The Corporate Shareholder Lawsuit Scam

Sometimes, the management of a corporation are caught doing something wrong and the share price abruptly tanks. The most common cause of shareholder lawsuits is accounting fraud. In other cases, insider trading or improper information disclosures can lead to lawsuits.

A group of shareholders file a lawsuit against the corporation. Typically, the plaintiffs are people who bought shares during a certain time period. Both the corporation itself and the senior executives are usually named as defendants.

The problem is that the management gets to pay for their defense out of the corporation's assets. Typically, the settlement or verdict is paid out of the corporation's assets. In other words, the management pays nothing for their wrongdoing. Most executive employment contracts state that the corporation pays the full cost in the event of such a lawsuit.

It seems kind of contradictory. The shareholders are the ones who were injured by the misconduct of management. The current shareholders wind up paying the legal costs and the settlement. It's almost like suing yourself!

In other words, management at a corporation is protected by "sovereign immunity", in much the same way a king claimed immunity from prosecution. The government makes the laws that regulate corporations and their management. Except in cases of truly egregious conduct, management is typically protected from paying the penalty if they do something wrong.