Abstract: Two developments have transformed the detection of corporate fraud in the last decade: the Securities and Exchange Commission’s Whistleblower Bounty Program (WBP) and the rise of activist short sellers. The WBP offers up financial bounties to individuals who bring forward actionable information about securities fraud. Activist shorts conduct due diligence to identify overvalued public companies, take short positions, reveal the negative information, and then enjoy trading profits if and when the stock tanks. Considered separately, these institutions are widely regarded as socially valuable innovations that help deter fraud.
But, it turns out, they are not fully separate. Activist shorts have been participating actively and effectively in the WBP—both directly (submitting tips, filing claims, and winning awards) and indirectly (partnering with insider tipsters). Their participation has transformed the WBP into an undercover outsourcing program: a new way for the Securities and Exchange Commission (SEC) to pay private professionals to do work that traditionally has been done by SEC staff.
This privatization might be defensible, indeed laudable, if it yielded more efficient deterrence than what the SEC could achieve on its own. Unfortunately, it likely does not. The SEC may be paying activist shorts for information they would have made public even without the prospect of bounty (because of their trading strategy). In such cases, the public bounty payment does nothing to incentivize additional fraud detection and is merely a windfall for the recipient. Those funds could be better spent by expanding the SEC’s own enforcement capacity.
