A federal judge has ruled that a public company did not have a duty to disclose the receipt of a Wells Notice from the SEC. In that case, shareholders filed a federal securities fraud class action lawsuit against a major investment bank, claiming that the bank had failed to disclose that it received a Wells Notice. The staff of the SEC uses Wells Notices to notify the target of an investigation that the staff intends to recommend to the five commissioners who preside over the SEC that the SEC should pursue an enforcement action against the target. After receiving the Wells Notice, the target is given an opportunity to submit a Wells submission explaining why the staff should not make such a recommendation to the SEC or why the SEC should not follow the staff's recommendation. In the case of the investment bank, the SEC commenced an enforcement action against the bank that resulted in a $550 million settlement.
Judge Crotty of the Southern District of New York held that the investment bank did not have an affirmative duty to disclose the receipt of the Wells Notice. Judge Crotty concluded that Item 303 of Regulation S-K under the Securities Act, which requires public companies to "describe briefly any material pending legal proceedings ... known to be contemplated by governmental authorities," (see 17 C.F.R. § 229.103) did not require the bank to disclose the Wells Notice because, even though a Wells Notice "may be considered an indication that the staff of a government agency is considering making a recommendation" to commence an enforcement action, a Wells Notice is "well short of litigation" and does not constitute a "legal proceeding" within the meaning of Regulation S-K. Judge Crotty noted that the Wells process, including the opportunity afforded to the target to submit a Wells submission, recognizes that "staff advice is not authoritative" and was "implemented so that the [SEC] would have the opportunity to hear a defendant's arguments before deciding whether to go forward with enforcement proceedings."
The plaintiffs argued that, even in the absence of Item 303, the investment bank had a duty to disclose the Wells Notice because it had previously disclosed that it had received requests for information from various government agencies about certain of its business practices and that it was cooperating with those requests. The plaintiffs claimed that the bank's failure to disclose the Wells Notice "misled the public into 'erroneously' concluding that 'no significant developments had occurred' ... ." Judge Crotty rejected that argument, holding that the bank's silence did not render the prior statements misleading because he bank had not predicted whether the investigations would result in an enforcement action and, in any event, the Wells Notice, by itself, did not indicate that litigation was "substantially certain to occur.
Richman v. Goldman Sachs Group, Inc., No. 10-3461, 2012 WL 2362539 (S.D.N.Y. June 21, 2012)