A federal judge ruled that a securities fraud action could not
be based on a financial company’s failure to disclose receipt of a Wells Notice from
the SEC. At best, said the court, a Wells Notice indicates not litigation but
only the desire of the SEC Enforcement staff to move forward, which it has no
power to effectuate. This contingency
need not be disclosed. While the investors claimed to want to know about the
Wells Notice, a corporation is not required to disclose a fact merely because a
reasonable investor would very much like to know that fact. (Richman v. Goldman
Sachs Group, Inc., SD NY, 10 Civ. 3461, June 21, 2012.)
The SEC provides a target of an investigation with a Wells
Notice whenever the Enforcement Division staff decides, even preliminarily, to
recommend charges. The party at risk of an enforcement action is then entitled,
under SEC rules, to make a Wells submission to the SEC, presenting arguments
why the Commissioners should reject the staff’s recommendation for enforcement.
In the court’s view, a party’s entitlement to make a Wells
submission is obviously based on recognition that staff advice is not
authoritative. Indeed, continued the court, the Wells process was implemented
so that the Commission would have the opportunity to hear a defendant’s
arguments before deciding whether to go forward with enforcement proceedings. Thus,
receipt of a Wells Notice does not necessarily indicate that charges will be
filed.
Item 103 of Regulation S-K requires a company to describe any
material pending legal proceedings known to be contemplated by governmental
authorities. Exchange Act Rule 12b-20 supplements Regulation S–K by requiring a
person who has provided such information in a statement or report to add such
further material information as may be necessary to make the required statements,
in light of the circumstances under which they are made, not misleading.
A Wells Notice may be considered an indication that the staff
of a government agency is considering making a recommendation, noted the court,
but that is well short of litigation that would have to be disclosed. Moreover,
the investors did not show that the company’s nondisclosure of the receipt of
Wells Notice made prior disclosures about ongoing governmental investigations
materially misleading; or that it breached a duty to be accurate and complete
in making
disclosures.
The court rejected the argument that the company had an
affirmative legal obligation to disclose receipt of the Wells Notice under
Regulation S-K, Item 103. There is nothing in Item 103 which mandates
disclosure of Wells Notices, emphasized the court. Item 103 does not explicitly
require disclosure of a Wells Notices, and no court has ever held that this regulation
creates an implicit duty to disclose receipt of a Wells Notice. When the regulatory investigation matures to
the point where litigation is apparent and substantially certain to occur, said
the court, then Section 10(b) disclosure is mandated. Until then, disclosure is
not required.
FINRA Rule 2010, and NASD Conduct Rule 3010 explicitly require
financial firms to report an employee’s receipt of a Wells Notice to FINRA
within 30 days. There is no dispute that the firm was bound by and violated
these regulations by failing to disclose receipt of the Wells Notice within 30
days.
However, federal courts have cautioned against allowing
securities fraud claims to be predicated solely on violations of NASD rules
because such rules do not confer private rights of action. The court reasoned
that these historic precedents are applicable to FINRA rules, since FINRA is the
NASD’s successor.