Vanguard Group has agreed to pay $40 million to retail investors and participants in small 401(k) plans who alleged that a fee-policy change in a target-date series caused them to incur high capital gains taxes.
Vanguard agreed to settle “solely to eliminate the burden and expense of further litigation,” said the agreement document filed Nov. 6 in a U.S. District Court in Philadelphia by attorneys representing plaintiffs, Vanguard, corporate officers and independent trustees.
“Defendants have determined that it is desirable and beneficial that the action be settled in the manner and upon the terms and conditions set forth in this stipulation," the document said.
The settlement represents the consolidation of five separate lawsuits — the first was filed in March 2022 — under the heading In Re Vanguard Chester Funds Litigation. Vanguard's target-date funds are organized as Vanguard Chester Funds, a Delaware statutory trust.
The parties announced an agreement in principle in September, achieved via mediation, but didn’t reveal details at that time. The settlement requires court approval.
“Defendants have denied, and continue to deny, that they have committed any act or omission giving rise to any liability or violation of law,” the document said.
“Defendants have denied, and continue to deny, each and all of the claims alleged by plaintiffs in the action, along with all the charges of wrongdoing or liability against them arising out of any of the conduct, statements, acts, or omissions alleged, or that could have been alleged, in the action,” the document said.
Plaintiffs alleged that a Vanguard fee policy enacted in December 2020 would trigger large capital gains taxes for certain accounts — both taxable and retirement.
Vanguard changed its fee schedule for institutional priced shares for a target-date series to $5 million from $100 million, which affected participants in 401(k) plans with assets of $5 million to $100 million as well as individuals in taxable accounts.
Vanguard's action caused at least 8,500 small 401(k) plans with 3.2 million participants to move from offering retail-priced shares to offering institutional shares, according to a November 2023 ruling by U.S. District Court Judge John F. Murphy, rejecting Vanguard's to dismiss the lawsuit.
Plans redeemed 490 million shares leading to an "unprecedented sales of assets (that) generated capital gains," the judge wrote. "The mass share redemption caused a sharp spike in capital gains distributions."
The policy didn't affect participants who kept their money in a 401(k) plan. "The Retail Fund shareholders that did not elect for a tax-advantaged account faced unexpected, sizable capital gains tax liabilities," the judge wrote.
"Some retail fund shareholders had to sell off other assets to cover the surprise tax bills," he added. "Other shareholders faced IRS and state law penalties for failing to pay the amount owed in capital gains taxes."
Vanguard subsequently merged its retail and institutional shares offering a tax-free exchange of retail shares to institutional shares. However, "some investors felt that the damage had already been done," the judge wrote.
The settlement affects investors who held the Vanguard Target Retirement Fund in 2021 in taxable accounts or “other relevant accounts” and who received capital gains distributions from the investor target retirement fund in 2021, the document said. It didn’t cite the number of investors affected by the settlement. The settlement covers those who invested a minimum of $1,000 in the target-date series before February 2022.
