RIABiz

News, Vision & Voice for the Advisory Community

RIABiz

Why Vanguard Group has proved impervious to a '$34.6 billion' whistleblower suit and why nobody's suggesting Vanguard execs should breathe easy

The SEC documented a 1981 OK on the asset manager's 'at-cost' fee structure - but if the IRS is egged on it could cost Vanguard bigtime in back taxes, penalties and future business

Tuesday, December 22, 2015 – 8:09 PM by Sanders Wommack
Admin:
no description available
Reuven Avi-Yonah: Will the IRS be willing to take on many millions of investors or is Vanguard too big to tax?


The intruder

The intruder

December 22, 2015 — 11:23 PM

There is too much nonsense about VGs liability by financial writers and experts who have failed to perform due diligence and read the most important documents: the Whistleblowers complaint and the NY state court’s decision dismisslng Danons claim that VG has underpaid NYS, not federal taxes. According the decision Danon and his lawyer met with the IRS 3 years ago to submit the information he had taken from VG. IRS as not taken any action on his claim. There is a very good reason that KIRS is un interested- VG has been filing tax returns with the IRS for 40 years using the same business model without any audit. The VG cost basis pricing structure is public knowledge -just go to VGs home page where it is described. Not exactly tax evasion.

The NYS attorney general declined to intervene in the NY lawsuit for the obvious reason that information acquired by violating the attorney client privledge is inadmissible under NY court precedents.

What escapes all the financial writers are the meritorious reasons why there is no reason to a claim for back taxes. One defense is that beneficiaries of the low cost fees is not VGI the investment arm of VG but the individual shareholders of VG funds who are the owners of the VG funds and are not members of the VG controlled group who are not subject to the transfer pricing regulation. Lower costs charged to VG investors mean the investors have higher taxable returns on their investments. Since the shareholders of VG funds benefit from the low fees there no violation of the tax law. A secondary question is why would the IRS now want to tax VG on a practice that It has not objected to for 40 years which VG has publicly disclosed.

Jeff McClure

Jeff McClure

December 23, 2015 — 9:33 PM

There is something rotten in Denmark here. Mr. Darion is, at least according to your article, an attorney. An attorney employed by someone is not only subject to attorney client privilege prohibitions on being forced to testify, but is specifically forbidden in most cases from using the knowledge gained in the relationship for private gain.

A second issue that must be considered is that the distributions made by Vanguard funds under the IAA of ’40 would have been reduced by the amount that Vanguard did not pay if retroactively the IRS determined Vanguard to be a taxable entity. That would mean that every shareholder of every fund would be eligible for a refund from the IRS. The IRS may not be particularly sensitive to political considerations, but 20 million letters to Congress demanding a refund after the IRS took no action would create a firestorm that even the IRS could not ignore.

Finally, there is indeed precedent in non-enforcement of a law that has been clearly and evidently unenforced for a long period: “Desuetude (is) lack of use; obsolescence through disuse. The doctrine holding that if a statute or treaty is left unenforced long enough, the courts will no longer regard it as having any legal effect even though it has not been repealed. Penal statutes may become void under the doctrine of desuetude if: (1) The statute proscribes only acts that are malum prohibitum and not malum in se; (2) There has been open, notorious and pervasive violation of the statute for a long period; and (3) There has been a conspicuous policy of nonenforcement of the statute.”

“Malum” means fundamentally immoral or damaging, while “malum prohibitum” means that something is simply illegal but not fundamentally immoral. If the IRS reviewed Vanguard’s tax returns for decades and found no cause for challenge, to suddenly determine that what it had allowed all those decades was a violation of the tax code and then to subject millions of innocent citizens to penalties would in all likelihood fail a judicial review. Note here that there could be no case for a criminal action as there was no effort to hide or disguise Vanguard’s policies, so any action by the IRS or the states would be a civil action. Another issue is that the IRS could see legislation enacted in this case as the beneficiaries of Vanguard’s low costs include millions of retirement fund participants. Technically, Vanguard is owned by its fund shareholders and opening the Pandora’s box of imposing back taxes and penalties on Vanguard might well involve a clawback of distributions.

All in all, the implications of an IRS or even a state action against Vanguard would have immense implications and pose a very high risk to all concerned. Not the least of the risks would be a court allowing a tax action based on an attorney violating client confidentiality.

Last but not least, somewhere in the IRS archives is a memo written decades ago in which some authority there determined that the initial return was legal. That would be a hard one to fight.

Ron Rhoades

Ron Rhoades

December 26, 2015 — 6:43 PM

Well-written article.

