Can a Wells Submission Prevent SEC Charges??

A Wells notice is an official communication from the SEC’s Division of Enforcement (or other division or program) notifying an individual or entity that a group of SEC staff have preliminarily determined to recommend enforcement action against them. The notice is issued at the staff’s discretion to the target(s) and explains the charges the SEC staff are considering.

A Wells notice is not a filed charge, and it is not a finding by the Commission. It also doesn’t establish a criminal violation by the U.S. Department of Justice. As a preliminary matter, though, a persuasive Wells submission can persuade the staff not to recommend an enforcement action (or persuade the staff to recommend an action based on narrow or lessened charges).

The SEC adopted the Wells procedure following a 1972 advisory committee report. The report recommended that the Commission adopt a procedure for allowing targets to respond to SEC staff recommendations “where appropriate.” While it appears to be the SEC’s intent to maintain the Wells procedure, the SEC generally proves civil violations by a preponderance of the evidence.

While responding to a Wells notice makes sense in theory, this theory may be impractical in practice, for a few reasons. First, it may be difficult to determine whether responding makes sense given the odds. The SEC publishes no denominator that can be used to calculate its verified Wells-submission success rate. Second, responding could also expose the target to admission, privilege, disclosure, and criminal risks that they would not otherwise face. To that end, responding to a Wells notice should be approached as a matter of strategy.

What happens after you receive a Wells notice?

The SEC Enforcement Manual describes the Wells process as follows:

• “The staff should ordinarily consider a Wells notice late in its investigation, after the staff has determined that, absent the defendant’s input, it has a good-faith basis for concluding that the defendant is likely responsible for a violation of the securities laws;” and,
• “A Wells notice should clearly state:

- (i) The legal provisions the staff considers to have been violated (or that the staff is considering treating as potentially violated) and provide a brief explanation of the basis for its belief,

- (ii) The date by which any response must be made...”

The manual also states: “de facto, the SEC is unable to confirm or deny whether any enforcement action is underway or will be brought against any specific individual or entity.”

While the Enforcement Manual contains guidance, the SEC has generally made it clear that this manual (and the SEC’s enforcement procedures, more generally) creates no enforceable rights. 17 C.F.R. § 202.5(c) reads, in relevant part, “Persons who become involved in preliminary or formal investigations may, on their own initiative, submit a written statement to the Commission setting forth their interests and position in regard to the subject matter of the investigation.” (The C.F.R. section is a reference to the SEC’s “Informal and Other Procedures” in its rules and regulations).

In SEC administrative proceedings, enforcement actions are commenced by the staff, with subsequent Commission approval to institute proceedings (and a subsequent opportunity for an ALJ hearing). C.F.R. § 200.30-4 grants this power to the Enforcement Division’s Director:

“Pursuant to the provisions of Pub. L. No. 100-181, 101 Stat. 1254, 1255 (15 U.S.C. 78d-1, 78d-2), the Securities and Exchange Commission hereby delegates, until the Commission orders otherwise, the following functions to the Director of the Division of Enforcement to be performed by him or under his direction by such other person or persons as may be designated from time to time by the Chairman of the Commission:

• . ..
• File an administrative-procedure order to institute an administrative proceeding where necessary;
• . .. (10) To institute subpoena enforcement proceedings in federal court to seek an order compelling the production of documents or an individual’s appearance for testimony pursuant to subpoenas issued pursuant to paragraph (a)(1) of this section;
• . .. ”

In the event that charges are recommended, SEC commissioners make the final determination. While the Division of Enforcement generally recommends charges in a substantial majority of cases, the SEC Commissioners may decline to authorize charges recommended by Enforcement staff if they find that there is insufficient evidence to prove the charges or if they find that it is in the Commission’s (or the public’s) interest not to charge a target.

