There are a lot of plaintiffs lawyers out there hoping to reap big rewards from the Securities and Exchange Commission’s 2-year-old whistle-blower program. When the SEC, acting at the direction of Congress in the Dodd-Frank Wall Street Reform and Consumer Protection Act, implemented procedures last August to pay tipsters a bounty for information leading to sanctions of more than $1 million, law firms started running advertisements targeting corporate insiders with evidence of securities violations at their companies. If you run a Google search using the phrases “whistle-blower” and “SEC,” you’ll see exactly what I mean.
Those bounties – and accompanying legal fees for whistle-blower lawyers – have been slow to materialize. So far, the SEC has rewarded only two tipsters, though according to The Wall Street Journal, the agency’s regional director in Los Angeles, Michele Wein Layne, told the American Bar Association on Saturday to expect more (and more substantial) bounty payments. There’s certainly been no shortage of prospective whistle-blowers reaching out to the SEC. In fiscal year 2012, the Journal reported, the agency received about 300 whistle-blower tips, from all 50 states and several foreign countries. The time lag between tips and rewards, Layne reportedly said, is because it takes a while for the agency to check out and act upon the information it receives.
Despite the SEC bounty program’s slow start, a professor at Vanderbilt University Law School, Amanda Rose, is arguing in a new working paper that if the agency efficiently handles tips, the whistle-blower program should make shareholder securities class actions obsolete. Rose, a onetime associate at Gibson, Dunn & Crutcher, is no fan of private securities fraud litigation. In 2011 she published a University of Pennsylvania law review paper entitled “Fraud on the Market: An Action Without A Cause,” which should give you a good indication of her point of view. I’m pretty sure her latest hypothesis isn’t going to win over the shareholder class action bar. Nevertheless, Rose makes a provocative case, and with the fundamental viability of securities class actions under threat from U.S. Supreme Court justices who have questioned the fraud-on-the-market reasoning of 1988′s Basic v. Levinson, plaintiffs lawyers should take care to know their enemies. (Hat tip to the CLS Blue Sky Blog, where I first heard about Rose’s paper.)
Rose’s paper is based on the premise that securities class action settlements don’t actually deter corporate fraud, but the revelation of wrongdoing does. She considers class action settlements merely a transfer of money from one group of innocent shareholders – those who pay for the corporate insurance coverage that funds just about every settlement – to another group, with legal fees an unfortunate and inefficient transactional cost. Shareholders with diverse portfolio don’t see any real returns, since sometimes they’re in the group paying insurance premiums and sometimes they’re in the group that receives settlement money. Meanwhile, settlements accomplish little in the way of deterrence, Rose believes, because corporate officers are almost never required to contribute their own money.
But officials can be dissuaded from engaging in wrongdoing by the knowledge that their equity stake in their company (and their personal reputations) will suffer from the exposure of fraud in a securities class action, according to Rose. The only shareholder fraud suits that have true deterrent value, she argues, are the very rare cases that reveal misconduct previously unknown to the market and regulators. Plaintiffs lawyers’ contribution to the process, in Rose’s view, is just in their ability to detect fraud based on public filings and to convince corporate insiders to give them information.