[Vanguard sued over taxable distributions in Target Date Funds]

[Barry Barnitz]

[Moved into a new thread from: Target date funds ... so much for "set and forget" [and WSJ article] --admin LadyGeek]

Yesterday, I saw on Bloomberg tv a mention of a lawsuit filed about this target date situation. Very interesting.

Here is a "news" article dealing with the class action suit: Vanguard Sued Over Taxable Distributions in TDFs, March 15, 2022.

Vanguard’s retail investors are suing the company, alleging breach of contractual fiduciary duty related to a change in investment minimums in the firm’s target-date funds that caused many smaller investors to take tax hits, according to news reports.

The complaint, filed Monday in Philadelphia federal court, accuses Vanguard of favoring large retirement plans over smaller investors when the firm cut minimums for its institutional target date funds from $100 million to $5 million in 2020... The change resulted in billions of dollars in fund transfers, which in turn led funds to unload some holdings and set off capital gains in taxable accounts.

The suit, which petitions for class status on behalf of investors in the funds nationwide, seeks statutory, enhanced or punitive damages, restitution and disgorgement, among other relief.

regards,

[Oicuryy]

The lawsuit complaint is available here.
https://www.classaction.org/news/lawsui ... d-sell-off

Ron

[Juice3]

[Thread merged into here --admin LadyGeek]

Anyone have any more background on this legal action?

https://www.barrons.com/advisor/article ... 1647366034

Three investors are suing Vanguard Group for alleged negligence and breach of fiduciary duty ...

[alex_686]

See this rather long thread.

viewtopic.php?f=10&t=366566

IMHO Vanguard dropped the ball but did nothing legally wrong.

[Juice3]

See this rather long thread.

viewtopic.php?f=10&t=366566

IMHO Vanguard dropped the ball but did nothing legally wrong.

Thanks Alex. I swear I did search here and did not find anything. We need a better keyword system!

[samsoes]

Wow, something like that would have thrown a sizeable monkey wrench into my carefully engineered MAGI (to keep myself in the ACA sweet-spot). I'm glad VTI and VXUS weren't involved.

[whodidntante]

See this rather long thread.

viewtopic.php?f=10&t=366566

IMHO Vanguard dropped the ball but did nothing legally wrong.

The OP there had a 1M dollar capital gains distribution. Oofta.

[cas]

Anyone have any more background on this legal action?

See also this Morningstar article:

Lessons From Vanguard Target-Date’s Capital Gains Surprise (January 28,2022)

[secondopinion]

The pains of doing a one fund portfolio; I have never done so and never will. As I keep seeing this happen with companies like Vanguard and Fidelity change their minds to the investor's disadvantage, it only confirms my stance.

-1 for such funds. Just design the portfolio with funds that are not vague as to what the index is. Take a little bit of time to save oneself from such a problem.

[whodidntante]

The pains of doing a one fund portfolio; I have never done so and never will. As I keep seeing this happen with companies like Vanguard and Fidelity change their minds to the investor's disadvantage, it only confirms my stance.

-1 for such funds. Just design the portfolio with funds that are not vague as to what the index is. Take a little bit of time to save oneself from such a problem.

They are fine in tax-advantaged accounts, but I would never hold one in taxable.

[VanGar+Goyle]

See this rather long thread.

viewtopic.php?f=10&t=366566

IMHO Vanguard dropped the ball but did nothing legally wrong.

Thanks Alex. I swear I did search here and did not find anything. We need a better keyword system!

The other post is about an unanticipated and large 17% 2040 Target Retirement Fund payout around 12/28/2021.
I don't know what you searched for, but searching for "Barrons" and "sue" might miss the post.
Searching for Vanguard surely finds too much

[secondopinion]

The pains of doing a one fund portfolio; I have never done so and never will. As I keep seeing this happen with companies like Vanguard and Fidelity change their minds to the investor's disadvantage, it only confirms my stance.

-1 for such funds. Just design the portfolio with funds that are not vague as to what the index is. Take a little bit of time to save oneself from such a problem.

They are fine in tax-advantaged accounts, but I would never hold one in taxable.

Right. But even then, it does not stop them from deviating from an investor's intended portfolio. I much rather be in control of my holdings than trusting they will do what I want.

