When a company receives a Wells notice from the staff of the Securities and Exchange Commission, whether or not it needs to disclose that to the public has been an open question for some time. Many did, but some did not.
Now a recent district court ruling sheds some light on the decision, ruling that under many circumstances a company has no automatic obligation to notify the public that it received a Wells notice.
A Wells notice is a written notification from the SEC's Division of Enforcement that a company is under investigation for potential violations of federal securities laws. The purpose of the notice in this early stage is to alert companies that they may soon face charges from the SEC. For most companies, it is the first indication that the SEC is looking into potential violations.
A Wells notice also gives potential defendants an opportunity to provide the SEC with a written response to the potential charges described in the notice. It is often viewed as an invitation to begin negotiations to settle the allegations, which is how most SEC charges are settled. After reviewing the Enforcement Division's recommendations and the letter of dispute, the SEC makes the ultimate decision as to whether to authorize an enforcement action.
The SEC issued a Wells notice to Goldman Sachs and two of its employees in July 2009 describing allegations that Goldman misled investors in a sub-prime mortgage product just as the U.S. housing market was starting to collapse. Although Goldman ultimately settled the charges and agreed to a $550 million penalty in July 2010, it did not notify the public that is was the target of an SEC investigation into the matter until the SEC officially charged the company with fraud in April 2010.
That's when plaintiffs, led by shareholder Ilene Richman, brought a complaint against Goldman for violations of federal securities laws. According to the plaintiffs, Goldman had not only a legal obligation, but also a duty to disclose receipt of the Wells notice in order to prevent its prior disclosures about government investigations from being misleading.
In late June the U.S. District Court for the Southern district of New York rejected that argument when it ruled on Richman v. Goldman Sachs Group, holding that the receipt of a Wells notice, in itself, does not trigger an “automatic” disclosure obligation. Securities experts say the decision marks the first time that a court has directly addressed the issue of when to disclose a Wells notice. “This is a case of first impression on that issue,” says Keith Miller, a partner and chair of the securities enforcement practice with law firm Perkins Coie, and a former SEC enforcement attorney.
For a long time many companies have interpreted the receipt of a Wells notice to mean that an enforcement action is imminent, and, thus, disclosure would have to be required. In fact, the reporting obligations for public companies under Regulation S-K Item 103 state that a company must “[d]escribe briefly any material pending legal proceedings … known to be contemplated by governmental authorities.”
“There comes a point when the company understands that litigation is imminent. At that point, the necessity for making that disclosure is much higher than when you just receive a Wells notice.”
—Keith Miller,
Partner,
Perkins Coie
“Prior to this decision, there was a lot of confusion by companies as to whether a Wells notice, standing alone, needed to be disclosed,” explains Randall Fons, a partner and co-chair of the securities litigation, enforcement, and white-collar defense practice of law firm Morrison & Foerster.
The reality is that many companies that receive Wells notices often do not face enforcement actions, so it is in their best interest not to publically disclose the receipt of one, especially where such a disclosure often leads to a decline in the company's stock price. “They don't want to take on the negative publicity when it may turn out that nothing is going to come out of it,” says Peter Henning, a former attorney in the SEC Division of Enforcement, and now law professor at Wayne State University.
Essentially, the court reached such a conclusion by explaining that a Wells notice is not a legal proceeding. “A corporation is not required to disclose a fact merely because a reasonable investor would very much like to know that fact,” the court stated. “At best, a Wells notice indicates not litigation but only the desire of the enforcement staff to move forward, which it has no power to effectuate. This contingency need not be disclosed.”
The court's ruling doesn't mean, however, that companies never have to disclose a Wells notice. Companies have a duty to make “accurate and complete” disclosures, but this does not mean they need to disclose everything—only enough such that what is revealed “would not be so incomplete as to mislead,” the court added.
Since not all Wells notices lead to official charges, the uncertain outcome likely explains why the SEC has never come out with any bright-line test mandating the public disclosure of a Wells notice, securities experts point out. “The SEC has always been leery about when companies should disclose,” says Henning. “I just don't think they want to get involved.”
The SEC likes to keep some gray area in the regulations to keep companies on their toes, says Henning. The Commission's concern is that, as soon as you establish a bright-line rule, “everyone will figure out how to avoid it,” he says.
WELLS NOTICE DECISION
Below is an excerpt from the decision in Richman v. Goldman Sachs Group:
When a corporation chooses to speak—even where it lacks a duty to speak—it has a “duty
to be both accurate and complete.” Caiola v. Citibank, N.A., 295 F.3d 312, 331 (2d Cir. 2002).
A corporation, however, “only [has to reveal] such [facts], if any, that are needed so that what
was revealed would not be so incomplete as to mislead.” In re Bristol Myers Squibb Co. Sec.
