Massachusetts orders Vanguard to repay investors $5.5 million for TDF taxes

Vanguard lowered the account minimum for an institutional target-date fund, causing a migration from the retail TDF, leaving those who held onto it in taxable accounts with a big capital gains bill.

Massachusetts ordered Vanguard Marketing Corp. to pay $5.5 million in restitution to people in the state who invested in Vanguard’s target-date retirement funds and were hit with unusually steep capital gains taxes after the asset management company reduced investment minimums in the accounts.

The company, a subsidiary of Vanguard Group Inc., reached a $6.25 million settlement with the state, Massachusetts Secretary of the Commonwealth William Galvin announced Wednesday. In addition to restitution, Vanguard agreed to pay $250,000 to administer the fund and to pay $500,000 to the state.

Many Vanguard TDF investors say they’ve faced significantly higher tax bills this year.

Massachusetts imposed the sanctions following an investigation it opened in January when it learned of potential tax disclosure and market issues pertaining to the TDFs that would “disproportionately impact” retail investors, Galvin’s office said in a statement.

Vanguard marketed and distributed both investor, or retail, and institutional TDFs. The company announced in December 2020 that it would reduce the investment minimum for institutional TDFs from $100 million to $5 million.

That move caused a stampede from the retail TDFs into the lower-fee institutional TDFs. Vanguard distributed “higher than usual long- and short-term capital gains to those investors who held Investor Vanguard TDFs in taxable accounts” as of late December 2021, states the memorandum of understanding between Massachusetts and Vanguard.

“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,” Galvin’s office said in a statement.

There were about 5,553 Massachusetts accounts affected, according to the MOU.

Galvin said he was standing up for ordinary investors.

“I’m pleased that my office has been able to secure meaningful relief for Massachusetts investors,” he said in a statement. “These extraordinary capital gains were caused by Vanguard’s conscious decision to benefit ultra-wealthy shareholders over main street investors. Firms should be putting retail investors first when making management decisions, and Vanguard failed to do that in this case.”

Vanguard did not admit nor deny any wrongdoing.

“We are glad to put this matter behind us and avoid the cost and distraction of a protracted process,” Vanguard spokesperson Emily M. Ferrell said in a statement. “As a client-owned organization, Vanguard has a long history of lowering costs and investment minimums to benefit investors and retirement savers. We remain committed to reducing the cost and complexity of investing to help more Americans reach their financial goals.”

Vanguard also is a facing a lawsuit on this issue in a federal court in Pennsylvania.