here's why you are wrong:

(1) See below Prime Money Market Fund February semiannual report for February 28, 2014; its yield is .01% and expense ratios between .10 and .17%; it would fail the 90% test. I said "endanger" funds to fail the test, not "cause" every fund to fail the test. A workable structure cannot permit *any* risk of failure.

http://www.vanguard.com/funds/reports/q302.pdf

I thought this would be the easiest/most intuitive explanation which is why I provided it rather other explanations less intuitively obvious. Here's another one that may help. As a business matter the tax exempt funds (which have low yields like Prime Money Market) cannot take slugs of active business income. Vanguard cannot tell investors who are seeking tax exempt income and only tax exempt income that they will also be getting some good old business income.

Also, the present expense ratios are the ratios without a markup; arms-length markups would be somewhat higher.

(2) Cooperative income is not simply passed through to owners (patrons) willy-nilly; it must be based on business the cooperative does with the patrons. This is very different from Vanguard's present method for determining expense ratios. And a cooperative must pay tax on income retained not paid as patronage dividends; cooperatives invariably retain income for business needs.

(3) Vanguard would also be subject to on its overseas business income because the overseas funds are not owners of Vanguard. To give you an idea how cooperatives operate, the annual report of a real cooperative is below.

http://annualreport.chsinc.com/FY2013/Overview.aspx

(4) Perhaps the easiest proof that Vanguard cannot be a cooperative is that its motion to dismiss makes no mention of cooperatives and acknowledges that Section 482 applies to its services to the funds.

It is true, talzara, that lawyers tend to care about the actual law (imagine that) but Section 482 is really, really basic. Suggesting that this issue is narrow and legalistic is like suggesting that it's narrow and legalistic to tax those wealthy people with UBS accounts. Their money is outside the US, right? Why should they have to pay tax on it?

One of the articles also made the obvious suggestion that the AG's decline may be political. Sure that's a big possibility (Vanguard manages New York's 529 plan!) but it seems short sighted. If Vanguard loses in any of the whistleblower's forums that decision will look suspect in retrospect. If the AG was focused on this it would have made more sense to kill it, to seek dismissal before the case was made public. Right now I would guess would-be whistleblowers to NY are wondering about this great False Claims Act they tout. I don't think I would ever be a whistleblower but I sure wouldn't be one in New York.

Finally, there's a huge issue that the press does not discuss and that this forum hasn't addressed. The NY case is based on a fraud statute that requires "knowledge" - actual knowledge or "reckless disregard." That is very, very different from the IRS case, which requires only liability. New York may have decided that it would be difficult to prove reckless disregard. We can't evaluate this without more facts because the Contingency Reserve is a separate grounds for the case (let alone whether the Section 482 issue meets the standard).
Last edited by won the lottery on Thu Feb 26, 2015 5:17 am, edited 1 time in total.

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Re: Vanguard sued for charging too little

Post by won the lottery » Thu Feb 26, 2015 4:21 am

I should add/stress that my conclusions are not based on anti-Vanguard sentiment. I love Vanguard and think its structure is quite workable even if its expense ratios increase modestly as a result of paying more tax (but remember that we don't know whether the WB is correct about Vanguard's failure to pay income tax). I've always been disappointed/annoyed that my firm's 401(k) plan has Fidelity rather than Vanguard funds.

It's just that senior tax lawyers are sort of amazed that the IRS missed it for so long (but Willens is right that it's not that surprising that they wouldn't be looking in a domestic/mutual fund context for 482 violations). Also, lawyers generally are intrigued by the spectacle of an attorney whistleblower. Again, not my area, and it's not that important for tax, but it's a big deal for SEC lawyers; my understanding is that the SEC whistleblower rules explicitly permit lawyer whistleblowers under some circumstances.

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Re: Vanguard sued for charging too little

Post by Seattlenative » Thu Feb 26, 2015 5:20 am

won the lottery wrote: But again, Vanguard will still be able to provide high value services and will still be more focused on client needs than most of its competitors. A current Vanguard vs. Fidelity thread includes tales of Fidelity acts that would never happen at Vanguard.
Two questions here, and perhaps these have already been answered within the thread.

a. Why has this WB vs. Vanguard case stayed in state court (New York) rather than being moved to Federal court? I can understand the plaintiff filing the initial complaint in state court, but I confess I'm baffled since there is diversity of citizenship involved here.

b. Where is the Vanguard vs. Fidelity thread?

