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I've never understood what happens to the money from investor lawsuits against companies. What happens to the money? How do I get my share? And am I being ripped off twice, once by the companies and then by the attorneys? Thanks, D.M.
: There are no money-back guarantees on Wall Street. If you invest in a stock that goes sour, then you get a tax loss and a learning experience. You don't get a refund.
Thus, make sure you're cautious with any solicitations from law firms that promise you money just because your stock went down. At some point, they all do, and it's rarely because of illegal activity.
That said, if you invest in a company and it turns out to be fraudulent along the lines of
, then there is a remote chance you can get some money back by participating in a class-action lawsuit. Just don't expect much for your hassle, even if the company was as guilty as those two criminal enterprises.
One can only imagine how clogged the U.S. court system would be if thousands of injured investors each lined up to sue a company alleged to have broken the law. Hence, class-action suits make the process easier by rolling all those little lawsuits into one big mega-case under the name of a single lead plaintiff.
Of course, the lead plaintiff will sue not only the company responsible but all of its enablers, like its investment banks and accountants, as well. That's because in cases like WorldCom or Enron, companies may go bankrupt, so the money is gone. And you can't squeeze blood or money from a stone!
The class-action lawyers can, however, squeeze it from other deep-pocketed concerns that would rather settle the cases and just get on with business. In May 2004, for example,
, WorldCom's main Wall Street backer, settled a class-action suit led by New York State Comptroller Alan Hevesi, agreeing to pay $2.65 billion to investors.
And nowadays, the class-action lawyers can also wring money from the offending company's directors. In January 2005 a group of former Enron directors agreed to a $168 million settlement of their portion of a class-action securities lawsuit.
The bigger bucks in the Enron class-action suit, which was led by the University of California, came from the likes of
, with a $222.5 million settlement;
Bank of America
, $69 million; and the international unit of now-defunct accountant Arthur Andersen, $40 million.
But while these settlement amounts seem mammoth to ordinary investors waiting for their fair shake, at the end of the day they mean very little to those taking part in the suit.
The lawyers take a substantial cut for their efforts, usually around a third of the award. Anything left over will be spread among thousands and thousands of ticked-off shareholders who took part in the suit. That means, in the best of cases, you will only receive a few pennies on the dollar for all your troubles.
Also, class-action suits can take several years to settle. Therefore, it's really not worth a big emotional investment.
Nevertheless, if you don't take those pennies to which you are entitled, then somebody else will. And maybe you'll get some satisfaction in getting something -- anything -- back.
So if you are an aggrieved investor and want to participate in a class-action lawsuit, then your first job is to sign up with a law firm involved in the action. There is no charge for enrolling with a law firm, and it can be done online for free on certain Web sites.
I am a new investor and I am trying to sort everything out. Could you please explain what "Leaps" are? Thank You, W.K.
Long-term Equity AnticiPation Securities, or LEAPS, are option contracts that allow investors to establish positions that can be maintained for a period of up to three years.
Why would an investor want to get bogged down in a three-year commitment? Well, let's first take a look at the basics of options before leaping into LEAPS.
Options allow you to make a bet on the direction of an underlying investment such as a stock, bond or market index without actually buying that investment. There are countless ways investors carry options -- from using them as a hedge to avoid a big loss in a stock to making very risky bets that a stock will rise or fall -- but they revolve around two simple choices: options to buy and options to sell.
An option to buy is known as a call; calls are bought when investors think the value of the underlying stock is going to rise. Here's how a call works: An investor pays a premium, which represents a fraction of the value of the underlying investment, for the right to buy a stock at a preset price, known as the strike price, within a given time frame.
After buying the call options, you have two choices. Let's give an example to make it clear what happens with the money. We'll say you bought 10 call options for 100 shares each of XYZ Co. for a premium of $500. The stock's price was $35 a share when you bought the option, and the strike price is $40. The options in this case expire in three months.
Hold the options until maturity (the day they are set to expire), then trade them at the strike price: If the stock is above the strike price, you make money if the difference exceeds your premium. So, if you exercise the option to buy the stock at $45 a share, the 1,000 shares would be worth $5,000 more than the strike price. Subtract the $500 premium, and you made $4,500 (minus fees you pay to your broker). You also have the option to trade the options before it expires, if you're happy with the profit at the time.
Say the stock stays at $35 the whole time, or drops lower. It wouldn't make sense for you to trade the options, because you would lose thousands of dollars. So, you let the options expire and all you lose is your $500 premium.
Investors also buy options when they think a stock or other security is going to decline in value. An option to sell a stock is called a put. When you buy put options, you buy the right the sell the underlying investment at a set strike price within a given time frame. The way buying put options works is similar to buying calls, except you hope for the underlying investment to go down. If so, you trade for a profit. If not, you swallow the premium.
Selling options works differently. Since the buyer is the one holding the cards, you are obligated to sell if the buyer wants to exercise the options. Investors can sell options to buy and options to sell: If you sell someone the right to buy an underlying investment from you, it is known as writing a call. If you sell someone the right to sell an underlying investment to you, that's called writing a put.
OK. Now that we have the basics down, let's skip ahead to LEAPS.
One of the advantages of LEAPS is that, because of their long-term expirations, the at-the-money strikes closely track the price of the underlying shares of stock. This can make LEAPS a great alternative for an investor who expects significant long-term growth in an underlying stock but who doesn't want to make the substantial capital outlay required for entering a long-term position in the stock.
Remember, each LEAPS contract, like standard equity options, represents 100 shares of the underlying security, providing tremendous leverage.
There is, however, a potential drawback to buying LEAPS instead of stock: LEAPS don't pay dividends. As more companies move toward paying dividends and as favorable tax rulings are phased in, this may be an important consideration for investors hoping for a steady yield from their portfolio.