A recent court case sheds light on the issue.
A recent federal court decision has ruled that a company’s failure to disclosure the receipt of a Wells Notice did not form the basis for a private securities fraud action against the company. Does this mean that public companies do not need to disclose the receipt of a Wells Notice by it or its officers? While that wasn’t the issue before the Court, it is a reasonable inference based on the language in the Court’s opinion. This article discusses the opinion, what the Court actually decided, and what reasonable conclusions can be drawn from the Court’s opinion.
A Wells Notice is a notice from the Securities and Exchange Commission (the “Commission”) that it is conducting an investigation of a company or individual for the purpose of determining whether further action will be taken by the Commission against the target. The Wells Notice outlines the basis for the investigation and states the processes whereby the target may respond to the Wells Notice (typically referred to as a “Wells Submission”). The issuance of a Wells Notice is a confidential, non-public process, as is the corresponding investigation by the Commission. The Commission will not publicly disclose the existence of a Wells Notice or an investigation unless a determination is made by the Commission to be bring an enforcement action against the target, leaving the Wells Notice and investigation process a confidential process, unless disclosed by the target.
Under Section 13 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), Regulation S-K Item 103, a reporting company is required to “[d]escribe briefly any material legal proceedings…known to be contemplated by governmental authorities.” Additionally, if a company has provided information in a report, whether required or not, Section 240.12b-20, requires a company to add sufficient material information, if any, that is necessary to make any statements made, in light of the circumstances under which they are made, not misleading.
Section 10(b) of the Exchange Act prohibits any person from using or employing “any manipulative or deceptive device or contrivance in contravention” of the Commission’s rules. Additionally, Rule 10b-5, promulgated under Section 10(b), prohibits “any device, scheme, or artifice to defraud” and “any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made…not misleading….”
Against this background, are companies and/or their officers, required to report receipt of a Wells Notice from the Commission in their periodic Exchange Act reports?
Richmond v. Goldman Sachs Group, Inc.
On June 21, 2012, the decision in Richmond v. Goldman Sachs Group, Inc., et al. was announced out of the United States District Court, Southern District of New York. In Richmond, the Plaintiffs filed a lawsuit claiming the Defendants (Goldman Sachs and two Goldman Sachs employees) violated Section 10(b) of the Exchange Act, Rule 10b-5 promulgated thereunder, and Section 20(a) of the Exchange Act due to their failure to disclosure the fact they had received Wells Notices from the Commission notifying them they were under investigation by the Commission into the role they played in certain securities instruments related to subprime mortgages, and securitizations, collateralized debt obligations.
Under the facts in Richmond, the Defendants were involved in investing and recommending certain securities instruments related to subprime mortgages, and securitizations, collateralized debt obligations. As a result of these activities, in August 2008, the Commission notified Goldman Sachs that it had commenced an investigation into Goldman Sachs role in certain investments and served Goldman Sachs with a subpoena. Goldman disclosed in its filings that it had received requests for information from various government agencies and self-regulatory organizations related to its involvement in certain securities instruments related to subprime mortgages, and securitizations, collateralized debt obligations. In July 2009, the Commission issued a Wells Notice to Goldman Sachs notifying Goldman Sachs that the Commission “intends to recommend an enforcement action” and giving Goldman Sachs an opportunity to respond to the recommendation. In response, Goldman Sachs provided a written Wells Submissions in September 2009. Thereafter, Goldman Sachs met with the Commission on numerous occasions. Two Goldman Sachs’ employees also received Wells Notices from the Commission regarding the same subject matter. Despite these notices and meetings, Goldman Sachs did not make any further disclosure regarding the investigations other than what it had already made and did not disclose the receipt of the Wells Notices by it or its employees. The lack of disclosure regarding these matters was the basis for the Plaintiff’s action against the Defendants.
The Court in Richmond determined that the Defendants failure to disclosure the receipt of the Wells Notices, the meetings with the Commission, etc., did not provide a basis for a Section 10(b) or Rule 10(b)(5) violation. In making its decision the Court noted that a Wells Notice from the Commission is a preliminary notification that the staff of the Commission intends to recommend charges against the target with the target having the opportunity to provide arguments via a Wells Submission as to why the Commission should reject the staff’s recommendation that an enforcement action be instituted against the target. The Court noted that a party’s ability to make a counter-argument via a Wells Submission is “based on recognition that staff advice is not authoritative.” Richmond, citing, WHX Corp. v. S.E.C., 362 F.3d 854, 860 (D.C. Cir. 2004)(citing 17 C.F.R. § 202.5(c). Based on this the Court recognized that the receipt of a Wells Notice does not necessarily mean that charges will be filed by the Commission against the target. Noting that Regulation S-K Item 103, requires a reporting company “[d]escribe briefly any material legal proceedings…known to be contemplated by governmental authorities” the Court noted that “[a]n investigation on its own is not a ‘pending legal proceeding’ until it reaches a stage when the agency or prosecutorial authority makes known that it is contemplating filing suit or bringing charges.” Richmond, citing ABA Disclosure Obligations under the Federal Securities Laws in Government Investigations – Part II.C.; Regulation S-K, Item 103: Disclosure of Legal Proceedings.” 64 Bus. Law. 973 (2009). Against this backdrop the Court’s position was that there is no duty, under either federal securities law or pursuant to the Commission’s rules and regulations, to disclose the receipt of a Wells Notice. However, the Court did leave the door open to the possibility that if a company’s prior disclosure on a topic was such that the receipt of negative news would need to disclosed to make the prior disclosure not misleading, then disclosure related to the receipt of Wells Notice could be required. For instance, if a company made prior optimistic statements, or statements that it had avoided regulatory investigation, or something of the like, then disclosure related to the receipt of a Wells Notice could be necessary in order to clarify the prior disclosure.
The Court’s decision in Richman is clear in its conviction that companies and individuals, absent prior disclosures that make disclosure necessary, will not have an obligation to disclose the receipt of a Wells Notice in most situations. While it is nice to have a clear statement on this issue, a couple things should be kept in mind. First, this case is likely not going to be the last word on this issue, especially given the increase in Wells Notices issued by the Commission. Second, the issues before the Court in Richman was whether Goldman Sach’s failure to disclose the receipt of a Wells Notice gave rise to a violation of Section 10(b) or Rule 10b-5, it was not for the Court to decide whether Wells Notices need to be disclosed or not in all situations. Therefore, even thought the Court’s statement on the issue was broad enough to be relied upon, careful consideration needs to be based on the facts of each case. Having said that I believe the Court’s statement is broad enough and clear enough that in most cases companies and company employees that receive Wells Notices do not need to disclose them in the company’s public filings, but obviously all companies should seek legal advice in each particular situation. It is also worth nothing that companies should take care to make sure its disclosure about an issue would not make the subsequent receipt of a Wells Notice required disclosure.
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Craig V. Butler, Esq. is an attorney with The Lebrecht Group, APLC, located in Irvine, California and Salt Lake City, Utah. He can be reached at (949) 635-1240 or via e-mail at email@example.com with questions or comments. Please visit our website at www.thelebrechtgroup.com for future updates and other information.