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Re: Vanguard sued for charging too little

Post by JamesSFO » Thu Feb 26, 2015 9:20 am

Seattlenative wrote:
won the lottery wrote: But again, Vanguard will still be able to provide high value services and will still be more focused on client needs than most of its competitors. A current Vanguard vs. Fidelity thread includes tales of Fidelity acts that would never happen at Vanguard.
Two questions here, and perhaps these have already been answered within the thread.

a. Why has this WB vs. Vanguard case stayed in state court (New York) rather than being moved to Federal court? I can understand the plaintiff filing the initial complaint in state court, but I confess I'm baffled since there is diversity of citizenship involved here.

b. Where is the Vanguard vs. Fidelity thread?
(a) Perhaps because it is a unique type of qui tam type action where the whistleblower is figuratively acting in the shoes of the state of NY. Also Vanguard may have strategically preferred to keep it in state court despite potential for diversity jurisdiction

(b) Only thread I know of active now, no horrors by Fido of particular note just some emphasis on higher cost options: viewtopic.php?f=10&t=158974

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Re: Vanguard sued for charging too little

Post by won the lottery » Thu Feb 26, 2015 11:59 am

The whistleblower's NY suit has to stay in NY courts because it is based on NY state tax law, not federal law. The whistleblower's IRS and SEC claims are federal but he doesn't pursue these, the IRS and SEC do.

Are any SEC lawyers on this thread? I'd like to understand the SEC claim more.

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Re: Vanguard sued for charging too little

Post by sesq » Thu Feb 26, 2015 12:14 pm

I appreciate the co-op discussion. It was actually my first thought when I read about this, but hadn't had time to brush up on the applicable rules.

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Re: Vanguard sued for charging too little

Post by JamesSFO » Thu Feb 26, 2015 1:19 pm

won the lottery wrote:The whistleblower's NY suit has to stay in NY courts because it is based on NY state tax law, not federal law. The whistleblower's IRS and SEC claims are federal but he doesn't pursue these, the IRS and SEC do.

Are any SEC lawyers on this thread? I'd like to understand the SEC claim more.
In general, Federal District courts have diversity jurisdiction over state law claims if the amount in controversy is high enough. So it may be some unique property of this qui tam statute OR that Vanguard preferred to stay in New York. (Or maybe lack of diversity if the whistleblower and Vanguard are both PA residents.)

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Re: Vanguard sued for charging too little

Post by talzara » Thu Feb 26, 2015 9:21 pm

won the lottery wrote:(1) See below Prime Money Market Fund February semiannual report for February 28, 2014; its yield is .01% and expense ratios between .10 and .17%; it would fail the 90% test. I said "endanger" funds to fail the test, not "cause" every fund to fail the test. A workable structure cannot permit *any* risk of failure.
So what? A mutual fund doesn't go away just because it fails the 90% test of 26 U.S.C. § 851. It merely loses the tax pass-through benefit for that year. The mutual fund itself is still governed by the Investment Company Act of 1940.

When rates are this low, the Money Market fund is only being used to park money, not as an investment vehicle. People don't care if they lose an extra 35% corporate tax on a measly 0.01% yield. At any reasonable interest rate, i.e., in any situation where investors actually care about losing the pass-through nature of the mutual fund, there is no danger of falling below the 90% threshold.
won the lottery wrote:Here's another one that may help. As a business matter the tax exempt funds (which have low yields like Prime Money Market) cannot take slugs of active business income. Vanguard cannot tell investors who are seeking tax exempt income and only tax exempt income that they will also be getting some good old business income.
Why not? 99% of the income would still be tax-free. The other 1% comes from a hypothetical markup on an already-low expense ratio. If investors decide to shun Vanguard and go to another company, they get to avoid that 1% of taxable income in return for the privilege of paying much more in expenses.

For example: T. Rowe Price's California bond fund has a 0.50% expense ratio and a 1.83% SEC yield. Vanguard's long-term California bond fund has a 0.20% expense ratio and a 1.91% SEC yield, plus better credit quality and shorter duration to boot. A hypothetical 10% profit on 0.20% expense ratio in an arms-length transaction = 0.02%. Let's say half of that goes to federal and California taxes. Why give up 0.08% in yield to avoid 0.01% in extra taxes?

