A Pennsylvania federal judge has thrown out a $40 million proposed class settlement between Vanguard and investors, ruling the deal would leave the class worse off than a separate agreement already secured by the U.S. Securities and Exchange Commission.

U.S. District Judge John F. Murphy said Monday the class settlement was not "fair, reasonable, and adequate" because investors were guaranteed the full $40 million through the SEC’s enforcement action — without sacrificing a $13 million chunk to attorneys.

“If a class is guaranteed to get more money if we reject a proposed settlement than approve it, are we obliged to reject it?” Judge Murphy asked in his opinion. “Our answer is yes.”

The class suit, filed in 2022, claimed Vanguard mismanaged its popular “set-it-and-forget-it” target-date funds, leading to surprise capital gains tax bills for retail investors after large asset sell-offs. While the class attorneys hailed the $40 million settlement as a strong result, the SEC’s later $135 million resolution with Vanguard covered many of the same issues and ensured the same $40 million payout for affected investors—without legal fees reducing the amount.

Investor John Hughes, an attorney at Milbank LLP, objected to the settlement in a personal capacity, calling the proposed deal an example of “class action abuse.” His objection brought the SEC deal to the court’s attention—something Judge Murphy said should have come from Vanguard or class counsel.

Though plaintiffs’ attorneys said they were unaware of the SEC resolution when they negotiated the class settlement in mediation, the judge expressed concern over their failure to disclose its eventual impact. Still, he said the issue was ultimately moot because the better deal—via the SEC—prevailed.

The rejected settlement would have left class members with just $25.4 million after attorneys' fees, litigation expenses, and incentive awards to named plaintiffs were subtracted. Under the SEC deal, that amount is fully preserved.

Vanguard argued the SEC settlement’s payout was only triggered if the court rejected the class settlement “on its own terms,” but Judge Murphy said the agency’s language was clear and required no such interpretation.

He also dismissed Vanguard’s warning that rejecting the class deal could disrupt future regulatory settlements, noting that the company could have worked with the SEC to avoid overlap.

Hughes declined to comment, and counsel for the parties did not immediately respond to inquiries.

The case is In re: Vanguard Chester Funds Litigation, No. 2:22-cv-00955, in the U.S. District Court for the Eastern District of Pennsylvania.