Court Holds A Wells Notice Does Not Trigger An Automatic Disclosure Obligation For Public Companies

Author:Ms Catherine Botticelli, Thomas J. Friedmann, Dennis Lawson and Emily E. Shea

United States District Judge Paul Crotty, sitting in the Southern District of New York, has issued a ruling holding that a public company did not have a duty, upon which a federal securities fraud claim could be based, to disclose the receipt of a Wells Notice from the Securities and Exchange Commission (SEC or Commission).1 A Wells Notice is a notice to the recipient that the staff of the SEC's Division of Enforcement (SEC staff) intends to recommend that the Commission pursue an enforcement action against the recipient. Under SEC Rules, in response to such a notice, the recipient is entitled to make a Wells submission presenting facts and argument as to why the SEC staff should not make such a recommendation.2 If the staff decides to goes forward with its recommendation, the Commission will review the recommendation and the Wells submission, and decide whether to authorize an enforcement proceeding. Accordingly, receipt of a Wells Notice does not necessarily indicate that charges will be filed.

In the current regulatory climate, public reporting companies are increasingly faced with the difficult question of whether to disclose the existence of a governmental investigation and subsequent receipt of a Wells Notice. Even though a Wells Notice may not be followed by an enforcement proceeding, disclosing a Wells Notice can cause a company's brand and its stock to be negatively impacted. The significance of a Wells Notice depends on many factors, including the nature of the SEC's allegations and a company's possible defenses. Balancing the desire to avoid unnecessary harm to the company and its shareholders with the need to comply with disclosure obligations can be a difficult task. The guidance in this regard has not been clear, and public companies often seek to avoid compounding regulatory problems by erring on the side of early, complete disclosure. Judge Crotty's decision holds that a public company does not have a duty to disclose the existence of a governmental investigation until "litigation is apparent and substantially certain to occur." Moreover, receipt of a Wells Notice, which "indicates not litigation, but only the desire of the enforcement staff to move forward," likewise does not automatically trigger a disclosure obligation.

Disclosure Obligations

"Silence, absent a duty to disclose, is not misleading" under the federal securities laws.3

The securities laws do not require disclosure of every fact â€" even facts that may be...

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