Anyone who wants to pay $2 to save 25 cents should feel free to leave Vanguard for the competition. Everyone else can stay with Vanguard and type an extra number into the computer at tax time.
won the lottery wrote:(2) Cooperative income is not simply passed through to owners (patrons) willy-nilly; it must be based on business the cooperative does with the patrons. This is very different from Vanguard's present method for determining expense ratios. And a cooperative must pay tax on income retained not paid as patronage dividends; cooperatives invariably retain income for business needs.
So what? If Vanguard becomes a cooperative, they should set the patronage rebate to be proportional to the business that each fund does with them. Vanguard Cooperative could easily structure the fees so as to ensure cash flow and minimize retained income.
won the lottery wrote:(3) Vanguard would also be subject to on its overseas business income because the overseas funds are not owners of Vanguard.
So charge them a tax gross-up. Vanguard is primarily an American company. There is greater risk from letting its US expense ratios creep up than from charging a tax gross-up to its overseas funds. Also, if Vanguard is truly interested in its customers rather than in empire-building, there's no reason these couldn't be spun off into a similar overseas organization.
won the lottery wrote: (4) Perhaps the easiest proof that Vanguard cannot be a cooperative is that its motion to dismiss makes no mention of cooperatives and acknowledges that Section 482 applies to its services to the funds.
No. That is the easiest proof that Vanguard isn't already a cooperative. That says nothing about whether or not Vanguard could restructure itself as a cooperative in the future. Since this is the first time that their corporate structure has been called into question, they never had any reason to consider doing this in the past.

--

I was responding to your post that said:
won the lottery wrote: There are a number of other reasons Vanguard could not be a Subchapter T corporation; Vanguard's operations don't meet, and couldn't meet, the cooperative qualification tests.
Perhaps I read that wrong, but I thought you meant that there was something in Vanguard's business model that absolutely, positively disqualifies them from becoming a Subchapter T cooperative.

Instead, all of your objections have only minor consequences. Considering that the alternative would be an increased expense ratio, these minor problems are tolerable. None of them seems to bar Vanguard from becoming a cooperative, if it had to.

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Re: Vanguard sued for charging too little

Post by talzara » Thu Feb 26, 2015 9:26 pm

won the lottery wrote:It is true, talzara, that lawyers tend to care about the actual law (imagine that) but Section 482 is really, really basic. Suggesting that this issue is narrow and legalistic is like suggesting that it's narrow and legalistic to tax those wealthy people with UBS accounts. Their money is outside the US, right? Why should they have to pay tax on it?
I'll address this question separately, since it's not related to cooperatives.

The guy with the Swiss bank account is not paying taxes, even though he cannot legally avoid them. He can only illegally avoid them by hiding the money away.

Vanguard, on the other hand, could legally avoid the taxes if they were to re-organize as a cooperative. That is very different from your example of a Swiss bank account, which is wrong not just in form but also in substance.

This case may be an interesting example of the importance of choosing the correct corporate form. However, there is little economic rationale behind it. Since 26 U.S.C. § 851 sets the passive income threshold at 90% rather than 100%, that practically invites its use as a safe harbor for any profits earned from a cooperative structure.

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Re: Vanguard sued for charging too little

Post by won the lottery » Fri Feb 27, 2015 4:47 am

A lot of good points, talzara, and it is a joy to be on a website with such lucid writers. (I mean this with all sincerity. I joined Bogleheads after reading threads on this topic that were way, way better than threads anywhere else).

In particular I think you're right that my original statement regarding Vanguard as a cooperative should have been phrased differently; I should have said that Vanguard could not operate as it does presently in cooperative form. I don't believe that the differences we have focused on are mere tweaks. For example; a little active business income in a tax exempt fund may be undesirable enough to enough investors that the tax exempt funds lose sufficient AUM causing increased expense ratios; an arms-length determination of prices and patronage dividends that qualify under cooperative rules would be less desirable than Vanguard's present method of determining expense ratios, etc.