Litig., 586 F.Supp.2d 148, 160 (S.D.N.Y. 2008) (citation omitted). The federal securities laws
“do not require a company to accuse itself of wrongdoing.” In re Citigroup, Inc. Sec. Litig., 330 F.Supp.2d 367, 377 (S.D.N.Y. 2004) (citing In re Am. Express Co. Shareholder Litig., 840
F.Supp. 260, 269-70 (S.D.N.Y. 1993)); see also Ciresi v. Citicorp, 782 F.Supp. 819,
823 (S.D.N.Y. 1991) (dismissing Exchange Act claims in part because “the law does not impose
a duty to disclose uncharged, unadjudicated wrongdoing or mismanagement”). Moreover,
“defendants [a]re not bound to predict as the ‘imminent' or ‘likely' outcome of the investigations
that indictments of [the company] and its chief officer[s] would follow, with financial disaster in
their train.” Ballan v. Wilfred Am. Educ. Corp., 720 F.Supp. 241, 248 (E.D.N.Y. 1989).
In In re Citigroup, plaintiffs' 10(b) claims premised on Citigroup's failure to disclose
“litigation risks associated with its Enron-related, analysis/investment banking and reporting
activities” were dismissed because “Citigroup was not required to make disclosures predicting
such litigation”; plaintiffs did not allege that litigation “was substantially certain to occur”; and
the SEC filings at issue contained some “discuss[ion of] pending litigation.” 330 F.Supp.2d at
377. Similarly, here, Plaintiffs do not allege that litigation was substantially certain to occur, and
concede that Defendants provided some notice about ongoing governmental investigations in
their SEC disclosures. Indeed, Plaintiffs cannot claim that a Wells Notice indicated that
litigation was “substantially certain to occur” because Jonathan Egol, a Goldman employee,
received a Wells Notice regarding the Abacus transaction and ultimately was not sued by the
SEC. While Goldman and Tourre were sued, the Defendants were not obligated to predict
and/or disclose their predictions regarding the likelihood of suit. See Ballan, 720 F.Supp. at 248.
Moreover, revealing one fact about a subject does not trigger a duty to reveal all facts on
the subject, so long as “what was revealed would not be so incomplete as to mislead.” In re
Bristol Myers, 586 F.Supp.2d at 160 (quoting Backman v. Polaroid Corp., 910 F.2d 10, 16 (1st
Cir. 1990)). Plaintiffs have not shown that Defendants were required to disclose their receipt of Wells Notice to prevent their prior disclosures from being inaccurate or incomplete, as their
receipt of Wells Notices indicated that the governmental investigations were indeed ongoing.
While Plaintiffs claim to want to know about the Wells Notices, “a corporation is not required to
disclose a fact merely because a reasonable investor would very much like to know that fact.” In
re Time Warner Sec. Litig, 9 F.3d 259, 267 (2d Cir. 1993). At best, a Wells Notice indicates not
litigation but only the desire of the Enforcement staff to move forward, which it has no power to
effectuate. This contingency need not be disclosed.
Source: Richman v. Goldman Sachs Group.
The only circumstances in which the SEC may try to communicate exceptions to the court's conclusion that “automatic” notification isn't required is if companies begin to interpret the decision as never needing to disclose a Wells notice, says Fons, who spent 18 years with the SEC.
Rather, what the court clarified in its opinion is that disclosure under Section 10(b) is only triggered when the regulatory investigation matures to the point where litigation is “apparent and substantially certain to occur.”
“There comes a point when the company understands that litigation is imminent,” says Miller. At that point, “the necessity for making that disclosure is much higher than when you just receive a Wells notice,” he says.
In its decision, the court did agree with the plaintiffs, however, that Goldman violated its disclosure obligations under the Financial Industry Regulatory Authority, which requires financial institutions to disclose a Wells notice within 30 days of receipt. Goldman's failure to report resulted in a $650,000 fine from FINRA.
Questions Remain
Miller says the Richman decision “gives some comfort” to those companies placed in the “regulatory quagmire” of whether to disclose receipt of a Wells notice, because it, at least, establishes some sort of standard.
Fons agrees that the decision should be helpful for each company in evaluating, based on its own individual circumstances, what the Wells notice means for disclosure. For example, he says, the types of questions companies should consider include:
Regarding the potential material implications on the company, is the center of the Wells notice a former employee who has already been terminated, or a sitting CEO?
Do we have reasonable defenses, or are we going to immediately enter into settlement negotiations knowing that a lawsuit is imminent?
What might be the potential outcome of an SEC enforcement action—a cease and desist order with no monetary action, for example, or potential fraud charges with large penalties?
Rather than automatically disclose the receipt of a Wells notice to the public based on a knee-jerk reaction, says Fons, the court's decision enables a company to analyze their own individual circumstances and effectively assess the best decision for them.
No comments yet