By Jim Wiandt, Site Editor

Taking its lawsuit against Vanguard to another level, Standard & Poor's requested that the Securities and Exchange Commission (SEC) hold a public hearing on Vanguard's application to launch its exchange-traded funds (ETFs).

Standard and Poor's is currently suing the Vanguard Group to prevent it from launching an ETF based on the S&P 500 index. The SEC plays a critical role in the launch of any ETF, because it must exempt the funds from certain regulations on a case-by-case basis. An excellent article written by Mercer Bullard, a former assistant chief counsel at the SEC and head of Fund Democracy, a shareholder advocacy group, helps to explain the tangled web of possible motivations and outcomes in the suit.

Vanguard claims that its Vipers are covered under its existing licensing agreement with S&P. Standard & Poor's, however, says that Vanguard must negotiate another agreement, because ETFs are a different financial instrument, not a different share class. The dispute reflects the race to the bottom that has hit not only expense ratios, but correspondingly licensing fees as well.

The Vanguard group has claimed throughout that its Vipers merely represent another share class of its open-ended funds. Internally, the Vipers will be treated like a share class, with investors being able to transfer funds from one account to another without taking a capital gains hit. This will be the case whether or not Vanguard prevails in its suit, though Vanguard now plans to charge investors $50 to move from its open-ended fund to its Vipers. Vanguard decided to implement the charge after it got wind of rumblings that some short-term investors would buy into the open-ended fund to circumvent commissions on the Vipers.

A Vanguard representative reached for comment noted that on nine different occasions since the Vanguard 500 opened in 1985, new share classes were added, and none of these additions prompted any protest from S&P. He said he feels that this situation is no different than any of the other occasions when, for example, new institutional share classes were added. An official in the Index Services department of Standard & Poor's/ McGraw-Hill declined to comment on the lawsuit.

Interestingly, the dispute likely involves more issues than just licensing fees. Bullard speculates that S&P may have negotiated some sort of limited exclusivity deal that would preclude them from licensing further ETFs based on the S&P 500. Thus, if Vanguard were to win its lawsuit, there might be pressure from both State Street Global Advisors (SSgA) - which manages SPY, the select Spider based on the S&P 500 and Barclays Global Investors (BGI) to renegotiate terms of their deals.
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