If the SEC decides to proceed with charges, the staff’s recommendation and any accepted Wells submission (that was received by the deadline) will be forwarded to the Commissioners. If the Commissioners authorize the enforcement action, the staff will then file the complaint (or administrative-procedure order) on behalf of the Commission.

It is important to recognize that, in federal-court enforcement actions, Commission authorization and filing are separate procedural events. For example, if the Commission authorizes filing a complaint, the action is not commenced until the staff actually files that complaint in federal district court. There is no single procedure that provides for a “single action” by the SEC Commissioners.

Should I submit a full response, limited response, or nothing?

The SEC’s Enforcement Manual describes the requirements for making a Wells submission as follows:

• “Wells submissions will generally be limited to 40 pages, excluding exhibits, unless a longer submission is expressly authorized by the staff;”
• “Any request for an extension of the response date must be made in writing to the appropriate Assistant Director and must state the basis for the request; and,
• “Submissions may be made on paper (including electronic submission) or in some cases through a conference if expressly permitted.
• All Wells submissions must include any proposed exhibit list separately, and a physical copy of the list must be submitted at the time of the Wells submission.”

The Enforcement Manual also states that any extension of the response deadline requires the agreement of the staff, and any request for an extension must be made in writing.

While a recipient is permitted to decline to make a Wells submission, it is important to note that if the recipient doesn’t make a Wells submission, the Enforcement Division staff can (and likely will) reject the recipient’s request for an extension of the response deadline.

Additionally, a recipient can choose to make a limited (or partial) Wells submission. However, as the Enforcement Manual states, the SEC staff may reject a Wells submission that:

• Exceeds the 40-page length limit (if an extension is not expressly authorized);
• Is not filed in compliance with the SEC’s requirements;
• Is not filed in compliance with the time or content limitations established by the Division of Enforcement;
• Attempts to restrict the SEC’s later use of the submission; or,
• Contains settlement offers.

As the Enforcement Manual explicitly states, any settlement offers must be delivered separately from a Wells submission.

As long as the deadline doesn’t present a problem, any additional request for an extension of the response deadline can also be a potential issue. In this situation, a timely decision is imperative, as the request for an extension must be made in writing.

In addition to making a Wells submission, SEC targets can also make requests for access to nonprivileged investigative materials. The Enforcement Manual states: “Staff may also, as a matter of discretion, grant a Wells recipient access to, and the ability to make, copies of the investigative file, upon written request and if such action does not compromise the integrity of the ongoing investigation.”

The SEC’s Enforcement Manual expressly provides for a post-Wells submission meeting, which should occur within four weeks of the submission and must include a member of senior leadership at the Associate Director level or above. However, as a matter of practice, generally, targets are entitled to have their counsel have a one-off meeting with the SEC’s Enforcement staff in order to discuss the proposed charges and the target’s defenses.

Can my Wells submission increase criminal or civil exposure?

While the SEC can refer cases for criminal securities prosecutions, the U.S. Department of Justice is the only entity that brings criminal securities prosecutions. When the SEC shares the information contained in a Wells submission with criminal authorities, the target of a Wells submission may be exposed to criminal liability.

This fact is further reinforced by the language contained in Form 1662: “The information provided herein may be used in any proceeding, including civil and criminal proceedings, as permitted by law.”

So, when responding to a Wells notice, it is important to be cognizant of any criminal liability that could be at issue. In particular, voluntary factual admissions can be used without compelling the speaker’s testimony (and, as such, does not implicate a speaker’s Fifth Amendment protection against compelled testimonial self-incrimination). That is, as long as there is no compelling of the target’s (or the target’s representative’s) testimony, the Department of Justice is permitted to pursue criminal securities charges.

So, when responding to a Wells notice, what are the odds of increasing (or mitigating) the risk of facing civil or criminal charges?

Well, proving criminal securities charges beyond a reasonable doubt is certainly harder than proving civil securities charges by a preponderance of the evidence. That, however, is not necessarily true of facing a criminal prosecution.

