Investors can move forward with their lawsuit accusing Vanguard of breaching its fiduciary duty of care by opening some of its institutional target date retirement funds to smaller shareholders, a decision that the investors say led to unexpected capital gains tax bills.
Judge John F. Murphy of the US District Court for the Eastern District of Pennsylvania held that the investors have established standing to bring the lawsuit and stated a plausible claim for breach of care against Vanguard’s officers and independent trustees. However Vanguard was successful in knocking down some other claims, including claims of gross negligence, unjust enrichment, and violation of California’s Unfair Competition Law.
The lawsuit challenges Vanguard Chester Funds’ 2020 move to lower the eligibility threshold to access its institutional funds to $5 million, down from $100 million. The change resulted in an “elephant stampede” out of Vanguard’s retail funds toward more favorable investment options, according to court documents. In order to meet a wave of redemption requests from as many as 8,500 401(k) plans, the retail funds had to sell off assets and distribute associated capital gains to remaining shareholders.
Murphy’s opinion, released Monday, notes that for shareholders that had invested through tax-advantaged accounts like 401(k)s, those gains were reinvested “without second thought.” But other shareholders faced large capital gains liabilities that forced them to sell off other assets to cover the unexpected tax bills, Murphy wrote, and some ended up being hit with IRS and state penalties for failure to pay.
Murphy rejected what he described as a “creative” argument by Vanguard that the investors didn’t have standing because the company may have “done the aggrieved investors a favor” by accelerating their timeline for paying taxes on their gains.
“The allegations make it plausible that Investors — most of which “do not plan to sell any share in the fund until the target retirement date"—would have paid less in capital gains taxes when liquidating their shares of the Target Date Funds upon retirement,” Murphy wrote. “The December 2020 decision plausibly deprived them of the exact benefit that the funds present to prospective investors: invest with us, save for retirement, make money, and pay less in taxes on the money you saved (and earned) upon retiring.”
The Rosen Law Firm PA and Dovel & Luner LLP represent the plaintiffs. Debevoise & Plimpton LLP is among the firms representing the defendants.
The case is IN RE VANGUARD CHESTER FUNDS LITIGATION, E.D. Pa., No. 22-cv-00955, 11/20/23.
