Vanguard Group, the largest manager of mutual fund assets in the United States, has reached a preliminary settlement agreement of $40 million to resolve a class-action lawsuit. This lawsuit claims that Vanguard’s actions led to significant tax liabilities for ordinary investors in its target-date retirement funds. The settlement, filed in U.S. District Court in Philadelphia, is pending judicial approval and aims to address the financial impact on investors who were unexpectedly burdened with large capital gains taxes.
The lawsuit originated from Vanguard’s controversial decision in December 2020 to lower the minimum investment threshold for its lower-cost funds, which were primarily intended for institutional clients. The minimum investment dropped from $100 million to just $5 million, resulting in a surge of retail investors moving into these funds. Plaintiffs argued that this influx caused a “stampede” into the lower-cost options, forcing higher-cost retail funds to liquidate assets to meet redemption requests. Consequently, investors who remained in the retail funds were left with substantial capital gains distributions and subsequent tax bills.
In 2021, one such fund—the Vanguard Target Retirement 2040 Fund—distributed an estimated 15.1% of its net asset value as capital gains, a dramatic increase from only 0.4% the previous year. This situation exemplifies the unintended consequences of Vanguard’s restructuring and highlights the complexities surrounding mutual fund taxation.
Vanguard’s target-date funds are designed to provide a diversified mix of stocks, bonds, and cash that gradually become less risky as investors approach retirement age. These funds are also intended to be tax-efficient; however, the recent developments have raised questions about their effectiveness in achieving this goal.
In a statement regarding the settlement, Vanguard expressed its commitment to supporting everyday investors and retirement savers. “We are happy to have reached an agreement that allows us to put this litigation behind us,” the company stated, while continuing to deny any wrongdoing.
This $40 million settlement follows another significant payout by Vanguard in July 2022 when it agreed to pay $6.25 million to resolve similar claims brought by Massachusetts Secretary of State William Galvin. These prior legal challenges underscore ongoing scrutiny regarding Vanguard’s management practices and fiduciary duties.
The plaintiffs’ legal team may seek up to $13.33 million for attorney fees, along with $985,000 for expenses and $240,000 allocated for the 12 named plaintiffs involved in the case. After these deductions, approximately $25.4 million will be available for distribution among other affected investors.
Lawyers representing the plaintiffs have indicated that while they believe their case had merit and could have resulted in damages exceeding $259.5 million, they recognized the risks associated with continuing litigation. They emphasized that reaching this settlement provides immediate recovery for impacted investors while avoiding the uncertainties of prolonged legal battles.
As this case progresses toward final approval, it serves as a critical reminder of the potential risks associated with holding mutual funds in taxable accounts. Financial advisors are encouraged to consider alternative investment strategies that may mitigate such tax implications for their clients.
The case is officially titled In re Vanguard Chester Funds Litigation, U.S. District Court for the Eastern District of Pennsylvania, No. 22-00955. The outcome will likely influence future practices within the mutual fund industry and prompt further discussions about investor protections and fiduciary responsibilities.
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