Vanguard, Facing Whistle-Blower Cases, Agrees to Pay Texas Taxes

  • Fund firm didn't charge itself enough for advising: ex-lawyer
  • Claim of underpaid taxes also made to IRS, SEC and California

Vanguard Group Inc. has reached an agreement to pay several million dollars in back taxes in Texas, the first known payout related to a whistle-blower’s accusation that the world’s biggest mutual-fund company underpaid its taxes by tens of billions of dollars.

The Texas action came after a former Vanguard tax lawyer alleged that the company provided services to its mutual funds at below the going price. Had the company charged its own funds at market rates, it would have brought in more income and paid more in taxes, the lawyer says. He’s made these allegations in claims filed with the Internal Revenue Service and the Securities and Exchange Commission, as well as with tax authorities in Texas and California.

The allegations run counter to those that have been levied against some mutual funds and private equity firms -- which have been accused of overpaying consultants at related companies, at investors’ expense.

Low fees have been Vanguard’s “entire raison d’etre,” said Daniel P. Wiener, editor of The Independent Adviser for Vanguard Investors. Generally, if the company is compelled to make larger tax payments -- a big “if,” he said -- it could be forced to raise expense ratios. That would be “a huge marketing black eye,” he said.

$3.4 Trillion

The privately held Malvern, Pennsylvania, company, with $3.4 trillion in assets around the globe, resolved its Texas tax liability without any penalty, said John S. Woerth, a spokesman. He declined to say how much the company paid.

Any speculation that Vanguard’s fees could change -- based on a presumption that Vanguard may have to pay other taxes, and that any such taxes would have a material impact on its fund costs -- is “suspect and speculative,” Woerth said, adding that the company remains “confident in our approach to paying the fair and appropriate amount of taxes.”

David Danon, who served as an attorney in Vanguard’s tax department from 2008 to 2013, claimed that the company should have reported “hundreds of millions of dollars of income” subject to Texas state tax. He filed his submission with the Texas Comptroller of Public Accounts in December 2013.

‘Confidential Informant’

Earlier this month, the Texas comptroller paid Danon about $117,000 for his role as a “confidential informant,” according to documents reviewed by Bloomberg News.

Under Texas law, whistle-blowers can receive up to 5 percent of what is recovered by the state --- which means Vanguard would have paid at least $2.3 million.

Danon’s attorney, Stephen Sorensen of Thomas, Alexander & Forrester LLP in Venice, California, said he didn’t know how much Texas had recovered as a result of his client’s information.

Lauren Willis, a spokeswoman for the Texas Comptroller of Public Accounts, declined to comment, citing confidentiality rules.

Danon has alleged that Vanguard’s mutual funds have been able to charge low fees in part because of the relationship between the operating company, Vanguard Group -- which employs the bulk of the company’s employees -- and the company’s mutual funds.

‘At Cost’ Services

Vanguard’s mutual funds owe no taxes as long as the bulk of their revenue -- such as capital gains and dividends -- goes to the funds’ holders. Vanguard Group charges for advisory services its employees provide to Vanguard mutual funds. The funds get those services “at cost,” Danon has alleged, while other mutual funds typically pay higher fees for such services to unrelated advisers.

Danon has argued that Vanguard is bound by federal and state tax laws requiring transactions between affiliated companies to be paid at “arm’s length” prices, or the prices that would be paid by unrelated parties. That means Vanguard Group’s income should have been higher, he has said, obligating it to pay more in taxes.

Vanguard’s discussions with Texas began as part of a routine tax audit, said Woerth. At no time during the discussions with the state’s tax authorities “were we asked to address apparent claims by our former in-house counsel,” said the Vanguard spokesman. “We were unaware of such claims until we learned of the payment in November 2015.”

A 2013 complaint filed by Danon in New York York State Supreme Court in Manhattan was dismissed last week, after a justice found Danon had improperly shared confidential company information as part of his filings.

The justice overseeing the case said she wasn’t ruling on the merits of Danon’s allegations and that her action didn’t affect the state’s ability to pursue them. Sorensen said he plans to appeal the New York decision.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE