PhillyDeals: Vanguard seeks to get suit thrown out

Vanguard Group, the Malvern mutual fund giant, wants a New York court to throw out a tax-fraud lawsuit that challenges the company's legal structure.

It alleges that David Danon, the ex-Vanguard lawyer who filed the complaint, violated basic rules of corporate lawyer behavior by accusing his former bosses.

Vanguard's memo, made public after New York Supreme Court Justice Joan A. Madden declined Vanguard's requests to keep case documents secret, argues that Danon "grossly betrayed" the $3 trillion-asset company, violated confidentiality requirements, and broke state legal ethics rules when he "stole hundreds of privileged and confidential documents" related to Vanguard tax practices.

Vanguard also defended its structure, noting it has been widely publicized since the company's founding by John C. Bogle 40 years ago. Vanguard spokesman John Woerth declined comment on the case.

Danon has argued that the harm Vanguard is doing other taxpayers - his suit estimates the company has illegally avoided more than $1 billion in federal income taxes - justifies his actions, under whistle-blower protection laws, which could pay him a cut of Vanguard taxes if the government were to get any money back.

But Vanguard says federal courts have killed comparable suits, including an action against Quest Diagnostics Inc. accusing the medical-testing company of paying kickbacks to insurers. The court disqualified the ex-company lawyer who sued, noting his privileged information tainted his case.

Danon's suit "is a brazen attempt by an in-house attorney to obtain a bounty as a whistleblower by suing his client with respect to the very issues on which he provided legal advice," Vanguard argued through its attorneys at the New York corporate law firm Jones Day.

Letting lawyers sue their patrons "would make a farce of the attorney-client relationship [and] destroy the very underpinnings of the legal system," Vanguard argues, according to court documents.

Danon "improperly accessed hundreds of privileged and confidential" Vanguard documents and sent them to a personal e-mail account after he was told he would have to look for another job in 2013, Vanguard added. The company denies Danon was fired in retaliation.

Vanguard Group is owned by Vanguard's mutual funds, which pay the company for management services. Danon's suit alleges the company lowballs the price of professional services so it shows little profit and pays little tax. Low taxes allow Vanguard to charge lower fees and lure business from tax-paying rivals. But that violates Section 482 of the Internal Revenue Code, which requires companies to charge market-rate prices, not lower "at-cost" prices, for services to related firms, Danon argued.

But Vanguard says that its "at-cost" practices benefit clients and that Vanguard officials' past testimony in congressional hearings about its structure should protect it from suits under whistle-blower rules.

"Only if the IRS (or a state such as New York) were to exercise their authority" and set inter-company payments higher than what Vanguard uses could Vanguard be accused of knowingly underpricing its services or underpaying its taxes, Vanguard adds in the memo.

"Vanguard's approach here is to shoot the messenger," Danon's lawyer, Stephen Sorensen, of Los Angeles, told me.

With the memo, Vanguard filed a copy of founder Bogle's letter to the Securities and Exchange Commission at the company's founding. It describes the 1970s mutual fund industry in rapid decline due to high fees, poor results, and conflicts of interest.

Bogle presented Vanguard's fund-owned and at-cost structure as a way to persuade Americans to start buying funds again.

Sorensen said Vanguard still hasn't shown a legal basis for its tax practices. Danon has until Nov. 17 to respond to Vanguard's request for dismissal.