Tag: Wells Notice

Why Is It Called a “Wells Notice”?

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In 1972, SEC Chairman William J. Casey appointed a committee to review and evaluate the Commission’s enforcement policies and practices. Chairman Casey appointed John A. Wells, a lawyer at Royall, Koegel & Wells in New York, to the committee. He also added and former SEC Chairmen Manny Cohen and Ralph Demmler.  Chairman Casey asked Jack Wells to be the Chairman of the Committee specifically because he was not a securities lawyer,

Thus began what is now knows as the Wells Committee.

The Committee started its work in January 1972, and published a report with forty-three recommendations for the Commission in June of 1972. Of the 43 recommendation in the report, recommendation 7:

“The conduct of an investigation should remain with in the control of the Commission; where circumstances permit, however, the Commission should as a general practice give a party against whom the staff proposes to recommend proceedings an opportunity to present his own version of the facts by affidavit or testimony under oath.”

They further elaborated in the report:

“We recommend that, except where the nature of the case precludes, a prospective defendant or respondent should be notified of the substance of the staff’s charges and probable recommendation in advance of the submission of the staff memorandum to the Commission and be accorded an opportunity to submit a written statement to the staff which would be forwarded to the Commission together with the staff memorandum.”

The “Wells submissions” operate as a last chance for respondents to persuade the SEC staff that an enforcement recommendation is not warranted. If that fails, the Wells submissions are submitted to the Commission, along with a staff recommendation memorandum, so the Commission will have both sides of the story when it considers a recommendation for enforcement.

Who Came up With the Idea?

Former SEC Commissioner Paul S. Atkins gives credit for the concept to former Chairman Hamer Budge:

“In 1970, just months before Chairman Budge left the SEC, the Commission issued a memo to the all division directors and office heads regarding procedures to be followed in enforcement proceedings. The memo had two significant components: (1) it required the staff to get Commission approval before engaging in settlement discussions, and (2) it required the staff to provide a summary of the defendant’s arguments in a recommendation memo sent to the Commission. The latter requirement became a subject of study by the Wells Committee….”

The Wells Committee observed that “[a]s a practical matter, only experienced practitioners who are aware of the opportunity to present their client’s side of the case have made use of [such] procedures.”

Is a Wells Notice Required?

The recommendations of the Wells Committee were met with mixed responses. The Commission apparently felt hamstrung by the mandatory-sounding nature of the phrase “except where the nature of the case precludes.” They did not formally adopt the proposal. In SEC Release No. 5310 the Commission found that it would not be “in the public interest” to adopt a formal rule and instead should give notice on a strictly informal basis. The Commission “cannot place itself in a position where, as a result of the establishment of formal procedural requirements, it would lose its ability to respond to violative activities in a timely fashion.”

What’s in a Wells Notice?

From the SEC Division of Enforcement Enforcement Manual:

  • identify the specific charges the staff is considering recommending to the Commission
  • accord the recipient of the Wells notice the opportunity to provide a voluntary statement, in writing or on videotape, arguing why the Commission should not bring an action against them or bringing any facts to the Commission’s attention in connection with its consideration of this matter
  • set reasonable limitations on the length of any submission made by the recipient (typically, written submissions should be limited to 40 pages, not including exhibits, and video submissions should not exceed 12 minutes), as well as the time period allowed for the recipients to submit a voluntary statement in response to the Wells notice
  • advise the recipient that any submission should be addressed to the appropriate Assistant Director
  • inform the recipient that any Wells submission may be used by the Commission in any action or proceeding that it brings and may be discoverable by third parties in accordance with applicable law
  • attach a copy of the Wells Release, Securities Act Release No. 5310
  • attach a copy of the SEC’s Form 1662 (“Supplemental Information for Persons Requested to Supply Information Voluntarily or Directed to Supply Information Pursuant to a Commission Subpoena”)

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SEC Attacks the Rating Agencies

The SEC took its first swing at the failure of credit rating agencies by serving a Wells Notice on Moody’s Investor Service.

At issue, according to the Moody’s filing, is the determination in 2007 that members of one of its European rating committees “engaged in conduct contrary to Moody’s Code of Professional Conduct.”  Members of a credit committee knew that some of the products had been given inflated ratings because of a problem in the company’s risk modeling software.

Moody’s is one of only 10 Nationally Recognized Statistical Rating Organizations under the Credit Rating Agency Reform Act of 2006.

The disclosure in Moody’s 10-Q states that the SEC “is considering recommending that the SEC institute administrative and cease-and-desist proceedings against MIS in connection with MIS’s initial June 2007 application on SEC Form NRSRO to register as a nationally recognized statistical rating organization under the Credit Rating Agency Reform Act of 2006.” The theory is that Moody’s description of its procedures and principles were “rendered false and misleading” as of the time the application because of the Company’s finding that a rating committee policy had been violated.

The case reminds me of the Hennessee Group action where the SEC brought an action against a hedge fund for failing to conduct adequate diligence. The reason was that the hedge fund claimed that they had a particular due diligence program, but failed to follow the program. The diligence failure by itself was not actionable, but failing to live up to your self-professed standards made it actionable.

It sounds the SEC is making a similar case against Moody’s. In their application, they claimed to have a certain procedure but failed to follow it. We all know that credit agencies did a poor job of rating CDOs. That by itself caused damages but may not be actionable. So the SEC is going after them for failing to follow their own self-professed standards and policies.

It’s too early to tell what may happen. A worst case scenario would be removing Moody’s status as a NRSRO.  Obviously that would be a nuclear option that would destroy the company. The SEC action sounds like it is related to Moody’s ratings of just one type credit product, so the effects might be minimal.

Will the SEC go after the other rating agencies? or will Moody’s be the sacrificial lamb to warn the others?

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