Vanguard takes steps to convince the government it’s not too powerful

Vanguard Group’s founder, the late John C. Bogle, predicted that a day would come when the Malvern investment giant and its low-fee index funds, after years of trillion-dollar growth, could get too big.

The company’s expanded agreement with a U.S. bank regulator not to interfere in corporate decisions — amid mounting claims that Vanguard and its closest rivals have gotten too big for the nation’s good — suggests the day Bogle warned about has arrived.

“Trees don’t grow to the sky,” Bogle liked to warn in regard to the rapid growth of any financial asset. In 2018, he applied the aphorism to Vanguard directly: With the company and its nearest index-fund rivals, BlackRock and State Street, on track to hold a combined 30%-plus of the shares of all U.S. public companies over the next few years, “I do not believe that such concentration would serve the national interest.”

At the time, Vanguard was joining other big Wall Street firms in campaigns to encourage companies to add women directors and reduce carbon-burning. Vanguard also reported voting against reelecting corporate directors slightly more often than other big investors.

It looked like good business at the time, shareholder lawyer Lawrence A. Cunningham wrote in Philadelphia-based Directors and Boards magazine last year. “Massive index funds” like Vanguard found championship of a few environmental, social, and governance (ESG) issues was “a good way to compete in a market where it’s not possible to compete on prices or returns” because the products are so similar, Cunningham said.

But Bogle foresaw a reaction. He urged Vanguard to avoid conflict by restraining itself from criticizing corporate boards and managers more than smaller investors would and to publicly disclose, detail, and audit its managers’ contacts with corporate officers.

That is what Vanguard promised last month to do — more than it was already doing — in a new “passivity agreement” with the Federal Deposit Insurance Corp., the powerful bank regulator and one of the few government agencies that can block even giant investors like Vanguard from buying certain must-have stocks.

Vanguard has agreed that it will give the FDIC a list of banks where it owns at least 9% of shares. It is near or at that level for hundreds of U.S. banks.

And for banks where Vanguard investors own 10% or more, the company has pledged not to act like a controlling owner. It won’t try to put its own people on the board, replace top managers, boost cash payments to shareholders, change corporate strategy, or influence industry lobbies or other shareholders to lean on companies. It has also promised detailed audits and bureaucratic reports to assure the government it’s really staying “passive.”

FDIC director Jonathan McKernan, who has been pressing Vanguard and other index funds relentlessly, declared the deal “a step in the right direction” and a victory over “the concentration of power in a few institutional investors.” The agency is seeking a similar agreement with BlackRock.

Vanguard in a statement suggested the pact won’t really change much: “Vanguard is built around passive investing and has long been committed to working constructively with policymakers to ensure that passive means passive. This agreement with the FDIC is another example.”

The new FDIC pact followed escalating attacks on Vanguard and other mainstream investment companies from Republicans in Congress and GOP-run states who say Wall Street in recent years went too far in trying to appease liberal activists.

“As Vanguard has grown, it has come under increasing pressure from regulators” and politicians, Jeff DeMaso told readers of his Independent Adviser for Vanguard Investors newsletters recently. “The risk for Vanguard is that regulators or courts limit their ability to buy certain stocks.”

DeMaso cited the 2022 campaign by oil states to get another U.S. agency, the Federal Energy Regulatory Commission, to bar Vanguard from buying utility stocks. That was after Vanguard joined the Net Zero Asset Managers Initiative, which urged companies to cut their carbon-burning on grounds it’s heating up the planet and could hurt investors. Vanguard promptly quit Net Zero, and other Wall Street firms followed.

Last summer, Vanguard began offering investors the option of voting their shares to specifically exclude environmental and social concerns, including any that Vanguard itself may support, through a voting-advisory option offered by Egan-Jones Inc. of Radnor.

Vanguard has also added a warning about the dangers of getting so big in its annual report to investors: “The more assets that Vanguard, its affiliates, and its external advisers manage, the more the Vanguard funds are or may be negatively impacted by ownership restrictions and limitations imposed by law, by regulation or regulators.”

Pressure is still mounting. Last fall, Texas’ elected Attorney General Ken Patton, joined by coal-producing states including West Virginia and Wyoming (but not Pennsylvania), sued Vanguard “for conspiring to constrict the market for coal” and purposely drive up prices by endorsing environmentalists’ call for companies to dig less coal for electric power plants. Patton noted that Vanguard, BlackRock, and State Street together own more than 30% (the figure Bogle had cited as a tipping point) of major coal producers such as Peabody Energy, giving investment managers “a power to coerce.” Vanguard declined comment on the coal lawsuit.

Is there evidence that the index funds unduly pressured banks? The FDIC cited no examples but referenced a late 2022 report targeting the leading index funds, titled The New Emperors, by Republican staffers of the U.S. Senate Banking Committee, which listed a string of complaints.

Noting that Vanguard and BlackRock at that time together owned 13% to 17% of the four largest banks (JPMorgan, Bank of America, Wells Fargo, Citigroup), they wrote that it was “not surprising” that those banks had “adopted environmental, social and government policies that are strikingly similar” to Vanguard’s and BlackRock’s own, including membership in the Net Zero Banking Alliance.

They added that Vanguard and BlackRock had joined a majority of Apple shareholders in support of a “racial equity audit” that the company’s executives opposed. After Apple’s “embarrassment,” said the staffers’ report, JPMorgan Chase, Pfizer, Verizon, and Amazon agreed to similar audits.

Similarly, BlackRock and State Street helped form a majority that boosted a shareholder proposal to study gender and racial pay gaps at Disney, again over management opposition. Chipotle, Home Depot, and Target then agreed to publish similar data.

Neither Congress nor federal agencies have commented on another Vanguard change: In 2018 the company voted investor shares against a record stock performance grant program to Elon Musk as chairman of Tesla, the electric carmaker. Last year, when Tesla put the $50 billion-plus payout up to a vote, Vanguard officials met with top Tesla leaders, then voted for the grant, though a Delaware judge has so far blocked it, pending a Tesla appeal.

In short, dreams of using shareholders’ votes to push environmental goals or social reform have dissipated, and Vanguard has made itself “a somewhat limited shareholder,” DeMaso said.

Most individual investors are looking for retirement cash, not to change the world, DeMaso said. He predicts Vanguard and index funds will remain popular: The index funds’ lost clout “is a reasonable tradeoff for the ability to own the entire stock market.”