Vanguard is set to resolve a lawsuit filed by investors over changes made to its target-date funds in 2020, which resulted in what investors claim were "massive tax bills."
The asset management giant and investors have reached an agreement in principle after private mediation, according to a court order from Judge John F. Murphy dated Sept. 23. While the settlement is not yet finalized and the specific terms remain undisclosed, it marks a significant development in a case that has drawn attention from advisors and retail investors alike.
The dispute centers around Vanguard's target-date funds, a staple for retirement portfolios due to their automatic rebalancing of stocks and bonds as the target retirement date approaches. In the lawsuit, investors allege that Vanguard's decision to lower the institutional investment minimum for these funds from $100 million to $5 million created a wave of redemptions from smaller retirement plans moving into the cheaper institutional class. This forced the retail-class funds to sell off significant portions of their holdings, triggering large capital gains that were then passed on to investors with taxable accounts.
For example, the lawsuit points out that Vanguard’s 2030 Retail Fund, which had not realized more than $285 million in net gains in any given year since 2015, saw a sharp increase in 2021 when it realized over $5.6 billion in net gains after the large-scale sell-off. Retail investors, particularly those holding these funds in taxable accounts, were hit with substantial tax bills as a result. The lawsuit claims that the 2030 Retail Fund’s capital gains in 2021 were over 1,200% higher than any previous year since 2015.
The investors initially filed their complaint in March 2022, accusing Vanguard of negligence and breach of fiduciary duty. They argue that the situation could have been avoided had Vanguard taken alternative measures, such as merging the retail and institutional tiers sooner. Notably, Vanguard did eventually merge the two tiers in September 2021, but by then, the damage had already been done.
The investors sought class-action status and monetary damages in their lawsuit. While Vanguard pushed to have the case dismissed, the court dismissed some claims in November 2023 but allowed others to proceed, paving the way for this latest settlement.
This case is not the first time Vanguard has faced scrutiny over its target-date funds. In July 2022, the company agreed to a $6.25 million settlement with Massachusetts state securities regulators over similar allegations that the changes to the target-date funds resulted in unexpected tax liabilities for investors.