[alex_686]

The pains of doing a one fund portfolio; I have never done so and never will. As I keep seeing this happen with companies like Vanguard and Fidelity change their minds to the investor's disadvantage, it only confirms my stance.

-1 for such funds. Just design the portfolio with funds that are not vague as to what the index is. Take a little bit of time to save oneself from such a problem.

The issue occurred not because it is a all-in-one-fund. The tax drag from the bond portion is small.

The issue was that there was a massive outflow of assets from the fund. Any mutual fund with such a high level of outflow would have triggered a massive tax bill. Note, a ETF structure would have sidestep the capital gains issue.

[bengal22]

Hmmm. Since investors are owners they are actually sueing themselves. Maybe they will settle out of court.

[secondopinion]

The pains of doing a one fund portfolio; I have never done so and never will. As I keep seeing this happen with companies like Vanguard and Fidelity change their minds to the investor's disadvantage, it only confirms my stance.

-1 for such funds. Just design the portfolio with funds that are not vague as to what the index is. Take a little bit of time to save oneself from such a problem.

The issue occurred not because it is a all-in-one-fund. The tax drag from the bond portion is small.

The issue was that there was a massive outflow of assets from the fund. Any mutual fund with such a high level of outflow would have triggered a massive tax bill. Note, a ETF structure would have sidestep the capital gains issue.

You might be right here, but still the risk is higher when it is in one fund. Maybe one reason to not be super loyal to one issuer; I shop for the best ETFs for my portfolio, and that sometimes leads to other issuers than Vanguard (not that they are going to do this again, but why limit one's scope?).

[whodidntante]

I had another thought. I learned right here on bogleheads.org that Vanguard is owned by their investors. So aren't these people suing themselves?

[loghound]

I had another thought. I learned right here on bogleheads.org that Vanguard is owned by their investors. So aren't these people suing themselves?

It's not, as far as I understand, ownership in the traditional sense. Having said that a subset of investors (folks who held TD in taxable accounts) are suing the company. If they win those settlement costs will be paid via higher fees (I presume) by everyone who uses their service.

As others have said I'm pretty sure it's not illegal, and they did disclose expected returns well before it happened, and as a general rule you shouldn't buy mutual funds towards the end of the year in taxable accounts but, yea, it was pretty painful in this case.

[runninginvestor]

Hmmm. Since investors are owners they are actually sueing themselves. Maybe they will settle out of court.

<<Insert Spiderman pointing meme>> ha

[sperry8]

See this rather long thread.

viewtopic.php?f=10&t=366566

IMHO Vanguard dropped the ball but did nothing legally wrong.

Dropped the ball is an understatement. They blew it big time. May not be illegal, but whatever marketing genius missed the ultimate issue, should be long gone I'd hope.

[Whakamole]

As others have said I'm pretty sure it's not illegal, and they did disclose expected returns well before it happened, and as a general rule you shouldn't buy mutual funds towards the end of the year in taxable accounts but, yea, it was pretty painful in this case.

Vanguard's announcement didn't help those who had held the funds for a year or more; capital gains on the stock-heavy funds were significant. There was no exit strategy which didn't cost investors.


I wonder if this suit will uncover why Vanguard held investor-class shares in TD funds.

[alex_686]

See this rather long thread.

viewtopic.php?f=10&t=366566

IMHO Vanguard dropped the ball but did nothing legally wrong.

Dropped the ball is an understatement. They blew it big time. May not be illegal, but whatever marketing genius missed the ultimate issue, should be long gone I'd hope.

I don't think it was a marketing decision.

You have company X with a independent board A. Board A's duty is to maximize value for the shareholders of X.

You have company Y with a independent board B. Board B's duty is to maximize value for the shareholders of Y.

By law Board A can's factor in how their decisions will impact company Y, they can only care about their shareholders of company X.

Company X is getting hammered by their competition so they decided to take some corrective action. So company X (Vanguard Institutional Target Date Funds) drops the minimum investment from 5m to 1m. This stops the blood loss as assets start flowing back into the fund. This also knifed company Y (Vanguard Retail Target Date Funds) as small 401(k) plans switched funds.

Don't let the fact that both companies have "Vanguard" and "Target Date" in their name. They are 2 totally separate companies. They have to operate in the interest of their own shareholders.

After the fact they merged the 2 funds. This is where they dropped the ball. In hindsight merging the 2 funds was the obvious answer.

