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By Mark J. Astarita, Esq.
Being the subject, target, or even a witness in an SEC or NASD investigation is not a pleasant experience. As I discussed in my column "When the SEC Comes Calling" a financial professional's involvement in a regulatory investigation or proceeding is extremely serious, and can be a career busting event.
While careful preparation and use of experienced counsel is the key to a successful outcome, prospective defendants (who are called respondents in these types of proceedings) have a valuable tool in their arsenal when dealing with the regulators - the Wells Submission.
The process starts with a Wells Notice - a notification from a regulator that it intends to recommend that enforcement proceedings be commenced against the prospective respondent. The notice references, in broad-strokes, the violation that the Staff believes has occurred.
Receiving a Wells Notice is hardly a positive event, as it signifies that you are the subject of an investigation and that enforcement proceedings are going to be commenced against you. However, a Wells Notice is rarely a surprise, and provides a unique opportunity for a prospective defendant to speak directly to the ultimate decision maker prior to the commencement of regulatory proceedings. The process by-passes the District or Regional Staff, and allows the prospective defendant to present his case against the commencement of the proceedings directly to the decision makers, without filtering or misunderstanding of the Staff.
There is no legal requirement for a regulator to provide a Wells Notice to you, however it is the practice of the SEC and the NASD to provide such notice. Procedurally, the SEC and NASD Staff (the people you are dealing with during the investigation) do not have the authority to commence proceedings. They need to obtain approval to commence proceedings. The approval process is handled without any input from the prospective defendant.
While there is no rule or regulation that requires that a prospective defendant be given the opportunity to address the decision maker prior to the filing of an action, in 1972, SEC Chairman William J. Casey appointed a committee (chaired by John Wells and commonly referred to as the “Wells Committee”) to review and evaluate the Commission’s enforcement policies and practices. Among the recommendations made by the Wells Committee was the following:
Although the SEC did not adopt many of the recommendations of the Wells Committee it did adopt this recommendation, and the notice is now known as a “Wells Notice” and the prospective defendant’s response is a “Wells Submission.” The NASD also uses a form of the procedure in its investigations.
The receipt of a Wells Notice typically does not come as a surprise to the prospective respondent, as there is almost always an investigation that leads up to the Wells Notice, and discussions with the SEC or NASD staff. The real question with a Wells Notice is whether to respond to the notice and whether to make the Wells Submission.
While it seems on the surface that a submission should be virtually an automatic response to a Wells Notice, nothing could be further from the truth. The fact is that most securities law practitioners do not make such a submission. The reason is that a Wells Submission is not privileged, it is not confidential, and anything that is alleged in the submission can be used against the prospective respondent at the hearing. Additionally, a Wells submission is discoverable - a well placed subpoena can obtain a copy of the submission, to be used in later civil litigation by private citizens.
Prospective respondents must keep this in mind in deciding whether to make such a submission, and must keep in mind that the SEC or NASD has conducted an investigation and made a determination to commence proceedings. It is therefore extremely difficult to argue factual matters in a Wells Submission. If you do, you are simply pointing out that there are disputed facts, and underscoring the fact that the Staff’s position is correct, if its facts are correct. The end result of a “factual” Wells Submission is a hearing, where the SEC Staff has been given advance notice of a respondent’s factual defenses, which they might not have otherwise obtained.
Therefore, a Wells Submission must be carefully considered, and should not be automatic. More often than not, a prospective respondent should be declining to make the submission. However, there are instances where the submission is a valuable tool in for the defense, and can be used effectively to limit the actual charges that are filed, and in some instances, avoid the proceeding altogether.
When do we respond to a Wells Notice? When there is a clear error in the facts (which I have never experienced) or in two other events – first, where there is a clear and compelling policy argument against the commencement of enforcement proceedings, or second, where the Staff is misinterpreting the law or the facts.
The first case is clearer, although rare. One of the submissions that I made came after a lengthy and extensive investigation of a wire house by the SEC Staff. The Staff informed my client, who was a former broker at the firm, that they were not looking to commence proceedings against individual brokers, but were investigating the firm itself, and the firm’s management. Of course, such a statement is not binding on the Staff, and the statement came early in the investigation. However, in our own investigation, we learned that the Staff was interviewing something on the magnitude of 50 former brokers of one branch, and was apparently telling each of these brokers that the investigation was of the firm, and not the individual brokers.
After approximately two years, my client, and apparently dozens of other brokers, received Wells Notices, informing them that the SEC Staff was recommending enforcement actions against each of them individually, for their conduct at their former firm, which had occurred 3-5 years earlier. It was our belief that the Staff was unable to make a case against its original target, the firm, and simply decided that since it had spent so much money on an investigation, it might as well commence proceedings against someone.
We decided to make a Wells Submission, arguing that the conduct alleged against our individual client, if true, was minor, and had been addressed in previous exchange investigations, without any enforcement proceedings. We also argued that the use of the Wells Notices to justify the Staff’s use of resources in the investigation of my client’s former employer was simply wrong, and that proceeding against the individual brokers was a further waste of the Staff’s time and resources, with no corresponding benefit to the goals of the Commission or the protection of the investing public. The SEC ultimately agreed, and no proceedings were commenced.
In a recent investigation, the NASD Staff decided to commence proceedings against a firm and its top producers for violation of an new, and unwritten, interpretation of the 5% Markup Policy and the so-called “Proceeds Rule”. Our submission was a lengthy and detailed analysis of the rule, and policy behind the rule, the failure of the Staff and NASD to notify any market participant of the new interpretation. We also argued that the firm and the brokers were following stated NASD policy in calculating markups and commissions. There were factual arguments, but those were designed to show that the alleged violations were not intentional, or significant in context.
Although negotiations had been ongoing for months with the Staff, those discussions were not productive, until our Wells Submission was made. The investigation was ultimately settled, and the NASD did not commence proceedings against any of the brokers.
I recently represented a sales trader who received a Wells Notice, alleging that he had violated the rules of fair practice by "url guessing." It seems that a public company was not particularity concerned about the publication of its earning releases, and numbered them sequentially - the press release for the first quarter ended in "1", the release for the second quarter ended in "2", and so on. In September, before the release of the third quarter earnings, analysts at the firm tried to find the press release - and they changed the URL of the second quarter press release URL from a "2" to a "3". Much to everyone's surprise, the third quarter press release appeared in the browser.
Analyst told sales trader, sales trader told customer, customer purchased. NASD investigation ensues, and we successful argued that "url guessing" was an accepted practice in the Internet age, that the issuer had actually released its earnings by posting the release in an unprotected portion of their web site.
While it is unclear if the NASD agreed, we received notification, after a receipt and review of the Wells Submission, that the NASD had decided not to proceed with an enforcement action.
As demonstrated by these examples, a Wells Submission can be a valuable tool for the defendant. It gives the prospective defendant the opportunity to speak to the decision maker and to have his or her position on the substance of the matter heard before a decision is made to commence proceedings. At the same time responding to a Wells Notice can ultimately harm a prospective defendant’s position at the hearing and in later negotiations. It is therefore extremely important for a prospective respondent or defendant to analyze the pros and cons with their attorney before making the submission.
Securities Law Blog
Nothing herein is intended as legal or financial advice. The law is different in different jurisdictions, and the facts of a particular matter can change the application of the law. Please consult an attorney or your financial advisor before acting upon the information contained in this article. SECLaw.com was created by and is sponsored by Mark J. Astarita, Esq., a securities attorney and partner in the law firm of Beam & Astarita, LLC, who represents financial professionals in a wide variety of matters. Mr. Astarita can be contacted by email at email@example.com.
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