Do Shareholders Get Paid in a Class Action Lawsuit?
Shareholder class action payments are often a recovery of capital, not a windfall. Learn the mechanics of how settlement funds are calculated and paid to investors.
Shareholders can receive payment from a class action lawsuit when they suffer financial harm due to corporate misconduct. These legal actions are brought by a group of investors on behalf of a larger class of shareholders who experienced similar losses. The goal is to recover damages from the company or its leadership for actions, like securities fraud or misleading statements, that negatively impacted the stock’s value.
Determining Your Eligibility for a Payout
To determine if a shareholder is eligible for a payout, one must first understand the concepts of the “class” and the “class period.” The class includes all investors who purchased or held the company’s stock within a specific timeframe, known as the class period. This period is precisely defined in the lawsuit and starts when the alleged corporate misconduct began and ends when the truth was revealed to the public, often through a corrective disclosure that causes a stock price to drop. Any shareholder who transacted in the company’s securities during this window may be part of the class.
The type of lawsuit filed directly dictates who receives a settlement payment. In a direct securities class action, the lawsuit is brought against the corporation for actions that harmed its shareholders, such as issuing misleading financial statements. If this type of case settles, the funds are paid directly to the eligible shareholders who can prove they suffered a financial loss because of the alleged fraud. This is the most common form of shareholder litigation where investors receive a direct cash payment.
A different outcome occurs in a shareholder derivative lawsuit. These suits are filed by shareholders on behalf of the corporation itself, usually against its directors or officers for breaching their fiduciary duties, which in turn harmed the company. In a derivative action, any settlement money recovered is paid back to the company’s treasury, not directly to the individual shareholders. The shareholders are intended to benefit indirectly, as the infusion of cash into the company’s balance sheet could increase the stock’s value over time.
How Settlement Funds Are Distributed
When a shareholder class action lawsuit is resolved, a settlement fund is created to compensate investors. Before any money reaches shareholders, several court-approved deductions are taken from this gross amount. These deductions include attorneys’ fees, which are a percentage of the total fund, and the administrative costs of the claims administrator hired to manage the distribution process.
After these costs are paid, the remaining amount is the “net settlement fund.” This money is distributed among the eligible shareholders who file valid claims. The distribution is allocated on a pro-rata basis, meaning each claimant’s payout is proportional to the size of their “recognized loss.”
A formula for calculating loss is detailed in a document called the Plan of Allocation, which is part of the court-approved settlement agreement. The Plan of Allocation outlines how to calculate an investor’s loss based on when they bought and sold their shares within the class period. The final per-share payout amount depends on the total number of valid claims filed and the sum of all recognized losses.
If funds remain in the net settlement fund after the initial distribution due to issues like uncashed checks, a secondary distribution may occur. This process ensures that as much of the settlement money as possible is returned to affected investors.
The Process for Filing a Claim
To participate in a settlement, shareholders must gather the necessary documentation. The central document is the “Proof of Claim” form, which is mailed or emailed to potential class members by the claims administrator. This form requires personal information and detailed records of stock transactions during the class period.
Shareholders must provide evidence of their stock purchases and sales, including the dates, number of shares, and prices. Official brokerage statements and trade confirmation slips are the best sources for this information. These documents are used by the claims administrator to validate the claim and calculate the recognized loss according to the Plan of Allocation.
Once the Proof of Claim form is completed and supporting documents are gathered, the shareholder must submit the package to the claims administrator by the specified deadline. Submission methods include mailing the physical documents or using a secure online portal created for the settlement.
The claims administrator then reviews all submitted claims for validity and calculates the payouts. This review can take several months or longer, depending on the case’s complexity and the number of claims filed. Once the review is complete and approved by the court, payments are issued to all shareholders with valid claims.
Tax Treatment of Shareholder Settlements
Receiving a payment from a shareholder class action settlement has specific tax implications. The Internal Revenue Service (IRS) treats the payment as a “recovery of capital,” meaning the money is a partial refund of the original investment. This adjustment compensates for a loss in the asset’s value.
This principle affects the stock’s cost basis. If the shareholder still owns the stock, the settlement payment reduces their original cost basis. For example, if an investor bought a share for $50 and receives a $5 settlement, their new cost basis becomes $45. This affects the capital gains or losses calculation when the stock is sold.
If the shareholder already sold the stock and reported a capital loss, the settlement payment is reported as a capital gain in the year it is received, limited to the amount of the loss previously deducted.
Any portion of the settlement designated as interest is taxable as ordinary income. Shareholders should consult a tax professional for guidance on their specific situation.