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Old 12-04-2015, 02:37 PM   #21
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I think the issue is that 35 cents of every $1 of profit would go to taxes and the remaining 65 cents would go back to fundholders.

So for example, if today the cost and charge are 30 and a fair value charge would be 100, under what some argue the fund manager would have a profit of 70, pay 25 in tax and push 45 back to the fundholders.... so net the fundholders would pay 55 (100-45) rather than 30.

The difference with a mutual insurer is that the mutual insurer is a single company so the tax issue doesn't exist... in this case the funds are separate legal entities that "own" the manager which is a separate legal entity but can't file a consolidated tax return. I seem to have a faint recollection that the structure passed muster with the IRS as some point but I don't recall the details.
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Old 12-04-2015, 03:03 PM   #22
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As I understand it the argument is that Vanguard charges its funds "cost" rather than "fair market" fees and expenses, and as a result doesn't make profits and doesn't pay taxes.

While it is true that Vanguard's ERs are less than average, their ERs are in the ball park with the larger and more competitive funds, so any complaint based on a charge that they are not charging a market fee is questionable since Fidelity and other other big players have similar ERs for similar funds...
Interesting angle that might actually work. Problem is, Vanguard Group intentionally charges their funds at cost. It will be near impossible to argue that transacting at cost meets the "arm's length" standard of section 482. That's not how rational unrelated parties behave.

Plus, if the cost (with tax advantage) is "close" to fair market, that seems to suggest that the underlying economics at Vanguard are less advantageous than it appears, just judging from fund ERs. From the article:

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Raising fees to cover those taxes could require quadrupling its average fee, according to Avi-Yonah, who is working with Danon on this issue.
Probably biased, since it came from someone working with Danon. But still, if that's even half accurate, it would put Vanguard at a severe disadvantage.

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In any event, it'll be in litigation and appeals for many years... probably longer than I'll be around. I don't see any big change in the near future...
You're probably right. But evidently, Vanguard is now paying taxes, penalties, and interest based on Danon's disclosures. That's a significant development from last time I read about this issue, which could motivate other states and the IRS to move quicker and more aggressively.
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Old 12-04-2015, 03:15 PM   #23
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The other thing is that who will get that profit? From what they say, the investors 'own' Vanguard.... so, if Vanguard made a profit, would it not have to send that profit to the investors?...
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I think the issue is that 35 cents of every $1 of profit would go to taxes and the remaining 63 cents would go back to fundholders.

So for example, if today the cost and charge are 30 and a fair value charge would be 100, under what some argue the fund manager would have a profit of 70, pay 25 in tax and push 45 back to the fundholders.... so net the fundholders would pay 55 (100-45) rather than 30....
Agreed. Good example. The net effect to investors (higher ER minus distribution of after-tax profit) would be the same EXCEPT for the new tax that was paid. Seems to me, the only real difference is that tax gets paid sooner and probably at a higher rate (i.e., as Vanguard Group provides services to funds) rather than later (as investors or their heirs sell fund shares to generate spendable cash). All fine and good for the IRS. Not so much for you and me.
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Old 12-04-2015, 03:50 PM   #24
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Originally Posted by pb4uski View Post
I think the issue is that 35 cents of every $1 of profit would go to taxes and the remaining 65 cents would go back to fundholders.

So for example, if today the cost and charge are 30 and a fair value charge would be 100, under what some argue the fund manager would have a profit of 70, pay 25 in tax and push 45 back to the fundholders.... so net the fundholders would pay 55 (100-45) rather than 30.

The difference with a mutual insurer is that the mutual insurer is a single company so the tax issue doesn't exist... in this case the funds are separate legal entities that "own" the manager which is a separate legal entity but can't file a consolidated tax return. I seem to have a faint recollection that the structure passed muster with the IRS as some point but I don't recall the details.
Are the mutual funds a single company? As I said, I do not know...