However, talzara, here's where we agree (I think). Vanguard's structure provides an inherent advantage to investors. A cooperative structure would enable it to avoid corporate level tax and increase that advantage, but my point is that even if Vanguard pays corporate income tax its structure would be superior to its competitors. Perhaps a cooperative structure could work (I am not expert in cooperatives or the mutual fund business, I do mostly international, transfer pricing and capital markets work). But then a partnership might work too, and that would avoid corporate level tax and provide far more flexibility than a cooperative. Partnerships are of course the common form of organization for investment management companies in settings that do not require a "blocker" (to avoid US business income, for example).

The reason I am skeptical that a mutual fund manager can be a pass through entity owned by mutual funds to avoid corporate income tax is that no one ever does it this way. The applications for SEC exemptive orders for structures similar to Vanguard that I have seen (manager owned by mutual fund; with some differences irrelevant to this point) all recite the need to block the manager's active business income from the mutual fund. If corporate level tax could be avoided in the structure I assume these managers would have done so. (I will look for links to some of these later today or tomorrow.)

Finally, my analogy to offshore accounts was meant to point out that tax avoidance is tax avoidance. A better analogy would have been Vanguard providing at-cost services to foreign funds (i.e., imagine Vanguard owned by foreign funds). In that case, below market pricing would shift income to funds and investors not subject to US income tax; clearly an improper avoidance of US tax. But a significant portion of Vanguard's funds are owned by retirement vehicles that are not subject to current tax so its at-cost services shift income to entities that receive preferential tax treatment. That is no less improper tax avoidance of tax than shifting income offshore.

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Re: Vanguard sued for charging too little

Post by won the lottery » Fri Feb 27, 2015 11:29 am

Here is an SEC no action letter that recites use of a blocker to avoid endangering the 90% test, snippets pasted below.

http://www.sec.gov/divisions/investment ... 110713.htm

"For federal income tax purposes, the Parent Company has made an election to be treated as a regulated investment company ("RIC") under the Internal Revenue Code of 1986 (the "Code") . . . . Parent Company will satisfy these source-of-income requirements if it derives, in each taxable year, at least 90% of its gross income from dividends, interest . . . ("Good RIC Income").

The Subsidiary, a Delaware limited liability company, manages the day-to-day operational and investment activities of the Parent Company . . . [T]he Subsidiary is a taxable entity under the Code.

Investment management fee income received for investment advisory services . . . does not constitute Good RIC Income for the Parent Company. Because the Subsidiary is a taxable entity under the Code, however, such fee income, if earned by the Subsidiary and subsequently distributed to the Parent Company, would constitute Good RIC Income for the Parent Company. You represent that the utilization of the Subsidiary as a tax "blocker" entity in this manner is a lawful method of tax planning under the Code."

This reminds me of another big issue; Vanguard income from services provided to other parties (not its owner funds). Even if it were a cooperative it would be subject to full tax on that income. See below the description from the whistleblower's complaint claiming that Vanguard's present approach is to shelter overseas income by providing services at less than cost to the funds (so $2 billion dividend from overseas operations, charge zero to the funds, voila, no income and no tax). This is absolutely bizarre, makes tax lawyers' jaws drop and would be just like parking money offshore. Perhaps there is more to the story, but I checked Vanguard Funds' service agreement and confirmed that it does in fact provide this; see below.

Section 4.2

http://taxprof.typepad.com/files/vanguard-complaint.pdf

66. Vanguard’s foundational document (the contract between VGI and the Funds—the “Funds Service Agreement” (the “FSA”)) demonstrates an astonishing instance of Vanguard’s continued belief that it is simply not required to pay U.S. federal or state income taxes. In 1999—when Vanguard expanded its operation to non-Fund operations—the FSA was revised to provide that income earned by Vanguard from non-fund businesses (“Non-Fund Income”) will be used to reduce expenses of the Funds.

67. That is, Vanguard shelters Non-Fund Income by charging less than cost to the Funds to create losses that offset that income, and believes that it could shelter Non-Fund Income equal to its entire $2 billion costs of providing services to the Funds.

http://www.sec.gov/Archives/edgar/data/ ... dfunds.htm

"4.2 Services to Others. The Service Company may render services to any person other than the Funds so long as:

A. The services to be rendered to the Funds hereunder are not impaired thereby.
B. The terms and provisions upon which the services are to be rendered have
been approved by the holders of a majority of the Shares.
C. The services rendered for compensation and, to the extent achievable, for the purpose of gaining a profit thereon. D. Any income earned and fees received by Service Company shall be used to reduce the total costs and expenses of Service Company."

