Vanguard has agreed to a settlement exceeding $100 million with the Securities and Exchange Commission (SEC) and state regulators over allegations of misleading statements regarding charges tied to its target-date retirement funds, which left some investors burdened with substantial tax bills.
This settlement follows a $40 million agreement in October to resolve a class action lawsuit. Investors in that case accused Vanguard of breaching fiduciary duties by making changes to its target-date funds that resulted in significant, avoidable capital gains distributions.
Target-date funds are widely used by investors seeking a simplified, automated approach to retirement savings. These funds adjust their allocation of stocks and bonds as they near their target date—typically the anticipated retirement year. Vanguard, a prominent asset manager, offers two tiers of these funds: one for institutional investors and another for retail investors and smaller institutions. Institutional funds have lower fees and higher minimum investment requirements. For example, the retail funds carried an average expense ratio of 0.14%, while institutional funds were set at 0.09%, according to the SEC.
In December 2020, Vanguard lowered the minimum investment for its institutional funds from $100 million to $5 million. This prompted a significant shift of assets from the retail tier to the institutional tier. Between December 2020 and October 2021, redemptions from retail funds soared to approximately $130 billion, compared to just $41 billion during the same period a year earlier. These mass redemptions forced retail funds to sell off assets, triggering capital gains distributions for remaining retail investors. Those holding funds in taxable accounts bore the brunt, facing substantial tax liabilities.
The SEC noted that Vanguard’s written policies and disclosures to investors were inadequate. The prospectuses for its target-date funds failed to warn about the potential for increased capital gains due to redemptions caused by newly eligible investors moving to the institutional tier. This oversight violated key investor protection standards.
"Materially accurate information about capital gains and tax implications is critical to investors saving for their retirements," said Corey Schuster, chief of the SEC’s Division of Enforcement’s asset management unit. "Firms must ensure that they are accurately describing to investors the potential risks and consequences associated with their investments."
Vanguard did not admit or deny the findings as part of the settlement agreement. A company spokesperson stated, “Vanguard is committed to supporting the more than 50 million everyday investors and retirement savers who entrust us with their savings. We’re pleased to have reached this settlement and look forward to continuing to serve our investors with world-class investment options.”
The investigation involved a multistate task force led by Connecticut, New Jersey, and New York, with support from the North American Securities Administrators Association (NASAA). Regulators scrutinized Vanguard’s actions over three years, ultimately concluding that the company’s processes failed to adequately protect retail investors from financial harm.
The settlement will see Vanguard pay $106.41 million, which will be distributed to affected investors. This is in addition to the $40 million payout from the class action lawsuit, where plaintiffs argued that Vanguard could have avoided triggering capital gains by merging its retail and institutional funds earlier. Vanguard implemented this merger in late 2021, effectively consolidating the tiers.
The case underscores the importance of clear communication and robust oversight in managing investment funds. For Registered Investment Advisors (RIAs) and wealth advisors, the settlement serves as a cautionary tale about how seemingly operational decisions—such as adjusting fund tiers—can have significant tax and financial implications for clients. Advisors must stay vigilant and thoroughly assess fund changes to ensure their clients' investments align with their financial goals and tax strategies.
