ANALYSIS-Goldman silence on probe a model others will avoid?
By Matthew Goldstein and Steve Eder
NEW YORK, June 4 (Reuters) – The decision of Goldman Sachs Group Inc not to tell shareholders that U.S. regulators might sue the bank over a subprime mortgage-linked security could cause other companies to rethink the way they handle regulatory investigations.
The investment banking powerhouse has said its lawyers found no reason to disclose a Wells notice from the Securities and Exchange Commission because the transaction at issue was relatively small and the case had little legal weight.
But another calculus may have been at work, too: the potential negative impact that disclosing the Wells notice would have had on the firm’s share price last fall.
A report last summer by Cornerstone Research, a securities litigation consulting shop, found that shares of companies that reported getting a Wells notice from the SEC incurred a “statistically significant market-adjusted” price decline.
A Wells notice is a letter indicating the likelihood of regulatory action and giving the people or company targeted a chance to respond.
The Cornerstone report, prepared at the request of the American Bar Association, found that on average, shares of companies dropped 2.6 percent after they reported the receipt of a Wells notice.
The ABA asked Cornerstone to conduct the study because disclosing a Wells notice and the likelihood of an SEC enforcement action is optional. The SEC does not require companies to disclose a Wells notice.
Goldman shares fell 12 percent on April 16, the day the SEC sued Goldman for civil fraud in connection with the structuring and sale of a $1 billion collateralized debt obligation. That was seven months after the bank received its Wells notice.
Despite the lack of an SEC requirement, some experts believe that companies should be obliged to disclose receipt of a Wells notice. Paradoxically, Goldman’s much publicized failure to do so could make other companies more likely to do so in the future.
“It would seem to me that for most public companies a Wells would be material to an investor,” said Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware.
A Goldman spokesman declined to comment on the Cornerstone report or whether it had an impact on the investment firm’s decision not to disclose the Wells notice.
“If it was up to me, I would make it a disclosable event,” said Donald Langevoort, a Georgetown University Law School professor. “I have seen too many cases where companies have not disclosed Wells notices and it just leaves a bad taste for investors.”
Cornerstone said that in the 58 cases it examined, not all stocks had significant declines. The researchers concluded that traders and investors were able to “discern firm-specific differences” in the significance of Wells notices.
In other words, some Wells notices carry worse news than others. Securities lawyers said it is not always easy for a company to know ahead of time which will be worse — the harm to its reputation from an investigation or the potential penalty if a violation is found.
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“Reputation harm is hard to calculate, much less to predict,” said David Martin, a partner with Covington & Securities and former director of the SEC’s Division of Corporation Finance. “But if a company’s stock declines by 10 percent after information is released, a reasonable investor would certainly have more than a germ of an argument that the information was material.”
In the case of Goldman, it appears the harm right now is more to its reputation than its bottom line. At most, analysts estimate it will cost Goldman between $500 million and $1 billion to settle the SEC lawsuit.
That’s not an insignificant sum, but it will hardly break the bank for Goldman, which earned $13.39 billion in 2009.
Goldman’s decision not to disclose the likelihood of an SEC lawsuit has sparked a number of lawsuits from investors who claim they were damaged by the sudden sell-off in its stock.
Even though Goldman and other Wall Street firms do not have to report Wells notices, individual employees are required to alert the Financial Industry Regulatory Authority if they are named in a Wells notice. Over the years, the securities industry’s self-regulatory agency has sanctioned brokers and other registered Wall Street employees for not disclosing a Wells notice.
It would likely take either federal legislation or an SEC rule to change the disclosure requirement. And for the moment, neither appears likely.
Even Elson, the corporate governance expert, said he is not ready to put a rule in place automatically requiring disclosure. “It has got to be a judgment call,” he said.
But given the fierce market reaction to Goldman’s failure to disclose its Wells notice, it may be much harder for companies to make those judgment calls in the future. (Reporting by Matthew Goldstein and Steve Eder; editing by John Wallace) ((email@example.com; 1-646-223-5773)) ((firstname.lastname@example.org; 646-223-6069))