But I do know that AIG has plenty of different legal entities.... I also know that Progressive does too... they are not mutual insurance, but just giving out a couple of examples on the for profit insurance companies....
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Old 12-04-2015, 04:21 PM   #25
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Yes, the mutual funds that you buy shares of are separate legal entities from the fund manager, fund administrator and fund marketer. The mutual fund is owned by us (the mutual fund shareholders) and has contracts with the fund manager, fund administrator fund marketer to provide investment management, fund administration and marketing services, respectively, to the mutual fund and in most cases are under common control and owned by the common control group's shareholders (like Fidelity).

Commonly, the fund manager, fund administrator and fund marketer are said to "sponsor" the mutual fund in that they set it up, provide seed money for it, do the marketing, etc. In theory, a mutual fund board could "fire" the manager and it has happened but is exceedingly rare because usually the mutual fund board is nominated by the fund administrator (talk about incestuous).
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Old 12-04-2015, 04:56 PM   #26
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Opps... I should have asked what I wanted to ask... not mutual funds, but mutual insurance companies!!!

I know how mutual funds work.... and their separate legal entities...
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Old 12-05-2015, 09:58 AM   #27
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I wonder if any of these lawsuits/settlements with state agencies has anything to do with vanguard migrating their mutual funds into their brokerage house, where you now have all mutual funds listed as part of your brokerage holdings? Same with dropping Pershing and using their own internal settlement divsion? (or perhaps that one was a different issue?)
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Moving away from Vanguard
Old 12-05-2015, 10:02 AM   #28
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Moving away from Vanguard

My question is any of you moving away from Vanguard proactively because of this situation? Or do you think it will take years to play out in the courts before anything affects us?

To me, it sounds like noise right now and I am going to ignore it and continue to run my plays with Vanguard until this gets more sorted out and formalized...

Thoughts?
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Old 12-05-2015, 10:24 AM   #29
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Your instincts are in line with mine. The zeitgeist is very "Harrison Bergeron" these days - let's "equalize" everyone, not by expecting more from those who do little, but by taking from those who have accumulated more.

https://en.wikipedia.org/wiki/Harrison_Bergeron
I've always hoped that if that does happen it waits until 2084, because I'll most likely be dead by then.
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Old 12-05-2015, 10:48 AM   #30
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Opps... I should have asked what I wanted to ask... not mutual funds, but mutual insurance companies!!!

I know how mutual funds work.... and their separate legal entities...
A mutual insurance company issues dividend paying aka participating policies (and also issues non-participating policies) and tracks actual/expected experience of sets of policies and dividends are declared to distribute any favorable experience. Usually, the premiums are very conservative so unless experience was very unfavorable to pricing assumptions there is likely to be a dividend.

Totally different animal from the Vanguard structure since it would all be in one legal entity although a mutual insurer might well have numerous non-insurance subsidiaries for different purposes (like perhaps managing, administering and marketing its own sponsored mutual funds).
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Old 12-05-2015, 10:50 AM   #31
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My question is any of you moving away from Vanguard proactively because of this situation? Or do you think it will take years to play out in the courts before anything affects us?

To me, it sounds like noise right now and I am going to ignore it and continue to run my plays with Vanguard until this gets more sorted out and formalized...

Thoughts?
Totally agree.. I'm not doing anything until it appears that there will be a change... after all, there is limited information on the details of the situation and Vanguard may well win the fight, either in court or in Congress.
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Old 12-06-2015, 12:25 PM   #32
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The other thing is that who will get that profit? From what they say, the investors 'own' Vanguard.... so, if Vanguard made a profit, would it not have to send that profit to the investors?


From the little I know, a mutual insurance company sends checks to policy holders if they collected more in premiums than paid out in claims... but I could be way off on this... just do not know for sure.
I have been with USAA for years which I believe is a "member owned" company. Every year I get a check for the excess between what I have paid in premiums and their cost.
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