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Re: Vanguard sued for charging too little

Post by in_reality » Sun Mar 01, 2015 9:19 pm

won the lottery wrote: I can't agree more about Bogle; it seems inconceivable that he intended to illegally avoid taxes. On the other hand, according to the WB he informed Vanguard of the tax liability, it has been publicly aired since August and the IRS has been auditing for two years. Vanguard's failure to acknowledge its liability quickly (if it has clear liability) will not help with the IRS or the SEC.
Oops I relent - perhaps Bogle can't really speak to the actions of Vanguard today. Reading the complaint it seems there have been changes in Vanguard since Bogle's tenure especially in the Contingency Reserve which is 1,000 times the size of all payments made for its claimed purpose over the nearly 15 years since it was established. In 2003, the Contingency Reserve was $283 million—much smaller than its present $1.5 billion balance and Vanguard disclosed the Contingency Reserve on “IRS Form 8886 Reportable Transaction Statement.” They no longer disclose it. http://taxprof.typepad.com/files/vanguard-complaint.pdf

One accusation is that the reserve is not properly declared as income and is earning interest which is also not reported.

Since executive compensation is not disclosed, I wonder how it could be found out if executives compensation is somehow connected to these reserves. I don't mean to suggest a deliberate attempt at anything, but just rather that it might inadvertently look that way.

I'm overseas and introducing Vanguard funds to co-workers now that they have been made available to their retirement accounts. I am anxious that bad publicity on a tax front would hit my creditability personally. I am going to recommend Vanguard anyway because they are still the gold standard for investment and I can't see that ever changing really. It'd be easy enough to explain but the language barrier kinda confuses things a little and makes things less clear...

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Re: Vanguard sued for charging too little

Post by Everlearning » Mon Mar 16, 2015 8:07 am

How soon will we know the conclusion to all of this? Is there a date set for a verdict yet?

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Re: Vanguard sued for charging too little

Post by talzara » Mon Mar 16, 2015 8:38 pm

won the lottery wrote:However, talzara, here's where we agree (I think). Vanguard's structure provides an inherent advantage to investors. A cooperative structure would enable it to avoid corporate level tax and increase that advantage, but my point is that even if Vanguard pays corporate income tax its structure would be superior to its competitors. Perhaps a cooperative structure could work (I am not expert in cooperatives or the mutual fund business, I do mostly international, transfer pricing and capital markets work). But then a partnership might work too, and that would avoid corporate level tax and provide far more flexibility than a cooperative. Partnerships are of course the common form of organization for investment management companies in settings that do not require a "blocker" (to avoid US business income, for example).
Yes, we do agree on that.

As I see it, the consequences are minimal no matter what happens:
  • If Vanguard wins, then nothing changes.
  • If Vanguard loses and converts to a cooperative, then almost nothing changes.
  • If Vanguard loses and converts to some other form of tax-advantaged structure, then almost nothing changes.
  • If Vanguard loses and has no choice but to go for-profit, then almost nothing changes.
Expense ratios would either remain unchanged, or go up minimally. For the lowest-priced share classes of index funds, not even a basis point. That's the advantage of low costs. Even if you add tax drag on top, it still amounts to very little.

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Re: Vanguard sued for charging too little

Post by talzara » Mon Mar 16, 2015 8:55 pm

in_reality wrote: Oops I relent - perhaps Bogle can't really speak to the actions of Vanguard today. Reading the complaint it seems there have been changes in Vanguard since Bogle's tenure especially in the Contingency Reserve which is 1,000 times the size of all payments made for its claimed purpose over the nearly 15 years since it was established. In 2003, the Contingency Reserve was $283 million—much smaller than its present $1.5 billion balance and Vanguard disclosed the Contingency Reserve on “IRS Form 8886 Reportable Transaction Statement.” They no longer disclose it. http://taxprof.typepad.com/files/vanguard-complaint.pdf
That's a direct quote from the complaint. Of course it's going to present a skewed view that makes it seem nefarious.

But consider what happens when a black swan actually hits. They might accumulate assets for year and years, possibly even decades. Then the entire reserve evaporates on one day.

If there's no reserve, then the current shareholders take the full hit. Meanwhile, last year's shareholders pay nothing, even though they simply got lucky that no black swan events happened. Of course there's a discrepancy between inflows and outflows. If outflows equaled inflows each year, then the expenses can't be "unanticipated."

This is a form of self-insurance, but for a rare event. It's more like hurricane insurance than worker's comp.

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Re: Vanguard sued for charging too little

Post by talzara » Mon Mar 16, 2015 8:59 pm

Everlearning wrote:How soon will we know the conclusion to all of this? Is there a date set for a verdict yet?
Not even close. No jury has been selected. No evidence has been presented. No witnesses have testified. We're barely into the preliminary motions.

Also, the trial is not that important. The IRS tax audit is what really matters. It's just that the trial is taking place in front of the public, while the IRS audit is taking place behind closed doors.

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Re: Vanguard sued for charging too little

Post by Silence Dogood » Mon Jul 20, 2015 6:31 pm

Any updates? I've got nothing.

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Re: Vanguard sued for charging too little

Post by rca1824 » Tue Jul 21, 2015 10:38 am

Buysider wrote:
Instead, Danon contends, Vanguard provides services to its mutual funds "at artificially low, 'at-cost' " prices. "As a result, Vanguard shows little or no profit and pays little or no federal or state income tax despite managing funds with nearly $2 trillion in assets."

This suit can't be serious? Reducing costs to minimize profits is perfectly legal. You only pay tax on profits.

Plus the taxes are passed on to investors anyway who now earn greater investment returns.

It is just like paying your employees above-market wages: it reduces corporate earnings and hence corporate taxes, but those wages paid are taxed in themselves by both the payroll tax and the employee's income tax. It is merely redistributing the tax burden, not evading them.
in_reality wrote:I am anxious that bad publicity on a tax front would hit my creditability personally.
Stay the course and ignore trolls and bullies. Otherwise you are giving them exactly what they want and letting them win.
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Vanguard could owe billions in back taxes

Post by nbseer » Wed Sep 23, 2015 7:55 am

[Thread merged, see below (next page). --admin LadyGeek]

Vanguard could owe billions in tax penalties.. which could lead to higher fees for fund investors in the future??

Last line in story: "Still, future Vanguard fees would "absolutely" rise, Willens said."

Link to story at Philly.com:

http://www.philly.com/philly/business/h ... taxes.html

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Re: Vanguard could owe billions in back taxes

Post by adamthesmythe » Wed Sep 23, 2015 8:01 am

This article seems to be a minor update on a long-running story. Maybe the moderator would like to link this to the old discussion.

Not much news except for some opinion from a few other lawyers.

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Re: Vanguard could owe billions in back taxes

Post by Toons » Wed Sep 23, 2015 8:07 am

nbseer wrote:Vanguard could owe billions in tax penalties.. which could lead to higher fees for fund investors in the future??

Last line in story: "Still, future Vanguard fees would "absolutely" rise, Willens said."

Link to story at Philly.com:

http://www.philly.com/philly/business/h ... taxes.html
Just something else that is out of my control,,,
Why worry about it.
If the fees rise,so be it.
If they don't that is also fine. :happy
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Re: Vanguard could owe billions in back taxes

Post by hlfo718 » Wed Sep 23, 2015 8:07 am

I never understand the argument of charging "too little" is illegal even it is a for profit organization. Wouldn't that also impact other low cost fund providers such as Fidelity and Schwab where their fees are pretty much the same as Vanguard's? Given the size of Vanguard's assets, what is a "reasonable" fee they charge to the funds? Just because other funds are charging x% shouldn't mean Vanguard has to follow them. Similar to Costco's pricing, where they don't mark up more than 15% of their merchandise. Since Costco's competitors may charge more, does that mean Costco is doing something illegal?

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Re: Vanguard could owe billions in back taxes

Post by cfs » Wed Sep 23, 2015 8:09 am

Nothing new.

Exactly. That lawyer is waiting for the big payday, he is the one making the big bucks. As far as the rest of the story, nothing new, move on. And talking about moving, now is the right time for me to do something productive, such as getting ready for my LUng distance workout before it gets toasty out there.

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Re: Vanguard could owe billions in back taxes

Post by stan1 » Wed Sep 23, 2015 8:10 am

At this point the case is a jobs program for attorneys who won't need to worry about job security for a long time. Nothing actionable.

