A federal judge ruled last week that an investor lawsuit against Vanguard regarding the asset manager's handling of target-date funds can proceed. While Judge John F. Murphy dismissed some of the investors' claims, others will move forward to the discovery phase. During this phase, the investors' lawyers will request documents and other evidence from Vanguard.

Allegations of Negligence and Breach of Fiduciary Duty

The group of investors, who are seeking class action status, filed their lawsuit in a federal court in Pennsylvania in March 2022. They accused Vanguard, the trust comprising the target-date funds, and the trust's trustees of negligence and breach of fiduciary duty. These allegations stem from changes made to the target-date funds that resulted in tax liabilities for some investors. The plaintiffs are seeking monetary damages and other relief.

Vanguard's Response

Vanguard agreed to pay $6.25 million in July 2022 as part of a settlement with Massachusetts' state securities regulator over similar allegations. However, a spokesman for Vanguard stated that the company intends to defend itself against the current lawsuit. While reviewing the ruling in detail, Vanguard expressed satisfaction with the dismissal of certain claims and vowed to vigorously defend against the remaining allegations.

Target-Date Funds and Vanguard

Target-date funds are popular low-cost investments for retirement savings, and Vanguard is one of the nation's largest asset managers. Vanguard offered two tiers of target-date funds—one for individual investors and smaller retirement plans, and another for institutional investors with larger asset portfolios. Both tiers utilized the same strategy and investments, as stated in the investors' lawsuit.

The Impact of Changes to Minimum Investment Requirements

In December 2020, Vanguard lowered its minimum investment requirement for institutional investors to $5 million. This decision triggered a selloff in the retail target funds as smaller retirement plans sold assets to transition funds into lower-cost institutional options. To redeem shares and raise cash, the retail funds were forced to sell assets, resulting in realized capital gains. These gains were then distributed among the remaining investors of the funds.

In conclusion, the investor lawsuit against Vanguard continues to progress, with some claims being dismissed and others moving forward. Vanguard maintains its intention to vigorously defend itself against the allegations made by the investors. The outcome of this lawsuit will have implications for both Vanguard and the target-date fund industry as a whole.

Unexpected Tax Liabilities for Investors in Target-Date Funds

Investors who held target-date funds in taxable accounts found themselves facing unexpected tax liabilities, according to a recent lawsuit. One plaintiff, Valerie Verduce, invested in Vanguard's 2020 and 2030 retail funds and held them in taxable accounts. In 2021, these funds distributed more than $60,000 in capital gains to her, resulting in a tax liability of over $9,000. The lawsuit claims that Vanguard could have pursued alternative options that would not have created these tax liabilities.

Vanguard, along with the trustees, sought to have the investors' lawsuit dismissed. They argued that the investors had not plausibly alleged any breach of fiduciary duty. Additionally, they stated that the eventual payment of taxes on capital gains would have been inevitable when the investors sold their shares in the future. The outcome of whether the plaintiffs would have been better or worse off without the 2021 capital gains distribution would depend on unknown future events. Therefore, Vanguard believed the lawsuit lacked merit.

Judge Murphy made a ruling on the case, allowing some of the investors' claims to proceed while dismissing others. He stated that the breach of fiduciary duty claims against the trustees and claims based on the duty of care against Vanguard's executives could move forward. However, he dismissed the breach of fiduciary claim against Vanguard itself. This was because Vanguard did not directly advise investors' individual decisions to invest in the target-date funds, despite advising the trust and trustees on operational and fund management matters.

In summary, while the lawsuit continues, some claims have been dismissed while others remain active. Investors allege breach of fiduciary duty against Vanguard's executives and trustees but not against Vanguard itself. The outcome of this legal battle will be closely watched by those who have faced unexpected tax liabilities as a result of holding target-date funds in taxable accounts.

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