There are other considerations to consider as well. For example, the Supreme Court has determined that an adverse inference can be drawn from a defendant’s silence in a civil proceeding. Baxter v. Palmigiano, 425 U.S. 308 (1976) reads, in relevant part, “While the Fifth Amendment cannot be used to compel testimony, a party to a civil action who invokes the Fifth Amendment to refuse to testify may be forced to bear the consequences of such refusal.”

Similar to the Supreme Court’s determination in Baxter v. Palmigiano, the SEC’s approach to civil proceedings is to allow an adverse inference.

There are other considerations to consider as well. While the Fifth Amendment bars compelling testimony that can be used to support criminal charges, the Supreme Court has not determined that criminal charges must be brought before civil proceedings. In United States v. Kordel, 397 U.S. 1 (1970), the court held that “There is no per se constitutional or due process bar to the government conducting parallel civil and criminal investigations and proceedings.”

Accordingly, facing a criminal prosecution is a distinct possibility when facing a civil enforcement action.

Given all of this, what should a Wells recipient do?

Again, this is a matter of strategy. In a perfect world, the SEC should have concluded its investigation, and, on the basis of its investigation, have presented a clear-cut case against an individual or entity.

However, a Wells submission is optional, and a recipient should use this to its advantage. This is why it is important to work with an experienced SEC defense counsel.

If your company (or you) is receiving a Wells notice, it is imperative to retain experienced counsel. Our law firm focuses on securities defense and will help you make an informed decision about whether or not to respond.

If you are facing this situation, Spodek Law Group handles federal criminal defense matters nationwide, from offices in New York and Los Angeles.

Could a Wells response waive privilege or require public disclosure?

There are other considerations. For example, taking an advice-of-counsel defense can potentially waive attorney-client privilege over relevant communications. As a result, any Wells recipient deciding to take an advice-of-counsel defense should be prepared to voluntarily waive attorney-client privilege, and potentially even work-product protection.

For public companies receiving a Wells notice, the question of whether to make a public disclosure is another issue. In general, corporations are obligated to make timely disclosures of all material information. The materiality of receiving a Wells notice depends on the circumstances at hand, and the public company’s obligation to make a public disclosure depends on whether any applicable reporting duties are triggered.

In any event, receiving a Wells notice does not automatically trigger an obligation to make an SEC Form 8-K filing. The decision regarding whether a public company should make a public disclosure should be made on an individual case basis.

Third, for companies and individuals that decide to communicate with the SEC, it is important to maintain attorney-client privilege and work-product protection. However, as a general rule, the voluntary disclosure of privileged communications to a third party, including the SEC, results in a waiver of the attorney-client privilege. While the common-interest doctrine can preserve attorney-client privilege in certain circumstances, the common-interest doctrine generally does not create attorney-client privilege.

Therefore, any voluntary disclosure of privileged communications should be made with caution, especially when it could affect third parties’ rights to assert the attorney-client privilege.

When determining whether a public company needs to make a public disclosure regarding an SEC investigation, the probability of an event happening and the magnitude of the event’s potential impact are both relevant factors. Basic Inc. v. Levinson, 485 U.S. 224 (1988), reads, in relevant part, “We have previously held that the probability and magnitude of the event must both be considered when assessing materiality in these circumstances.”

Again, the decision regarding whether or not to make a Wells submission, whether or not to make a public disclosure, and whether or not to rely on advice-of-counsel is a matter of strategy.

To that end, our law firm focuses on securities defense and will help you make an informed decision.

If your company (or you) is receiving a Wells notice, it is imperative to retain experienced counsel. At Spodek Law Group, we focus exclusively on securities defense, and our former SEC defense attorneys and federal prosecutors will help you make an informed decision about whether or not to respond to a Wells notice.

Don’t wait. If you (or your company) received a Wells notice, contact Spodek Law Group right away, and speak with one of our former SEC defense attorneys and federal prosecutors.

Will the SEC confirm my investigation ended without charges?