[shess]

Hmmm. Since investors are owners they are actually sueing themselves. Maybe they will settle out of court.

That sounds silly, but having the subset of owners affected by the distribution suing the majority of owners not affected by the distribution seems a little less silly.

[sperry8]

See this rather long thread.

viewtopic.php?f=10&t=366566

IMHO Vanguard dropped the ball but did nothing legally wrong.

Dropped the ball is an understatement. They blew it big time. May not be illegal, but whatever marketing genius missed the ultimate issue, should be long gone I'd hope.

I don't think it was a marketing decision.

You have company X with a independent board A. Board A's duty is to maximize value for the shareholders of X.

You have company Y with a independent board B. Board B's duty is to maximize value for the shareholders of Y.

By law Board A can's factor in how their decisions will impact company Y, they can only care about their shareholders of company X.

Company X is getting hammered by their competition so they decided to take some corrective action. So company X (Vanguard Institutional Target Date Funds) drops the minimum investment from 5m to 1m. This stops the blood loss as assets start flowing back into the fund. This also knifed company Y (Vanguard Retail Target Date Funds) as small 401(k) plans switched funds.

Don't let the fact that both companies have "Vanguard" and "Target Date" in their name. They are 2 totally separate companies. They have to operate in the interest of their own shareholders.

After the fact they merged the 2 funds. This is where they dropped the ball. In hindsight merging the 2 funds was the obvious answer.

Agreed. I used the wrong nomenclature. But merging was the answer pre-hindsight and someone didn't think through the ramifications of the decision prior. That person, should be gone.

[neurosphere]

I'm positive this has already been said in multiple threads, but it seems this concern with TD funds is "one and done", in that of course it could happen again and so now it's a known risk for TD funds and prudence is necessary if used in taxable accounts. Similar to how Dodge and Cox had massive capital gains distributions from their funds a few year ago (if i'm recalling correctly). It was surprising in magnitude but not that unexpected for an active fund and of course people assumed TD funds, especially from Vanguard. But now, all that's needed is a disclaimer in the prospectus and marketing materials about distribution risks because it's not as if any TD fund company is going to promise to forever after keep distributions below some arbitrary value. I guess the obvious rebuttal is that a similar thing happened in the past at some other fund company (e.g. Fidelity) and yet many (including myself!!) were caught by surprise.

I'm certain that prior to any lawsuit being announced Vanguard was taking steps to prevent future lawsuits (whether through language/warnings or putting in place some mechanism this won't happen again, e.g. fund mergers).

[ifish100]

I just completed the painful process of paying the LTCG tax due to the debacle VG created for my Target Date Fund in Taxable issue. Despite asking VG twice for clarification for Estimated Taxes for 2022, the simple questions of... 1) Did the opportunity for the exodus of Investor Funds to Institutional Funds end as of Feb 28, 2022? and 2) if it did end what amount of LTCG were generated up through Feb? I have not received a simple answer to those questions. If one looks on the website information for the TD fund it says zero, so it is impossible to determine if there is a second wave of a tax bomb in 2022 also.

Unless you want to grossly overestimate your Estimated taxes for 2022 you really need to know that.

Does anyone have an understanding of when that allowed exodus was to stop or does it exist forever? Since they seem to be avoiding the question, one wonders if 2022 will not be a second attack at tax time.

I wish they would give TG in taxable owners the ability split off the underlying funds, without tax consequences, just split them off.

[ruud]

You have company X with a independent board A. Board A's duty is to maximize value for the shareholders of X.

You have company Y with a independent board B. Board B's duty is to maximize value for the shareholders of Y.

By law Board A can's factor in how their decisions will impact company Y, they can only care about their shareholders of company X.

Company X is getting hammered by their competition so they decided to take some corrective action. So company X (Vanguard Institutional Target Date Funds) drops the minimum investment from 5m to 1m. This stops the blood loss as assets start flowing back into the fund. This also knifed company Y (Vanguard Retail Target Date Funds) as small 401(k) plans switched funds.

Don't let the fact that both companies have "Vanguard" and "Target Date" in their name. They are 2 totally separate companies. They have to operate in the interest of their own shareholders.

As documented in the SAI, the investor and institutional target date funds are both part of the same trust and have the same boards of directors, so A=B (and possibly X=Y) in your analogy above.

