In a turn of events that even the presiding judge called a “strange situation,” the federal court system has rejected a $40m settlement for investors who felt they were wronged by fund giant Vanguard.
The class action suit, which alleged Vanguard misrepresented capital gains distributions and tax consequences for retail investors who held investor shares of its target retirement funds in taxable accounts, was filed in late 2022.
Vanguard settled the claim in November 2024, but by then the case had spurred an investigation by the SEC. In January, the regulatory body officially agreed with the plaintiffs and ordered Vanguard to pay $106.4m for misleading statements related to the complaint.
Effectively, the investors won.
However, US District Judge John Murphy in Philadelphia said the initial settlement offers “no value” for the plaintiffs.
The $106.4m the SEC had ordered Vanguard to pay included $92.91m in relief for investors, and a $13.5m civil penalty. The relief was to be paid in addition to the $40m class action suit.
However, Vanguard had negotiated a deal with the SEC whereby it could reduce its payment by $40m if the settlement was approved. So, effectively, if the settlement is rejected by the court, Vanguard must pay the $40m to the SEC instead.
Murphy pointed out in his opinion that through the settlement, one-third of the $40m, over $13m, would go to attorney’s fees, but that if the money sent directly to the SEC, it would go fully to investors.
Murphy noted Vanguard’s counsel was unhappy because it had only found out about the SEC settlement after it was public announcement. The US court system was also left out of the loop, however, only learning about the SEC settlement when a class member brought it to their attention.
“He asks us to reject the proposed class settlement because how can any settlement stand when it is guaranteed to net the class less money,” Murphy asked. “A simple and compelling point.”
The settlement has been put into a fund which will be distributed to harmed investors.
Backstory
In December 2020, Vanguard announced its minimum investments amounts on its institutional shares of the funds had been significantly lowered, from $100m to $5m.
This spurred a large number of investors to switch to the institutional plan due to its much lower expenses. In order to meet those redemptions, the investor tranche had to sell underlying assets, but with gains due to the markets at the time.
The SEC found that meant investors who decided not to switch incurred larger than normal capital gains distributions, tax liabilities and deprivation of compounding growth of assets.
On top of that, the SEC also found the investor tranche prospectuses were misleading because while they addressed capital gains in general, they didn’t include the potential for increased capital gains due to the switches.
