Vanguard Conflicted

Is the reputed asset manager swimming in too many lanes?

Vanguard just settled with the SEC for nearly $20 million. The charge?

Hiding the fact that its “advisors” were financially rewarded for pushing clients into Vanguard’s Personal Advisor Services (PAS).

First, in their defense, don't ask a barber if you need a haircut. Vanguard has more business lines than simply investments — including advisory services. That if you called Vanguard for investment help, and they steered you toward another service offered by them, shouldn't be that surprising.

The fine is for not disclosing financial incentives that representatives of the company may have received for the referral. Okay, so consumers are highly protected and this sort of sales approach requires some reporting.

I don't geek out on regulatory policy, but am a complete wonk for how financial institutions can (and should) design their business model around their clients.

Of course we should be frustrated that Vanguard, an industry beacon FOR the client, is fined for not fulfilling its very duty to clients. But large organizations will inevitably make mistakes and have bad actors, and as such it's on them to do two key things: (1) decide what type of business they want to run, and (2) set guardrails and procedures when they derive revenue from various internal business lines so as to reduce conflicts of interest.

Financial organizations can launch many complementary services, providing opportunities for cross-sales and iffy practices.

Just look at banks: accounts, credit cards, mortgages, auto loans, lines of credit, etc.

And they can get a way with a lot as long as it's disclosed...

But it doesn't mean they should.

This same Vanguard built its brand on “investor-first” low-cost purity. The firm that practically shamed the rest of Wall Street into lowering fees for the benefit of you, the consumer. And yet, behind the veil, its own salesforce was incentivized with bonuses and promotions for one thing: getting you to buy more Vanguard.

Again — I think the headline sounds worse than it is. Vanguard is a business. So it's the disclosure that's the issue, not treating salespeople like salespeople. I don't know how any company could retain talent if they didn't pay them out for being talented.

The Vanguard Business Model

When I consider a client-centric business model, I question whether Vanguard should be delivering personal financial advice at all.

If you create and sell mutual funds/ETFs, AND then enter the business of financial advice (including telling people what mutual funds/ETFs to buy), you swim across lanes.

And so — there is a structural conflict of financial institutions with too many revenue streams. Yes, it may be legal with the appropriate disclosures.

No, I am not thrilled when I see it.

Vanguard is not unique here. Fidelity, Schwab, JPMorgan, Merrill — many of the giants offer “advisors” whose primary toolkit is their own funds.

That means the firm wears three hats at once:

• Manufacturer: they design the products

• Distributor: they sell the products

• Advisor: they recommend the products

  
  

When all three roles are under one roof, the advice you get can't be assumed product-agnostic. The line between fiduciary and salesperson blurs. And the client, often unknowingly, is the one who pays.

The Madoff Parallel

The disgusting shadow of Bernie Madoff casts over this.

Madoff was advisor, fund manager, and custodian all in one. Clients gave him money, he managed the funds, and he held the assets. Total control. Total fraud.

Vanguard is not Madoff. Its custodial structure is legitimate. But the overlap of roles — advisor and fund manager — is still a cousin to the conflict. Vanguard can't Ponzi-steal your money, but they're still a suboptimal financial advisor.

The Investor Takeaway

You can find good people with good intentions everywhere. And dare I say, especially at Vanguard! It is a fantastic company that has done tremendous good for the world.

But if you want the optimal environment for personal financial advice, you want:

• Product-agnostic

• Transparent advisor compensation

• No cross-selling

My Own Experience With Vanguard

Businesses that operate with multiple business lines have to be mindful of their dispersed stakeholders. My own experience is that Vanguard has their ducks in a row, and does right by their clients.

Two weeks ago, just before this news hit, I received a call from them.

I am a client (Peltoma uses some Vanguard funds for our clients), and when speaking to a representative at Vanguard PAS, a prospective client of our firm had mentioned that they were also exploring hiring us.

And Vanguard must have a database to run names through in this situation...

Because I got a courtesy call to ask if it was okay if Vanguard PAS competed for the business of advising this family, or if I wanted Vanguard to back off. I appreciated the call. It's a high integrity move.

And of course the answer is yes, please compete. There are many ways to deliver advice, and consumers should be empowered to find the one that works best for them.

Boutique advisory firms like mine may not have the resources of a $10 Trillion fund company, but we also aren't distracted and conflicted by being a fund company.

My business model has only one revenue stream (i.e. fees paid by clients), and it architects the best environment for un-conflicted, personal financial advice. There are dozens of firms similar to us, and we bang our heads wondering why any client would want something else.

No matter how good Vanguard investments are, they can't create that environment.

No matter how many disclosures Vanguard makes, they can't create that environment.

That's a business decision they've made to both sell investments and deliver advice, and no matter how highly I think of their mission, they'll have to live with it.

End.