[alex_686]

You have company X with a independent board A. Board A's duty is to maximize value for the shareholders of X.

You have company Y with a independent board B. Board B's duty is to maximize value for the shareholders of Y.

By law Board A can's factor in how their decisions will impact company Y, they can only care about their shareholders of company X.

Company X is getting hammered by their competition so they decided to take some corrective action. So company X (Vanguard Institutional Target Date Funds) drops the minimum investment from 5m to 1m. This stops the blood loss as assets start flowing back into the fund. This also knifed company Y (Vanguard Retail Target Date Funds) as small 401(k) plans switched funds.

Don't let the fact that both companies have "Vanguard" and "Target Date" in their name. They are 2 totally separate companies. They have to operate in the interest of their own shareholders.

As documented in the SAI, the investor and institutional target date funds are both part of the same trust and have the same boards of directors, so A=B (and possibly X=Y) in your analogy above.

Yes, you are correct. I mentioned that in my post. They have now merged. In 2021 they were 2 separated entities with separate boards.

[UpperNwGuy]

Hmmm. Since investors are owners they are actually sueing themselves. Maybe they will settle out of court.

I invest in Vanguard ETFs. I can assure you that I am not an owner of Vanguard. Any public relations fluff to the contrary is categorically false. Let me repeat, Vanguard is not owned by the investors.

[ruud]

Yes, you are correct. I mentioned that in my post. They have now merged. In 2021 they were 2 separated entities with separate boards.

They were part of the same trust (Vanguard Chester Funds) even before the funds were merged, so they had a single board.

From the SAI again (emphasis mine):

Effective as of the close of business on February 11, 2022, the previously announced reorganization of each Vanguard Institutional Target Retirement Fund, each a series of Vanguard Chester Funds (the Trust), with and into each corresponding Vanguard Target Retirement Fund listed in the table below, each also a series of the Trust, is complete.

[jshaffer740]

Hmmm. Since investors are owners they are actually sueing themselves. Maybe they will settle out of court.

They’re also suing the trustees and certain executives, I believe, who would likely be insured. So it’s possible that this would be a net positive for fund owners if much of it comes from insurance payouts.

[ruud]

They were part of the same trust (Vanguard Chester Funds) even before the funds were merged, so they had a single board.

Or maybe your point is that technically the boards were separate entities, but it is the exact same set of people sitting on them.

[CAP_theorem]

After these capital gains are paid for will I be in a position of having to pay for those gains again in the future? Or am I just paying the taxes earlier?

[BayAreaDude]

Note, a ETF structure would have sidestep the capital gains issue.

Vanguard's prospectus for TDFs has the following paragraph:

"Potentially disruptive redemptions. Vanguard reserves the right to pay all or part of a redemption in kind—that is, in the form of securities—if we reasonably believe that a cash redemption would negatively affect the fund’s operation or performance or that the shareholder may be engaged in market-timing or frequent trading. Under these circumstances, Vanguard also reserves the right to delay payment of the redemption proceeds for up to seven calendar days. By calling us before you attempt to redeem a large dollar amount, you may avoid in-kind or delayed payment of your redemption. Please see Frequent-Trading Limitations for information about Vanguard’s policies to limit frequent trading."


Could Vanguard have avoided this debacle by processing the disruptive redemptions in kind? My understanding is that in kind redemptions is how ETFs gain their tax efficiency, so I am wondering why Vanguard didn't use them here.

[btq96r]

I've got hit with some bigger than before capital gains the last two years, but with the markets being a bit crazy and my using the Vanguard Capital Opportunity Fund (VHCAX) in my non-retirement brokerage account, it's not unexplainable.

I'm scratching my head as to why anyone would use a target date fund in a non-retirement account. Wanting to keep the same funds after maxing out retirement contributions, maybe? Or just don't know about VTSAX and VBTLX and how to set an AA?

[ScubaHogg]

I've got hit with some bigger than before capital gains the last two years, but with the markets being a bit crazy and my using the Vanguard Capital Opportunity Fund (VHCAX) in my non-retirement brokerage account, it's not unexplainable.

I'm scratching my head as to why anyone would use a target date fund in a non-retirement account. Wanting to keep the same funds after maxing out retirement contributions, maybe? Or just don't know about VTSAX and VBTLX and how to set an AA?

