
Vanguard's Low Blow - tptacek
http://www.bloombergview.com/articles/2016-02-10/vanguard-is-more-mutual-than-most-mutual-funds
======
JumpCrisscross
To summarise, Investment Managers manage Funds. When you invest in a mutual
(or hedge or venture or wine [1]) fund, you put money in to a Fund. The Fund
then pays an Investment Manager a fee for managing it. (Of course, you, the
investor, indirectly pay this fee.)

Vanguard is mutualized. This means the Funds _own_ the Investment Manager.
Unsurprisingly, the Funds vote for lower fees. The result is Vanguard charging
its funds staggeringly lower fees than average [2]. This also means Vanguard
makes less profit than competing Investment Managers.

Enter this guy [3]. He observes Vanguard paying less tax (on account of making
less profit) than its competition. He concludes that Vanguard is dodging its
tax bill. Vanguard, he argues, should be taxed _as if_ it charged the higher
fees it doesn't. They should also pay the back taxes they would have owed if
they had charged these fees and earned those profits, again, that they didn't.
This last part is helpful because he likes the whistleblower bonus the IRS
would pay him if the case succeeds [4]. (Or maybe not [5].)

If this sounds bonkers, it's because it likely is. We don't tax SpaceX _as if_
it were bilking the U.S. government on par with its competition. In any case,
the boosted post-fee gains from Vanguard's funds are still taxed at the
individual level. But my pie is better than your pie and so the idiots get
their air time.

[1]
[http://www.wineinvestmentfund.com/disclaimer.aspx?url=http:/...](http://www.wineinvestmentfund.com/disclaimer.aspx?url=http://www.wineinvestmentfund.com/index.aspx)

[2] [https://investor.vanguard.com/mutual-funds/low-
cost](https://investor.vanguard.com/mutual-funds/low-cost)

[3] [https://www.linkedin.com/in/david-
danon-a0a5017](https://www.linkedin.com/in/david-danon-a0a5017)

[4] [http://www.newsweek.com/2015/12/25/vanguard-whistleblower-
ta...](http://www.newsweek.com/2015/12/25/vanguard-whistleblower-tax-dodge-
complaint-400901.html)

[5]
[http://articles.philly.com/2015-11-19/business/68386489_1_da...](http://articles.philly.com/2015-11-19/business/68386489_1_david-
danon-new-york-state-joan-madden)

~~~
jacquesm
In nl we have one particularly crazy tax called the 'huurwaarde forfait'. It's
basically a total fiction, the idea is that if you own a house that you are
financing you are not renting, and this then rent that you are not spending -
tadaa - is income.

~~~
yummyfajitas
Economically this is correct - you do have an imputed stream of rental income
from a property. You are just choosing to consume it directly (by living in
the house) rather than sell it to another party, receive money and turn the
money into other consumer goods.

Imagine an alternate scenario. You own a home, but rent it out. Also, you rent
an equivalent home from another person. In this alternate scenario, you'd have
to pay income taxes on the rent you receive. Similarly, if your employer gave
you free rent in a house they owned, you'd need to pay tax on the value of
that rent.

Economically there is no good reason to distinguish between these two cases.
It sounds like NL is doing things right, or at least righter than the US.

~~~
rayiner
It's a special case of the more general case of taxation of non-market
services.

Say A is a stay at home dad, B is his spouse, and C works at an office. B and
C both make $10 per month and there is a 20% flat tax. So total tax revenue is
$4. Now, say that A wants to live a life of leisure. So he hires C to do
nannying on the side, and they pay her $3 per month. Now, total income is $23,
and total tax revenue is $4.6. But the same amount of work is being done as
before! All that's happened is an activity moved from the non-taxed domestic
realm to a taxed market one.

~~~
mikeash
It makes sense economically, but at some point you have to draw a line. Should
I be taxed when I cook a meal for myself, because it's a valuable service that
would cost $X if I had somebody do it for me? Should I be taxed based on the
price of transportation if I walk somewhere? Breathing?