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Re: Vanguard could owe billions in back taxes

Post by hornet96 » Wed Sep 23, 2015 8:53 am

hlfo718 wrote:I never understand the argument of charging "too little" is illegal even it is a for profit organization. Wouldn't that also impact other low cost fund providers such as Fidelity and Schwab where their fees are pretty much the same as Vanguard's? Given the size of Vanguard's assets, what is a "reasonable" fee they charge to the funds? Just because other funds are charging x% shouldn't mean Vanguard has to follow them. Similar to Costco's pricing, where they don't mark up more than 15% of their merchandise. Since Costco's competitors may charge more, does that mean Costco is doing something illegal?
This is a very complicated subject (transfer pricing), but there are legitimate reasons for having these rules in place. As noted in the article:
Danon noted that Vanguard is a for-profit company, and is bound by the same basic principles of federal tax law as other companies, which do not allow companies to charge artificially low prices for services done by affiliates. Otherwise it would be too easy to use internal pricing to move profits out of higher-tax countries like the United States to lower-tax countries, as some major manufacturers have been accused of doing.
I believe the basic principle of the case is that Vanguard is essentially "sheltering" the true value of their profits by taking advantage of their unique entity structure in a way that was never intended to be allowed by the IRS (or the SEC). It's not about what they are actually charging the funds for their services, it's about what the true fair market value is of those services performed for affiliated entities (the funds). I'd have to go back and read through the huge post on this last year to refresh my memory though.

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Re: Vanguard could owe billions in back taxes

Post by Raymond » Wed Sep 23, 2015 9:18 am

This is already the subject of a long-running thread:

"Vanguard sued for charging too little" - 7/26/2014
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Re: Vanguard could owe billions in back taxes

Post by exrook » Wed Sep 23, 2015 9:26 am

Whistleblowers can get a share (15-30%) of whatever the government recovers, so of course his lawyers are estimating a huge liability. Might be a very large payday for him.

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Re: Vanguard could owe billions in back taxes

Post by Boglenaut » Wed Sep 23, 2015 9:29 am

stan1 wrote: Nothing actionable.
It is actionable for someone considering where to open a new account.

I personally give it very small weighting and ignored it; all the same it is a factor one may want to consider.

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Re: Vanguard could owe billions in back taxes

Post by Big Dog » Wed Sep 23, 2015 9:58 am

It's not about what they are actually charging the funds for their services, it's about what the true fair market value
Uh, no. There are several ways to calculate the transfer price, and one is cost-plus. So, if Subsidiary A can produce widgets at a much lower cost than the "market," due to efficiencies, smarts, whatever, then Subsidiary A can charge the parent a lower-than-market cost for Subsidiary A's widgets.

Simplistically, there is nothing in stone that says Vanguard must pay New York City's "market" rates if they can obtain brilliant advice from say, low cost Alabama.

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Re: Vanguard could owe billions in back taxes

Post by hornet96 » Wed Sep 23, 2015 10:09 am

Big Dog wrote:
It's not about what they are actually charging the funds for their services, it's about what the true fair market value
Uh, no. There are several ways to calculate the transfer price, and one is cost-plus.
Uh, yes. Where do you think the valuation of the "plus" component comes from? Is cost + $1 viewed as acceptable under the transfer pricing rules for purposes of calculating tax liabilities? Who decides what a reasonable "plus" component is under tax law? (Hint: it's not the company charging for the services).

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Re: Vanguard could owe billions in back taxes

Post by in_reality » Wed Sep 23, 2015 10:16 am

Consider too that the estimate of billions, according to that article, is based on the Morningstar average for a mutual fund which is actually really high.

Look at Schwab's Total Stock Market SWTSX -- it's a mutual fund and not the rock bottom ETFs which generally are cheaper at all companies -- with an ER of 0.09%. Morningstar says the average fee is 1.09%.

CSIM (Charles Schwab Investment Management) is a subsidiary of The Charles Schwab Corporation and collects 0.05% of the AUM leaving 0.04% for the distributor Charles Schwab & Co., Inc. and The Charles Schwab Corporation (not sure what the split is there).

So even if Vanguard is completely wrong about transfer pricing, I think a very inflated and artificial number is being thrown out as to what they might actually owe. Again, that is on the assumption that they owe anything which may or may not turn out to be true. I suspect they perhaps owe a little on their big contingency fund which normally would have taxes paid on the incoming money before it is put aside, but lack true accounting knowledge to be sure of that.

