FINRA fines Vanguard $950,000 over decade of cost basis errors

Vanguard's brokerage arm will pay a $950,000 fine after the Financial Industry Regulatory Authority found it sent customers inaccurate cost basis information on account statements, trade confirmations and Forms 1099 for about 11 years. In some cases, the errors led investors to pay the wrong amount of tax.

Vanguard Marketing Corp., the Malvern, Pennsylvania-based broker-dealer registered with FINRA, agreed to a censure and the fine in a letter of acceptance, waiver and consent handed down Tuesday and made public on Wednesday.

It is the second time in just over three years that FINRA has sanctioned the unit over flawed customer statements.

Cost basis is the original price paid for a security, including reinvested dividends and capital gains distributions, plus commissions and fees. It determines the gain or loss an investor reports when shares are sold. FINRA said technology problems, some involving an unnamed third-party vendor, distorted that figure across Forms 1099, account statements, and trade confirmations in several ways.

The first involved so-called "rollback reruns." When Vanguard received updated cost information on a multi-lot position after a customer had already sold part of it, the system of a third-party vendor it worked with reprocessed the entire position as if the new data had always been there. The recalculation could show a customer selling a different tax lot than the one actually sold, and in effect allowed the cost basis of a lot already sold to be used again.

In about 6,000 transactions, the reruns overrode customers' instructions about which specific lots to sell, replacing them with the lot a different relief method would have picked. FINRA said this caused some customers to overpay or underpay taxes.

Share class conversions of mutual funds and ETFs posed another issue. When staff manually converted several funds in the same account on the same day, every converted share received the same transaction identification number. Because the vendor used that number to map cost basis, it could not tell the positions apart and spread cost bases across funds. That affected about 200 accounts and roughly 8,500 statements.

A similar flaw in some automated conversions hit about 3,000 more accounts. It occurred when a customer held the same fund in cash and margin positions, when third-party funds offered through a Vanguard program were converted, or when a conversion was canceled and rebooked with an "as of" date.

Read more: Judge gives blessing to $25M settlement in Vanguard target-date fund tax lawsuit

The third issue, which also had the broadest reach, concerned a rounding mismatch. Vanguard's stock record and the third-party vendor's system calculated share quantities to different numbers of decimal places. The resulting "position breaks" touched about 150,000 positions in 100,000 accounts and up to 5.7 million statements. Nearly all the differences were less than one share, and FINRA said they did not change the number of shares customers owned or how their trades were executed.

Complaints, red flags unaddressed

Vanguard self-reported the issues under FINRA Rule 4530(b), according the FINRA, which nonetheless faulted the firm for failing to act on warning signs. At least 25 customers complained in writing, according to the order, including 18 complaints about position breaks, seven about rollback reruns and one about a share class conversion.

Vanguard produced a periodic position-break report and corrected breaks when a sale or other tax-realization event occurred, FINRA said. But it never checked whether statements issued before those events had shown the correct cost basis. The firm also knew the vendor sometimes overwrote customers' transaction histories, yet it did not systematically address the problem until a comprehensive internal investigation in 2023.

FINRA found violations of its rules on communications with the public (Rule 2210), books and records (Rule 4511), supervision (Rule 3110) and standards of commercial honor (Rule 2010).

Vanguard's proactive steps

In setting the penalty, FINRA credited the firm with taking substantial steps after it discovered the problems.

Vanguard added controls and documentation around known system issues, hired additional staff and managers to oversee cost basis reporting, and reviewed its systems for other cost basis problems, which it then fixed. It also raised the rollback rerun issue with FINRA staff on its own after the investigation was already underway.

The firm reportedly hired an outside consultant to quantify the harm from the account statement issues. It has voluntarily paid approximately $1.9 million to customers who may have overpaid taxes, including compensation for time out of the market, and to those who had to refile past returns or consult a tax professional.

"Vanguard remains committed to supporting everyday investors and retirement savers," the firm said in an emailed statement to InvestmentNews. "We are pleased to have resolved this matter."

The settlement follows a May 2023 case in which the same unit accepted an $800,000 fine over misleading money market information. In that matter, FINRA found Vanguard overstated projected yields and income for certain money market funds, misstated investment returns on statements and failed to reasonably investigate red flags.

Vanguard's summer push into the advisor market

The penalty also arrives as Vanguard deepens its push into the independent advisor channel.

Late last month, Vanguard announced it had agreed to acquire Altruist, the RIA custody and technology platform it first invested in in 2020. The companies did not disclose financial terms, though Axios reported a price of $4.6 billion in cash. Altruist is expected to operate as a standalone business under its current leadership and brand.

"The need is broad, but the capacity to provide high-quality advice is limited," Vanguard CEO Salim Ramji said in a statement announcing the deal.

Weeks before the Altruist announcement, Vanguard settled a lawsuit brought by shareholders of Just Invest, a direct indexing firm it had acquired in 2021. Court documents show the case settled in July. The founders had alleged that Vanguard acted to reduce performance payments tied to the deal and later fired them without cause.

Vanguard has also rolled out custom model portfolios that advisors can tailor. The offering lets advisors adjust Vanguard's existing models to reflect client preferences and is available through Vestmark, SS&C Black Diamond Wealth Solutions and Orion.