It seems that we typically draw the line at the individual or household. If
not there, then where should it go?

~~~
Steuard
I don't know the answer to this question, but it's clearly related to the fact
that work done to maintain one's own household gets left out of pretty much
every measure of costs or productivity. (I suppose it's probably some form of
externality. I ought to study more economics.)

Given traditional gender roles, this is one factor that has historically led
to massive undercounting of women's total contribution to the economy, which
could potentially lead to distortions in selecting good public policy. (It's
certainly not _just_ a women's issue, but that's one of its big impacts.)

------
naaaaak
"They charged less than their competition. That's potential tax revenue lost.
They are therefore thieves." is the dumbest argument I've ever heard.

How is this even an issue, let alone the basis for a legal case?

~~~
morgante
> They charged less than their competition

It's a lot less crazy than it sounds, because they are wholly owned by
Vanguard. So the customer is effectively setting the fees.

There are certainly scenarios where you could see how this is clearly abusive.
As a contrived example, imagine if Apple moved its legal headquarters to
Ireland and made California into a subsidiary. They would still have to pay
the California subsidiary for the design services it provides, but they could
set those fees at way below market price and thereby shift all tax liabilities
to a lower tax jurisdiction. We have transfer pricing rules in place to
prevent this.

The situation is more complicated than this because the fund (the client) is
not a profit-seeking corporation, so it's not arbitrarily moving funds around.
It's an odd scenario where the customers are _also_ the owners.

~~~
wlievens
Customers being owners is not that odd; it's called vertical integration.

~~~
morgante
In the context of B2B it's not at all odd, you're right. (In fact, that's the
whole reason transfer pricing rules exist.)

In the current era, it is however uncommon for consumers to simultaneously own
and (exclusively) be the customers of a company. (Historically, that is of
course the entire principle of mutual funds.)

~~~
snowwrestler
This is what co-ops are, and as far as I know they do not face special tax
reporting or payments.

~~~
morgante
Depending on structure, co-ops often _do_ face special tax reporting
requirements.

Moreover, in this case the fact that Vanguard is a co-op is a redeeming
factor. If it were a typical corporation charging itself below-market transfer
prices, that would likely be illegal.

------
mark_l_watson
This story irritates me. I have been using Vanguard for decades and have
always been very happy with their services.

Strange lawsuit. Horrible if the case goes against Vanguard. We live in a
strange world.

~~~
AstroJetson
Yes, long term Vanguard client here. Because I opted to go with someone with
lower costs the other funds are unhappy and want Vanguard to pay more in
taxes?

So does the shoe then fit if Vanguard triples their fees making them the most
expensive, do the other management companies then need to pay taxes on the
difference between their now lower fees and Vanguards?

I think this is a ploy by the management firms that are being undercut and in
a tight market (or a down market) the management fees become important.

~~~
morgante
> I think this is a ploy by the management firms that are being undercut and
> in a tight market (or a down market) the management fees become important.

I'm pretty sure it is almost exclusively a ploy by David Danon (who brought
this complaint) to extract a massive whistleblower fee.

~~~
AstroJetson
Good point. I'm pretty sure that Vanguard has thought this through. The
article says "Danon collected a $117,000 whistle-blower bounty in Texas in
November, meaning that Vanguard paid the state at least $2.3 million. It’s
possible that Vanguard’s payment had nothing to do with the fee issue." So I'm
going to guess it's some other arcane thing they missed.

------
ryporter
If this lawsuit succeeds, then we'll live a surreal world where financial
companies are routinely hammered for charging high fees...and for charging low
fees. Perhaps we should have a state-mandated price list for all financial
services.

~~~
pc86
I'm sure you could find that proposal _somewhere_ in Bernie's policy briefs.

~~~
Zigurd
Actually, Sanders proposed postal banking. That's not the same as Vanguard
extending mutual ownership to the fund managers, but it's roughly the same
effect: Retail banking and investing is a rip off in many cases, and having an
alternative structure is going to save the small investors and retail banking
customers many tens of billions of dollars.

------
akadien
I'm going to report David Danon to the IRS. He could have made more income as
Wall Street corporate lawyer instead of working for Vanguard as a tax lawyer.
The extra income he could have made would have resulted in more income taxes
to the government. Obviously, he is a tax dodger.

Did I get that right?

------
pilom
For a less biased view about why Vanguard really does do things wrong in the
eye of the law even if it sounds perfectly reasonable to you and me, try this:
[http://www.joshuakennon.com/vanguard-accused-of-
nearly-35-bi...](http://www.joshuakennon.com/vanguard-accused-of-
nearly-35-billion-tax-abuse/)

~~~
luckydude
This is a very good read and it lead me to think about this somewhat
differently.

