On January 17, 2025, the SEC announced the settlement of administrative proceedings brought against a registered investment adviser for allegedly making materially misleading statements relating to capital gains distributions and potential tax consequences to retail investors in target date mutual funds advised by the adviser and held in taxable accounts. The settlement also resolved parallel investigations of the adviser by securities regulators of numerous U.S. states and territories which was coordinated by the North American Securities Administrators Association (NASAA). In addition, on November 25, 2024, the U.S. District Court for the Eastern District of Pennsylvania preliminarily approved a settlement between the adviser and a class of retail investors in the target date funds who claimed that the adviser breached its fiduciary duty.

The settlements relate to a December 2020 reduction in the investment minimum for “institutional” versions of the target date funds from $100 million to $5 million, following which it is alleged that there was an “elephant stampede” out of the more costly retail funds and into the more affordable institutional funds. The SEC and retail investor plaintiffs claimed that the significant redemptions out of the retail funds led to an unprecedented sale of assets by the retail funds to fulfill the redemptions, which led to a sharp spike in capital gains distributed to shareholders that did not leave the retail funds.

The SEC Order

According to the SEC order, the prospectuses for the target date funds were materially misleading because, although they stated that the funds’ distributions may be taxable as ordinary income or capital gains and that capital gains distributions could vary considerably from year to year as a result of the funds’ “normal” investment activities and cash flows, the prospectuses failed to disclose the potential for unusually large capital gains distributions resulting from redemptions by investors who switched to the institutional versions of the target date funds in which they were now eligible to invest. The SEC also alleged that the adviser 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.

The SEC found that the adviser violated the anti-fraud provisions of the Investment Advisers Act of 1940, specifically Section 206(4) and Rules 206(4)-7 and 206(4)-8 thereunder. The SEC also found that the adviser caused the funds to violate the anti-fraud provisions of the federal securities laws, specifically Section 17(a)(2) of the Securities Act of 1933 and Section 34(b) of the Investment Company Act of 1940.

Without admitting or denying the allegations, the adviser agreed to cease and desist from future violations, to be censured, to pay $18.2 million in disgorgement and prejudgment interest (that will be deemed satisfied by the adviser's payment of $92.91 million in pursuant to the multi-state settlement) and to pay a civil monetary penalty of $13.5 million, for a total amount of $106.41 million to be distributed to affected investors. The $92.91 million due pursuant to the multi-state settlement is based on the adviser’s agreement to pay $135 million in remediation, which the adviser is entitled to offset by the $40 million class action settlement (to the extent the settlement is finalized) discussed below and $2.09 million in other claims. In agreeing to the settlement, the SEC considered the adviser’s remedial actions and cooperation afforded the SEC staff.

Class Action Settlement

As stated above, on November 25, 2024, the U.S. District Court for the Eastern District of Pennsylvania preliminarily approved a settlement between the adviser and a class of retail investors in the target date funds who claimed that the adviser breached its fiduciary duty when it reduced the investment minimum for the institutional versions of the target date funds leading to the significant redemptions out of the retail versions of the funds and the resulting capital gains distributions to the remaining investors in the retail funds. Pursuant to the settlement, which is subject to further consideration at a March 11, 2025 hearing, the adviser will pay $40 million into a settlement fund to be dispersed to the class of plaintiff investors who submit a proof of claim. Subsequently, certain class members have filed objections to the settlement, claiming that the amount of the settlement is too small and the proposed attorneys’ fees (representing approximately one-third of the settlement amount) are too large. Should the settlement be terminated or withdrawn, or rejected by the court, the $40 million settlement amount will be added back to the $92.91 million due under the multi-state settlement.

The SEC order is available here and a related press release is available here.

The NASAA press release regarding the multi-state settlement is available here.

The stipulation of settlement and related order and motion were issued under the caption In Re Vanguard Chester Funds Litigation, No. 2:22-cv-00955 (E.D. Pa.).