Multiple reasons. I’ll throw out some

- it’s simple. Keeping it easy in case a surviving spouse needs to take over
- individual is just new to investing and knows just enough to stick with index funds
- a TDF looks and smells based on its name like it’s appropriate for someone, you know, saving for retirement. The underlying funds are routinely recommended as appropriate for individuals in taxable accounts. It’s not intuitive someone who doesn’t spend their time on BHs it’s got a weird weak point where u might have to pay a bunch of capital gains even if you took no capital gains. It’d be like owning your house and randomly one day the tax man shows up and says you owe capital gains on any equity growth
- VG definitely didn’t highlight the fact they didn’t think TDFs shouldn’t be in taxable (and I mean highlight, not buried in fine print on page 37 of a legal compliance document

[kd2008]

Bogleheads sometimes ..er ..always live in lala land where they have far superior knowledge and expect lay people to have the same.

US is a litigious nation. Coffee cups are labeled here this may be hot.

Suing multi-trillion-dollar asset company is what attorneys dream about.

The sooner Vanguard settles and makes it go away, better it is for the long run.

The process of litigation will require discovery of facts where Vanguard will have to reveal a lot that it does not want to ..including compensation structure.

[exodusNH]

After these capital gains are paid for will I be in a position of having to pay for those gains again in the future? Or am I just paying the taxes earlier?

You paid the taxes earlier. Those taxes were always going to be due, unless one's plan was to die before spending the money, allowing your heirs to get the step-up basis.

If you are still working, you might have paid more taxes than you would have than when in retirement. There is a 0% cap gains rate that you're more likely to qualify for if you're not drawing a salary. Or, the extra income (even if reinvested) might have pushed you into the 20% cap gains bracket or even into NIIT.

[exodusNH]

- VG definitely didn’t highlight the fact they didn’t think TDFs shouldn’t be in taxable (and I mean highlight, not buried in fine print on page 37 of a legal compliance document

As alex_686 had stated multiple times, Vanguard is not permitted to give tax advice.

[anon_investor]

IMHO Vanguard dropped the ball but did nothing legally wrong.

+1. Agreed. I am sure there is some language in the prospectus that warns the investor to check with a tax advisor.

Even the prospectuses for their tax managed accounts warn that they may not achieve their tax efficient objective, and those fund's have the objective to be tax efficient, target date funds aim for no such thing.

[burritoLover]

For different reasons (likely an index change), Vanguard also had a $5.18/share capital gains distribution for VIGI International Dividend Appreciation ETF so it isn't just isolated to target date funds or mutual funds. Tax efficiency seems way down the list in importance for Vanguard. Most of their ETFs should be tax efficient but will that hold going forward?

[Jack FFR1846]

I would expect that if this class action is successful, the plaintiffs who were hit with $1M in taxable gains will get a check for $1.34 after court costs and attorney fees.

I'm another one who believes that clients of Vanguard funds could create a class action lawsuit because of the false advertisement that Vanguard perpetuates that fund owners are owners of Vanguard. They aren't. No more than I'm an owner of Schwab because I own SCHB. Of course with Schwab, it I want to become an owner, I can buy stock in the company. And see executive compensation.

[anon_investor]

I would expect that if this class action is successful, the plaintiffs who were hit with $1M in taxable gains will get a check for $1.34 after court costs and attorney fees.

I'm another one who believes that clients of Vanguard funds could create a class action lawsuit because of the false advertisement that Vanguard perpetuates that fund owners are owners of Vanguard. They aren't. No more than I'm an owner of Schwab because I own SCHB. Of course with Schwab, it I want to become an owner, I can buy stock in the company. And see executive compensation.

Actually I am sure SCHB actually owned Schwab stock, so constructively you are a Schwab shareholder!

[ScubaHogg]

- VG definitely didn’t highlight the fact they didn’t think TDFs shouldn’t be in taxable (and I mean highlight, not buried in fine print on page 37 of a legal compliance document

As alex_686 had stated multiple times, Vanguard is not permitted to give tax advice.

Bit of a cop out. They could simple say, “hey, we will probably realize large capital gains in this fund from time to time. Plan appropriately.”

Or even better plan in such a way not to force large capital gain distributions on people.