The whistleblower is making the case that if Vanguard had kept all the profits
then there would have been a $34B tax bill. But that's an assumption. It's far
more likely that Vanguard would have paid out the extra money as a dividend so
that there was no profit. Or they figure out some way to pay it out as extra
shares in the investments, perhaps there is some way to make it be like
unrealized gains so that there is no tax event until you take it out.

Can anyone who has some background shoot holes in the thoughts above?

To me this case looks shaky but I'm not a lawyer, tax guy, or even much of an
investor (I do have money at Vanguard for whatever that is worth).

~~~
hospes
I think it is even more likely that Vanguard would never gained number of
customers it did, if they charged regular market rates.

So the whole "if, else, else if" thing in "whistle-blower's" argument is
ridiculous.

------
evanpw
This article seems to lean heavily on the argument "if the law said this, it
would have bad consequences; therefore, the law doesn't say this",
complementary to the popular argument "this thing is bad, therefore this thing
is illegal / unconstitutional".

------
sonium
Slightly off-topic: a lot of Vanguard's ETFs are synthetic. Is there anyone
who can say something about the risk involved in this in contrast to non-
synthetic ETFs?

Edit: As it turns out most or all of Vanguard's ETFs are physical.

~~~
Zr40
I was under the impression that a lot (if not all) of Vanguard's ETFs are
physical, not synthetic. Can you name one of these synthetic ETFs?

~~~
sonium
I believe VOO is a synthetic fund.

~~~
Zr40
VOO is not synthetic. Quoting the overview page[1]:

> Employs a passively managed, full-replication strategy.

[1]:
[https://advisors.vanguard.com/VGApp/iip/site/advisor/investm...](https://advisors.vanguard.com/VGApp/iip/site/advisor/investments/productoverview?fundId=0968)

------
ryporter
I don't understand the central claim of this lawsuit:

"Vanguard is cheating state and federal tax authorities by charging its
customers much less than other fund companies do."

This simply isn't true. A list of the 100 lowest ETFs [1] shows several form
the Schwab near the top of the list.

[1] [http://etfdb.com/compare/lowest-expense-
ratio/](http://etfdb.com/compare/lowest-expense-ratio/)

~~~
francoisdevlin
This list is incomplete. I own some VSTAX (Vanguard, .04%) and FUSEX
(Fidelity, .04%) etfs, neither are on this list. I've seen even lower
mentioned at Vanguard (The "institution" version of VSTAX, .02%)

~~~
cowsandmilk
I assume by VSTAX you mean VTSAX? That is on there as the ETF version is VTI.
And institutional versions of the fund are not ETFs... they are only available
to institutions, and for the .02% rate, you need to invest 100MM, which is the
opposite of being exchange traded.

------
slagfart
Why is this being upvoted? We can basically be certain that this guy is either
a shill, or drunk.

Product is cheaper than the competition. Boo hoo.

~~~
kspaans
Because it's an interesting example of tax laws being, for lack of a better
word, wonky.

~~~
slagfart
Tax should be on profit, not revenue or turnover. By offering lower fees,
Vanguard transfers wealth from the investment fund industry to the consumers
of its products.

I see no difference between what Vanguard is doing here, and what WhatsApp did
for instant messaging - disrupting an incumbent industry with a new and cheap
option.

I don't see how anything about it is wonky. Care to explain?

~~~
harryh
The difference is that Vanguard is owned by it's customers so the low fees are
transferring wealth from the consumers back to the consumers while (allegedly
illegally) lowering their tax bill.

It's the ownership structure that makes things different.

