On May 19, 2025, the United States District Court for the Eastern District of Pennsylvania (the “Court”) denied final approval of a $40 million proposed settlement in a major class action lawsuit against The Vanguard Group, Inc. (“Vanguard”) and related parties (“Defendants”). The lawsuit stemmed from Vanguard’s decision to lower the investment minimum for its institutional target date funds (the “Institutional Funds”), which in turn caused a mass exodus from higher-cost retail target date funds (the “Retail Funds”).1 The settlement denial was triggered by a late-breaking challenge to the settlement raised by a member of the proposed class. A lawyer by trade, the class member objected to the settlement on the novel basis that Vanguard was already obligated to pay $40 million to a Fair Fund pursuant to a parallel SEC settlement. This interesting challenge caught the Court’s attention. Ultimately, the Court agreed with the class member, denied approval of the settlement, and sent the case back to active litigation.2 This somewhat unexpected settlement denial highlights the importance of carefully considering and planning for the interplay between settlements with regulators and civil plaintiffs.3
Civil Litigation Background
Prior to 2021, Vanguard maintained two tiers of target date retirement funds: Institutional Funds, available to retirement plans with over $100 million invested, and Retail Funds, available to all other investors.4 The Institutional Funds had lower fees than the Retail Funds. In December 2020, Vanguard reduced the minimum investment for the Institutional Funds from $100 million to $5 million.5 As The Wall Street Journal reported in 2022, Vanguard’s decision triggered an “elephant stampede” of newly eligible investors fleeing the Retail Funds for the Institutional Funds, forcing the Retail Funds to liquidate substantial assets to meet redemptions.6 These liquidations generated large capital gains, which ultimately were absorbed by investors who remained in the Retail Funds. Shareholders in the Retail Funds who held their investments in taxable accounts faced significantly increased tax liabilities from the unexpected capital gains distributions.7 For example, according to The Wall Street Journal, one investor was hit with more than a $150,000 tax bill.8
In 2022, shareholders in the Retail Funds who did not hold the Retail Funds in tax-advantaged accounts initiated a class action lawsuit on behalf of themselves and similarly situated investors against Vanguard, its corporate officers, the trust comprising the target date funds, and the trustees.9 Plaintiffs alleged nine claims, including breach of fiduciary duty, gross negligence, breach of the covenant of good faith and fair dealing, unjust enrichment, and violations of state law consumer protection statutes.10 Plaintiffs’ primary claim alleged that Defendants failed to consider the tax consequences for retail investors when Vanguard decided to lower the Institutional Funds’ investment minimums.11
In November 2023, the Court granted in part a motion to dismiss, but allowed Plaintiffs’ claims of breach of the covenant of good faith and fair dealing, violation of various states’ consumer protection laws (except for California’s), and common law breach of fiduciary against the independent trustees and officers of the Retail Funds to proceed to discovery.12 Before the Court ruled on class certification, the parties reached a $40 million settlement in September 2024 (the “Proposed Civil Settlement”).13 The Court preliminarily approved the Proposed Civil Settlement on November 25, 2024, pending a final fairness hearing on March 11, 2025.14 Notably, under the Proposed Civil Settlement, approximately $14.3 million of the $40 million settlement would be paid to Plaintiffs’ counsel for attorneys’ and other fees.15
SEC Enforcement Action and SEC Settlement
During the litigation, the SEC was conducting an investigation into the same facts underlying Plaintiffs’ theories and, on January 17, 2025, the SEC reached a settlement with Vanguard, which consented to the entry of an Order on a neither admit nor deny basis (the “SEC Settlement”).16 In connection with the SEC Settlement, the SEC made findings that Vanguard failed to properly consider the potential tax consequences for investors holding taxable accounts and failed to properly disclose the associated risks.17 The SEC found that Vanguard violated Section 17(a)(2) of the Securities Act, Section 206(4) (and Rules 206(4)-7, 8 promulgated under that section) of the Advisers Act, and Section 34(b) of the Investment Company Act.
Furthermore, the SEC ordered Vanguard to pay $106 million: $13,500,000 as a civil money penalty and $92,910,000 in disgorgement and prejudgment interest, all of which was to be put into a Fair Fund to be distributed to affected investors.18 The $92,910,000 that Vanguard was required to pay into the Fair Fund reflected an offset of $40 million to reflect the anticipated settlement in the class action. However, under the terms of the SEC Settlement, this $40 million offset would be reversed if Vanguard did not pay the $40 million settlement in the class action.
