Lawsuit Says Vanguard Caused Smaller Investors to Pay ‘Substantial’ Capital Gains Taxes After Retail Target-Date Fund Sell-Off

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A proposed class action alleges The Vanguard Group and its top officers and trustees harmed taxable investors financially when the firm caused an “elephant stampede” sell-off of the assets of certain target-date funds in December 2020.

The 28-page suit says that after Vanguard opened its lower-fee institutional target-date funds—which are typically used by $100 million-plus retirement plans—to all retirement plans with at least $5 million in assets, its retail target-date funds—typically used by individuals and retirement plans with less than $100 million—were forced to sell off as much as 15 percent of their assets to raise the cash needed to move over to the less expensive, but otherwise identical, institutional funds. 

When a target-date fund sells assets, it is required by federal law to distribute any capital gains to shareholders, the suit says. While large investors can typically reinvest these capital gains without incurring tax liability, smaller, ordinary investors, who hold these funds in taxable accounts, must pay taxes on the distributions, even when they automatically reinvest them, the case explains. 

For these smaller investors, the December 2020 sell-off of Vanguard’s retail funds caused the retail funds to recognize capital gains on the assets, according to the lawsuit. While larger retirement plans were relatively unscathed, taxable investors, whose recognized capital gain distributions after the sell-off were “unprecedented,” were left “holding the tax bag,” the lawsuit alleges. 

The case contends that Vanguard had other ways to lower retirement plan costs without hurting taxable investors yet either did not consider these options or outright did not care about hurting smaller, taxable investors. 

“This was a gross violation of Vanguard’s fiduciary duties (among other legal duties),” the complaint claims. 

The lawsuit looks to represent all U.S. investors in Vanguard’s retail funds who held these funds in taxable accounts and who received 2021 capital gains distributions. 

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