[RubyTuesday]

I didn’t read the earlier thread, but seems like Vanguard could have done in-kind redemptions to minimize the cap gains being pushed to the surviving fund holders. Was there some reason that wasn’t done? I’ll review the complaint and earlier thread to see if I can answer my own question before someone answers me here. Ready, set, go…

[exodusNH]

- VG definitely didn’t highlight the fact they didn’t think TDFs shouldn’t be in taxable (and I mean highlight, not buried in fine print on page 37 of a legal compliance document

As alex_686 had stated multiple times, Vanguard is not permitted to give tax advice.

Bit of a cop out. They could simple say, “hey, we will probably realize large capital gains in this fund from time to time. Plan appropriately.”

Or even better plan in such a way not to force large capital gain distributions on people.

Be as annoyed as you want, but it is *illegal* for them to give tax advice of any sort.

I'm not saying they handled the situation well; they wound up merging the funds.

[RubyTuesday]

I didn’t read the earlier thread, but seems like Vanguard could have done in-kind redemptions to minimize the cap gains being pushed to the surviving fund holders. Was there some reason that wasn’t done? I’ll review the complaint and earlier thread to see if I can answer my own question before someone answers me here. Ready, set, go…

My very quick read is that Vanguard probably could have avoided this cap gain realization by merging the institutional fund with the other funds prior to reducing minimums and also could have forced in-kind redemptions on those selling to move to institutional.

Did they have a fiduciary duty to do one or both of these? Did they have a fiduciary duty NOT to lower minimums?

[alex_686]

They were part of the same trust (Vanguard Chester Funds) even before the funds were merged, so they had a single board.

Or maybe your point is that technically the boards were separate entities, but it is the exact same set of people sitting on them.

Rudd, you hit the nail on the head.

I don't know if the word "technically" conveys the right sense. Technically speaking, when the board meets it has a fiduciary duty to act in the best interest of only their shareholders. This can create interesting conflicts of interest when the exact same people have to convene a meeting for another company which they must only act in a fiduciary duty to that company.

It is at times like this that wish that I had saved a glorious 60-page white paper on the evolution of mutual fund governance so I could share it.

[rkhusky]

Does anyone else look at the unrealized capital gains that their funds currently have? Vanguard posts that for all their funds. Not sure about other brokerages.

[alex_686]

Could Vanguard have avoided this debacle by processing the disruptive redemptions in kind? My understanding is that in kind redemptions is how ETFs gain their tax efficiency, so I am wondering why Vanguard didn't use them here.

Yes, technically they could. However, ETFs are set up for in-kind distributions. Mutual funds are not.

For context, when was the last time you chose to take a in-kind distribution instead of cash when you redeemed shares? We are looking at portfolios that held between 1m to 5m in the retail fund. As institutional money goes this is small unsophisticated side of things. As a portfolio manager who wanted to shift funds why would you not use the standard simple exchange process which has no costs associated with it? Why would you want to use a fancy complex process of in-kind redemptions? Now there are reasons one might chose the in-kind redemption but these tend to be edge cases that larger sophisticated money would use.

[exodusNH]

I didn’t read the earlier thread, but seems like Vanguard could have done in-kind redemptions to minimize the cap gains being pushed to the surviving fund holders. Was there some reason that wasn’t done? I’ll review the complaint and earlier thread to see if I can answer my own question before someone answers me here. Ready, set, go…

Remember, these were the collective actions of 10000s of individual holdings. It's hard to argue that Joe Programmer's $55,000 holding of target date 2050 would be "disruptive" to the fund. It certainly wasn't market timing. They have a duty to provide daily liquidity.

How would they issue stock to people holding the accounts in a 401k that has no provision for that?

Vanguard did not handle this well. But there's a big difference between that and illegal. In retrospect, they should have just merged the funds.

People like to say "sue!!!!!!" It's usually the people who have never dealt with the legal system. Nothing there works like a layperson expects. I learned this the hard way when I learned that "time is of the essence" is a clause that allows either side to walk away from the deal if a timeline wasn't met, even by a small amount.

My SO was involved in a contentious estate issue. The person causing the contention was instructed to show up in court on a specific day and time. The person asked the judge for a delay because it wasn't a convenient time. The judge denied it.

Come the day, after my SO travelled 2 hours to the court room with their lawyer, the other person wasn't there. The judge's response? "I guess they had somewhere else to be."