Vanguard agrees to pay clients $19.5 million in conflict-of-interest case filed by SEC

When Vanguard Group in 2020 stepped up efforts to supplement its famously low money-management fees by expanding its Personal Advisor Service, the company said on its website that Vanguard advisers were paid a salary, not commissions tied to sales, so they “have no financial incentives to recommend certain products,” and “they’ll always put your interests first.” The claims were echoed in two of Securities and Exchange Commission filings based on the service.

Vanguard has since raised more than $300 billion for the advisory business, collecting up to 0.3% of each customer’s assets as a yearly fee.

The “no financial incentives” claim wasn’t true, according to the SEC. Vanguard advisers were paid more in merit-based compensation and through promotions if they sold more. The SEC prepared a lawsuit accusing the fast-growing Malvern-based investment giant of failing to properly disclose its advisers’ special incentives to push the service.

On Aug. 29, Vanguard Advisers Inc. agreed to settle the claim, paying $19.5 million into a fund for advisory clients between August 2020 and December 2023. The company had been “failing to adequately disclose conflicts of interest when recommending to prospective clients and existing clients that they enroll in Vanguard Advisers’ managed account program, known as Personal Advisor Services,” according to the SEC.

“We are pleased to have reached an agreement to put this matter behind us,” Netanel Spero, a Vanguard spokesperson, said in a statement, not commenting on other questions.

It was the latest litigation step left over from the tenure of Mortimer “Tim” Buckley as Vanguard’s fourth chief executive, from 2018 to 2024.

In January, after five years of negotiations and legal filings, Vanguard agreed to pay $106 million to the SEC and state securities regulators for its failure to warn hundreds of thousands of investors that changes in fund rules could trigger unexpected capital-gains taxes. A $25 million settlement of private lawsuits by investors hit by those taxes is pending final approval in federal court in Philadelphia, following a scheduled January hearing.

In July, Vanguard was sued by the founders of Just Invest, an Oakland, Calif., “direct indexing” firm that Vanguard bought in 2021 in a rare acquisition. Their suit accused Vanguard of buying a lucrative business only to let it languish, reducing both potential competition, and the founders’ payout.

In the disclosure case, Vanguard in 2020 reported it had paid advisers “discretionary bonuses” — words it replaced in 2021 with “variable compensation” — in a brochure advertising the service, pointing out that this created a “financial incentive” to recommend Vanguard Personal Advisor Service over other Vanguard products.

But, as with Vanguard’s website, the company’s detailed supplement to the brochure and Vanguard’s SEC customer service summary filing describing the service in plain language, claimed there were no such bonuses, “contradictory” to the brochure, the SEC added.

Starting in August 2020, as the Buckley regime increased emphasis on fee-based businesses, Vanguard ran performance reviews that “incentivized its financial advisers ... to enroll and retain clients,” according to the SEC.

The advisers contacted Vanguard investors to review their accounts and draw up investment plans. The investors who were persuaded to set up advisory accounts for ongoing financial guidance were charged up to 0.3% a year of their account assets, payable in quarterly installments.

The minimum for most clients to qualify for advisers was $50,000 invested in eligible Vanguard accounts. Advisers who persuaded clients to buy the service could achieve merit promotions and higher pay if they made a lot of sales.

If they landed clients with at least $500,000, the advisers could qualify for performance bonuses, depending on how many they persuaded and what proportion of total clients they were able to sell, and how many they retain over time. Clients with at least $5 million were handed up to another group.

There were other bonus considerations, such as cooperation with other Vanguard employees, but sales were “the anchor,” according to the SEC. Average bonuses and increases boosted advisers’ incomes by 10% to 15%, sometimes more.

Vanguard corrected its website and filings to detail advisers’ incentives in 2023, the SEC said.

The fines won’t hit Vanguard hard. As a private, for-profit company, Vanguard doesn’t report revenues, but Morningstar fund analysts estimate Vanguard’s fund fee revenue totaled $8.7 billion last year, based on the company’s average fees multiplied by its $10 trillion-plus in customer assets. (That’s less than half the total revenues reported by publicly traded rival BlackRock, which also manages high-fee real estate and private-equity funds.)

“In plain English: Vanguard failed to tell clients that its advisers had a financial incentive to steer — and keep — them" with Vanguard’s advisory service, wrote Jeff De Maso, editor of the Independent Vanguard Adviser newsletter. “More than a little ironic for a firm that built its brand railing against hidden fees and conflicts of interest.”

He prescribed “a dose of transparency” to burnish Vanguard’s reputation.