While the SEC generally retains closed-investigation records for 15 years, these records remain subject to FOIA exemptions and other disclosure restrictions. When the SEC sends out termination notices to the subjects of closed investigations, the notices explicitly state that the notifications do not exonerate the recipients. They also state that the notifications do not preclude the SEC from reopening the investigations.

While the SEC does not publish comprehensive annual counts of how many Wells notices were issued, how many responses were made, and how many investigations were closed without charges, this statistic will likely be released on the SEC’s website in the future. The SEC also explicitly states that the issuance of a Wells notice is neither “a final determination to pursue an enforcement action,” nor does it “preclude the staff from continuing to investigate the matter.”

While it is not possible to be completely sure of how much time is left in an investigation, it is also true that the SEC does not have a rule that establishes how much time must pass before a Wells recipient will be notified of the staff’s final determination. However, FOIA Exemption 7(A) expressly protects records whose release “could reasonably be expected to interfere with enforcement proceedings.”

With the SEC actively relying on FOIA Exemption 7(A), this will make it difficult to confirm if the investigation is officially closed.

Spodek Law Group recommends having a detailed and informed discussion with our former SEC defense attorneys and federal prosecutors if you are considering making a Wells submission. We are here to help you make an informed decision about how to approach the situation.

Which lawyer rules matter during a Wells response?

Is there a “Lawyers’ 80/20 Rule”? As we discuss below, the lawyers’ 80/20 rule is a play on the so-called 80/20 rule (or Pareto principle), which states that approximately 80% of consequences (or effects) are caused by 20% of causes (or efforts). The Pareto principle is widely used in the business and economics world; however, it is not a legal doctrine, rule, or statute. While there are some laws, rules, and standards that use “80%” and “20%” (for example, in federal income tax law), there is no federal securities rule called the “80/20 Rule” that governs the making of Wells submissions.

What about the Strickland v. Washington test? In Strickland v. Washington, 466 U.S. 668 (1984), the Supreme Court adopted a two-part test for determining whether a defendant’s legal representation in a criminal trial met the constitutional requirements of the Sixth Amendment. For a defendant to prove ineffective assistance of counsel under Strickland, (i) counsel’s performance must have been “deficient,” and, (ii) the deficient performance must have “prejudiced” the defendant. Importantly, though, the Strickland test only applies to criminal cases. The Sixth Amendment also requires the appointment of counsel for defendants in criminal cases. Importantly, however, neither the Sixth Amendment nor the Strickland test governs ordinary civil enforcement actions brought by the SEC.

What about the ABA Model Rules (also referred to as “Model Rules”)? There are several ABA Model Rules that limit a lawyer’s representation of a client during a Wells investigation. ABA Model Rule 1.2(d) prohibits a lawyer from knowingly assisting a client with conduct that the lawyer knows is criminal or fraudulent. ABA Model Rule 3.3(a) prohibits a lawyer from knowingly offering false evidence. ABA Model Rule 3.4(a) prohibits a lawyer from unlawfully obstructing access to evidence. In fact, these rules apply whether the proceeding is civil or criminal in nature.

However, like other ethics rules, these Model Rules are adopted by state ethics rules and bars, not the ABA. As a result, these rules do not actually become binding upon lawyers in a state unless (and to the extent that) the relevant state has adopted them. Still, even if a state has not adopted these rules, the ABA Model Rules of Professional Conduct generally serve as benchmarks for ethical legal practice.

Are these any of the laws and rules that you need to worry about? Not necessarily. But, these laws, rules, and standards are all worth considering when deciding how to approach a Wells response, and you’ll want to make sure your legal representative is familiar with them as well.

Talk to Spodek Law Group

Every case turns on its own facts, and general information is no substitute for advice about yours. Todd Spodek, managing partner of Spodek Law Group, and the firm's attorneys defend federal criminal and white collar matters nationwide. Reach the firm at 212-300-5196.