The suit, filed Tuesday by Mike McQueary, alleges defamation and misrepresentation and says the university's treatment of him has caused "much distress, anxiety and embarrassment."
McQueary reported seeing Sandusky and a boy in a locker room shower in 2001 but police weren't notified. A Penn State-commissioned report concluded officials concealed the attack due to fears of bad publicity.
McQueary was put on administrative leave in November; his contract expired in June. The suit says his future coaching earnings would have totaled at least $4 million over 25 years.