Vanguard Fined $106.41 Million for Target Date Fund Violations

In a significant development, the Securities and Exchange Commission (SEC) has fined Vanguard Group, Inc., one of the world's largest investment advisors, $106.41 million for violations involving target date retirement funds. The fine, announced on January 17, 2025, stems from Vanguard's failure to disclose potential capital gains tax consequences to investors and misleading prospectuses regarding capital gains distributions.

Vanguard's changes to its target date retirement funds in December 2020 had substantial impacts on retail investors. The firm lowered the minimum investment requirement for its Institutional Target Retirement Funds (TRFs) from $100 million to $5 million, encouraging smaller retirement plans to move into the cheaper institutional tier. This migration led to a large number of sales of Investor TRF shares, forcing the funds to sell highly appreciated assets to meet the redemptions. As a result, retail investors who held target-date funds in taxable accounts faced historically larger capital gains distributions and tax liabilities, depriving them of the potential compounding growth of their investments.

The SEC's order found that Vanguard's prospectuses for Investor TRFs, distributed in 2020 and 2021, were materially misleading. They stated that the funds' distributions may be taxable as ordinary income or capital gains, and that capital gains distributions could vary significantly from year to year due to the funds' "normal" investment activities and cash flows. However, the prospectuses failed to disclose the potential for increased capital gains distributions resulting from the redemptions of fund shares by newly eligible investors switching from the Investor TRFs to the Institutional TRFs. This omission was a significant oversight, as it did not inform investors of the potential tax implications of the migration of shareholders between the two fund tiers.

Vanguard also failed to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and rules thereunder with respect to the accuracy of the funds' disclosures. This failure to establish adequate internal controls contributed to the materially misleading prospectuses and the lack of transparency regarding the potential capital gains tax consequences for investors.

The SEC's investigation found that Vanguard violated the Advisers Act and caused violations of the Securities Act and the Investment Company Act. As a result, Vanguard agreed to be censured, cease and desist from future violations, and pay $18.2 million in disgorgement and prejudgment interest, along with a $13.5 million civil penalty, totaling $106.41 million to be distributed to affected investors through a Fair Fund.

The settlement resolves the SEC's investigation along with settlements of parallel investigations of Vanguard announced today by the Office of the New York Attorney General (NYAG), the Connecticut Department of Banking, and the New Jersey Office of the Attorney General (NJAG) on behalf of the North American Securities Administrators Association (NASAA).

In response to the fine, Vanguard stated, "Vanguard is committed to supporting everyday investors and retirement savers and is happy to have reached an agreement that allows us to put this litigation behind us."

The fine serves as a reminder for investment advisors to maintain transparency and accuracy in their disclosures, particularly regarding potential tax implications for investors. Retail investors should also be vigilant in reviewing fund prospectuses and staying informed about changes that may impact their investments.