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Vedder Thinking | Articles Pennsylvania District Court Allows Claims Regarding Target Date Funds' Unexpected Tax Liabilities to Proceed

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On November 20, 2023, the U.S. District Court for the Eastern District of Pennsylvania granted in part and denied in part defendants’ motions to dismiss plaintiffs’ claims of breach of the fiduciary duty of care, breach of the covenant of good faith and fair dealing, and other claims made by investors in “retail” target date mutual funds against the funds’ adviser, certain officers of the adviser and the funds’ independent trustees.

The plaintiffs’ claims stem from a December 2020 reduction in the investment minimum for “institutional” versions of the target date funds from $100 million to $5 million. The plaintiffs, investors in the corresponding “retail” target date funds who held their shares in taxable accounts, claimed that due to the lower expense ratios of the institutional funds there was an “elephant stampede” out of the more costly retail funds and into the more affordable institutional funds. The plaintiffs claimed that the significant amount of redemptions out of the retail funds led to an unprecedented sale of assets by the retail funds in order to fulfill the redemptions, which led to a sharp spike in capital gains distributed to shareholders that did not leave the retail funds. As a result, the plaintiff shareholders faced large unexpected capital gains tax liabilities, and these shareholders sued the funds’ adviser, certain officers of the adviser and the funds’ independent trustees alleging breach of the fiduciary duty of care and breach of the covenant of good faith and fair dealing, among other claims. The defendants filed motions to dismiss the investors’ claims.

To survive a motion to dismiss, a party must simply allege facts that, if true, would “plausibly suggest” an entitlement to relief. In considering the motions to dismiss the plaintiffs’ claims, the court assumed the accuracy of the plaintiffs’ factual allegations and drew “all reasonable inferences” in favor of the plaintiffs. The court held that the plaintiffs plausibly alleged that the funds’ independent trustees and the adviser’s officers knew of the tax consequences and neglected the risks when lowering the institutional target date funds’ minimum investment amount and that the plaintiffs’ unexpected capital gains tax liabilities resulted in a plausible injury in-fact. However, the court found that the plaintiffs failed to allege a plausible fiduciary relationship with the adviser. The court therefore permitted the plaintiffs’ claims against the target date funds’ independent trustees and the adviser’s officers to proceed, but dismissed the claims against the adviser.

The court memorandum was issued under the caption In Re Vanguard Chester Funds Litigation, No. 22-955 (E.D.Pa. Nov. 20, 2023).



Professionals



Nathaniel Segal

Shareholder



Jacob C. Tiedt

Shareholder



Mark Quade

Associate



Jake W. Wiesen

Associate



Marylyn Harrell

Associate