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In a key decision on Monday, a federal judge tossed out Vanguard Group's $40 million settlement with investors over unexpected tax bills.

The ruling says the deal doesn't help investors because they already received compensation through a different settlement with the US Securities and Exchange Commission (SEC).

Judge John Murphy of the US District Court in Philadelphia said the $40 million deal offered "no value" to investors. He pointed out that Vanguard's earlier SEC settlement from January already set aside $135 million for affected investors.

According to Reuters, this amount includes the same $40 million from the tossed deal, as well as $2.1 million for individual claims.

"The named plaintiffs, their counsel, and Vanguard cannot deny the math," Judge Murphy wrote in a 25-page opinion.

He explained that accepting the proposed settlement would actually give investors less money because more than $13 million would go to lawyers' fees.

The judge found the settlement was not "fair, reasonable, or adequate," saying it would reduce investors' total payout unnecessarily.

His decision followed an objection raised by John Hughes, an attorney and member of the investor class. Hughes argued that the SEC deal already provided what the class action settlement promised — without the legal fees.

Vanguard's Target-Date Fund Deal Tossed by Federal Judge

Although Vanguard's lawyers argued that Hughes misunderstood the SEC agreement, the judge sided with Hughes.

Vanguard also warned that rejecting the settlement could make it harder for companies to resolve lawsuits that run parallel to government enforcement actions. Still, the court did not agree.

The legal trouble began after Vanguard changed the rules for its target-date mutual funds in December 2020.

The firm lowered the required investment for lower-cost institutional shares from $100 million to $5 million, MarketScreener said.

As a result, many investors switched out of the higher-cost retail shares. This caused retail funds to sell off assets, triggering capital gains taxes for remaining investors.

These target-date funds are popular for retirement planning, as they automatically adjust investment risk over time. They are also designed to reduce tax impact — something that didn't happen in this case.

Vanguard, based in Valley Forge, Pennsylvania, had $10.4 trillion in assets under management as of January 31.

The rejected case is officially known as In re Vanguard Chester Funds Litigation, filed in the US District Court for the Eastern District of Pennsylvania.

No comments were provided by Vanguard, the investors' legal team, or John Hughes following the ruling.