How the SEC’s New Whistleblower Program Changes the Securities Fraud Class Action Debate

amanda rose

The SEC’s new whistleblower bounty program promises financial rewards to eligible individuals who voluntarily provide the agency with original information about securities law violations, if that information leads to an enforcement action resulting in $1 million or more in sanctions.  The program has spawned considerable debate, but the controversy thus far has been focused on the program’s insular design—with many criticizing, for example, the SEC’s choice to allow whistleblowers who bypass their internal compliance departments to recover bounties.

In a new article, Better Bounty Hunting: How the SEC’s New Whistleblower Program Changes the Securities Fraud Class Action DebateI explore the bounty program’s broader implications.  I argue that the program profoundly affects the longstanding debate over so-called “fraud-on-the-market” (FOTM) class actions.  FOTM class actions are lawsuits brought by entrepreneurial lawyers on behalf of a large class of dispersed shareholders, alleging that misstatements or omissions by corporate officers artificially inflated the price class members paid for their shares on the secondary market.   Few defend FOTM class actions on compensatory grounds; this is because public corporations almost always fund the settlements in these suits (directly or through insurance), such that they ultimately result in a transfer of funds between innocent shareholders.  But some believe FOTM class actions may nevertheless serve a deterrence function.   Insofar as FOTM class actions help to detect fraud, they are correct—or, rather, they were correct.  As explained in Better Bounty Hunting, the SEC’s new whistleblower program, if successful, will replicate the fraud detection benefits of FOTM class actions while simultaneously increasing the costs of such suits—rendering them a pointless yet expensive redundancy.  If instead the SEC proves incapable of effectively administering the bounty program, Better Bounty Hunting explains why amending it to include a qui tam provision similar to the one found in the False Claims Act would offer several advantages over retaining FOTM class actions.   Either way, the bounty program has important and previously unrecognized implications that policymakers should not ignore.

A link to the full text of the article is available here.