SEC investigations have become more common in recent years as the still relatively new Chair, Mary Jo White, and others have focused resources and attention on enforcement. (See this speech, for example.) It is now well established that there is no rule-specific requirement to disclose an SEC investigation, whether informal or formal. This is true even after receiving a Wells Notice, which informs the recipient that the SEC staff intends to recommend to the SEC that charges be brought. (See Richman v. Goldman Sachs Group, Inc.) SEC rules specifically require disclosure (on Form 10-K and Form 10-Q) only when an enforcement proceeding has commenced (Regulation S-K, Item 103).
Yet, companies go back and forth over whether to “voluntarily” disclose an investigation prior to the commencement of an enforcement action. And some commentators take the view that early disclosure is the preferred route, all things being equal.
My view is that companies should not disclose the existence of an investigation absent a specific reason to do so (more on that below). The reason is that there is no way to predict how an investigation might turn out or its timeline, particularly since the Enforcement Division can be maddeningly opaque on both points. It’s not uncommon, for example, for the staff to begin an investigation based on relatively little information or for an investigation to run for years with little apparent progress. And even if your own internal investigation determines that wrongdoing has occurred, it can be difficult to predict what sanctions or proceedings may occur as a result.
Even so, specific circumstances may indeed move the needle from “no disclosure” to “disclosure” at some point during the investigation process. The following considerations are frequently offered in favor of voluntary early disclosure:
If early evidence of wrongdoing is clear and the wrongdoing is significant (for example, embezzlement by the CEO or widespread financial fraud), other company disclosures (for example, MD&A) could be impacted. This would very likely necessitate disclosing the wrongdoing and related investigation in order to provide a complete and accurate picture of the company’s future prospects.
Depending on the nature of the investigation, the SEC might plan to contact third parties (vendors, suppliers, creditors, etc.) for information, making it difficult to avoid information leaks and maintain confidentiality.
Your investor relations personnel or outside public relations advisors might insist that early disclosure is necessary to get ahead of, and control, the message.
Non-disclosure can raise tricky questions about whether insiders or the company may trade in or issue company shares, depending on highly subjective materiality determinations that can easily be second guessed in retrospect.
Early disclosure can cut off the damage-calculation period for any class action litigation that may arise down the road based on the ultimate outcome of the investigation.
Because the Enforcement Division has become so much more active in recent years, the stigma of being investigated is perhaps less than it used to be.
The point is that disclosure of an investigation is a complex, subjective, fact-specific determination, and early disclosure may be the right thing to do in some circumstances. Because the SEC rules do not require disclosure of an investigation before it becomes an enforcement proceeding, it’s appropriate to start from the perspective that no disclosure will be made unless or until there is a compelling reason to do so.