Analysis: Goldman judge cuts Wells notice disclosure burden

(Reuters) - A federal judge’s decision that otherwise went against Goldman Sachs Group Inc has made it easier for companies to defeat shareholder claims that litigation threatened by the U.S. Securities and Exchange Commission should be disclosed.

U.S. District Judge Paul Crotty in Manhattan said Goldman could not be sued under federal law for securities fraud for failing to disclose it had received a Wells notice from the SEC, though news of a notice often causes a negative market reaction.

The case related to Goldman’s alleged failure to disclose conflicts of interest in its sale of risky collateralized debt obligations such as Abacus 2007 AC-1, which led to a $550 million settlement between the bank and the SEC.

A Wells notice shows that SEC staff intend to recommend civil charges and lets a recipient mount a defense. But it is SEC commissioners themselves who decide whether to bring a case.

“At best, a Wells notice indicates not litigation, but only the desire of the enforcement staff to move forward,” Crotty wrote. “When the regulatory investigation matures to the point where litigation is apparent and substantially certain to occur, then ... disclosure is mandated.”

Goldman got its Wells notice in July 2009, but that was not revealed until the SEC accused it of fraud the following April. Two employees, Fabrice Tourre and Jonathan Egol, also got Wells notices, and the SEC eventually charged Tourre with fraud.

Peter Henning, a law professor at Wayne State University, said Crotty’s decision is the first to conclude that receipt of a Wells notice does not trigger an automatic disclosure obligation, including for companies that like Goldman may have earlier made general disclosures about regulatory probes.

“The tension is that investors want to know everything, and companies want to reveal nothing,” Henning said. “Judge Crotty’s decision pushes the trigger point for when disclosure is required to a later date. That’s good for companies. From an investor transparency point of view, this is not helpful.”

A 2009 study by Cornerstone Research found that 17 of 58 Wells notice disclosures from April 2002 to January 2007 triggered large stock price declines. It also found that these 58 announcements, when analyzed collectively, triggered statistically significant stock price declines.


Goldman shares fell 12.8 percent on April 16, 2010 when the SEC announced its civil fraud lawsuit over Abacus, wiping out more than $12 billion of the Wall Street bank’s market value.

By the end of June, after more details had emerged about Goldman’s CDO, the shares had fallen nearly 29 percent.

Another U.S. regulator, the Financial Industry Regulatory Authority, in November 2010 fined Goldman $650,000 for failing to reveal the Wells notices that Tourre and Egol had received.

In his decision, Crotty did let the Goldman shareholders pursue claims that the bank failed to disclose it had bet against some CDO it was selling, and let billionaire hedge fund manager John Paulson bet against securities he chose for Abacus.

Still, the judge said that while companies have a duty to make “accurate and complete” disclosures, this did not mean they needed to disclose everything, but rather enough such that what was revealed “would not be so incomplete as to mislead.”

He explained: “A corporation is not required to disclose a fact merely because a reasonable investor would very much like to know that fact.”

Robert Daines, a professor and governance specialist at Stanford Law School, said the judge tied his holding close to the facts of the case, making the broader impact unclear.

“Because a Wells notice is issued before the SEC knows much about the case, the notice may or may not turn out to be important,” he said, “and so the SEC has long taken the position that a Wells notice may or may not be material information.”

Henning said Crotty’s decision could prompt an SEC review of Regulation S-K, which sets out reporting requirements for public companies. But he also said greater disclosure obligations could backfire on the agency by forcing more disputes into the open.

“A Wells notice serves a purpose for the SEC, to prod companies to settle,” he said. “But if it is something companies must disclose immediately, the SEC may become more reluctant to issue a notice, and that could reduce its flexibility.”

SEC spokesman John Nester declined to comment.

The Tourre case remains unresolved. Egol was not charged.

The case is Richman v. Goldman Sachs Group Inc, U.S. District Court, Southern District of New York, No. 10-03461.

Reporting By Jonathan Stempel in New York; Editing by Phil Berlowitz