Massachusetts Secretary of the Commonwealth William F. Galvin announced July 6 that Vanguard Marketing Corporation has agreed to provide restitution to thousands of Massachusetts investors who got huge tax bills in the wake of a decision designed to benefit certain retirement plans.
Now, in case you’re wondering how the latter led to the former—the details were outlined in a lawsuit filed earlier this year. According to the suit, beginning in December 2020, Vanguard caused an “elephant stampede” sell-off from its Retail Funds (which, by the way, included some retirement plans) by choosing to open its Institutional Funds (which hold the same assets as the Retail Funds) to all retirement plans with at least $5 million, so that retirement plans invested in the Retail Funds could sell their shares and move over to cheaper, but otherwise identical, Institutional Funds—a move, the suit complains was designed “…to keep its competitive edge against other mutual fund providers.”
However, the suit (and a Wall Street Journal report) explained that, in order to raise cash to redeem so many shares, the Retail Funds were forced to sell off as much as 15% of their assets (or even more)—and when those assets were sold, the Retail Funds recognized capital gains on the assets—capital gains distributions to investors that the suit claims were “unprecedented” (and by that, they mean 40 times previous levels). Retirement plans weren’t impacted—but “it left taxable investors holding the tax bag. The shift left those with less than $5 million who held Investor TDFs in taxable accounts to pay the large capital gains tax bills that resulted.[i]
Massachusetts Agreement
As for Galvin’s announcement, it notes that the agreement with Vanguard was reached as a result of an investigation Galvin’s office commenced in January, after his Securities Division became aware of potential tax disclosure and marketing issues with TDFs, disproportionately impacting retail investors.
Under the agreement, Vanguard has agreed to establish a $5.5 million fund to make restitution payments to eligible Massachusetts claimants for a portion of the tax liabilities that they incurred as a result of capital gains distributions related to the investment minimum changes made to Institutional Vanguard TDFs. Vanguard will pay an additional $250,000 to administer the fund. Beyond that, Vanguard will make a one-time payment of $500,000 to the Commonwealth.
Galvin plans to reach out to potentially eligible investors directly to inform them that they may be entitled to financial restitution from Vanguard. Any funds remaining in the Massachusetts Vanguard TDF Fund after investors have received payments will be distributed to the Worker and Small Investor Protection Fund.
According to a press release, information provided by Vanguard to the Securities Division, long and short-term capital gains were distributed to over 5,000 Massachusetts accounts, affecting thousands of Massachusetts investors.
[i] For some perspective, the suit—separate from the actions taken by Galvin—outlined the impact on the three named plaintiffs. Valerie M. Verduce invested in Vanguard’s 2020, 2030, and 2040 Retail Funds; in 2021, her funds distributed over $60,000 in capital gains, and she estimated that her resulting tax liability will be over $9,000. Catherine Day invested in Vanguard’s 2025 and 2030 Retail Funds in a taxable account. In 2021, her funds distributed over $80,000 in capital gains, and she estimated that her tax liability will be over $12,000. Anthony Pollock invested in Vanguard’s 2025 and 2035 Retail Funds, and in 2021, his funds distributed over $105,000 in capital gains. He estimated that his tax liability will be over $36,000.