Specifically, the SEC Settlement stipulated that:
[I]n the event Vanguard does not pay the $40 million under the [Proposed] Settlement, as a result of the termination or withdrawal of the Stipulation of Settlement or the Court’s rejection of the Class Action Settlement, Vanguard will be obligated to pay the $40 million into the [Fair Fund] within 10 days of such termination or rejection.19
Investor Challenge to the Proposed Civil Settlement
Following preliminary approval, the Court received several objections from class members, but chose to focus on one brought by John Hughes on February 17, 2025.20 Hughes argued that, because of the final SEC Settlement, the class would receive $40 million from Vanguard regardless of whether the Proposed Civil Settlement was approved.21 In this regard, Hughes argued that the Proposed Civil Settlement was valueless. In fact, he posited that “the class actually is better off rejecting [the Proposed Civil Settlement] since the SEC Fair Fund will not deduct the $14,450,790.90 in fees and incentives plaintiffs seek here.”22 Hughes further urged the Court to reject the Proposed Civil Settlement on the basis that “rejection keeps [the] case alive, potentially yielding additional, incremental recoveries later. . . .”23
In response, Plaintiffs’ counsel contended that they did not know about the SEC Settlement prior to agreeing to the Proposed Civil Settlement.24 Furthermore, they argued that the SEC Settlement merely provided a “backstop” to the recovery since the SEC Settlement came “four months after the Parties signed a binding term sheet at the mediation, and nearly two months after the Court preliminarily approved the Proposed Civil Settlement.”25 Finally, because SEC distributions take around seven years to fully dispense payment, Plaintiffs’ counsel claimed that the present value of the $40 million class recovery from the SEC would be reduced to $26.5 million in the future, making the Proposed Civil Settlement more valuable due to quicker payment.26
Vanguard too argued in support of the Proposed Civil Settlement. Vanguard insisted that the SEC Settlement was never “intended to be used as a reason to reject” the Proposed Civil Settlement and was instead designed to protect the class if the Proposed Civil Settlement was denied for other reasons.27 Furthermore, Vanguard pointed to the harm caused to public policy in rejecting the Proposed Civil Settlement in favor of companies and government regulators coming to negotiated resolutions, which often “include offsets for class action settlements.”28
Court’s Decision and Parties’ Failure to Consider SEC Order During Settlement
The Court agreed with Hughes and rejected the Proposed Civil Settlement on May 19, 2025. The Court identified the following issues with the Proposed Civil Settlement:
- The clear language of the SEC settlement guaranteed $40 million payment to the class, rendering the Proposed Civil Settlement superfluous.29
- The class will receive more money from the SEC settlement than the Proposed Civil Settlement because the SEC settlement is not reduced by fees/incentives.30
- It is not against public policy to reject the Proposed Civil Settlement because regulators and settling parties can and should “add specific language in the settlement agreements to limit when guarantee provisions are invoked.”31
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The Court’s decision underscores one area of focus associated with settling parallel regulatory and civil proceedings. This is not an uncommon issue in securities and qui tam matters. There is an underlying concept that merits consideration, which is that plaintiffs should not be able to seek windfall recoveries beyond their actual harm. It is worth noting that in SEC matters, the SEC can impose a civil penalty and seek to disgorge ill-gotten gains received by defendants versus providing restitution to harmed plaintiffs. In the criminal setting, however, resolutions of Department of Justice matters include mandatory restitution, which is usually broader than SEC disgorgement but can be a separate tool to the extent that the ill-gotten gains did not come from harmed parties. To minimize risk, defendants simultaneously navigating regulatory and civil settlements should consider the following:
- Maximize coordination between legal teams negotiating civil and regulatory settlements;
- Where possible, avoid settling regulatory matters prior to finalizing civil settlements as regulatory settlements generally increase plaintiffs’ leverage and may, as in the case of the Vanguard litigation, be used as grounds for invalidating unfinalized civil settlements;
- Structure civil settlements in a manner such that they provide additional value to any parallel regulatory settlement; and
- Where possible, avoid language in regulatory settlements that could be read as guaranteeing specific civil recoveries.
