On Thursday, a U.S. District Court in New York ruled that Goldman Sachs could not be sued for fraud under the federal securities laws for failing to publicly disclose that it had received a Wells notice from the Securities & Exchange Commission ("SEC"). The Court's decision, Richman v. Goldman Sachs Group, Inc., et al., No. 1:10-cv-03461-PAC, slip op. (S.D.N.Y. June 21, 2012), held that there is no "automatic" obligation to disclose receipt of a Wells notice under the federal securities laws. The Court went further, providing some guidance to companies grappling with the always-difficult issue of whether to disclose the receipt of a Wells notice.

BACKGROUND

After the staff of the SEC's Enforcement Division investigates a matter and believes that it has established that a violation of the federal securities laws has occurred, it will often issue a "Wells notice" to the individuals and entities that the staff believes are responsible for the violation. That Wells notice informs potential defendants that the staff intends to recommend to the Commission that charges be brought for violation of the securities laws. The recipient of the notice is then allowed to make a written "Wells submission" to the SEC, arguing why the proposed charges should not be brought. The Commission will then review the staff's recommendation, along with the Wells submission, and decide whether to authorize an enforcement action, typically in the form of a lawsuit or administrative proceeding.

Companies frequently struggle with whether to publicly disclose the receipt of a Wells notice. On the one hand, a Wells notice is not a final determination by the SEC that it will be bringing an action against the company. Rather, it is only a statement by the staff that it intends to make an enforcement recommendation, which can be accepted or rejected by the Commission. And, despite that no final decision has been made by the SEC, disclosure of a Wells notice often leads to a decline in the company's stock price, which may unnecessarily harm shareholders. On the other hand, a Wells notice can be a significant event for a company, depending on the nature of the SEC case, prior disclosures by the company, possible defenses to the staff's allegations, and a host of other factors. As a result, many – though not all – companies have chosen to disclose the receipt of Wells notices.

Although the Richman court acknowledges that the question of whether to disclose a Wells notice is fact specific, it does provide comfort to companies that are considering not disclosing the receipt of a Wells notice based on the facts and circumstances of the particular investigation.

In Richman, Goldman had disclosed in several of its public filings that the SEC and other self-regulatory organizations were conducting an investigation related to Goldman's business in collateralized debt obligations. At the conclusion of the SEC's investigation, the enforcement staff issued Wells notices to Goldman and two of its employees, informing them that the staff intended to recommend enforcement action. Goldman elected to not disclose the receipt of those Wells notices, and the SEC subsequently filed a complaint against Goldman and one of the two employees.

The Richman plaintiffs brought suit against Goldman, arguing that Goldman violated Section 10(b) and Rule 10b-5 of the Exchange Act because (i) Goldman had an affirmative legal obligation to disclose its receipt of the Wells notices; and (ii) Goldman had a duty to disclose the receipt of Wells notices in order to prevent its prior disclosures about government investigations from being misleading. The Court rejected both arguments.

NO AFFIRMATIVE DUTY TO DISCLOSE WELLS NOTICES

The Richman Court began its analysis by looking at the statutory disclosure requirements found in the Exchange Act. Under Section 13 of the Exchange Act, Regulation S-K Item 103, a company is required to "[d]escribe briefly any material pending legal proceedings . . . known to be contemplated by governmental authorities." 17 C.F.R. § 229.103. In looking at the specific disclosure requirements of Regulation S-K, the Court concluded that nothing in Item 103 mandated the disclosure of a Wells notice. The Court explained that a Wells notice was not a legal proceeding, stating, "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 then went on to analyze Goldman's disclosure obligation under Section 10(b), and held that "[w]hen the regulatory investigation matures to the point where litigation is apparent and substantially certain to occur, then 10(b) disclosure is mandated . . . Until then, disclosure is not required."

Plaintiffs also argued that Goldman was required to publicly disclose the receipt of the Wells notices because FINRA's rules specifically required that Goldman notify it of the Wells notices within 30 days of receipt. As a result, plaintiffs argued, Goldman had an affirmative, legal duty to make disclosure. The Court acknowledged that Goldman violated a FINRA rule by failing to disclose the Wells notices to FINRA. However, the Court found that a securities fraud claim cannot be predicated solely on a violation of a FINRA rule, as a violation of a FINRA rule does not create a private right of action. The Court concluded that the receipt of the Wells notices, standing alone, did not give rise to an affirmative duty to disclose.

GOLDMAN'S PRIOR DISCLOSURE OF THE SEC'S INVESTIGATION ALSO DID NOT GIVE RISE TO A DUTY TO DISCLOSE WELLS NOTICES

The Court further rejected plaintiffs' argument that Goldman's prior disclosures about governmental investigations triggered a duty to disclose its subsequent receipt of Wells notices. Specifically, plaintiffs argued that by failing to disclose that the SEC's investigation had resulted in Wells notices, Goldman misled the public into erroneously concluding that no significant developments had occurred that made the investigation more likely to result in formal charges.

The Court acknowledged that, when a company chooses to speak, it has a duty to be both accurate and complete. This did not, however, require a company to disclose all facts on the subject. Nor did it require a company to accuse itself of wrongdoing or predict the outcome of the SEC's investigation. The Court reasoned that, because plaintiffs did not allege that litigation was "substantially certain to occur," Goldman did not have a duty to predict and/or disclose its predictions regarding the likelihood of suit. The Court concluded that nothing about Goldman's prior disclosures gave rise to a duty to disclose the subsequent receipt of Wells notices.

COMPANIES SHOULD CONTINUE TO CAREFULLY EVALUATE DISCLOSURE OBLIGATIONS UPON RECEIPT OF A WELLS NOTICE

The Richman decision may give some comfort to companies who choose not to publicly disclose a Wells notice. But despite Richman's holding that Goldman did not have an affirmative obligation to disclose receipt of a Wells notice under the securities laws, companies should continue to carefully evaluate whether – under the specific circumstances presented – disclosure is required under the federal securities laws. For example, such disclosure may be required in order to prevent prior disclosures from being misleading; because the particular circumstances suggest litigation is "substantially certain to occur;" or because the receipt of a Wells notice would be deemed, in and of itself, to be material to the company.

To view the Court's decision, click here.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved