Can You Sue for Stock Losses? Should You?

Investors are a daring lot. They put their hard earned cash into pieces of paper that promise a part ownership in a company they’ve probably never physically seen. All they have to go by is the annual statements the company publishes. 

The assumption that your investment involves risk is a prerequisite. There are protections in place, but when things go wrong (and they often do), investors are left to see their paper-profits turn into paper-losses right before their eyes. Most people see this possible loss as a necessary risk of doing business – you win some, you lose some. 

However, some don’t see it that way at all.  In fact, some investors on the losing end of an investment think that taking legal action is the solution.

Though at first such an idea may strike you as just another example of Americans thinking they can sue over anything, it does make some sense. It all started with the notion that publicly traded companies had the responsibility of releasing financial information, a shift that began in the 1930’s. Companies were required to prove their business was doing well by being honest, and investors were supposed to take their word and decide whether to buy or sell. 

But companies aren’t always honest, or even accurate, and this has left the door open for some investors to try and sue the company if the stock they’ve invested in suddenly drops. 

There have been attempts by Congress to clamp down on frivolous lawsuits since the mid-1990’s, but such lawsuits still exist. Investors can’t sue as individuals, their lawyers need to obtain Class Certification, which requires the court to agree that the case represents all the investors who bought the stock leading up to the bad news announcement. This is a massive hurdle for most enterprising lawyers, but some get through. 

At this point, things only get tougher. The case can only be won if certain things are proved in court. First it must be proved that the company lied about something and that the investors relied on that inaccurate piece of information to make their decision. That last bit is the toughest to explain, since many investors probably bought the stock without being exposed to the misinformation. 

These sorts of class action suits are muddled in ambiguity. There’s simply no way to show that a company’s stock drop was directly the result of a certain announcement or that the losses suffered were caused by the company’s decision to hide details.

This brings us to the real question:  Is it even a good idea to sue for stock losses? To try to answer this question, let's take a deeper look…

A shareholder is, in fact, entitled to compensation if the company’s management has published corporate disclosures that were incorrect or inappropriate. But, as discussed above, these cases are really very difficult to win. 

So, as an individual investor, it simply doesn’t make financial sense to fight such a case if the loses on an individual stock were less than $100,000. If, however they were higher, a class action lawsuit is a much better option. If there is already an existing class action lawsuit that you can join, it’s a much better idea to join the pre-existing case rather than to pursue the case independently. 

You should be beware that most cases of this nature end up with payments of only 5 or 8 cents to every dollar that was lost in the stock plunge. That may seem like a paltry amount, but if the initial investment or stock losses were substantial enough, you could be awarded a decent chunk of change.  And something is better than nothing.

One recent case in which a group of investors felt duped by a lie that directly impacted their investments was that of Volkswagen.  The German car manufacturer has publicly admitted to rigging 11 million diesel cars with software that could trick emissions tests.  This admission caused a huge drop in stock value.

To understand that in real-world terms, consider St. Clair Shores Police and Fire Retirement System, a pension fund that invested $200,000 in 2011. Since this news broke, the value of their investment has dropped a whopping 33% in just one month. So, in this instance, it made perfect sense for the investors to sue Volkswagen for the recent plunge in its stock.

And such class action lawsuits are only increasing with every passing year. According to Reuters, they’ve increased annually by 9%, and there were 166 such cases filed in 2013 alone.

But before you join those others, it may be prudent to read a report put out by the U.S. Chamber of Commerce's Institute for Legal Reform, which suggested that these types of lawsuits were mostly very costly mistakes. The pennies on the dollar recovered were not worth the time, effort and money spent pursuing the case. 

For investors who have lost big due to the dishonesty of corporate bigwigs, it’s natural to want to take action that both punishes the culprits and rewards the victims. But before you proceed with such a big decision, you should speak with an attorney who can give you an honest and realistic look into the probable outcome. It may seem unfair, but the system makes such a lawsuit fairly unfeasible. 

About the Author:  Andrew May is a commercial and finance attorney who specializes in FINRA interview and arbitration cases.  He is the founding member of May Law in downtown Chicago and he enjoys sharing his expertise with readers on a variety of investing and business blogs.  To learn more, visit www.mayLawpc.net.