Vanguard group will pay $106.4 million to settle charges brought by the Securities and Exchange Commission and state officials from New York, Connecticut and New Jersey over alleged misleading statements in fund prospectuses that led retirement plan investors to incur high capital gains taxes.
Vanguard in December 2020 changed its fee schedule for institutional priced shares for a target-date series to $5 million from $100 million. In the first half of 2021, “a substantial number of small- and medium-sized retirement plan investors in the Investor (Target Retirement Funds) redeemed fund shares to switch to the Institutional TRFs due to the lower minimum investment amount and lower expense ratio,” the SEC said in its Jan. 17 order.
To meet these redemptions, the Investor TRFs had to sell underlying assets at elevated prices due to the rising financial markets that had rebounded from pandemic lows and reached new highs, the SEC noted. As a result, retail investors of the Investor TRFs who did not switch and continued to hold their fund shares in taxable accounts faced historically larger capital gains distributions and tax liabilities and were deprived of the potential compounding growth of their investments, the SEC said.
From November 2020 to October 2021, capital gains distributions for the Investor TRFs as a percentage of net asset value averaged 9.69%, nearly seven times larger than the 1.39% average from November 2019 to October 2020, according to the SEC.
“These capital gains distributions accelerated the investors’ incurrence of tax liability and deprived them of the potential compounding growth of their investments in the Investor TRFs through retirement,” the SEC said.
Vanguard Investor TRFs’ prospectuses, effective and distributed in 2020 and 2021, were materially misleading because they stated that the funds’ distributions may be taxable as ordinary income or capital gains, and that capital gains distributions could vary considerably from year to year because of the funds’ “normal” investment activities and cash flows, according to the SEC.
The prospectuses failed to disclose the potential for increased capital gains distributions, the SEC said. Vanguard also failed to adopt and implement written policies and procedures reasonably designed to prevent violations of the (Investment) Advisers Act, the agency added.
In response, a Vanguard spokesperson said in a statement, “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.”
This settlement resolves the SEC’s investigation along with settlements of parallel investigations of Vanguard announced Jan. 17 by the Office of the New York Attorney General, the Connecticut Department of Banking and the New Jersey Office of the Attorney General on behalf of the North American Securities Administrators Association.
Vanguard did not admit to or deny the SEC’s findings, but did agree to a censure and to pay $18.2 million in disgorgement and prejudgment interest. That total will be deemed satisfied by the payment of $92.9 million in relief ordered by the states’ settlements and a $13.5 million civil penalty, for a total amount of $106.4 million. Those funds will be distributed to affected investors through a fund established by the SEC.
The $106 million settlement is in addition to the $40 million that Vanguard agreed in November to pay to settle an investor class action lawsuit.