Unfortunately, the tax code does not have a provision that permits Vanguard to be a not-for-profit company. There are 20+ business types that qualify, but Vanguard’s is not one of them.

One possible fix is Congress enacting a change to tax law, to grant Vanguard (or other fund companies) the opportunity to secure non-profit status. Perhaps with some retroactive effect. Of course, any such legislation, even if introduced, would be fought by other asset managers – who have deep pockets when it comes to influence in Washington, D.C.

I wonder if any other fund complexes, or discount broker-dealers with proprietary funds, face similar issues. Fidelity’s Spartan 500 Index Advantage matches Vanguard’s 500 Index Admiral Shares low fees at 0.05% annual expense ratio (AER). (Although Vanguard’s Institutional Share class has 0.04% AER). Schwab’s index fund has a 0.09% AER.

I also wonder how much “profit” Vanguard would be required to possess, and whether $35B is the “right number” if the IRS inquiry is successful. Some other for-profit large companies have taken a low-cost strategy as a means to build market share, over the long term. One example is Amazon, which has a very-low-profit mentality as it seeks to grow and gain market share worldwide. This delights its customers, as prices are lower. Similar to Vanguard.

There is likely much below the surface, including a long history of Vanguard filing tax returns (with no IRS challenge to same), and perhaps some correspondence between the IRS and Vanguard from its early days.

Only time will tell. But the situation is worth watching, by all advisers who recommend Vanguard’s funds or ETFs.

Brooke Southall

Brooke Southall

December 27, 2015 — 4:03 AM

Ron and Jeff,

I am always grateful for your well thought-through comments.

Intruder,

I don;t think I know you but I appreciate your stirring things up.

Brooke

Leigh Ann Harris

Leigh Ann Harris

December 29, 2015 — 9:31 PM

I must say a very well written and one of the easiest articles to understand the David Danon tax story. I would like to make few points and express my views….1. David Danon was a Corporate Tax Attorney….it was his job, whistleblower protection should apply to the job you have, attorney client privilege should not trump possible fraud, if it does, we need to change something…because as we say in the south, 'that dog don’t hunt.” 2. I agree with Tamar Frankel,” the real defendant here is the authorities’ the law is the law is the law….don’t care how you can twist it by saying look how many investors benefited by Vanguard doing it their way they had lower costs and well it was great for all those people who invest in Vanguard, which quite frankly are a whole lot of sheeples who are clueless as to what Vanguard is doing to America, employees and society….educate yourself people on things outside of fees, expenses and returns and see how Vanguard owns a dominant share in every single corporation in America and is majority stockholder in almost every single company in America, I call that a dictatorship, and no good can come from that…oh, I see, you think Vanguard is ethical and has integrity, get your head out of the sand, read Glassdoor reviews, https://www.glassdoor.com/Reviews/vanguard-reviews-SRCH_KE0,8.htm, where only 56% of employees would recommend Vanguard to a friend or where on a score of 1-5 their employees give them a 3.1 one of the worst in the industry….or how about looking at the outstanding lawsuits, www.vanguardlawsuits.com, where Vanguard has a pattern of retaliation, age discrimination, racial discrimination, abusing FMLA….or how about the fact there is a current class action lawsuit for not paying employees fairly against Vanguard, Beagan Wilcox Volz wrote December 18,2015 at Ignites, you get the picture yet. 3.It’s not fair to competition, we need free competitive markets not monopolies, not good 4. I hope every state follows TX lead, those southerns have some sense…oh, you neglected to say Texas wrote David Danon a check for $117k …hummm and John Woeth says not related to Whistleblower case, don’t think so John (I got my info from David Cay Johnston’s Newsweek article on this and he mentioned the $117) 5. And Vanguard, how about putting some substance behind your defense, this 'it’s Vanguard leave me alone’ well that doesn’t cut it with the small town simple southern gal, I don’t have an ivy league education but I have a whole lot of common sense and well quite frankly my common sense says when all you can say is 'we have always done it that way’ well, to say it again 'that dog don’t hunt’....THE END. (my blog www.whyileftvanguard.com, I RESIGNED because I could not represent as a Certified Financial Planner a company that was so incredibly unethical…and I was giving advice to clients with $10million or more in assets when I resigned)

OneOfThePack

OneOfThePack

June 21, 2022 — 5:59 PM
If only we VG investors were really getting all that payback!

RIABiz Directory

The Industry Sourcebook for RIAs

   |    LISTING


RIABiz Directory sponsored by:

Directory Sponsor Logo