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Re: Vanguard could owe billions in back taxes

Post by hornet96 » Wed Sep 23, 2015 10:45 am

in_reality wrote:Consider too that the estimate of billions, according to that article, is based on the Morningstar average for a mutual fund which is actually really high.

Look at Schwab's Total Stock Market SWTSX -- it's a mutual fund and not the rock bottom ETFs which generally are cheaper at all companies -- with an ER of 0.09%. Morningstar says the average fee is 1.09%.

CSIM (Charles Schwab Investment Management) is a subsidiary of The Charles Schwab Corporation and collects 0.05% of the AUM leaving 0.04% for the distributor Charles Schwab & Co., Inc. and The Charles Schwab Corporation (not sure what the split is there).

So even if Vanguard is completely wrong about transfer pricing, I think a very inflated and artificial number is being thrown out as to what they might actually owe. Again, that is on the assumption that they owe anything which may or may not turn out to be true. I suspect they perhaps owe a little on their big contingency fund which normally would have taxes paid on the incoming money before it is put aside, but lack true accounting knowledge to be sure of that.
I agree that the numbers being thrown out there are likely to be wildly inflated, although in the end any additional tax liability is likely going to be greater than $0. If I recall the argument correctly, Vanguard has basically shifted operating profits to tax-exempt entities (the funds) and then loaned themselves back those same profits in the form of the "contingency reserve," with no real intent on repaying those intercompany loans, and having never paid taxes on them. That "reserve" has built up over many years, of course, and I'm sure there are many other complicated issues or rules that I don't fully understand.

In any event, it will be interesting to see how all of this unfolds, especially in light of the recent IRS pressures in this area (e.g. Coca-Cola).

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Re: Vanguard could owe billions in back taxes

Post by IlliniDave » Wed Sep 23, 2015 11:19 am

I'm neither an attorney nor did I stay at a Holiday Inn Express recently, but it seems to me that because of Vanguards structure all the imputed profit goes to the shareholders who retain a larger share of their investment returns and pay taxes on their investment income as individuals. It's not like Vanguard is hoarding immense piles of money (their 'contingency fund' excepted, which is what I thought the whole thing was about). They simply lower their costs to their customers. I never knew there was a requirement that a non-not-for-profit had to make some certain minimum amount of profit, or was not allowed to pass along a cost savings to their customer.
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Re: Vanguard could owe billions in back taxes

Post by MrKnight » Wed Sep 23, 2015 11:32 am

hlfo718 wrote:I never understand the argument of charging "too little" is illegal even it is a for profit organization. Wouldn't that also impact other low cost fund providers such as Fidelity and Schwab where their fees are pretty much the same as Vanguard's? Given the size of Vanguard's assets, what is a "reasonable" fee they charge to the funds? Just because other funds are charging x% shouldn't mean Vanguard has to follow them. Similar to Costco's pricing, where they don't mark up more than 15% of their merchandise. Since Costco's competitors may charge more, does that mean Costco is doing something illegal?
I don't know the specifics of the story, but the issue of a business model of selling at a loss is related to a breakdown in the free market's ability to allocate resources efficiently. The underlying purpose of the free market is the efficient allocation of resources. When it does not accomplish this task, there is a market failure.

Now, monopolies, or other businesses that have significant influence on the market, can sell items at a loss to drive out competition. If the organization is small, the effects may be immaterial. Larger organizations may have a large material impact on the market however.

The questions I think is whether we as a society feel that it is prudent to have market competitors such as Vanguard. I would actually argue that no, it isn't prudent. The vast majority benefits from Vanguard's business model as it stands. I guess the next question is would Vanguard be able to abuse their position in the future.

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Re: Vanguard could owe billions in back taxes

Post by adamthesmythe » Wed Sep 23, 2015 11:44 am

Raymond wrote:This is already the subject of a long-running thread:

"Vanguard sued for charging too little" - 7/26/2014
That's the one.

The way I read this most recent article- basically "nothing new" on this long-running dispute. It reads like an attempt to keep it in the news. I am mildly curious to see what happens but I'm not holding my breath.

I do wonder whether Vanguard is taking a go-slow approach.

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