Public companies being investigated by the SEC often face difficult decisions about whether, when, and to what extent they should disclose the government inquiry. This is especially true in deciding whether to disclose the receipt of “Wells Notices,” which notify recipients that the Enforcement Staff may recommend that the Commission pursue formal charges against the company.
Though clients often ask whether they are required to disclose their receipt of Wells Notices, there are no clear rules in this regard. And until recently, there has been little or no guidance from the courts as to public companies’ disclosure obligations with respect to Wells Notices. In Richman v. Goldman Sachs Group, Inc., however, Judge Paul A. Crotty of the Southern District of New York held that public companies have no affirmative duty, upon which a securities fraud claim can be based, to disclose their receipt of Wells Notices.
In Richman, Goldman Sachs disclosed in SEC filings that it had “received requests for information from various governmental agencies and self-regulatory organizations” and that it was “cooperating with the requests.” Goldman Sachs did not, however, subsequently disclose the Wells Notices received by the company and its employees. Goldman Sachs’ receipt of Wells Notices was not publicly known until FINRA announced that it had fined Goldman for failing to disclose its employees’ receipt of Wells Notices.
Plaintiffs brought a securities class action lawsuit against Goldman Sachs, arguing that its failure to disclose its receipt of Wells Notices violated the company’s disclosure obligations. Specifically, plaintiffs argued (1) that Goldman Sachs had an affirmative legal obligation to disclose its receipt of a Wells Notice under Regulation S-K and/or FINRA and NASD rules, and (2) that Goldman Sachs had a duty to disclose its receipt of Wells Notices in order to prevent its prior disclosure of the SEC investigation from being misleading.
No Affirmative Duty to Disclose Wells Notices
The Court rejected plaintiffs’ argument that Goldman Sachs had an affirmative legal duty under Regulation S-K and/or FINRA and NASD rules to disclose its receipt of Wells Notices.
Under Regulation S-K, public companies are required to describe in public filings “any material pending legal proceedings . . . known to be contemplated by governmental authorities” and to supplement such disclosure with “further material information” necessary to keep prior disclosures up-to-date and accurate.
The Court declined to imply in Regulation S-K an obligation to disclose Wells Notices, acknowledging 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 is it contemplating filing suit or bringing charges.” The Court continued:
A Wells Notice may be considered an indication that the staff of a government agency is considering making a recommendation, . . . but it is well short of litigation. . . . [N]o court has ever held that a company’s failure to disclose receipt of a Wells Notice constitutes an actionable omission [upon which plaintiffs can base securities fraud claims].
The Court later simplified the point, explaining that Regulation S-K “does not explicitly require disclosure of a Wells Notice, and no court has ever held that this regulation creates an implicit duty to disclose receipt of a Wells Notice.”
The Court acknowledged that FINRA Rule 2010 and NASD Conduct Rule 3010 require financial firms to report an employee’s receipt of a Wells Notice, but declined to rely on these rules as independent bases for a securities fraud claim. Judge Crotty explained that 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.”
No Duty to Disclose Wells Notices Triggered by Prior Disclosures
The Court also rejected plaintiffs’ argument that Goldman Sachs’ prior disclosure of a pending government investigation created a duty to later disclose its receipt of Wells Notices.
The Court held that Goldman Sachs’ nondisclosure did not make its prior disclosures misleading, and did not constitute a breach of Goldman Sachs’ duty to be accurate and complete in its disclosures. The Court reasoned that “[w]hen a corporation chooses to speak – even where it lacks a duty to speak – it has a duty to be both accurate and complete.” Further, “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.”
To satisfy the accuracy and completeness requirement, the law does not impose a duty to disclose “uncharged, unadjudicated wrongdoing or mismanagement,” nor does it require companies to “predict . . . the imminent or likely outcome of investigations.” In Richman, no disclosure obligation arose because plaintiffs could not prove, based on a Wells Notice, that “litigation was substantially likely to occur.” “At best,” the Court said, “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.”
Judge Crotty’s decision brings much needed clarity to public companies’ disclosure obligations with respect to Wells Notices. It is worth remembering, however, that this is only one judge’s opinion, and its precedential value might not extend beyond the facts and circumstances present in Richman. It is unclear from Crotty’s ruling, for example, whether the receipt of a Wells Notice would trigger a disclosure obligation where a company had not previously disclosed the existence of any government investigation. Although the Richman decision provides some guidance to public companies, disclosure decisions must still be carefully weighed in light of all the circumstances.
This post was co-authored by Robert Plotkin and Kurt Wolfe.