A federal judge has rejected a proposed $40 million class-action settlement between Vanguard and investors who allege they were saddled with avoidable capital gains taxes due to the firm's 2020 restructuring of its target-date funds.
The ruling adds another chapter to an ongoing legal battle that has drawn scrutiny from regulators and raised fiduciary concerns within the asset management community.
U.S. District Judge John F. Murphy ruled that the settlement would shortchange investors, particularly in light of a separate regulatory resolution that already provides meaningful compensation. In his decision issued Monday, Murphy concluded that approving the settlement would result in a worse outcome for the plaintiffs compared to what they would receive through an existing SEC-backed fund distribution. “If a class is guaranteed to get more money if we reject a proposed settlement than approve it, are we obliged to reject it? Our answer is yes,” Murphy wrote.
At the center of the dispute are changes Vanguard implemented in 2020 to its target-date fund lineup. Investors allege that those changes—specifically the merging of institutional and retail share classes—triggered large capital gains distributions in taxable accounts. The resulting tax liabilities, they argue, could have been avoided had Vanguard exercised better fiduciary judgment.
The plaintiffs filed suit in March 2022 in federal court in Philadelphia, accusing Vanguard of breaching its fiduciary duty. The proposed $40 million settlement was announced in late 2023 and would have allocated approximately one-third—$13 million—to attorneys’ fees, with the remainder distributed to affected investors. At the time, it appeared the agreement would resolve the claims and put the matter to rest.
However, the situation shifted significantly in January 2024 when Vanguard reached a separate $135 million settlement with the Securities and Exchange Commission and state regulators. That deal included the creation of a distribution fund for affected investors, offering them partial redress without the need to pursue further litigation.
Crucially, that regulatory agreement allowed Vanguard to reduce its payment to regulators by $40 million if the class-action settlement were approved. In effect, the class-action funds would offset part of Vanguard’s regulatory obligations, but at a cost to investors—specifically, the $13 million in legal fees that would be deducted from their recovery.
“Vanguard is on the hook for $135 million regardless of whether we approve or reject the settlement in this case,” Murphy wrote. “But it matters to the class (and plaintiffs’ counsel). If we approve, the harmed investors lose $13 million to attorneys’ fees. If we reject, the harmed investors get that $13 million themselves, through the SEC settlement—and could very well recover even more because this litigation will continue.”
Murphy’s reevaluation was prompted by an objection from John Hughes, a Vanguard client and member of the proposed class. Hughes, who is also an attorney, flagged the interplay between the two settlements and argued that the class-action deal was not in the best interests of the investors it sought to represent.
The judge credited Hughes for raising a critical issue that had not been addressed by either Vanguard or the plaintiffs’ legal team. “He drew our attention to something no party in this case thought to,” Murphy noted in his opinion. That objection led the court to reassess the fairness and adequacy of the proposed settlement under the Federal Rules of Civil Procedure.
The litigation underscores a key risk for RIAs and advisors recommending target-date funds in taxable accounts: namely, that fund structure changes—even when operationally sound—can create unintended tax consequences. The Vanguard case highlights the importance of understanding fund mechanics, asset flows, and share class conversions, particularly for clients with non-qualified holdings.
From a fiduciary standpoint, the case also raises questions about how fund managers weigh investor outcomes when implementing large-scale fund changes. “If a fiduciary considers two options to accomplish the same objective, and option A carries certain drawbacks that option B does not, could choosing option A breach a fiduciary duty?” Murphy wrote. “We said ‘maybe’ and sent the case into discovery.”
That line of reasoning remains central to the plaintiffs' case. Their core argument is that Vanguard could have pursued alternative paths to restructure its target-date funds without triggering tax events for investors in taxable accounts. Whether the firm’s actions rose to the level of a fiduciary breach will likely continue to be litigated.
A Vanguard spokesperson and attorneys for the plaintiffs were unavailable for comment following the ruling.
With the class-action settlement rejected, both sides are now expected to return to the negotiating table. Meanwhile, affected investors will continue receiving payments under the SEC’s $135 million distribution plan, which remains in force. Whether those distributions will be sufficient—and whether investors could secure additional compensation through further litigation—remains to be seen.
For wealth advisors and RIAs, the broader takeaway is clear: asset location continues to matter, and product changes made by fund sponsors—even well-intentioned ones—can have material consequences for taxable investors. It also reinforces the growing pressure on fund managers to clearly disclose the operational and tax implications of fund actions that affect client portfolios.
The case is a reminder to advisors to perform due diligence not just on fund performance and fees, but also on how structural shifts within mutual fund or ETF offerings could create unintended tax exposures. As the regulatory environment becomes more attuned to these risks, asset managers and fiduciaries alike will need to maintain a sharper focus on investor outcomes across account types.
In the meantime, the legal battle continues—offering investors and industry participants alike a rare look at how fund governance, tax fairness, and fiduciary responsibility collide in the complex world of retirement investing.
